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Introduction to transfer pricing in Portugal
Transfer pricing rules
- Portugal’s transfer pricing (TP) legislation is part of the Corporate Income Tax Law and is based on the arm’s length principle as per Article 9 of the OECD Model Tax Convention on Income and Capital, ie it follows the OECD Guidelines.
- TP rules apply to Portuguese taxpayers, including local branches of foreign companies and is up to the taxpayer to confirm its transfer pricing meets the standard or to adjust its tax return accordingly.
- The filing of transfer pricing documentation is generally not mandatory except for large taxpayers, but because of the self-assessment regime, transfer pricing analysis and documentation is required to help protect against penalties. If the Tax Authorities request transfer pricing documentation, the taxpayer would typically have a pre-defined deadline in which to respond.
- The OECD’s Master File and Local File concept is regarded as best practice. In addition, for larger groups (over €750m) Portugal has implemented CbCR (Country by Country Reporting).
- Portuguese transfer pricing rules follow the OECD Guidelines. The Guidelines, updated in July 2017, should be used for interpretation of the arm’s length principle.
- Portuguese Tax Authorities’ have several binding rulings, instructions, and general guidance on their view of transfer pricing matters, and much of this content is publicly available.
Transfer pricing methods
- The most appropriate pricing method should be selected on a transaction by transaction basis, providing the most reliable measure of an arm’s length result in each case. The current OECD methods, namely the comparable uncontrolled price, resale price, cost plus, transactional net margin, and profit split methods are all accepted but the method used must be in line with the functional and risk profile of the entity. Other methods can also be used if justifiable and appropriate.
- There is no priority among the acceptable methods as long as the result is at arm’s length. In practice, however, a ‘natural hierarchy’ may be said to favour the comparable uncontrolled price method.
- Portugal has a self-assessment regime, where the onus is on the taxpayer to ensure that transfer pricing regulations are adhered to. Those under €3 million in turnover do not need to have an organized transfer pricing file. Portuguese corporate income taxpayers need to specify annually in their annual tax returns whether they have been involved in related party transactions. The specific transaction amounts need to be detailed in the corporate income tax return.
Transfer pricing documentation
Preparation of transfer pricing documentation
- Portugal accepts the OECD transfer pricing documentation model based on the Master File and Local File (BEPS Action 13) approach. This approach is considered best practice.
- Lack of carefully prepared documentation will generally result in fines, whether or not there are adjustments to be made.
- Portugal has also introduced CbCR (Country by Country Reporting) regulations which are effective for fiscal years starting on or after 1 January 2016 for groups with revenues over €750m.
- Any documentation should be prepared in Portuguese (preferable) or English.
- Typically, there are four types of documentation that should be kept: primary accounting records, tax adjustment records, records of transactions with associated parties and documentation demonstrating the arm’s length result.
Master and local file
- Although the Master and Local file structure is best practice and should help with penalty protection, the current documentation requirements are not prescriptive. Tax authorities’ view is that transfer pricing documentation should usually include a background to the company, a group structure, an outline of the key intercompany transactions under analysis, an analysis of the key functions, assets and risks of the company, an industry analysis and an economic analysis including supporting evidence such as comparables, if required. The key is that it explains the value driving activities and the management of risk in the group and shows that the policies are at arm’s length.
- Transfer pricing documentation must be preserved, as all tax and accounting documentation, for a period of 10 (although the statute of limitation is generically of four years).
Some risk factors for challenge
- High risk business models include commissionaire and toll manufacturing.
- Limited risk distributor and contract services/ contract R&D arrangements could also potentially be affected, especially where significant people functions are in Portugal.
- Persistent losses in a 'low risk' entity
- Licensing payments to low tax jurisdictions
- Business restructurings, or changes in TP model, can also trigger a challenge - however, if the previous TP method no longer appears the most appropriate, it should always be reviewed.
- The main penalty specifically defined for transfer pricing is that related to the non-compliance with the obligation to possess a transfer pricing file. This fine varies between €1,000 and €10,000.
- Penalties may also be applicable for late or no payment of tax due (in this case because of manipulation of transfer prices). These penalties vary between 30% and 100% of tax due. In addition, a 4% compensatory interest rate exists.
- Non-compliance with CbCR and notification requirements can draw penalties ranging also between €1,000 and €10,000. Daily penalties may also apply where information is consistently not provided.
Economic analysis and how to demonstrate an arm’s length result
- Tax Authorities will expect to see that a search for potential internal comparables has taken place before defaulting to an external database search for comparables.
- Note that where databases are used, contrary to popular understanding, there is no specific requirement that the interquartile range be used (however, it will often be calculated as a means to eliminate outliers, given that incomplete information will always be an issue in external database searches).
- Unfortunately, the Tax Authorities sometimes use their own comparables. There are also no published TP 'safe harbours' and the key is the facts and circumstances of the specific case.
Advance Pricing Agreements (APAs), dispute avoidance and resolution
- Advanced Pricing Agreements (APAs) are written agreements between a business and the Tax Authorities to govern the appropriate transfer pricing method for a forward-looking period. There are very few of them.
- Portugal has an extensive treaty network, and the Mutual Agreement Procedure (MAP) will often be available when double tax occurs.
- There are usually no 'secondary adjustments' or recharacterisation sought where a TP adjustment is made, but interest and penalties may be applied.
- Transfer pricing rules apply to all companies that engage in related party transactions. However, the obligation to have a specific transfer pricing file only applies to companies with a turnover higher than three million euros that engage in such related party transactions.