Portuguese Supreme Court Rejects Free Capital Transfer Pricing
Table of Contents
Case Information
Court: Supremo Tribunal Administrativo, Secção do Contencioso Tributário
Case number: 02070/09.7BELRS.SA1
Citation: JSTA00071998; SA22026050602070/09
Applicant: AT – Autoridade Tributária e Aduaneira (Recorrente/Representante da Fazenda Pública)
Respondent: Banco 1… – Sucursal em Portugal (Recorrida/Impugnante)
Jurisdiction: Portugal
Judgment date: 06/05/2026
Judgment Summary
The Supremo Tribunal Administrativo unanimously dismissed an appeal brought by the Autoridade Tributária e Aduaneira (AT) against a judgment of the Tribunal Tributário de Lisboa dated 21 September 2022. That first-instance judgment had annulled an additional IRC assessment and corresponding compensatory interest charge relating to the 2006 tax year, issued against Banco 1… – Sucursal em Portugal, a Portuguese branch of a French-resident bank.
The AT had added €1,108,441.37 to the branch's taxable profit on the basis that the branch held insufficient free capital relative to its total assets when compared with the ratio maintained by its parent, and that the interest paid on the corresponding intercompany loans was therefore not fully deductible. The AT relied on Article 58 of the CIRC (the arm's length transfer-pricing rule), the Portugal-France double tax convention, and OECD reports and commentaries.
The Supreme Administrative Court held that Article 58 of the CIRC, in the version applicable at the relevant date, is a classical transfer-pricing provision designed to correct the terms of transactions that have actually taken place. It does not authorise the tax authority to recharacterise a financing transaction as equity and then apply a pricing correction to the recharacterised transaction. No other provision of Portuguese law or of the applicable version of the Portugal-France convention covered that situation. The court confirmed the annulment of the assessment and ordered the AT to pay costs.
Background
Banco 1… is a credit institution incorporated and resident in France. It operates in Portugal through a branch (sucursal) that is subject to supervision by the Banco de Portugal and is taxed on the profits attributable to that establishment under Article 3(1)(c) of the CIRC.
At the beginning of 2001, the French parent requested the Banco de Portugal to approve the cancellation and repatriation of the capital assigned to the Portuguese branch, amounting to €21,982,721.64. The Banco de Portugal did not object to that request [fact C of the proven facts].
In the financial year 2006, the branch obtained medium-term and overnight financing from Banco 1… Madrid (a related entity). The branch treated those funds as loans and deducted the interest paid as a business expense. Using the Comparable Uncontrolled Price method and interbank money-market rates for the euro area as the external comparable, the branch concluded that the interest rates charged by Banco 1… Madrid were consistent with the arm's length principle under Article 58(1) of the CIRC [fact I of the proven facts].
During 2008, the AT's Transfer Pricing Unit sent the branch a series of requests for information about its free capital, its asset composition, and its capital structure relative to independent entities operating in Portugal [fact D of the proven facts]. A general tax inspection covering the 2006 tax year was opened under Service Order No. …22 of 02/09/2008 [fact F].
Core Dispute
Following the inspection, the AT concluded that the branch's equity-to-total-assets ratio (approximately 0.314% as at 31 December 2006, with total assets of €1,376,979,890.43 and equity of €4,327,382.19) was disproportionately low compared with the equivalent ratio of the French parent. Applying the Comparable Uncontrolled Price method and referencing paragraph 83 of the 1984 OECD Report on the taxation of multinational banking enterprises, the AT determined that a portion of the intercompany loans should be treated as free capital, meaning that the corresponding interest was not deductible. The resulting adjustment was €1,108,441.37, added to the branch's 2006 taxable profit [fact I of the proven facts].
The AT issued additional IRC assessment No. …70, dated 17 June 2009, for a total of €49,876.57 (including compensatory interest) [fact K]. A separate compensatory interest charge totalling €78,749.76 was also issued, together with a settlement statement showing a balance payable of €288,632.73 [fact L].
The branch challenged the assessment before the Tribunal Tributário de Lisboa, arguing that Article 58 of the CIRC did not provide a legal basis for recharacterising debt as equity, that the 2008 OECD Report on the Attribution of Profits to Permanent Establishments was not in force in 2006, and that its retroactive application would violate the constitutional principles of legality and legal certainty. The first-instance court agreed and annulled the assessment. The AT then appealed, ultimately reaching the Supreme Administrative Court after the Tribunal Central Administrativo Sul declared itself hierarchically incompetent on 15 January 2026.
Court Findings
The court first clarified the applicable legal framework. The taxable subject is a non-resident entity with a permanent establishment in Portugal under Articles 2(1)(c) and 5(1) of the CIRC, and the profits attributable to that establishment are determined as if it were a resident taxpayer pursuant to Article 55(1) and (2) of the CIRC. The relevant income category is business profits, making the Portugal-France double tax convention (introduced into Portuguese law by Decree-Law No. 105/71 of 26 March) applicable under its Article 7, not any provision relating to the taxation of interest as such.
The court held that the AT had not contested the arm's length character of the interest rate itself; its sole challenge was whether part of the intercompany loans should be recharacterised as free capital, rendering the corresponding interest non-deductible. The court found that Article 58 of the CIRC is a classical transfer-pricing rule whose scope is confined to correcting the terms of actual transactions. It is not a tool for recharacterising a financing transaction as equity and then applying a correction to the recharacterised arrangement. The provision covers the correction of transactions that have occurred, not the requalification of transactions prior to correction.
The court also noted that, in any event, free capital has no direct bearing on the components used to compute taxable profit (gains, losses, and positive or negative equity movements under Articles 20, 23, 21, and 24 of the CIRC), so even a proven free capital allocation could not itself be corrected under Article 58.
The court then considered whether the OECD Model Tax Convention, its commentaries, or OECD guidelines could extend the scope of Article 58. It concluded they could not. OECD instruments of the relevant period constitute soft law; they carry no direct legal force and cannot substitute for, or anticipate, positive domestic legislation. The court referred to OECD Transfer Pricing Guidelines point 1.36 (1995 version), which states that the tax authority's analysis must proceed on the basis of the transaction as actually structured by the parties and that, save in exceptional circumstances, the authority should not disregard or substitute actual transactions.
On the question of the 2008 OECD Report on the Attribution of Profits to Permanent Establishments and the 2008 revision of the commentaries to Article 7 of the OECD Model Convention, the court endorsed the first-instance court's analysis. The 2008 commentaries introduced a substantive new approach, the Authorised OECD Approach, which for the first time formalised the concept of free capital allocation to permanent establishments. Because the changes were substantive rather than merely clarificatory, they could not be read back into conventions concluded under earlier versions of the Model. The Portugal-France convention was governed by the pre-2008 version of Article 7, and the new interpretive approach could not apply to tax years before 2008. The court also noted that no requalification procedure under a specific anti-avoidance rule, the general anti-avoidance clause in Article 38(2) of the LGT, or the simulation provision in Article 39 of the LGT had been initiated, as would have been required before any recharacterisation could take place.
Outcome
The Supreme Administrative Court unanimously dismissed the AT's appeal, confirmed the judgment of the Tribunal Tributário de Lisboa dated 21 September 2022, and annulled the additional IRC assessment No. …70 and the corresponding compensatory interest charge relating to the 2006 tax year. Costs were awarded against the AT.
TP Method Highlighted
The branch itself applied the Comparable Uncontrolled Price method, using external comparable data in the form of interbank money-market rates for the euro area (MMI), and concluded that the interest rates paid to Banco 1… Madrid were consistent with the arm's length principle [fact I of the proven facts]. The AT also purported to apply the Comparable Uncontrolled Price method to determine the free capital deficit, referencing paragraph 83 of the 1984 OECD Report, which holds that the proportion of a bank branch's working capital treated as equity should be of the same order as the ratio of equity to total assets for the banking group as a whole. The court did not rule on whether the method was appropriate, as it had already concluded that no method could lawfully be applied to the recharacterisation exercise the AT sought to carry out.
Major Issues / Areas of Contention
- Whether Article 58 of the CIRC, in the version applicable in 2006, provided a legal basis for the AT to recharacterise part of an intercompany loan to a branch as free capital and thereby disallow the corresponding interest deduction.
- Whether the Portugal-France double tax convention (introduced by Decree-Law No. 105/71 of 26 March), in its version applicable in 2006, supported the attribution of free capital to the Portuguese branch for the purpose of limiting interest deductibility.
- Whether the 2008 OECD Report on the Attribution of Profits to Permanent Establishments and the 2008 revisions to the commentaries on Article 7 of the OECD Model Convention could be applied retroactively to the 2006 tax year, given that they introduced substantive rather than merely clarificatory changes.
- Whether OECD guidelines and commentaries, characterised as soft law, could be applied directly to create or extend a tax obligation in the absence of implementing domestic legislation.
- Whether, before recharacterising a financing transaction as equity under the arm's length principle, the AT was required to initiate a specific requalification procedure, such as a general anti-avoidance or simulation proceeding, which it had not done.