The MIBC’s Economic Substance Requirements

As the international tax landscape continues to evolve toward greater alignment and transparency, multinational investors operating under the Madeira International Business Centre (MIBC) must be particularly vigilant regarding the attribution of profits to Portuguese establishments. The OECD’s Authorised Approach (AOA) to profit attribution provides the globally accepted framework, and Portugal, through both legislative reform and administrative guidance, has adopted and internalised this approach.

This article provides a comprehensive analysis of the AOA and its implementation in Portugal, specifically within the context of the MIBC. It also explores the intersection between profit attribution and economic substance requirements, two pillars critical to the sustainability of tax advantages granted under this regime.

I. The Authorised OECD Approach: Functional Delineation as the Core of Attribution

The AOA, as endorsed by the OECD in its 2008 and 2010 reports, represents a paradigm shift from the older “limited independence” model. Under the AOA, permanent establishments (PEs) are deemed functionally separate and distinct enterprises to apply the arm’s length principle, despite lacking legal personality.

The methodology for attributing profits follows a two-step process:

1. Functional and factual analysis: This involves identifying the economically significant functions performed, assets used, and risks assumed by the PE, referred to as “Significant People Functions” (SPFs). In a head office-branch model, this analysis determines which part of the enterprise performs the relevant value-driving functions.
2. Pricing of internal dealings: Once the functional delineation is complete, the next step is the hypothetical pricing of internal dealings, such as the provision of services, the transfer of assets, or the use of intellectual property, using OECD Transfer Pricing Guidelines as the benchmark.

The AOA explicitly authorises the deduction of notional expenses such as interest or royalties in internal dealings, provided these dealings are recognised as having economic substance and are priced at arm’s length. This contrasts with the previous OECD commentary (pre-2008), where internal charges for such dealings were generally non-deductible except under narrow exceptions.

II. Implementation in Portugal: From Legal Reform to Regulatory Alignment

Until 2014, Portugal adhered to a restrictive application of Article 7 of the OECD Model Convention, reflecting the earlier OECD position. The turning point came with Law No. 2/2014, which reformed the Corporate Income Tax Code (Código do IRC) to reflect the AOA in national law.

Key legislative changes include:

• Article 55(2) of the IRC Code now explicitly allows the deduction of general administrative expenses allocated to a PE, provided they comply with the arm’s length standard.
• Article 63 of the IRC Code, governing transfer pricing, was also updated to apply not only to associated enterprises but explicitly to dealings between a Portuguese PE and other parts of the same entity, whether resident or non-resident.
• The Ministerial Order (Portaria) No. 268/2021, Portugal’s comprehensive regulation on transfer pricing, endorses the application of the OECD’s 2008 and 2010 reports on the attribution of profits to PEs. It mandates that these guidelines be used as interpretative instruments in complex PE scenarios.

In practice, this means that the Portuguese tax authority (Autoridade Tributária e Aduaneira – AT) expects PEs, particularly those operating under the MIBC, to maintain robust transfer pricing documentation and economic justification for the attribution of income and expenses.

III. Interplay with the MIBC Regime: Tax Incentives and Substance Requirements

Entities operating under the MIBC may benefit from a 5% corporate income tax rate, exemptions on withholding taxes (dividends, interest, royalties), and a broad network of double taxation treaties. However, these advantages are conditional upon strict compliance with economic substance criteria and profit attribution principles.

1. Substance Requirements

Under the current framework, MIBC-licensed companies must fulfil the following:

• Create at least one full-time job in Madeira within the first six months of operation;
• Invest a minimum of €75,000 in the first two years (waived if six or more jobs are created);
• Maintain an actual presence in Madeira, including operational infrastructure, nd locally-creating activity.

These substance requirements are not merely formalistic. They are critical in ensuring that the profits declared and taxed in Madeira correspond to real economic activity, thus withstanding scrutiny under domestic anti-abuse rules and international BEPS standards.

2. Profit Attribution in Practice

For MIBC companies, especially in maritime services, consulting, intellectual property management, and digital commerce, attributing profit to a Madeira-based establishment involves:

• Demonstrating that the Significant People Functions are performed in Madeira (e.g., decision-making authority, contract negotiation, IP development);
• Justifying the ownership and control of assets, such as servers, IP rights, or vessels, as being genuinely situated or administered from Madeira;
• Ensuring that risk management and assumption (e.g., credit, market, operational risk) are demonstrably exercised by staff or agents located in Madeira.

Failure to substantiate these criteria can result in reallocating profits to other jurisdictions under domestic transfer pricing audits or mutual agreement procedures (MAPs) under double tax treaties.

IV. Treaties and the Relevance of the OECD Commentary

Portugal has made reservations on the OECD Model Convention, particularly retaining the right to apply the pre-2010 version of Article 7 in treaties not yet updated. Nonetheless, under Article 8(2) of the Portuguese Constitution, tax treaties prevail over domestic law in case of conflict.

Thus, where an MIBC company is dealing with a jurisdiction applying the pre-2010 Article 7, Portugal follows a hybrid position:

• The 2008 OECD Commentary is considered interpretative, to the extent it does not conflict with earlier commentaries.
• Internal guidance encourages using the AOA framework wherever possible, particularly where it supports consistency and avoids double taxation.

This nuanced approach reinforces the importance for MIBC companies to maintain rigorous documentation, including:

• Functional analyses of their operations;
• Transfer pricing reports aligned with OECD standards;
• Evidence of economic substance and effective control from Madeira.

V. Strategic Considerations and the Role of Consultation on MIBC Companies

Given the sophisticated and integrated nature of today’s tax compliance environment, especially within the EU and OECD frameworks, prospective investors and existing operators within the MIBC should prioritise early-stage planning.

A professional tax consultation is not a bureaucratic formality, but a strategic imperative. Such a consultation ensures:

• Proper entity structuring to avoid the inadvertent creation of additional PEs in other jurisdictions;
• Accurate functional delineation of activities and clear delineation of internal dealings;
• Alignment of operational substance with declared profit attribution.

At Madeira Corporate Services (MCS), our team combines legal, fiscal, and operational expertise to support clients in ensuring that their tax positions are compliant and optimised within the domestic and international law framework.

To book a strategic tax consultation, please visit our website at www.mcs.pt and select “Book a Meeting” at the top right of the homepage.

Conclusion:  Aligning MIBC Compliance with Opportunity

Applying the Authorised OECD Approach to permanent establishments and its integration into Portuguese law requires MIBC companies to move beyond formalistic compliance. Instead, it demands genuine alignment between form and substance, operational reality and financial reporting.

By integrating the AOA with robust economic substance in Madeira, investors can unlock the full potential of the MIBC’s tax advantages while maintaining alignment with OECD, EU, and Portuguese standards. The result is a secure, efficient, and internationally respected platform for global business.

MCS

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