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Portugal: Court decision, underpriced controlled transaction and application of TNMM

Portugal: Underpriced controlled transaction, TNMM

The administrative court issued a decision regarding a transfer pricing issue—specifically concerning an underpriced controlled transaction that was tested through the application of the transactional net margin method (TNMM).


Related content

The Administrative Court (Centro de Arbitragem Administrativa—CAAD) issued a decision in case n.º 511/2018-T (10 October 2019) concerning the sale of raw materials and goods by a company to related parties.  


  • Company A is a Portuguese entity, part of G Group, and is engaged in the production, sale and distribution of footwear, fashion accessories and related products.
  • Company C and Company D are subsidiaries of G Group (the parent company, a resident of India). Therefore, Company C and Company D are considered to be related parties of Company A under the Portuguese domestic rules.
  • In the tax years at issue (2013 and 2014), Company A sold raw materials and goods to Company C and Company D, and then sold the same type of raw materials and goods to unrelated entities.
  • An independent auditor (conducting the statutory audit work for Company A) issued a modified opinion showing a reserve to Company A’s financial statements, as a result of the non-compliance with the transfer pricing documentation obligations.
  • The Portuguese tax authority conducted a tax audit of Company A requiring the submission of the transfer pricing documentation that was then prepared during the tax audit.

Following the analysis of the transfer pricing documentation, the tax authority issued a tax audit report and assessed additional tax with reference to the sale of footwear-related raw materials and goods from Company A (as seller) to Company C and Company D (as buyers)—these are the “controlled transactions”—and finding the non-compliance of these transactions with the arm’s length principle. Thus, an adjustment was made to Company A´s taxable income. 

At issue

In this regard:

  • Company A had tested the controlled transactions through the application of the TNMM through the use of a database (external comparables) based on several and non-justified profit level indicators (ten (10) in 2013 and eight (8) in 2014) in testing Company A´s overall profitability. Nevertheless, Company A’s ratios were within the arm´s length ranges for 2013, but with reference to 2014, several ratios recorded by Company A fell outside the arm´s length ranges. No transfer pricing adjustments were made.
  • The Portuguese tax authority did not agree with the economic analysis performed by Company A in testing the controlled transactions. In the tax authority’s view, once it verified that Company A had similar transactions (sales of raw materials and goods) with unrelated third parties, and the characteristics of those transactions were similar to the ones being tested, these third-party transactions were viewed as preferable when applying the TNMM. Company A did not make use of internal comparables or justified the reasons for those transactions being disregarded; rather, Company A tested the controlled transactions under a global and indirect analysis through the examination of its overall business profitability (considering the financial results affected by transactions with related and unrelated parties, the latter being material).

The Portuguese tax authority conducted an economic analysis through the application of the TNMM, using exclusively internal comparables, and determined the “profit margins” (sales price less cost price) recorded in the transactions with independent third parties, by category (raw materials and goods). Moreover, the tax authority made use of the information disclosed by Company A, disregarding the transactions related to stock-sales (“leftovers” from collections), faulty product sales, and non-profit samples because these were not standard reference transactions. Given the lack of information, the tax authority was not able to allocate the selling, general, and administrative expenses to each category of transactions being tested, with the analysis being performed on a gross margin level.

The tax authority emphasized that, when internal comparables exist, these would be preferable because such transactions would mostly better reflect the functions performed and risks assumed by a taxpayer. Additionally, testing the overall profitability would need to be limited to those situations where: (1) transactions have not been established with unrelated parties or the characteristics, functions, and risks underlying those demonstrate that the transactions are not comparable and not possible of being adjusted: and (2) total (or almost total) income or costs reflected in the financial statements are deemed with related parties and the tested party assumes routine functions and risks within the business model established with the counterpart(s).

The Portuguese tax authority, thus, concluded that there was non-compliance of the arm’s length principle, and adjusted Company A’s transfer prices and, consequently, its taxable income.

Court decision

A request for judicial review of the findings of the tax authority and the resulting tax assessment was made of the court, and the court (CAAD) issued its judgment in favor of the tax authority on the ground that even though the tax authority’s analysis showed some weaknesses, it was the most appropriate methodology to test the transactions under analysis.  

KPMG observation

The Portuguese tax authority recently has adopted what appears to be a heightened awareness regarding transfer pricing matters, and thus has moved to improve its analysis and arguments in transfer pricing disputes.

Tax professionals have noted that it may be prudent for transfer pricing analyses not to be performed solely as a means of complying with a documentation requirement. With its many transfer pricing audits and disputes, the Portuguese tax authority has been gaining knowledge, and therefore, a taxpayer’s economic analyses and documentation must be as strong, robust, and bullet-proof as possible because this information is the first line of defense for taxpayers.


For more information, contact a tax professional with KPMG’s Global Transfer Pricing Services group in Portugal:

Susana Pinto | +351 2124 87391 |

Luísa Silva | +351 2124 87420 | 

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