Taxing authority and tax law
Tax authority: Portuguese General Tax Directorate (“DGCI”)
Tax law: Article 63 of the Corporate Income Tax Code establishes the arm’s length principle
Relevant regulations and rulings
Ministerial Order 1446-C/2001 of 21 December 2001 (Transfer Pricing Ministerial Order), issued by the Minister of Finance, implements Article 63 of the CIRC regarding the application of the transfer pricing methods, cost-sharing agreements, documentation requirements and the corresponding adjustments procedure.
A detailed APA procedure, setting out the APA submission requirements, APA process and fees was implemented by Ministerial Order 620-A/2008 of 16 July (which came into force on 17 July).
Furthermore, a general anti-avoidance provision applies to all simulated transactions and the rules embodied in the thin-capitalization, CFC and anti-tax haven regimes may be used in the general context of transfer pricing.
OECD guidelines treatment
The Portuguese regulations and tax practice in general follow the OECD Transfer Pricing Guidelines.
Business restructurings were already specifically addressed in the Portuguese transfer pricing regulations as activities that must rely on the arm’s length principle, but the approaches stated in the new Chapter IX of the OECD Transfer Pricing Guidelines are likely to affect the transfer pricing audit activity.
The Masterfile concept foreseen in the Code of Conduct on transfer pricing documentation for associated enterprises in the European Union was not yet adopted in the Portuguese legislation, as the same addresses all the relevant topics contained therein, despite being more rigorous in terms of contents.
Priorities/pricing methods
The transfer pricing methods described in the Portuguese legislation are based on the OECD Transfer Pricing Guidelines and, thus, do not introduce significant changes to the widely accepted methods recognized among transfer pricing administrators and practitioners. However, the Portuguese rules also state (paragraphs 1 and 2 of Article 4 of the Transfer Pricing Ministerial Order) that the most appropriate method should be applied to a controlled transaction or to a series of transactions in order to determine whether those transactions comply with the arm’s length principle.
This principle reflects a best method rule. This means that a taxpayer is expected to use the method or methods most suitable to each case, thus explaining not only the reason why a certain method is considered as the most appropriate to test whether the controlled transactions comply with the transfer pricing rules, but also why other methods are rejected.
Hence, the Portuguese tax authorities recognize both the transactional and profit-based methods in the OECD Transfer Pricing Guidelines and, theoretically, any method is acceptable provided that it can be justified and that the traditional transactional or profit-based methods are not applicable.
Transfer pricing penalties
Transfer pricing adjustments are subject to the general tax penalty regime and, thus, are subject to withholding, late payment and bad-faith penalty provisions. Penalties for non-compliance with mandatory contemporaneous documentation rules may reach EUR 100,000 per year and per company. A late payment interest penalty is also applicable for transfer pricing adjustments at the rate of 4% per year.
Failure to comply with documentation requirements may result in a possible reversion of the burden of proof and the application of secret comparables.
It is expected that the transfer pricing rules will be extended by the publication of specific legislation on penalties for non-compliance with the documentation obligations in the near future.
Penalty relief
The general tax penalty regime applies. The determination of penalties will be made on a case-by-case basis.
Documentation requirements
The Portuguese transfer pricing rules require taxpayers with a turnover and other income in excess of €3m in the prior year to prepare contemporaneous documentation in Portuguese, which should provide evidence of market parity regarding the terms and conditions agreed, accepted and practiced in the agreements made with related parties, as well as the selection and utilization of the best method. The regulations divide the documentation between relevant, supporting documentation and that which is applicable to cost contribution arrangements and intra-group services.
The transfer pricing documentation should include:
- Related-party status, according to the definition presented in Article 63 of the Corporate Income Tax Code (a company subject to a substantially favorable tax regime or included in the Portuguese offshore blacklist is considered to be a related party, independent of other related-party criteria)
- Characterization of the taxpayer’s activity and that of the related parties with which it engages in commercial and/or financial transactions
- Identification of all intercompany transactions, comprising the volume, terms and conditions of the transactions for the past three years, or for the period in which they occurred (if less)
- A functional analysis for each relevant transaction
- Technical studies focusing on essential areas of business
- A description of the method used and demonstration of how the prices were calculated
- Information about Portuguese comparables (geographical comparability requirement)
- The legal entity organization structure
- All intercompany contractual agreements and unrelated-party agreements
Documentation deadlines
For companies adopting the calendar year for tax purposes, the documentation must be prepared by 15 July of the year following the one which it concerns or the 15th day of the seven month after the corresponding tax year-end for those not using the calendar year.
All Portugal-based companies have a statutory obligation to keep available and in good order their tax documentation file for the relevant year for a 10-year period. It must be kept at the Portuguese establishment or premises and should be prepared by the last working day of the six-month period following the tax year-end. However, the tax authorities may, and do, ask for documentation on transactions at any time after they take place.
Statute of limitations on transfer pricing assessments
Assessment is possible during the four years after the end of the assessment year. The transfer pricing documentation must be kept by the taxpayer for 10 years.
Return disclosures/related-party disclosures
The main disclosure requirements at this level are contained in annexes A, B, C and H (transfer pricing annexes) of the Annual Tax and Accounting Return (“IES/DA”), which include (on a yearly basis) the following information:
- Identity of the related entities
- Amount of transactions conducted with each of the related parties
- Confirmation that proper contemporaneous (annual) documentation in support of transfer prices adopted was timely prepared and is currently retained
The deadline for submission is the same as for the annual documentation. Taxpayers have to state in good faith in the annual declaration whether they have complied with the contemporaneous documentation requirements. Criminal ramifications may result in the case of misleading information.
Audit risk/transfer pricing scrutiny
Since January 2004, entities resident in blacklisted offshore countries or territories are deemed related parties for transfer pricing purposes. Additionally, in 2007, the Portuguese tax authority began making positive adjustments to taxpayers’ taxable profits as a result of tax audits. These adjustments are based on a benchmark computed with the financial information of an internal database called MGIT.
In respect to the comparables analysis performed by the tax authority, the following issues are relevant:
- Entities with a recurrent loss situation are excluded from the comparables final sample
- Comparables identification is not disclosed in the final sample
- A transaction is considered arm’s length only if within the computed interquartile range
- Only the median of the interquartile range of the benchmark is considered when the tax adjustments are made
More recently special emphasis is being put on the quality of comparables, namely on royalty CUP analysis. Head-office interest charged to branches is the most recent area of scrutiny and adjustments. Cross-border restructuring is also an area of intense scrutiny.
APA opportunity
An APA program was included in the Portuguese corporate income tax code in 2008. Taxpayers are now allowed to negotiate clearance for a period of three years regarding a transaction with transfer pricing implications.
We expect this area will develop significantly within the next few years.
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