Reverse Merger Tax Deductibility of Financing Costs Under IRC – CAAD Arbitral Decision 110/2017-T

ARBITRAL DECISION

The Arbitrators José Pedro Carvalho (Arbitrator President), Tomás Castro Tavares and Jorge Carita (who voted dissenting on the main decision, as per dissenting opinion attached), appointed as arbitrators at the Administrative Arbitration Centre, hereby agree to form an Arbitral Tribunal:

I – REPORT

On 13 February 2017, A…, S.A., taxpayer…, with headquarters at Street …, no.…, …, …-… …, submitted a request for constitution of an arbitral tribunal, pursuant to the combined provisions of articles 2 and 10 of Decree-Law no. 10/2011, of 20 January, which approved the Legal Regime for Arbitration in Tax Matters, as amended by article 228 of Law no. 66-B/2012, of 31 December (hereinafter, abbreviated as RJAT), seeking declaration of illegality of the tax acts of Corporate Income Tax Assessment and interest no.…, relating to the fiscal year 2011, and no.…, relating to the fiscal year 2012, in the total amount of €513,685.33.

To substantiate its request, the Claimant alleges, in summary, that, by means of a merger by incorporation, the incorporating company (Claimant) assumed, by operation of law and immediately, all the assets of the incorporated companies, including the financing costs incurred by the incorporated company to acquire its equity stakes, therefore the deductibility of the expenses in the legal sphere of the Claimant cannot be questioned, unless there is proof of fraud or abuse.

On 14-02-2017, the request for constitution of the arbitral tribunal was accepted and automatically notified to the Tax Authority.

The Claimant proceeded to appoint an arbitrator, having indicated the Honourable Mr. Professor Doctor Tomás Castro Tavares, pursuant to article 11/2 of RJAT. Pursuant to article 11, paragraph 3 of the same provision, the Defendant appointed as arbitrator the Honourable Mr. Dr. Jorge Carita.

The arbitrators appointed by the parties were appointed and accepted their respective duties. Pursuant to article 6, paragraph 2, subsection b) of RJAT and article 5 of the Regulation for Selection and Appointment of Arbitrators in Tax Matters, the present Rapporteur was appointed to preside over this Arbitral Tribunal, who, within the applicable time limit, also accepted the appointment.

On 17-04-2017, the parties were notified of this last appointment, and did not manifest any intention to refuse it.

In accordance with the provision in subsection c) of paragraph 1 of article 11 of RJAT, the collective Arbitral Tribunal was constituted on 04-05-2017.

On 08-06-2017, the Defendant, duly notified for this purpose, submitted its defence, defending itself solely by way of objection, alleging, in summary, that the deduction by the Claimant of financial nature charges related to its own acquisition, arising from the merger with the company that acquired it, cannot be accepted tax-wise, as they are not indispensable for the realisation of the profits or gains subject to tax or for the maintenance of the source of income, pursuant to paragraph 1 of article 23 of the Corporate Income Tax Code.

By order of 12-06-2017, pursuant to subsections c) and e) of article 16, and paragraph 2 of article 29, both of RJAT, the holding of the meeting referred to in article 18 of RJAT was waived, as well as the presentation of submissions by the parties.

In the same order, a deadline of 60 days was set for the rendering of final decision.

The Arbitral Tribunal is materially competent and is regularly constituted, pursuant to articles 2, paragraph 1, subsection a), 5 and 6, paragraph 1, of RJAT.

The parties have legal personality and capacity, are legitimate and are legally represented, pursuant to articles 4 and 10 of RJAT and article 1 of Ordinance no. 112-A/2011, of 22 March.

The case does not suffer from any nullities.

Thus, there is no obstacle to the examination of the case.

Having considered all the foregoing, it is necessary to render

II. DECISION

A. FACTUAL MATTER

A.1. Facts Established as Proven

1. The Claimant was, in 2011 and 2012, registered for the conduct of the activity of "Manufacture of boilers and radiators for central heating, main CAE – 25210 and Manufacture of non-electric appliances for domestic use, secondary CAE – 27520".

2. The Claimant began its activity on 01-07-1978, being classified at those same dates, for Corporate Income Tax purposes, under the general regime for determining taxable profit.

3. On 2 May 2008, the Claimant was transformed into a public limited company, with capital of €2,400,000.00.

4. On 28 July 2008, the shareholders of the Claimant and the Risk Capital Investment Fund for Qualified Investors C…, entered into a contract-promise of sale and purchase of the shares of the Claimant.

5. On 22 September 2008, company B…, SGPS, SA was established, having as its corporate purpose the management of equity stakes in other companies as an indirect form of conducting economic activities.

6. This company was established only for the purpose of establishing another company, D…, S.A.

7. On 25 September 2008, D…, S.A. was established, having as its corporate purpose the manufacture of household utilities and equipment for the use of renewable energies in the metallurgical sector, as well as any and all related or connected activities.

8. D…, S.A. was created by B…, SGPS, with the sole purpose of acquiring the Claimant.

9. On 1 October 2008, a contract of sale and purchase of the shares of the Claimant was executed with D…, SA, for the value of €15,250,000.00.

10. On the same day, 1 October 2008, the following contracts were executed:

i. Two supply contracts, between B…, SGPS and D…, S.A., the first, in the amount of €4,000,000.00, at an annual interest rate of 8%, for the purpose of providing the financial means necessary for the normal functioning of D… (cash and financing needs), and the second, in the amount of €2,880,000.00, at an annual interest rate of 15%, for the purpose of meeting the cash and financing needs of D…, in order to make viable the acquisition of the shares of A…, supplies that totalled €6,880,000.00;

ii. A financing contract between the Savings Bank of Vigo, Ourense and Pontevedra (E…) and D…, S.A. in the amount of €8,000,000.00, intended for the acquisition of all the shares of A… by D…, S.A.

1. In clause 12.1, subsection f) of the loan contract between D… and E…, it was stipulated as an additional obligation of the borrower (D…) "To proceed with the merger with company A…, by incorporation of the latter, within a maximum period of 1 (one) year".

2. The share capital of the Claimant became, following the acquisition thus financed, held 100% by D…, S.A., being that at that time the share capital of D…, S.A. was held 100% by B…, SGPS, and this was held 88.73% by C…, Risk Capital Investment Fund for Qualified Investors.

3. On 29 June 2009, a merger project was prepared by incorporation, approved on 31/08/2009, between the Claimant (incorporating company) and company D…, S.A. (incorporated company), by means of the global transfer to the Claimant of the assets of the incorporated company.

4. Once the merger was registered in the commercial register, D…, S.A. was extinguished and all its respective rights and obligations were transferred to the incorporating company, the Claimant.

5. In the said merger project, the following reasons were stated:

i. The participating companies belong to the same group;

ii. Rationalisation of administrative costs and exploitation of existing synergies.

1. The merger project made the effects of that merger retroactive to 1 January 2009.

2. The companies participating in the merger project chose to maintain the Claimant, considering, in summary, that it has operated in the market for more than 30 years and has valuable goodwill that is reflected, in particular, in the maintenance of lasting commercial relationships with suppliers, clients and financial institutions, in the trust that the company enjoys in the market, and also in the notoriety of the name and brands associated with its products.

3. With the incorporation of D…, S.A. into the Claimant, its shares were extinguished, and there occurred an exchange of equity stakes by means of the delivery of all the shares (96,000) in which the capital stock of the Claimant was divided to the sole shareholder of D…, S.A., B…, SGPS.

4. The Tax Authority considered that the merger by incorporation operation in question fulfilled the conditions for application of the tax neutrality regime.

5. Subsequently to the acquisition of 100% of the capital of A…, it proceeded to share with its shareholder D… the same corporate purpose and administrators.

6. From an accounting point of view, the operations of the incorporated company (D…, S.A.) were considered as carried out for the account of the incorporating company, the Claimant, as from 1 January 2009, pursuant to subsection i) of paragraph 1 of article 98 of the Commercial Companies Code.

7. The corporate structure relevant to the case before us was as follows:

[Structure diagram omitted]

1. D…, S.A. did not conduct operational activity, the activity it conducted consisting of financial investments making use of bank loans from third parties and from its shareholder, B…, SGPS.

2. Following the registration of the merger by incorporation, the accounting of the Claimant, as at 31/12/2009, presented the following entries:

i. In Liabilities, the item of debts to third parties of medium and long term – debts to credit institutions, in the amount of €7,000,000.00, corresponding to the bank loan contracted by D…, S.A., in the total amount of €8,000,000.00;

ii. €1,000,000.00 was accounted for as debts to third parties of short term – debts to credit institutions;

iii. Of the debt to shareholders (B…, SGPS) relating to supplies, in the total amount of €6,880,000.00, €2,880,000.00 was accounted for as a medium and long term debt and €4,000,000.00 as short term debt.

1. Both the bank loan and the supplies received had as their sole and exclusive purpose the acquisition of the equity stakes of the Claimant by D…, SA, in 2008.

2. The profit and loss statement of the Claimant for 2009 shows, in addition to the increase in operational activity compared to the previous year, an amount in the financial costs item that amounts to €954,106.11 (approximately 15% of total costs), compared to 2008, which was only €88,828.56.

3. The said increase in financial costs resulted from the accounting of financial charges arising, both from the bank loan and from the supply contracts executed in 2008 by the incorporated company, D…, S.A.

4. Because of the merger, the Claimant came to hold a liability corresponding to the assumption of responsibility for financing previously contracted by D…, S.A.

5. As a result of the said merger operation, the taxable profit of the Claimant in 2009 was €1,603,718.12, whereas in 2008 it was €2,158,879.07.

6. Following an external inspection action of general scope conducted by the Tax Authority pursuant to service order no. OI2014…, corrections were made to the taxable amount of Corporate Income Tax for the fiscal years 2011 and 2012 of the Claimant.

7. In the fiscal years 2011 and 2012, the Claimant actually incurred the following charges, which before the merger were in the sphere of D…:

[Table of amounts omitted]

1. The amount of €860,006.99 assessed for 2012 was reduced to €814,324.73 following the exercise of the right to prior hearing by the now Claimant, the Tax Authority having accepted that from the balance of account 69111 (financing interest) indicated in annex 7 of the draft report (€157,527.66) should be subtracted the amount in credit of €45,682.26 relating to interest on the loan granted by E….

2. As a result of the tax inspection and the conclusions set forth in the Inspection Report, the Tax Authority made the following corrections to the taxable amount of Corporate Income Tax determined by the Claimant in relation to 2011 and 2012:

[Corrections table omitted]

1. The Tax Authority considered that the said financing costs could not be accepted as tax costs, as they were not indispensable for the realisation of the profits or gains subject to tax or for the maintenance of the source of income, pursuant to paragraph 1 of article 23 of the Corporate Income Tax Code.

2. Following this, Corporate Income Tax assessments and interest no.…, relating to fiscal year 2011, and no.…, relating to fiscal year 2012, were issued, respectively in the amounts of €253,848.00 and €259,837.33.

3. The Claimant paid the Corporate Income Tax additionally assessed in relation to 2011, as well as the statutory additions, in a total of €253,848.00, on 3 December 2015.

4. The Corporate Income Tax additionally assessed in relation to 2012, as well as the statutory additions, in a total of €259,837.31, was paid by the Claimant on 4 December 2015.

5. The Corporate Income Tax assessments and interest relating to 2011 and 2012 identified above were the subject of a gracious claim presented on 4 April 2016 at the Tax Office of….

6. The gracious claim referred to was rejected by order of the Head of the Tax Justice and Contentious Division of the Finance Department of… dated 10 November 2016, notified to the representatives of the Claimant by registered mail with acknowledgement of receipt on 15 November 2016.

A.2. Facts Established as Not Proven

With relevance to the decision, there are no facts that should be considered as not proven.

A.3. Reasoning for the Factual Matter Proven and Not Proven

With regard to the factual matter, the Tribunal need not pronounce itself on everything that was alleged by the parties; rather, it is its duty to select the facts that matter for the decision and distinguish the proven from the not proven matter (cf. article 123, paragraph 2, of the Tax Procedural Code and article 607, paragraph 3 of the Civil Procedure Code, applicable by virtue of article 29, paragraph 1, subsections a) and e), of RJAT).

Thus, the facts relevant to the judgment of the case are chosen and defined in accordance with their legal relevance, which is established in light of the various plausible solutions to the legal question(s) (cf. former article 511, paragraph 1, of the Civil Procedure Code, corresponding to the current article 596, applicable by virtue of article 29, paragraph 1, subsection e), of RJAT).

Thus, taking into account the positions assumed by the parties, in light of article 110/7 of the Tax Procedural Code, the documentary evidence and the case file attached to the record, the facts listed above were considered as proven, with relevance to the decision.

Allegations made by the parties and presented as facts, consisting of strictly conclusive statements incapable of proof and whose truthfulness is to be assessed in relation to the concrete factual matter above established, were not given as proven or not proven.

B. LAW

The situation presented in this case is of relatively simple configuration and can be, summarily and in its essential features, described as follows:

• The Claimant, in 2009, was the incorporating company in a merger by incorporation operation (known as reverse merger), in which the company that held 100% of its equity stakes was incorporated;

• The said incorporated company held, in its liabilities, debts arising from financing and supply contracts, which had been entered into in order to acquire it, and whose amounts had been applied in the acquisition of all the equity stakes of the incorporating company;

• By effect of the merger operation, the company resulting therefrom (now Claimant) succeeded to the incorporated company in the said obligations (financing and supply debts), and had, in the years now in question, 2011 and 2012, to bear the corresponding charges, it being certain that, by effect of that same operation, the stakes of the Claimant that formed part of the assets of the incorporated company (its shareholder), did not pass to its ownership, and shares of the now Claimant were allocated to the shareholder entity of that incorporated company, in exchange for the stakes it held in this latter, which also by force of the same operation were extinguished.

The question posed is, similarly, of simple configuration, and concerns solely the assessment of whether, as the Tax Authority contends, the expenses corresponding to the charges relating to the financing and supply costs borne by the now Claimant in the fiscal years in question meet the requirements of article 23/1 of the Corporate Income Tax Code, relating to their indispensability for the realisation of the profits or gains subject to tax or for the maintenance of the source of income, and, consequently, whether they can be deducted in determining the taxable profit thereof, in the respective fiscal years.

This, in essence, is what is presented to this arbitral tribunal for decision.

Let us see then.

From a general point of view, Claimant and Defendant converge on what has been the established trajectory in national doctrine and jurisprudence regarding the indispensability of expenses, whose essential features can be synthesised as follows:

• The judgment on the indispensability of expenses incurred implies that their contribution to the obtaining of profits or gains subject to tax or to the maintenance of the source of income be verified;

• "The legal notion of indispensability is thus defined on an economic-business perspective, by direct or indirect fulfilment of the ultimate motivation of contribution to the obtaining of profit" and "the fiscal deductibility of the cost depends only on a causal and justified relationship with the company's activity." (Supreme Administrative Court Decision, of 30-11-2011, in case no. 0107/11);

• "Costs (…) cannot but respect the taxpayer company itself. That is, in order for a certain amount to be considered a cost of that company, it is necessary that the respective activity be developed by it itself, not by other companies." (Supreme Administrative Court Decision, of 30-05-2012, in case no. 0171/11);

• "A concept of indispensability that, moving away definitively from the idea of causality between expenses and income, places the emphasis on the relationship of expenses with the activity conducted by the taxpayer, that is, considering that the said concept of indispensability is verified whenever expenses are incurred in the interest of the company, in the pursuit of its respective activities." (Supreme Administrative Court Decision, of 04-09-2013, in case no. 0164/12);

• The concept of indispensability is of case-by-case application, and the nexus of economic causality cannot be disconnected from the factuality of the particular case;

• "The Tax Authority cannot evaluate the indispensability of costs in light of criteria concerning the opportunity and merit of the expense. A cost is indispensable when it relates to the company's activity, and costs foreign to the company's activity will be only those in which it is not possible to discern any causal nexus with the profits or gains (or with income, in the current expression of the code - cf. art. 23, no. 1, of the Corporate Income Tax Code), explained in terms of normality, necessity, congruence and economic rationality." (Central Administrative Court of the South Decision, of 16-10-2014, case no. 06754/13);

• "The indispensability of the cost must result simply from its connection to business activity. If the cost is not foreign to the company's activity, that is, if it relates to the company's normal activity (regardless of whether the degree of intensity or proximity is greater or lesser), and if its existence is accepted (one is not facing an apparent or simulated cost), the cost is indispensable." (Central Administrative Court of the North Decision, of 20-11-2011, case no. 01747/06.3BEVIS);

• "From the legal notion of cost provided by art. 23 of the Corporate Income Tax Code, it does not follow that the Tax Authority may call into question the principle of freedom of management, scrutinising the propriety and opportunity of the company's management decisions and considering that only costs that directly produce profits for the company or prove convenient for the company can be fiscally accepted. The indispensability referred to in art. 23 of the Corporate Income Tax Code as a condition for a cost to be deductible does not refer to necessity (the expense as a sine qua non condition of profits), nor even to convenience (the expense as convenient for business organisation), under penalty of intolerable interference by the Tax Authority in the taxpayer's autonomy and freedom of management, but requires only an economic causality relationship, in the sense that it suffices that the cost be incurred in the interest of the company, in order, directly or indirectly, to obtain profits.

The legal notion of indispensability is thus defined on an economic-business perspective, by direct or indirect fulfilment of the ultimate motivation of contribution to the obtaining of profit. Indispensable costs are equivalent to expenses incurred in the interest of the company or, in other words, in all acts abstractly subsumed in a profit-making profile. This objective deliberately brings economic and fiscal categories closer, through a primarily logical and economic interpretation of legal causality. The necessary expense is equivalent to any cost realised in order to obtain income and that represents an economic loss for the company. As a rule, therefore, the fiscal deductibility of the cost depends only on a causal and justified relationship with the company's activity. And outside the concept of indispensability will remain only acts not in accordance with the corporate purpose, those that do not fall within the company's interest, particularly because they do not aim at profit." (Supreme Administrative Court Decision, of 30-11-2011, case no. 0107/11);

• "The rule is that properly accounted-for expenses are tax costs; the criterion of indispensability was created by the legislator, not to allow the Administration to interfere in company management, dictating how it should apply its means, but to prevent the fiscal consideration of expenses that, although accounted for as costs, do not fall within the scope of the company's activity, were incurred not for its pursuit but for other foreign interests. Strictly speaking, these are not true company costs, but expenses that, having regard to their object, were abusively accounted for as such. Without the Administration being able to evaluate the indispensability of costs in light of criteria concerning their opportunity and merit.

The concept of indispensability cannot only not be equated with a strict judgment of imperative necessity, as has been said, but also cannot be based on a judgment about the convenience of the expense, necessarily made ex post facto. For example, expenses incurred on an advertising campaign that proved fruitless cannot, solely as a function of that result, be stated to be unnecessary.

The judgment on the opportunity and convenience of expenses is exclusive to the businessman. If he decides to make expenses in order to pursue the company's purpose but is unsuccessful and those expenses prove, in the end, unfruitful, they do not cease to be tax costs. But any expense that is accounted for as a cost and proves foreign to the company's purpose is not a tax cost, because it is not indispensable.

We understand (…) that, under penalty of violation of the principle of tax capacity, the Administration can only exclude expenses not directly ruled out by law under strong motivation that convinces us that they were incurred beyond the corporate objective, that is, in the pursuit of another interest that is not business-related, or, at the very least, with clear excess, deviant, in relation to the objective needs and capabilities of the company." (Supreme Administrative Court Decision, of 29-03-2006, case no. 01236/05);

Thus, the decision criteria being consensual, it remains solely to apply such criteria to the particular case, a task that, that one, rises to other levels of difficulty.

This operation of applying said criteria to the type of situation presented in the present case was already attempted in arbitral cases nos. 14/2011-T, 101/2013-T, 87/2014-T, 42/2015-T, 92/2015-T, 93/2015-T, and 88/2016-T, all of the Administrative Arbitration Centre.

In the three latter cases, given the relevance for the framing of the issue to be decided, an analysis of each of the preceding decisions was undertaken, in terms that will now be followed very closely.

In case 14/2011-T, the Tribunal addressed, among other matters, a question identical to the one now before us.

From the very learned discussion in that decision, we highlight:

• "To decide on the deductibility of financial charges arising from the loan in question, what matters, on this point, is the objectivity of the operation documentally proven in the case and its relationship with the topics contained in paragraph 1 of article 23 of the Corporate Income Tax Code; it is incumbent here only to verify, as the Claimant itself refers, whether the funds obtained were actually applied to purposes foreign to the activity of the company that owes them. Hypothetical elements, such as the options, very often numerous and diverse, that the company could have taken, or the possibilities of structuring the operations in other ways, also often numerous, are not relevant to the assessment of the matter at hand, given that what is at issue here is not hypothetical situations, situations that could have happened but did not, but rather occurrences verified in the reality of life, as they are considered proven. Indeed, what falls to this Tribunal to undertake is the supervision of the legality of the tax act challenged taking into account the concrete elements of the case submitted to it and the body of evaluations made and justifications presented by the Tax Authority.";

• "The fiscal deductibility of interest borne depends on a judgment as to its indispensability for the realisation of profits or gains subject to tax or for the maintenance of the source of income (body of paragraph 1), even explicitly stating subsection c) of paragraph 1 of this provision that these foreign capital interest rates are "applied in the business operations".";

• "Thus, it is strictly in relation to the entity whose costs are in question, taking into account the business activity it develops, that it matters to assess the fiscal deductibility of financial charges. This fiscal deductibility presupposes, then, that the costs incurred with financial charges possess a causal connection with the business activity developed, particularly that they serve the development of the activity of the company owing them. Consequently, as MARIA DOS PRAZERES LOUSA observes, "The Problem of Interest Deductibility for the Purpose of Determining Taxable Profit" in Studies in Honour of Dr. Maria de Lourdes Correia e Vale, Lisbon, 1995, p. 349, interest borne by a company in relation to loans cannot be accepted as deductible when it is manifestly proven that the funds obtained are "diverted from business operations and applied to purposes foreign to them". In another formulation found in RUI DUARTE MORAIS, Notes on Corporate Income Tax, Coimbra, 2007, p. 87, "if the charge was determined by other motivations (personal interest of shareholders, administrators, creditors, other companies in the same group, business partners, etc), then such cost should not be considered indispensable";

• "To apply the requirement of indispensability of costs to the case at hand, it is incumbent to verify, on the basis of all relevant facts and circumstances, the actual and concrete allocation of the loan for which the interest borne is the remuneration, in other words, it is important to consider the destination or use of the funds obtained in relation to which the taxpayer seeks to fiscally deduct, for the purpose of determining its taxable profit, the interest and other associated charges it bore.";

• "It emerges clearly from the factual matter given as proven that the funds in question have as their purpose, destination and use the acquisition of the Claimant's own equity stakes by company D... SGPS, therefore the allocation of the loan is not connected with the activity or with assets held by the company owing it, here the Claimant, but rather with assets held by its own shareholder.";

• "The equity stakes in question thus form part of the assets of D..., shareholder of the Claimant, and not of the Claimant itself (in which case they would constitute treasury shares), therefore the ownership and enjoyment of such asset, to whose acquisition the financing is attributable and the financial charges borne by the Claimant without any counterpart are incurred, benefits exclusively the shareholder D... and not the Claimant.";

• "Precisely, it is verified in the case that the entity that can enjoy, in its own interest, as a source of income this asset is not the entity that bears, exclusively, the costs relating to the financing of the asset acquisition (the Claimant), but rather a distinct entity, in this case its sole shareholder (D...).

This asset, it bears noting, consists of the Claimant's own shares, thus incurring in costs with a loan that served to finance the acquisition of its capital by another entity. It is not possible, therefore, not to recall here the disfavour with which the legislator itself regards this type of situation in the terms arising from article 322 of the Commercial Companies Code, which provides, in paragraph 1, that: "A company cannot grant loans or in any other manner provide funds or grant guarantees for a third party to subscribe or otherwise acquire shares representing its capital".

We have, then, that the costs incurred with the loan in question are not applied in the business operations of the Claimant itself, in its business activity, nor do they serve to maintain the source of income-producing. Such costs, although entered in the Claimant's accounting, do not benefit its activity or its business interest, but rather benefit a third party, in this case its sole shareholder D... SGPS.

There is not, therefore, here the "balancing or matching" between the costs incurred with financial charges and the respective profits, which should be considered as relevant in the context of the requirement of indispensability of costs for fiscal purposes as provided for in art. 23 of the Corporate Income Tax Code".

This decision also includes a dissenting vote, from which the following is highlighted:

• "The first question is whether the indispensability of financial charges should be judged with respect to the merged company or with respect to the company benefiting from the merger. Such judgment must be made, in a first instance, from the perspective of the company that contracted the financial charge and cannot be made from the individualised perspective of the merger's beneficiary company. It is not questioned that the charges assumed by the merged company are deductible from it, pursuant to article 23, no. 1, subsection c) of the Corporate Income Tax Code (interest on foreign capital applied in business operations).";

• "From the moment the assets of the merged company are globally transferred to the merger's beneficiary company (ex-article 67, no. 1, subsection a) of the Corporate Income Tax Code, applicable to the case) with extinction of the merged companies, the fiscal deductibility of the financial charges assumed must be evaluated, for fiscal-legal purposes, in the context of the merger.

The merger implies the transfer of rights and obligations to the beneficiary company (article 112 a) of the Commercial Companies Code), and, in this case, we have two possible interpretive lines to judge the requirement of indispensability of a cost: one line is to consider that since the cost was considered deductible in the sphere of the merged company, it continues, in principle, to be deductible in the sphere of the merger's beneficiary company, given that the debt is transferred to the latter company and the merged company has lost its existence; and only thus will it not happen if there has been abusive behaviour or a transfer of debt that violates the law (for example, because the principle of intangibility of the beneficiary company's capital is not observed). The other interpretive line implies considering the perspective of the commercial operation of the whole of the entities involved, in an interpretation that values substance over form (article 11, paragraph 3 of the General Tax Law). The relationship of economic causality between the assumption of a cost and its realisation in the interest of the company must take into account the joint purposes of the entities involved in the merger.

In cases of leveraged acquisitions, both of the lines referred to have been followed in other legal systems: the first line, the application in principle of the ordinary regime, followed by correction based on abuse, is adopted by the tax administration and the application of the general anti-abuse clause controlled by French courts (see Cases with leveraged acquisition: see for example a case of share exchange, with exceptional dividend distribution: Council of State no. 320313, of 27.1.2011, Reporter Mme Cécile Isidoro; LBO et abuse of law, Tax Procedures, Review of Tax Law, no. 15, of 14.4.2011, pp. 36-42; cf. Also, a case of share exchanges: Council of State no. 301934, 08.10.2010, Reporter M. Jean-Marc Anton; and a case of asset entry: Council of State no. 313139, of 8.10.2010, Reporter M. Patrick Quinqueton);

The second interpretive line is adopted in the German legal system explicitly for cases of reverse merger: since the share capital is safeguarded, it is understood that there is no hidden dividend distribution and the debt is transferred to the merger's beneficiary company (the affiliate company): see in this regard Thomas Rödder/Peter Wochinger "Downstream Merger mit Schuldenübergang", DStR, 2006, pp. 684-689, and the jurisprudence and doctrine cited therein).

In the case at hand, I understand that interest borne by Corporate Income Tax taxpayers as remuneration for loans contracted and other associated financial charges are, in principle, deductible as costs in the determination of taxable profit in accordance with the provision in article 23 of the Corporate Income Tax Code, no. 1, subsection c), according to which, in the wording in force in 2007, "shall be considered costs or losses those that are demonstrably indispensable for the realisation of profits or gains subject to tax or for the maintenance of the source of income", namely "charges of a financial nature, such as interest on foreign capital applied in business operations". In the case at hand, the "indispensability" and "application in business operations" were associated with the merger operation, given that this operation was agreed with the bank financing the loan (cf. nos. VII and VIII of the decision on facts given as proven), therefore the interpretation from the perspective of the commercial operation of the whole of the entities involved implies the recognition of the debt and interest as tax costs of the merger's beneficiary company.

In general, in a reverse merger, even if the indispensability of interest relating to a loan had been originally evaluated only at the level of the parent company (which was not the case), they must henceforth be evaluated, for tax purposes, in the context of the company's overall business transaction (see Thomas Rödder/Peter Wochinger "Downstream Merger mit Schuldenübergang", DStR, 2006, p. 685).";

• "Admitting then that article 23, no. 1, subsection c) of the Corporate Income Tax Code must take into account the activity of the whole company participating in the merger operation and not only the beneficiary thereof (the Claimant), it would then be necessary to ascertain whether the motivations for the reverse merger were essentially or primarily fiscal, applying article 38, no. 2 of the General Tax Law as to the deductibility of interest.".

In the case now before us, it was considered that "the entity that can enjoy, in its own interest, as a source of income this asset is not the entity that bears, exclusively, the costs relating to the financing of the asset acquisition (the Claimant), but rather a distinct entity, in this case its sole shareholder (D...).", and that "the costs incurred with the loan in question are not applied in the business operations of the Claimant itself, in its business activity, nor do they serve to maintain the source of income. Such costs, although entered in the Claimant's accounting, do not benefit its activity or its business interest, but rather benefit a third party".

With great respect, it appears that the position that prevailed in the decision under analysis is open to criticism in some of its structural aspects.

Thus, the consideration that "the costs incurred with the loan in question are not applied in the business operations of the Claimant itself, in its business activity, nor do they serve to maintain the source of income", will suffer, from the outset, from some imprecision with relevant consequences for the conclusions to be drawn.

For, except for better opinion – and always with the greatest respect due – "costs" are not, ontologically, susceptible of "application". What is, instead, susceptible to application is the counterpart of those costs, which, in the case and in the terminology of subsection c) of paragraph 1 of the Corporate Income Tax Code, will be the "foreign capital" obtained through financing and supply contracts. It happens that, in the argumentative framework in which the said consideration is situated, the reference to "costs" is – it is believed – not interchangeable with the reference to "foreign capital".

Indeed, the foreign capital obtained by the incorporated company, by way of financing and supply contracts, was entirely applied (exhausted) when acquiring the equity stakes of the company, later, its incorporating company. In the case(s) this is the reality: the amounts obtained through financing and supply contracts (the "foreign capital", in the terminology of subsection c) of paragraph 1 of article 23 of the Corporate Income Tax Code), did not persist until a post-merger moment, to be then redirected in their purpose, but, at that moment, were already entirely applied.

It will not militate against the conclusion formulated, it is believed, the finding that the pecuniary payment obligations for the interest on the borrowed capital persist in the post-merger moment, which is evident, since what is in question is precisely their deductibility. Indeed, the application referred to in subsection c) of paragraph 1 of article 23 of the Corporate Income Tax Code relates to "foreign capital", and not to any obligations.

Thus, it is believed that, in any of its possible meanings, the above-stated assertion is not susceptible to acceptance. Indeed, in its literal tenor, costs will not be susceptible of application. Relating it to "foreign capital", remunerated by the pecuniary payment obligations for interest, the same were already entirely applied, therefore the assertion cannot be held valid that the "foreign capital" remunerated by "the costs incurred with the loan in question are not applied in the business operations of the Claimant itself, in its business activity, nor do they serve to maintain the source of income", since there was no alteration in the application thereof, it being certain that neither the decision in question, nor the Tax Authority itself, at any moment, questioned that, at the moment the "foreign capital" was applied, it was applied in the business interest of the entity that applied it.

Thus, it is believed that the judgment according to which there was a diversion in the application of the counterpart of the expenses whose deductibility is questioned cannot be validated, since that application, at the moment the expenses are accounted for, was, as we have just seen, totally exhausted.

It could, then, be questioned whether the indirect product of the expenses (the stakes of the company subsequently incorporating) were "diverted", and in some way, the assertion that "the entity that can enjoy, in its own interest, as a source of income this asset is not the entity that bears, exclusively, the costs relating to the financing of the asset acquisition", may point to an argument in that sense, which should, however, be held to be substantially distinct from the former.

In any case, the above-stated assertion is not subscribed to, primarily, since it is considered that there is not an identity (although there is a similarity) between the "asset" that was held, pre-merger, by the merged company and the "asset" that passed, post-merger, to the shareholder company thereof, given that the effect of the merger by incorporation is not the transmission of the stakes held by the incorporated company to its shareholder(s), but the allocation by the incorporating company of its own shares to the shareholder(s) of the incorporated company.

Therefrom it follows then, among other things, that the acquisition of the stakes of the incorporating company (now Claimant) by the shareholder(s) of the incorporated company is not the counterpart of the financing contracted by the latter, nor even of the product of the application of such financing, but – rather – of the stakes it held in the latter and from which it is deprived by force of its extinction, effect of the merger.

In other words: the shares of the Claimant that, in the case, B… came to hold, following the merger, are not the shares of the Claimant that D… held, and in whose acquisition the financing discussed was applied, nor do they come to it by exchange for such shares, but are counterpart of the shares of D… that B… held, and which, by virtue of the merger, it ceased to hold.

The understanding of what has just been expounded also points to another conclusion, with which what was decided in the case now in analysis will be incompatible: the circumstance that the allocation of shares of the company resulting from the merger to the shareholder(s) of the merged company does not have as its cause the product of the financing and supply contracts contracted by the latter implies that there was no "diversion", even, of the indirect product of those financing and supply contracts to the shareholder(s) of the merged company.

Possibly, it could be questioned – and it is not – the amount of shares of the incorporating company allocated to the shareholder(s) of the incorporated company. However, even there it is possible to detect a balance on principle, reflected in the circumstance that the value allocated to them is precisely the same as they held before. Indeed, pre-merger, the shares of the incorporated company would have, roughly, the value corresponding to the shares of the incorporating company (which, to the extent that the whole of its share capital is held, is precisely equivalent to its value), less the liability incurred for their acquisition. Post-merger, the stakes allocated to the shareholder(s) of the incorporated company thus have precisely the same value, with no unjustified benefit accruing to them.

It will not be, therefore, for all that has been expounded, accurate to state, fundamentally, that there will be a company that owns and benefits from the asset and another that bears the costs, at least not in a sense different from what already occurred before the merger, in which the shareholder(s) of the incorporated company was, ultimately, by way of the appreciation of their stakes, benefited from the payment, by the incorporated company, of the cost of acquisition of the incorporating company, the incorporated company being the one bearing the costs leading to such appreciation. This will be precisely the situation post-merger, in which the stakes allocated to the shareholder(s) of the incorporating company have – exactly, as we have seen – the same value as the stakes they held before in the incorporated company, and will be valued, just as before the merger, as the financing contracted is reimbursed.

Thus, in summary and by what has been expounded, the conclusions of the Decision in question cannot be ratified as to, in the situations that concern us, verifying that:

• The entity that can enjoy, in its own interest, as a source of income this asset is not the entity that bears, exclusively, the costs relating to the financing of the asset acquisition (the Claimant), but rather a distinct entity, in this case its sole shareholder;

• The costs incurred with the loan in question are not applied in the business operations of the Claimant itself, in its business activity, nor do they serve to maintain the source of income;

• The costs incurred with the loan rather benefit a third party.

Remaining to be addressed is the consideration globally underlying the decision in question, of the Claimant, when it incurs them, no longer being in possession of the indirect product of the expenses it bears, which is a different question from that on which the decision in analysis was based, in understanding that there is a third party as beneficiary of that product (which, as we have seen, will not be what occurs), and which will be assessed further below.

As regards the dissenting vote of advisor Ana Paula Dourado, it is noted that its synthetic character also leaves some margin for criticism.

Indeed, referring that "the fiscal deductibility of the financial charges assumed must be evaluated, for fiscal-legal purposes, in the context of the merger.", associating it with the need to "consider the perspective of the commercial operation of the whole of the entities involved", and specifying that the ""indispensability" and "application in business operations" were associated with the merger operation, given that this operation was agreed with the bank financing the loan", suggests that in the evaluation to be made, the doors should be opened to the consideration of perspectives that do not restrict themselves to those of the companies directly participating in the merger process (incorporating or incorporated), which, as will also be seen, is understood not to be the case.

In case 101/2013-T, the Tribunal was likewise instructed to issue a decision on a question identical to the one now before us.

From the also very learned discussion in that decision, we highlight:

• "A conclusion in the sense of such indispensability is not ruled out by the eventuality of the company being able to pursue its activity without realising certain expenses, but only by a judgment in the sense that the expenses in question do not have the potential to positively influence the obtaining of profits.

A conclusion in the sense of the dispensability of expenses for the obtaining of taxable profit must rest on a demonstration that even if the expenses in question had not been made, the profits or gains that were actually obtained could be obtained.

Which means that a conclusion in the sense of the indispensability of expenses for the obtaining of profits or gains is only to be ruled out if it can be stated that those expenses did not have the potential to positively influence them.

Thus, it is not necessary to demonstrate, in order to attribute fiscal relevance to financial charges, that they actually produced a positive result.

It is sufficient that they be acts that can be accepted as management acts, acts of the type that a company carries out with the objective of increasing income and with tendential potential to provide such increase.

In this matter, the control of the Tax Authority must be a control by the negative, rejecting as costs only those that clearly do not have the potential to generate increase in gains, the competent administrative agent cannot set itself up as a manager and qualify indispensability at the level of good and bad management, according to his feeling or personal sense; it is sufficient that it is an operation carried out as a management act, without entering into the assessment of its effects, positive or negative, of the expense or charge assumed for the results of the realisation of profits or for the maintenance of the source of income»";

• "What is at issue shifts to merely ascertain whether a hypothetical lack of indispensability of those charges for the realisation of the activity of clinical analyses carried out by the Claimant in the year 2008 can lead to the irrelevance of those costs for the determination of the company resulting from the merger.";

• "The interpretation adopted by the Tax Authority and Customs Administration, in making the correction of the Claimant's taxable matter, which resulted in ascertaining the relevance of financial charges to the activity of clinical analyses carried out by the Claimant in the year 2008, would come down to the fact that profits obtained by D ..., S.A, during the year 2008, were relevant for the formation of the Claimant's taxable profit, without the corresponding negative relevance of the costs incurred to obtain them, which is manifestly against the principle of relevance of the «net result of the fiscal year».

Thus, it is immediately concluded, by this route, that the interpretation carried out by the Tax Authority and Customs Administration is wrong and embodied in the determination of the Claimant's taxable profit in the sense that the indispensability of the financial charges supported by D ..., S.A., should be assessed in light of the activity of the Claimant and not that of the latter.";

• "This transfer of results is, by force of article 17 of the Corporate Income Tax Code, that of the net results of the company or companies to be merged, therefore it is unequivocal that the costs that are to be considered indispensable for the incorporated company to obtain its respective profit or maintain its source of income are transferred to the incorporating company, being treated as costs of this one, for purposes of determining its taxable profit in the year in which the merger occurs.

Finally, it is said that this is also the interpretation imposed by the constitutional principle that «the taxation of companies fundamentally focuses on its real income» (article 104, no. 2, of the Constitution of the Portuguese Republic) and the principle that income taxes essentially rest on tax capacity (article 4, no. 1, of the General Tax Law), therefore this is the interpretation to be adopted from a perspective consistent with the Constitution and that bears in mind the unity of the legal system, which is the primary element of legal interpretation (article 9, no. 1, of the Civil Code).

It is thus concluded that the correction made, in understanding that the relevance of the financial charges supported by D ... S.A. relating to the year 2008, should be assessed in light of its relevance for the activity of clinical analyses carried out by the Claimant in that year and in not considering as costs of the Claimant the costs of D ..., S.A. relevant for determination of its own taxable profit, suffers from the vice of violation of law, in particular article 23, no. 1, of the Corporate Income Tax Code, which justifies its annulment [article 135 of the Code of Administrative Procedure, subsidiarily applicable by force of the provision in article 2, subsection c), of the General Tax Law]."

As regards what was decided in this case, it should be noted from the outset that the situation here at issue is restricted to the year in which the merger occurs, a situation that explains the tenor of the fundamental decision criterion there chosen, which concerns the understanding that "the interpretation adopted by the Tax Authority and Customs Administration, (…) would come down to the fact that profits obtained by D ..., S.A, during the year 2008, were relevant for the formation of the Claimant's taxable profit, without the corresponding negative relevance of the costs incurred to obtain them, which is manifestly against the principle of relevance of the «net result of the fiscal year»" and that, as such, "the costs that are to be considered indispensable for the incorporated company to obtain its respective profit or maintain its source of income are transferred to the incorporating company, being treated as costs of this one, for purposes of determining its taxable profit in the year in which the merger occurs.".

This latter conclusion, disconnected from the particular case, is exposed to criticism, insofar as it appears to follow a simplistic line, set aside in the dissenting vote of case 14/2011-T, and which here is followed, according to which once the deductibility of an expense is established in the sphere of the incorporated company, one shall necessarily recognise that deductibility in the sphere of the incorporating company.

Furthermore, the said fundamental decision criterion presents, in itself, as pledge of its internal coherence, limitations. Thus, on one hand, the justification of the relevance of the expenses incurred by the merged company, in function of the parallel relevance of the gains obtained by it, in the sphere of the company resulting from the merger, will only be proper up to the moment in which the merger was executed; that is, the expenses supported by the merged company are justified, still as such, with the gains generated by it, also still as such, one not being able to directly transpose such criterion to the post-merger phase (which, note, in the case in analysis was limited to little more than a week), since there are already in question expenses that have no correspondence in gains in the sphere of the company resulting from the merger.

In case 87/2014-T, the Tribunal was, once more, called upon to pronounce itself on a question identical to the one now before us.

From the also very learned discussion in that decision, we highlight:

• "The fact that the financing with the respective charges and responsibilities was the subject of transfer within the context of a merger by incorporation (…) does not imply that its fiscal treatment in the incorporating company must be, without more, the exact mirror of what occurred in the incorporated company.

Note, from the outset, that in order to reach any conclusion on the deductibility of financial charges in the incorporating company, no element is obtained from the conception that one adopts, in general terms, as to the legal nature of the merger, whether one considers that it is a phenomenon of universal succession of the incorporated company to the incorporating company or whether one considers that it is the modification of the companies involved by means of transformation. (...)

But neither is any conclusion drawn from the tax neutrality regime itself (...) since this regime did not, at any moment, contemplate the transmissibility to the incorporating company of the fiscal treatment conferred on costs in the incorporated company";

• "The fiscal deduction of financial charges incurred in the year 2009 must be assessed in the context of the Claimant's own business situation, taking into account the normative criteria resulting from paragraph 1 of article 23 of the Corporate Income Tax Code, which is indeed the decisive legal framework in light of which the matter of the case must be resolved.

Hence, in compliance with the provision of paragraph 1 of article 23 of the Corporate Income Tax Code, it is perfectly appropriate to verify, as the Tax Authority did in the tax inspection of the fiscal year 2009 it carried out and which is here under examination, whether the assumptions of fiscal deductibility of costs with interest were satisfied taking into account the Claimant's activity and the taxation period in question (cf. article 18 of the Corporate Income Tax Code), independently of what was happening in the incorporated company.(...)

It is thus concluded that the fact that certain financial charges were previously fiscally deductible within the context of determining the taxable amount of a certain company does not mean, by itself alone, that they necessarily are in the same terms within the context of the company that, by merger, incorporated that one.

Indeed, so much is it so that the Claimant itself recognises that the maintenance of the deductibility of the interest on a certain financing initially contracted depends on the assumption that "the financing remains allocated to the same purpose"(...)

Therefore, the matter that actually matters to decide for the solution of the case before us concerns the verification in the year 2009, taking into account the situation of the Claimant, of the nexus of economic causality between the assumption of the financial costs in question and their realisation in the interest of the company.";

• "Taking into account this guideline, to apply the requirement of indispensability of costs to the case at hand, it is decisive to ascertain, on the basis of all relevant facts and circumstances, the actual and concrete allocation of the financing for which the interest borne is the remuneration or, in other words, it is important to verify the destination or use of the funds obtained in relation to which the taxpayer seeks to fiscally deduct, for the purposes of determining its taxable profit, the interest and other associated charges it bore.(...)

As such, the Claimant bore in the year 2009 financial charges in relation to the whole of the financing in question (...), but the equity stakes relating to the capital of the Claimant itself, to which that financing was also intended (...), do not belong, naturally, to the Claimant, but are rather held by "B" BV, which does not bear the corresponding costs of that financing (...)."

• "This means that the financial charges borne in the fiscal year 2009 attributable to the acquisition of the capital of "A" do not find nexus of economic causality with the interest and activity of the Claimant itself, having no potential for generating profits in its legal sphere.

Those equity stakes, in truth, can only generate taxable income (dividends in light of the distribution of profits by the participated company, capital gains in light of the sale of the stakes) in the legal sphere of the company holding the stakes (the "B" BV), not in the legal sphere of the debtor of the financial charges (the Claimant here). As such, the financial charges in question are not intended to finance the business activity of the Claimant itself, in particular the investment in equity stakes held by it, but rather concern equity stakes held by a third party.

Now, as referred to above (no. 14), the fiscal deductibility of costs, by force of the principle of indispensability provided for in article 23 of the Corporate Income Tax Code, presupposes a nexus of economic causality between the costs in question and their realisation in the interest of the company.

It is, therefore, necessary, for purposes of their fiscal relevance, that the expenses incurred with financial charges possess a connection of causality with the business activity developed, particularly serving the development of the activity of the company owing them, in order to obtain profits. Consequently, as MARIA DOS PRAZERES LOUSA observes, ["The Problem of Interest Deductibility for the Purpose of Determining Taxable Profit," in Studies in Honour of Dr. Maria de Lourdes Correia e Vale, Lisbon, 1995, p. 349], interest borne by a company in relation to loans cannot be accepted as deductible when it is manifestly proven that the funds obtained are "diverted from business operations and applied to purposes foreign to them".

In this sequence, equally invoke what is referred to in the decision of the Central Administrative Court of the North of 14.3.2013, case no. 01393/06.1BEBRG: "only shall be considered costs of the fiscal year those that are demonstrably indispensable for the realisation of profits or gains or for the maintenance of the source of income but of the company itself and not of a third party. That is, costs must be reported to the activity developed by the company in question and not by another company".".

• "The financial charges indicated have as their purpose, destination and use the acquisition of the Claimant's own equity stakes by company "C", SGPS, therefore, in that regard, the allocation of the loan is not connected with the activity or with assets held by the company owing those charges, the Claimant here, but rather with assets that came to be held by "B" BV, as sole shareholder of the Claimant.".

In this case, the decision line of case 14/2011-T was resumed and developed.

Thus, adding to what was discussed there, it is stated in the decision now under analysis that "the fact that financing with the respective charges and responsibilities was transferred within the context of a merger by incorporation (…) does not imply that its fiscal treatment in the incorporating company must be, without more, the exact mirror of what occurred in the incorporated company.", that "in order to reach any conclusion on the deductibility of financial charges in the incorporating company, no element is obtained from the conception that one adopts, in general terms, as to the legal nature of the merger" and that "neither is any conclusion drawn from the tax neutrality regime itself", conclusions which are entirely subscribed to.

The conclusion is equally subscribed that "the fact that certain financial charges were previously fiscally deductible within the context of determining the taxable amount of a certain company does not mean, by itself alone, that they necessarily are in the same terms within the context of the company that, by merger, incorporated that one", not subscribing, however, and as will be seen below, the assumptions on which the same rests, not from an abstract point of view, agreeing that "the fiscal deduction of financial charges incurred (…) must be assessed in the context of the Claimant's own business situation, taking into account the normative criteria resulting from paragraph 1 of article 23 of the Corporate Income Tax Code", and that "to apply the requirement of indispensability of costs to the case at hand, it is decisive to ascertain (…) the actual and concrete allocation of the financing for which the interest borne is the remuneration or, in other words, it is important to verify the destination or use of the funds obtained in relation to which the taxpayer seeks to fiscally deduct, for the purposes of determining its taxable profit, the interest and other associated charges it bore", but from a point of view of its application to the particular case, where it was understood that "the Claimant bore in the year 2009 financial charges in relation to the whole of the financing in question (...), but the equity stakes relating to the capital of the Claimant itself, to which that financing was also intended (...), do not belong, naturally, to the Claimant, but are rather held by "B" BV, which does not bear the corresponding costs of that financing (...)." that "Those equity stakes, in truth, can only generate taxable income (dividends in light of the distribution of profits by the participated company, capital gains in light of the sale of the stakes) in the legal sphere of the company holding the stakes (the "B" BV), not in the legal sphere of the debtor of the financial charges (the Claimant here).", that "the financial charges in question are not intended to finance the business activity of the Claimant itself, (…) but rather concern equity stakes held by a third party.", and that "the allocation of the loan is not connected with the activity or with assets held by the company owing those charges, the Claimant here, but rather with assets that came to be held by "B" BV, as sole shareholder of the Claimant."

As we have already seen, regarding case 14/2011-T, the stakes of the incorporating company held, ultimately, by the shareholder(s) of the incorporated company, are not the counterpart of (do not have their cause in) the financing contracted by the latter, but, rather, are the counterpart of (have their cause in) the equity stakes of the incorporated company, which are extinguished in the merger process.

Therefore, the understanding that the company resulting from the merger is bearing the costs of financing that are counterpart of benefits obtained by third parties cannot be subscribed to.

Likewise, and as also explained above, it is not considered that the situation before us is a case of application of the criterion cited to MARIA DOS PRAZERES LOUSA, according to which "interest borne by a company in relation to loans cannot be accepted as deductible when it is manifestly proven that the funds obtained are "diverted from business operations and applied to purposes foreign to them", given that – manifestly – the funds obtained were not "diverted" from the sphere of the company resulting from the merger, since the same were already entirely applied (exhausted) when the merger process was executed.

There remains, again here as previously regarding case 14/2011-T, to determine the decision-making relevance, in light of the criteria already established, of the finding that the Claimant no longer is in possession of the indirect product of the financial expenses it bears, which will be done hereinafter.

Finally, the arbitral tribunal constituted in case 42/2015-T was called upon to pronounce itself on a question analogous to the one now before us (being that in this case the merger was not reverse).

From that the following is highlighted:

• "The legal interpretation of the concept of "indispensability", as set forth in article 23 of the Corporate Income Tax Code at that time, has been, as doctrine and jurisprudence show, equated with costs incurred in the interest of the company; expenses borne within the activities arising from its corporate purpose. Only when the expenses result from decisions that do not meet such requirements should they then be disregarded.";

• "Now the Supreme Administrative Court, in the context of Case 0779/12, in a recent Decision, of 24-09-2014, rules out the interpretation of article 23 of the Corporate Income Tax Code as necessarily implying an obligatory connection, a balancing or connection between costs and profits.";

• "It is apparent that the thesis of the Tax Authority, according to which only financial charges resulting from capital applied in business operations would be deductible (and even so it would be missing to define what is meant by "business operations") does not result from the law. The terms "namely" and "such as", which we underlined, emphasise that financial charges of capital applied in business operations are deductible, but do not exhaust the universe of deductible financial charges.

These shall be so, even if not applied in the said business operations; provided they pass the general test of indispensability, are proven and are not ruled out by another fiscal-legal norm.

Now, the concept of indispensability, as has been seen, is consensually interpreted as implying that the expenses concern the activity or interest of the company. Thus, financial charges that fall here, even if not being applied in activities considered operational or of "business operations", can meet conditions of indispensability.

And, as will be seen below, the charges here in dispute are related to the Claimant's activity, since they result from the financing of assets held by it and that even generate income of an operational nature.";

• "The Tax Authority is wrong when it calls into question the deductibility of financial charges, in the Claimant's sphere, on the grounds that these are disconnected from its activity, from its own interest, and that the funds obtained were not applied in business operations.

Indeed, as a consequence of the merger operations, the same company (the Claimant) came to hold, as patrimonial elements accounted for or recognised in its balance sheet, the assets and liabilities of the operational companies (...) and continued to record, also in its balance sheet, the equity and financial liabilities that supported the equity stakes that previously represented this set of patrimonial elements.(...)

In short, the merger maintains in the Claimant the financing for which it paid interest, and had as patrimonial consequence the joining, in the same balance sheet, of the assets that such debt financed and continued to finance. Not already financial assets, but their real translation into assets and liabilities of an operational nature.";

• "Even in a strict perspective of nexus between income and expenses, it exists. The income derived from the business is related to the interest paid for its acquisition. In a patrimonial perspective there is, even, greater approximation between assets and capital financing them, now registered in the same entity.".

This arbitral case, notwithstanding agreeing with what is understood to be the adequate sense of the decision, contains, in its respective reasoning, subject matter that, transposed without more to the present case, is also open to criticism.

Thus, when it is stated that "the thesis of the Tax Authority, according to which only financial charges resulting from capital applied in business operations would be deductible (and even so it would be missing to define what is meant by "business operations") does not result from the law. The terms "namely" and "such as", which we underlined, emphasise that financial charges of capital applied in business operations are deductible, but do not exhaust the universe of deductible financial charges.", it is suggested that the justification of the deductibility of the expenses in question is obtained outside the scope of the provision of subsection c) of paragraph 1 of article 23 of the Corporate Income Tax Code, in the part that refers to the deductibility of "interest on foreign capital applied in business operations", which, as will be seen below, does not appear to be the case.

On the other hand, the consideration that "the merger maintains in the Claimant the financing for which it paid interest, and had as patrimonial consequence the joining, in the same balance sheet, of the assets that such debt financed and continued to finance. Not already financial assets, but their real translation into assets and liabilities of an operational nature", will not be directly transposable to the case before us, given the circumstance – factually unavoidable – that, here, the financing whose costs are borne in the sphere of the company resulting from the merger was intended, immediately, for the acquisition of the equity stakes of the company that, in the merger, would be the incorporating company and of which, in the legal sphere of the company resulting from that corporate reorganisation process, such stakes are absent.

Taking into account that the reasoning of the present decision follows, essentially, the line decided in arbitral cases 92 and 93/2015-T, subsequently adopted in arbitral case 88/2016-T, it will be necessary to also assess the dissenting opinion issued in that last decision, which, being subsequent to those, was not considered in them.

From the outset, just as, in a general manner, all positions that pronounce themselves in the same sense as such dissenting opinion, does not clearly assume its position regarding situations of non-reverse merger by incorporation, that is, situations precisely identical to the situation before us (and to the one assessed in that case 88/2016-T), but in which, instead of the entity participated incorporating the entity participating, as is the case, it is the entity participating that incorporates the participated.

This clarification, from the point of view of the positions which, in situations such as the present, sustain the non-deductibility of the financial charges arising from financing applied in the acquisition of the stakes of one of the entities participating in the merger, by another of the entities also participating therein, is of particular importance, since the position that is adopted regarding such question, whatever it may be, will invalidate a substantial part of the foundations on which such positions rest, evidencing the essential contradiction on which such positions rest.

It is also the case, with all due respect, of the dissenting opinion at hand, which, very clearly, is synthesised in its paragraph 7, where it states that "the entire operative procedure from the contract promise between the shareholders of the Claimant and the Fund H… is subordinated to the following objective: acquisition of the whole of the share capital of the Claimant by group E… and placement of the debt resulting from the respective financing in the very company acquired - the Claimant - the only entity with relevant operational activity and with income that, as has been said, makes possible the fiscal deduction of the charges borne as a result of debts contracted by a third party for the acquisition of its own shares.".

Now, the opinion in question, as has been stated, does not assume what would be the result of its application to a situation of non-reverse merger, that is, whether in that situation it would judge the same type of expenses as deductible or not, and that:

• In the first case, that is, if in those situations of non-reverse merger it admitted the same type of expenses as deductible, it would be disregarding one of the structural pillars of its argument, namely the circumstance that, also in that case, the objective of the acquisition of the whole of the share capital of a company by another (vehicle) with the placement of the debt resulting from the respective financing in the very company acquired, the only entity with relevant operational activity and with income that makes possible the fiscal deduction of the charges borne, would be verified;

• In the second case, that is, if in those situations of non-reverse merger it did not also admit the deductibility of the same type of expenses, it would be disregarding another of the structural pillars of its argument, namely the circumstance that in that case, there would not be the existence of debts contracted by a third party for the acquisition of the shares of the company bearing the financial charges.

What has just been expounded makes clear, it is believed, that the position now at hand rests structurally on assumptions substantially incompatible, and whose framing, as has been seen above, and will be developed below, should be another.

Such positions, always with the greatest respect that they deserve, are justified essentially, it is believed, by a repulsion, in some way instinctive and also ideological, to the result arising from the position which they oppose – the circumstance that the expenses borne with financing for the "acquisition of the business" are fiscally subtracted from the profits generated by the business itself – without managing to present conclusive arguments that invalidate the conclusion that such result was indeed intended by the legislator.

Thus, and from the outset, one cannot lose sight of the fact that what is at issue is a merger operation, legally admitted and regulated in our legal system, in the terms that the legislator, including the fiscal legislator, saw fit to do.

There is no verification, as far as the concrete data of the case, and the reasoning of the Tax Authority displays, of any abuse or other abnormal use of such legal operation. Therefore, the effects arising therefrom should be those that arise from the law, even if, subjectively, each one may understand that it is – within the framework of its legal normality – an operation that justifies or does not justify the legal treatment that the legislator gave to it.

On the other hand, agreeing or disagreeing, it is to be noted that situations such as the said – of expenses borne with financing for the "acquisition of the business" being fiscally subtracted from the profits generated by the business itself – have nothing foreign to tax law, the legislator having perfect knowledge of this same fact, for many years, it being well known that fiscal policy has acted for many years, and continues to act, as an incentive to company indebtedness.

Beginning with the simplest example, think of the situation of a company being created and which, for the conduct of its activity, needs an investment of 1M€ to establish the structures necessary for the creation of its productive capacity. Its shareholder(s) - being that many times there is only one effective shareholder - can endow the company to be created with share capital in the necessary amount, or create the new company with minimum share capital, and finance it in that same amount. In this case, the costs with the financing will be deductible in the created company, and, if the shareholder entity has financed itself to obtain the capital with which it financed the new company, the cost of such financing will also be deductible in the sphere of this one, being that, in either case, once the financing is paid, necessarily with the product ("profit") of the created entity, the creating entity will have come to own a profit-generating company, with the product of the financing (1M€) in its assets, all paid with the profits generated by the business itself.

Developing the same example, in the same scenario, if the creating company decides to sell the created company to a third company, before the reimbursement of the financing has begun, at zero cost, also selling the pending financing (by its respective nominal value or, for example, by such value increased by the interest contracted on such financing), the charges with the pre-existing financing will continue to be deductible in the sphere of the created company, and, if the acquiring third company has financed itself to acquire the financing to be reimbursed, the charges of that one will be deductible in the sphere of that one. In the end and in both cases, once the financing is reimbursed, the acquiring third company will have become owner of the created company, such acquisition having been paid with the profits generated by the business itself.

Likewise, and proceeding, if the financing has been reimbursed to the acquiring company (or if it has not, for the case it will be the same, the example being more impressive in the hypothesis that is developed), and this decides to sell the establishment of the created company (understanding by that all the assets and liabilities thereof) to a fourth company, which financed itself for the respective acquisition and which, for example, did not have any other asset in its assets, the charges with that financing would be deductible in the sphere of this fourth company, notwithstanding the payment of the same being made at the expense of the "establishment" acquired. Once the financing is paid, the fourth company becomes owner of the materiality of the created company, having, once again, such acquisition been paid with the profits generated by the business itself.

That is, and in summary: situations of use of an "operational activity and generating income" are common and accepted, to pay the costs of the acquisition of the same. From here, one could argue that merger situations, reverse merger situations, or both, present differences and/or specificities justifying different treatment from the rest. However, it will be clear that the argument that is at issue does not have the relevance or essentiality attributed to it, and that those differences and/or specificities of the merger processes should justify or not the treatment that is concluded to be given to the financial charges in question.

Now, this leads to the second of the pillars of the thesis at hand – the existence of debts contracted by a third party for the acquisition of the company's own shares bearing the financial charges – which, as has been already seen and will be developed below,

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