A recent Portuguese arbitration case cuts to the heart of a question that comes up regularly in transfer pricing practice: when are working capital adjustments appropriate, and how far can a tax authority go in dismissing them?
The case involves a limited-risk distributor, a TNMM benchmarking study, and a tax authority that accepted the comparable companies but quietly discarded the adjustments applied to them. The court didn’t let that slide.
The Case at a Glance
The Portuguese taxpayer acted as a limited-risk distributor for a UK principal — a routine structure where the local entity handles day-to-day distribution while the principal absorbs most of the commercial risk. To test whether its intercompany pricing was arm’s length, the taxpayer applied the Transactional Net Margin Method, selecting 15 comparable companies and running working capital adjustments against them.
The Portuguese Tax Authority (AT) didn’t challenge the 15 comparables. It simply removed the working capital adjustments, recalculated the benchmark, and arrived at a median margin of 1.97%. The taxpayer’s result no longer fit the range. An income tax assessment followed.
How the Benchmarking Was Built
Why the Adjustments Were Applied
Independent distributors carry their own inventory, extend credit to customers, and manage their own payable cycles. Each of those positions has a financing cost embedded in it. A limited-risk distributor, insulated from most of that exposure, will naturally show a different financial profile — and if you don’t account for that difference, you’re not actually comparing like with like.
Receivables
Companies with high receivables are effectively financing their customers. That cost shows up in their margins.
Inventory
Businesses carrying large inventory absorb holding costs and obsolescence risk — both of which inflate the profitability benchmarks of independent comparables relative to a limited-risk entity.
Payables
Strong supplier credit terms provide a financing advantage that reduces effective working capital costs. Ignoring this distorts comparability in the opposite direction.
After adjusting for all three, the taxpayer’s operating margin of 0.98% fell comfortably within the arm’s length interquartile range.
The Tax Authority’s Challenge
The AT’s position was straightforward, if technically thin. It accepted the comparable set without objection, then stripped out the working capital adjustments and recalculated the benchmark median at 1.97%. On that basis, the taxpayer’s margin was outside the range, and a transfer pricing adjustment followed.
What the AT did not do was explain why the adjustments were invalid. No technical reasoning. No evidence that the adjustments reduced the reliability of the analysis. Just a revised number and an assessment.
What the Court Decided
The Arbitral Tribunal ruled entirely in the taxpayer’s favour, annulling the tax assessment and ordering the AT to pay indemnity interest.
The Burden of Proof Principle
The core of the ruling came down to burden of proof. The AT had accepted the comparables and then removed the adjustments with no technical justification — effectively cherry-picking the parts of the benchmarking study it found convenient while discarding the rest.
What tax authorities must demonstrate
The Tribunal was clear: if a taxpayer applies adjustments grounded in the OECD Transfer Pricing Guidelines and supported by functional analysis, a tax authority cannot simply delete them. To successfully challenge an adjustment, the authority must show:
- why the adjustment reduces the reliability of the analysis
- what evidence supports that conclusion
- how the revised benchmark better reflects arm’s length conditions
Without that reasoning, the assessment doesn’t stand.
Why This Case Stands Out
Working capital adjustments are common in TNMM studies. Most of the time, their financial impact is modest — a few basis points applied mainly as documentation discipline rather than to materially shift the arm’s length range.
This case was different. The adjustments moved the median by nearly a full percentage point. That’s precisely why the AT targeted them, and why the court’s response carries weight. When adjustments are consequential, they attract scrutiny — which is exactly when the quality of the underlying analysis matters most.
What This Means for Your Transfer Pricing Documentation
The Role of Working Capital Adjustments in Audit Defence
Working capital adjustments aren’t technical window dressing. They’re part of the evidence that your benchmarking reflects economic reality rather than a convenient set of numbers.
Functional analysis comes first
The adjustments only hold up if the functional analysis behind them is solid. You need to document clearly why the tested party’s working capital profile differs from the comparables, not just apply a formula.
Assumptions must be explicit
Every adjustment involves assumptions about financing rates, working capital days, and capital employed. Those assumptions need to be stated, sourced, and defensible.
The economic rationale must connect to the financial data
Courts and tax authorities will look at whether the adjustment actually reflects the economic reality of the transactions. If the numbers don’t follow logically from the functional profile, the adjustment is vulnerable.
How Reptune Supports Benchmarking Consistency
Managing working capital adjustments across multiple jurisdictions, each with its own comparables, functional profiles, and documentation requirements, is where transfer pricing teams lose consistency.
Reptune helps tax teams centralise benchmarking data, standardise the comparative analysis process, and ensure that the economic rationale behind adjustments is documented consistently across all intercompany transactions. When a tax authority comes asking, the analysis is already there.
The Portuguese case is a useful reminder that transfer pricing disputes aren’t just won on numbers. They’re won on the story behind them, and whether that story holds together under scrutiny.
