You should have said you would reimburse return postage cost if it was faulty, as you didn't I would just refund and forget about slugging it out with Paypal.

I would have offered a refund of item price only on return if it turned out to be as described and then I may have spend the time to argue the toss with Paypal but if you just said return it and you would refund in full with return costs that is what you should do and take it as a not too expensive lesson on how to word things more precisely if it happens again.