Process: 133/2017-T

Date: October 31, 2017

Tax Type: IRC

Source: Original CAAD Decision

Summary

CAAD arbitral case 133/2017-T addresses the fundamental tax principle of cost indispensability under Article 23 of the Portuguese Corporate Income Tax Code (CIRC). The dispute arose when the Tax Authority (AT) issued an additional IRC assessment for the 2012 tax year, disallowing EUR 5,120,780.68 in interest expenses incurred by the claimant company on a loan from its parent company B. The AT argued these financial charges were not indispensable for generating taxable income or maintaining the income source, claiming a duplication of financing costs related to the same commercial property. The claimant company had obtained two loans: one from bank C (EUR 90,146,382.86) and another from parent company B (EUR 69,473,566.83), both used to acquire 100% of the equity stake in company D, which owned the A commercial center. The claimant contended the loans served legitimate business purposes, concentrating economic risks and income flows in a single entity, and that both the claimant and D maintained distinct operational activities with separate income and expenses. The arbitral tribunal, constituted on May 2, 2017, comprised arbitrator-president Councillor Maria Fernanda dos Santos Maçãs and co-arbitrators Professor Miguel Patrício and Dr. Luís Miranda da Rocha. Following witness examination on September 22, 2017, both parties submitted written arguments in October 2017. The case illustrates critical issues in Portuguese corporate tax law regarding the deductibility of financing costs, the application of the indispensability test, and the tax treatment of corporate restructuring operations involving related entities.

Full Decision

ARBITRAL AWARD

The arbitrators Fernanda Maçãs (arbitrator president), Miguel Patrício and Luís Miranda da Rocha (co-arbitrators), appointed by the Deontological Council of the Administrative Arbitration Centre (CAAD), to form the collective arbitral tribunal, hereby render the following

I – Report

1.1. A…, Limited Unipersonal Company, with NIPC…, registered office at …, no.…, …, …, …, …-… … (hereinafter referred to as the "Claimant"), following an additional Corporate Income Tax (IRC) assessment for the 2012 tax year, filed on 22/2/2017 a request for constitution of an arbitral tribunal and arbitral ruling, pursuant to Articles 2.º, no. 1, para. a), 5.º, no. 3, para. a), 6.º, no. 2, para. a), and 10.º, no. 1, para. a), and no. 2, all of Decree-Law no. 10/2011, of 20/1 (Legal Regime of Arbitration in Tax Matters, hereinafter referred to as "RJAT"), in which the Tax and Customs Authority (AT) is respondent, seeking the "annulment of the additional assessment of Corporate Income Tax ("IRC") for the 2012 tax year, pursuant to which taxable income for the said tax year was determined in the amount of EUR 203,738.54".

1.2. By decision of the President of the Deontological Council of the Administrative Arbitration Centre, the following were appointed as arbitrators in the present proceedings: as arbitrator-president, Councillor Maria Fernanda dos Santos Maçãs, and as co-arbitrators Professor Miguel Patrício and Dr. Luís Miranda da Rocha.

1.3. The present Arbitral Tribunal was constituted on 2/5/2017.

1.4. The AT submitted its response on 7/6/2017 (accompanied by the respective administrative file on 8/6/2017), arguing, in summary, for the complete rejection of the Claimant's petition.

1.5. By order dated 25/6/2017, the Tribunal denied, for the reasons set forth therein, the request for production of witness evidence, and further waived the need to hold the meeting provided for in Article 18.º of the RJAT, without prejudice to the parties being able to request the production of oral arguments.

1.6. On 3/7/2017, the Claimant filed a request stating that it did not wish to forgo witness evidence production, "as it believes that such evidence is essential to the discovery of truth," and the Respondent, exercising its right to respond, expressed the opposite view.

1.7. By order of 16/7/2017, the Tribunal, after setting aside the previous order of 25/6/2017, scheduled for purposes of holding a hearing on trial, pursuant to said Article 18.º, the date of 22/9/2017, at 2:00 p.m.

1.8. On 22/9/2017, at 14:00, the examination of the sole witness that had been called by the Claimant took place at the CAAD, as scheduled. In the hearing record, 2 November 2017 was set as the deadline for rendering the arbitral award.

1.9. The Claimant submitted written arguments on 9/10/2017 and the Respondent submitted its arguments on 19/10/2017.

II – Arguments of the Parties

2.1. To support the arbitral petition, the Claimant argues that: a) "the said additional tax assessment results from a correction to the taxable income for IRC purposes made by the Inspection Services of the AT, in the amount of EUR 5,120,780.68, concerning the disallowance, for purposes of determining taxable profit in IRC, of the expense corresponding to interest borne by the Claimant on a loan contracted with B…, considering, in essence, that such charges are not indispensable for the realization of income subject to tax or for the maintenance of the income source, pursuant to Article 23.º of [CIRC]"; b) "to that end, the Tax Inspection Services of the AT invoke [...] that «(...) we are faced with two financings: -C…, in the amount of €90,146,382.86, intended to finance the acquisition of 100% of D…; and –B… (parent company), in the amount of €69,473,566.83, intended to finance the acquisition of the property 'Commercial center and shopping park designated A…, property of D… (...)»"; c) "the Tax Inspection Services thus understood that, given the purpose of the aforementioned loan – purchase of a property that never came to fruition, with the Claimant opting to purchase the equity stake in the company owning the property –, the respective financial charges could not be fiscally deductible, as they do not comply with the requirements of Article 23.º of the IRC Code"; d) "in the context of the operation of acquisition of company D…, carried out in October 2007, the Claimant obtained the [two above-mentioned loans]. In turn, part of the amount of the loan contracted with bank C… – more specifically, EUR 42,663,800.00 – was used in a loan agreement entered into between the Claimant and company E…, Unipersonal Limited Company, Lda. [...] (see Document 9 attached and reproduced)"; e) "the total value of the loan contracted with B… (EUR 69,473,566.83) and the partial value of the loan contracted with the bank (EUR 48,006,200.00) were used for the acquisition of the entire equity stake in D…, whose acquisition price amounts to EUR 118,522,228.97, as per the statement of accounts of the Claimant as of 31 December 2007"; f) "it is verified, therefore, that the loan agreement entered into between the Claimant and B…, similarly to the loan granted by C…, was intended for the acquisition of the entire equity stake in company D… in the amount of EUR 118,522,228.97"; g) "In fact, beyond the change in corporate structure, nothing else changed in the structure of the commercial complex A…: – company D… continued to operate the property passively ('bare walls'), namely maintaining a lease agreement of the property with the Claimant; and – the Claimant continued to manage the commercial center A… through the execution of shop use agreements with shopkeepers"; h) "The Inspection Services of the AT state that, in the case under analysis (with regard to the loan contracted by the Claimant with B…), there is «a duplication of financial charges related to the said property» [...]. The Inspection Services of the AT further understand that «to these charges are indirectly added, through fiscal transparency, the financial charges borne by company D… with the financing for the same property»"; i) "The Claimant understands, however, that the line of reasoning of the Inspection Services of the AT has no foundation given the factual situation, since, as has already been extensively stated, the commercial complex of A… involves two distinct entities, each with distinct income and charges resulting from the specific economic activity of each"; j) "the loans obtained by the Claimant from B… and bank C… – Branch in Portugal, were used by the Claimant for: (i) financing company E…, Lda., and (ii) acquiring 100% of company D… . [...] after the acquisition of company D…, it is verified that, beyond the change in corporate structure, nothing else changed in the structure of the commercial complex A… [...]. Given this situation, it is also verified that the tax treatment of both entities – D… and the Claimant – did not suffer any alteration, in that these entities continued to carry out the same operational activity"; l) "from an economic perspective, the above-mentioned structure – acquisition of the entire equity stake in D… – made perfect sense, as the economic risks of the operation and the income flows are concentrated in the same entity – the Claimant. That is, the operation of acquisition of the entire equity stake in D… was intended to create a business unit, in which the set of economic activities related to A… were concentrated, namely the management of the property itself and, likewise, the management of the commercial activities developed therein"; m) "It is therefore established that the loans obtained by the Claimant, in particular the loan obtained from B…, had a purely economic motivation which was to obtain capital to pay the market price of the entire equity stake in D…, which, in turn, made perfect sense to be held by the Claimant, since it allowed concentrating in the same entity the risks of the operation with the income flows generated at the level of the Claimant"; n) "It is therefore concluded that the choice for the corporate structure that came to be adopted did not have – nor has – any tax purpose, specifically with regard to the alleged duplication of charges [therefore the IRC assessment and respective compensatory interest, relating to the 2012 tax year, should] be annulled, for incorrect qualification of the tax facts"; o) "contrary to the position taken by the Inspection Services of the AT, none of the amounts granted as a loan to the Claimant were intended to purchase the property, in the literal sense, owned by D… . In fact, [...] the loan amounts were intended for (i) financing the entire acquisition of the equity stake in D… and (ii) financing E…, Lda."; p) "as of the date of the transaction, D… had (i) an asset whose market value was EUR 171,677,000 and (ii) as stated in the inspection report, a bank debt of EUR 55,000,000 [...]. Given its assets and liabilities, it is therefore established that as of the date of the facts, the entire equity stake in D… was valued at EUR 116,677,000 (EUR 171,677,000 – EUR 55,000,000). However, to this value adjustments to the balance sheet had to be added, which determined that the acquisition price of the entire equity stake in D… would be EUR 118,522,228.97"; q) "as per the balance sheet as of 31 December 2007 of the Claimant, the 100% stake in the capital of D… was acquired by the Claimant for the amount of EUR 118,522,228.97, which was necessarily paid through loans in the total amount of EUR 117,479,766.83, namely: (a) EUR 69,473,566.83, relating to the loan agreement entered into with B… and (b) EUR 48,006,200, relating to the loan with bank C… . In turn, the remaining amount needed for payment of said equity stake, EUR 1,042,462.14, was paid by the Claimant through available funds"; r) "Contrary to the action taken by the Inspection Services of the AT, a literal interpretation of the loan agreement entered into by the Claimant with B… should not be made [...]. In fact, notwithstanding the fact that the loan agreement with B… makes reference to the acquisition of the property A…, it would be, as is natural, impossible to conceive of a scenario in which the Claimant acquires 100% of the equity stake in company D… [...] and subsequently acquires the said property from D… itself. In truth, in substance, buying 100% of the equity stake in D… is equivalent to buying indirectly 100% of the property held by D…. [...]. Moreover, on this point, it should be noted that the direct acquisition of the property never occurred, nor was it even in the plans and objectives of the Claimant, and the loan obtained from B… always aimed at the acquisition of the entire equity stake in D…"; s) "if there is doubt as to whether the loan obtained from B… was or was not intended for the acquisition of the property itself – doubts which [...] the Claimant understands do not exist given the documentation to which the AT had access and the amounts involved in the acquisition of the equity stake in D…– such doubts which the rules provided for in nos. 1 and 2 of Article 11.º of the LGT do not permit to clarify, the principle of economic substance of the same should always have been observed rather than the form which the operations (content of the loan agreement) assumed – which was not done by the AT"; t) "it should be considered that the fact that the loan agreement entered into between the Claimant and B… establishes that the loaned amount is intended for the acquisition of the property owned by D…, while it is established that, from an accounting and material standpoint, the said loan was in fact intended for the acquisition of the equity stake in the said company, the Tax Inspection Services should have considered this situation for all legal purposes. In truth, the AT cannot and should not make corrections to the taxable income of taxpayers having as the sole basis the letter of a contract, while disregarding purely and simply the factual situation, which is evidenced in the Claimant's accounts, in the purchase and sale agreements and in the remaining loan agreements obtained and granted"; u) "It is therefore established that, given the facts presented and similarly to the charges borne with the bank loan (C…), the charges borne with the loan obtained from B… should also be accepted for tax purposes, pursuant to Article 23.º of the IRC Code, since, as has been extensively proven, both loans were used for the acquisition of the entire equity stake in D…"; v) "Both at the level of the financings obtained for acquisition of 100% of the equity stake in D…, and at the level of the operation of exploitation of the commercial center A…, the fiscal transparency regime did not result in any duplication of charges but, on the contrary, ensured full compliance with the principles of elimination of double economic taxation and fiscal neutrality"; x) "the decision to acquire 100% of the equity stake in D… on the part of the Claimant is motivated within the framework of a management action which was to consolidate, in a single entity, the economic risks of the operation and the income flows of the property, and such action enhances the obtaining of taxable income. In turn, the decision to finance company E…, Lda., also generates, as indeed results from the Inspection Report itself, taxable income (with the interest charged to the said entity) [...]. In light of the above, it is therefore clear that the financial charges borne by the Claimant fall unquestionably within the scope of its object and activity, that is, are of economic interest within the scope of its direct economic activity"; z) "within the framework of the concept of indispensability of costs [...], it is undisputed that both loan agreements entered into by the Claimant had as their sole objective to increase profit and thus give rise to taxable profit, thus fulfilling the test for application of Article 23.º of the IRC Code, with regard to the fiscal deduction of charges related to such acquisition"; aa) "should the Claimant's petition be upheld, there is no doubt that, pursuant to the aforementioned [Article 43.º of the LGT], compensatory interest is due, calculated from the date of payment (i.e., 17 November 2016) until the effective and full reimbursement by the AT, at the rate of 4% per annum, pursuant to no. 5 of Article 24.º of the RJAT, no. 10 of Article 35.º, and no. 4 of Article 43.º of the LGT, Article 559.º of the Civil Code and Ordinance no. 291/03, of 8 April. The accruing interest should also be added, counted from the date of presentation of the present action and until effective and full payment, calculated at the maximum legal rate in force."

2.2. By the foregoing, the Claimant requests that the present arbitral ruling be "found to be entirely well-founded and, as a consequence: (i) the correction to the taxable income for IRC purposes for 2012 in the amount of EUR 5,120,780.68 be annulled, on the grounds that such correction incurs a breach of law, for error in the legal and factual assumptions, resulting in the incorrect application of Article 23.º of the IRC Code; (ii) the IRC assessment no. 2016… and the respective account settlement demonstration no. 2016…, in which the total tax value and respective compensatory interest of EUR 203,738.54, relating to the 2012 fiscal year, be annulled, on the grounds that it is affected by a violation of law, proceeding with the reimbursement of the amounts indebtedly paid by the Claimant, plus accrued and accruing compensatory interest, calculated at the maximum legal rate, until effective and full payment, all with the legal consequences."

2.3. For its part, the AT alleges, in its response, that: a) "The loan obtained from C… amounted to €90,146,382.86 and was made on 25 October 2007 for a period of 10 years. In order to remunerate the capital provided by C…, the parties agreed on payment of an interest rate corresponding to the Euro swap rate plus a spread of 50 basis points (0.5%). After analyzing the contracts corresponding to the said financing operations, it was possible to establish that the financing obtained from C… AG, in the amount of €90,146,382.86, is «intended for the pursuit of its commercial activities», namely for financing the operation of acquisition of 100% equity stake in company «D… - Real Estate Company S.A.», NIF …. In fact, according to information obtained from the transfer pricing file, it is stated (on page 12) that «in October 2007 the group decided that A… would acquire 100% of the equity stake in D…- Real Estate Co. SA (hereinafter referred to as D…), NIF …»"; b) "With this decision, the Claimant came to hold a 100% equity stake in the capital of D…"; c) "The loan obtained from B… was in the amount of €69,473,566.83. [...]. The financing obtained from B… was executed in order to be used «to finance the acquisition of the property», which according to the same agreement, 'Property' means the commercial center and shopping park designated by A…, located at …, Portugal». It should be noted that said property was owned by company «D… », as provided in the AT's property system"; d) "In these terms, we are faced with two financings: - C… AG, in the amount of €90,146,382.86, intended to finance the acquisition of 100% of D… and, - B… (parent company), in the amount of €69,473,566.83, intended to finance the acquisition of the property «Commercial center and shopping park designated A…», property of D…, which was subject to analysis throughout the inspection report"; e) "the analysis of the financial investment item allowed the inspection services to verify and confirm that on 2012/12/31, the Claimant held a 100% equity stake in company D…- Real Estate Company S.A., NIF…, acquired on 31 October 2007"; f) "being the Claimant holder of 100% of Company «D… », it is verified that 100% of the taxable income of the latter is imputed to the Claimant. [...]. [...] with «D… » covered by the fiscal transparency regime, pursuant to Article 6.º of the CIRC, it is concluded that all of its taxable income should be imputed to the Claimant and taxed in the sphere of the latter, which occurs in the case at hand"; g) "from 2007 onwards, the Claimant ceased to present Taxable Profit, even with the integration of the positive taxable result of "D…", through fiscal transparency, concluding that the taxable income imputed by "D…" to the taxpayer within the scope of fiscal transparency is absorbed by the losses that the company in question determines in its activity"; h) "From the analysis conducted on the Claimant's IES, the SIT verified that the net results, and the negative fiscal results, are due essentially to the high financial charges, borne from 2007 onwards, with the financing contracted for the purchase of 100% of the equity stake in the capital of D…, as well as the loan for the acquisition of the property «Commercial center and Shopping Park designated A…», property of «D… ». [...]. From consultation of the information contained in the IES, it also resulted that, since 2007, the total equity capital of the company has been declining significantly as a result of the financial charges and the recording of impairments. That is, despite operational income always having been positive, the equity capital has been deteriorating, both through financial charges and the recording of impairments on the acquisition of the equity stake in D…"; i) "As we have stated, the Claimant contracted two financings. One to acquire 100% of the shares in D… and another to acquire the property «Commercial center and Shopping Park designated A…», property of D…"; j) "If we analyze the operations and their impact on results, combined with the framework for taxation purposes under IRC of each of the entities, we conclude that, indirectly, a duplication of financial charges occurs in the sphere of the Claimant"; l) "The singular characteristics of the Claimant's tax situation reside in the combination of the following facts: (i) Holding of an equity stake representing 100% of the capital of a company covered by the fiscal transparency regime – D…; (ii) Such equity stake having been acquired from a group company through recourse to borrowing by other companies in the same group; and (iii) Having contracted a financing for acquisition of a property, owned by D…, whose shares are held 100% by A…"; m) "In this context, it is then necessary to know what legal basis legitimizes the fiscal deductibility of the financial charges borne by the Claimant with the loans contracted to finance the acquisition of the property «Commercial center and shopping park designated A…» owned by D…, which constitutes a transparent company, when the latter is already held 100% by A… . Now, in light of the provisions, as of the date of the facts, in Article 23.º of the CIRC, expenses are considered deductible those that are proven to be indispensable for the realization of income or gains subject to tax or for the maintenance of the income source. In the situation sub judice, doubt arises regarding the existence of a direct connection between the financial charges borne by the Claimant and the realization of income or gains subject to tax, for that reason the application of the fiscal transparency regime to the subsidiary company, the income that contributed to the determination of the taxable income imputed to A… are offset by the expenses borne by this, with the financial charges for acquisition of the property"; n) "it must be concluded that the company (A…), here Claimant, is bearing not only the financial charges associated with the loan contracted to finance the acquisition of the equity stake in the subsidiary company (D…) that it holds, but also the financial charges associated with the loan contracted to finance the acquisition of the property «Commercial center and Shopping Park designated A…» owned by D… . We are therefore faced with a duplication of financial charges related to said property"; o) "given the purpose of the financing of € 69,473,566.83 [«for acquisition of the property 'Commercial center and shopping park designated A…', which is property of D…, whose shares were acquired by A…»], it should be noted, as stated in the respective agreement, and was duly demonstrated in the inspection report, it was verified that the provisions of Article 23.º of the CIRC were not complied with, therefore the corresponding financial charge, in the amount of € 5,120,780.68, was not considered an expense of the fiscal year for tax purposes, having been added to the taxable result for 2012"; p) "The Claimant therefore requested a financing of €69,473,566.83, which generates financial charges of €5,120,780.68, for acquisition of a property that indirectly is already its own and with respect to which it already bears the corresponding charges by virtue of the 100% stake it holds in D… . In turn, D… holds another financing that had been obtained at the time of construction of the property in question"; q) "As a result of the corrections made in the amount of €5,120,780.68, explained and substantiated in the RIT, the taxable result of the Claimant changed from a loss in the amount of €1,574,262.83 to a corrected profit of €3,546,517.85"; r) "the company A… is bearing not only the financial charges associated with the loan contracted to finance the acquisition of the equity stake in the subsidiary company (D…) that it holds, but also the financial charges associated with the loan contracted to finance the acquisition of the property " Commercial Center and Shopping Park designated A…". Therefore, we are faced with a duplication of financial charges related to said property. It is therefore established that the singular element that characterizes the situation under analysis and which allows the double deduction of financial charges has to do with the concentration, in the same company – the Claimant – of financial charges, all related to the same property, which causes an accumulation in that company of a set of expenses and which subverts the objectives, namely that of neutrality and combating tax evasion, pursued by the fiscal transparency regime"; s) "We thus reiterate our understanding that the Claimant requested a financing of € 69,473,566.83, which generates financial charges of € 5,120,780.68, for acquisition of a property that indirectly is already its own by virtue of the 100% stake it holds in D…, holder of the property, and with respect to which it already bears the corresponding charges. In turn, D… holds another financing that had been obtained at the time of the property's construction, facts which lead to the disregard as an expense for tax purposes of the amount of € 5,120,780.68."

2.4. The AT concludes, in summary, that, "the corrections being effected, in fact and in law, being duly substantiated, no defect or illegality being able to be ascribed to them, the present arbitral action should be found to be without merit, absolving the Respondent of the petition, with the legal consequences."

III – Procedure

3.1. The Arbitral Tribunal was duly constituted and is materially competent.

3.2. The Parties have standing and capacity, being duly constituted.

3.3. The process is not affected by nullities.

It is necessary to decide.

IV – On the Merits

IV.1. Factual Matter

4.1. With relevance for the appraisal and decision of the case, the following facts are considered proven:

i) The Claimant is a limited liability company constituted in December 2002 and whose corporate purpose is the purchase and sale of the property of the commercial center designated as «A…», its lease, operation and management, as well as any other acts or transactions directly related to the aforementioned activity;

ii) By reference to the 2012 fiscal year, the Claimant was subject to a tax inspection, in fulfillment of the Service Order no. OI2015…, of 19/6/2015, within which the Tax Inspection Services of the AT requested elements relating to the financial charges of the said fiscal year, which were made available by the Claimant (see Documents 4 and 5 attached to the file);

iii) The Claimant was subsequently notified of the Final Inspection Report, which came to correct the Claimant's taxable income in the amount of €5,120,780.68, relating to the financial charges deducted by it (see Doc. 6 attached to the file). As a consequence, the Claimant was notified of the IRC assessment statement no. 2016…, of the compensatory interest assessment statement no. 2016 … and, also, of the account settlement demonstration no. 2016…, in which the amount of €203,738.54 was determined to be paid (see Docs. 1 to 3 attached to the file);

iv) The said additional assessment, now at issue, results from a correction to the taxable income for IRC purposes effected by the Tax Inspection Services of the AT, in the above-mentioned amount of €5,120,780.68, concerning the disallowance, for purposes of determining taxable profit in IRC, of the expense corresponding to the interest borne by the Claimant on a loan contracted with B…, for the reason that such charges are understood to not be indispensable for the realization of income subject to tax or for the maintenance of the income source, pursuant to Article 23.º of the CIRC, in the version at the time of the facts (see Inspection Report, attached as Doc. 6 to the file);

v) According to the said Report, the loan contracted with B… would have been used "to finance the acquisition of the property" which, according to the agreement, means "the commercial center and shopping park designated by A…" (see Doc. 6). In the understanding of the AT, set forth in that report, there is "duplication of financial charges related to the said property" (see Doc. 6), for the reason that the company in question "is bearing not only the financial charges associated with the loan contracted to finance the acquisition of the equity stake in the subsidiary company (D…) that it holds, but also the financial charges associated with the loan contracted to finance the acquisition of the property «Commercial center and shopping park designated A…» property of D… ." (see Doc. 6);

vi) In the context of the operation of acquisition of company D…, carried out in October 2007, the Claimant obtained the two loans contained in Docs. 7 and 8 attached to the file (one with B…, in the amount of €69,473,566.83, and another with bank C…– Branch in Portugal, in the amount of €90,670,000.00). In turn, part of the amount of the loan contracted with bank C… was used in a loan agreement entered into between the Claimant and company E…– Management of Commercial Center, Unipersonal Limited Company, Lda., as can be seen from the reading of Doc. 9 attached to the file;

vii) The total value of the loan contracted with B… (€69,473,566.83) and part of the loan contracted with the bank were used for the acquisition of the entire equity stake in D…, whose acquisition cost amounted to €118,522,228.97 (see, in this regard, points 21.º, 23.º, 44.º and 54.º of the Claimant's petition and point 66.º of the Respondent's response, and, also, the explanations given by the sole witness called);

viii) As per Documents 6 and 11 attached, the acquisition value of €118,522,228.97 corresponds to the value of the (only) asset of D… (the commercial center A…) – whose market value was, according to an appraisal made by independent entity F…, €171,677,000.00 (see Doc. 11) –, to which was deducted the value of a bank debt of €55,000,000.00 (see Docs. 6 and 11) and added minor balance sheet adjustments;

ix) As per the balance sheet of the Claimant as of 31/12/2007, the 100% stake in the capital of D… was acquired by the Claimant for the aforementioned amount of €118,522,228.97, which was paid using the two loans referred to above (with B… and Bank C…);

x) Regarding the operation relating to the loan granted by the Claimant to company E…– Management of Commercial Center, Unipersonal Limited Company, Lda., the connection of the amount granted by the Claimant to the amount made available [through the "financing agreement"] by bank C… to the Claimant is verified by reading the agreement that was entered into between this and E… (see Doc. 9), having, as results from the Inspection Report, generated taxable income (see pages 9-10 of Doc. 6 attached to the present file);

xi) On 17/11/2016, the Claimant proceeded with the payment of tax relating to the additional IRC assessment for the 2012 fiscal year and accrued, in the amount of €203,738.54 (see doc no. 12, submitted by the Claimant);

xii) The Claimant filed the present arbitral ruling petition on 22/2/2017.

4.2. There are no unproven facts material to the decision of the case.

IV.2. Substantiation of Factual Matter

The facts considered pertinent and proven are substantiated by the free evaluation of the positions set forth by the parties, the documentary evidence submitted to the file, including the instructional proceedings.

The critical analysis of witness evidence produced at the hearing was also taken into account, namely with regard to the clarification of the facts contained in point vii) of the evidence. The witness testified in a coherent, sustained manner and revealed mastery of the reasons for knowledge material to the provision of information.

V – On the Law

In the case under analysis, there are three contested legal issues: 1) whether there exists duplication of financial charges related to the same property, as alleged by the AT; 2) whether the charges borne by the Claimant are justified in light of Article 23.º of the CIRC; and 3) whether compensatory interest is owed to the Claimant.

Let us examine them.

V.1)

The Respondent, in its response, alleges that "the Claimant contracted two financings. One to acquire 100% of the shares in D… and another to acquire the property «Commercial center and Shopping Park designated A…», property of D…", and that, "if we analyze the operations and their impact on results, combined with the framework for taxation purposes under IRC of each of the entities, we conclude that, indirectly, a duplication of financial charges occurs in the sphere of the Claimant". The respondent further adds that such conclusion results from the "singular characteristics of the Claimant's tax situation [and results] from the combination of the following facts: (i) Holding of an equity stake representing 100% of the capital of a company covered by the fiscal transparency regime – D…; (ii) Such equity stake having been acquired from a group company through recourse to borrowing by other companies in the same group; and (iii) Having contracted a financing for acquisition of a property, owned by D…, whose shares are held 100% by A…".

Considering the proven factuality and the documentary elements brought to the file, it is verified, in effect, that the additional IRC assessment now at issue results from a correction to the taxable income for IRC purposes effected by the SIT of the AT, in the amount of €5,120,780.68, concerning the disallowance, for purposes of determining taxable profit in IRC, of the expense corresponding to interest borne by the Claimant on a loan contracted with B… . The AT understands, in essence, that such charges are not indispensable for the realization of income subject to tax or for the maintenance of the income source, pursuant to Article 23.º of the CIRC, in the version at the time of the facts (see Inspection Report, attached as Doc. 6 to the file).

It is also verified that, in the context of the operation of acquisition of company D…, carried out in October 2007, the Claimant obtained the two loans contained in Docs. 7 and 8 attached to the file (one with B…, in the amount of €69,473,566.83, and another with bank C…– Branch in Portugal, in the amount of €90,670,000.00). In turn, it is established that part of the amount of the loan contracted with bank C… (€42,663,800.00) was used in a loan agreement entered into between the Claimant and company E…, Unipersonal Limited Company, Lda., as can be seen from the reading of Doc. 9 attached to the file.

The central question revolves around whether, as alleged by the AT, the loan contracted with B… was used "to finance the acquisition of the property" designated as «A…» (thus, see Report of the SIT), or whether this did not occur, despite the text of the agreement entered into with B… .

In this regard, the Claimant alleges that "it should be considered that the fact that the loan agreement entered into between the Claimant and B… establishes that the loaned amount is intended for the acquisition of the property owned by D…" should not be material, since it is demonstrated and "it is established, from an accounting and material standpoint, [that] the said loan [with B…] was in fact intended for the acquisition of the equity stake in the said company [D…]".

Despite the wording of the loan agreement entered into between the Claimant and B… pointing to the direct purchase of property A… (and not to the indirect acquisition, through acquisition of the entire equity stake in D…), owned by D…, the truth is that the values recorded in the Claimant's accounts (and which were not challenged) do not permit the conclusion that the said loan was intended for the acquisition of said property.

It appears, in this manner, pertinent to take into account the consolidated doctrine and jurisprudence which point toward making prevail, in the field of Tax Law, substance (economic) over form (legal).

It is thus justified, in the present case, to verify whether the accounts (as a translation of economic reality) of the Claimant confirm or rather disprove the suspicion of economic reality that the Respondent raises in light, essentially, of the legal appearance given by the letter of the loan agreement entered into with B… (an appearance that is not denied or contradicted by the Claimant).

Let us examine.

From careful reading of the file, it is concluded that the documents of the accounts of the Claimant (accounts whose truthfulness, it is reiterated, is not challenged by the Respondent) belie the legal appearance given by the reading of the above-mentioned agreement.

These are the elements that permit reaching such conclusion (see, also, points vii) to ix) of the proven facts):

A) The total value of the loan contracted with B… (€69,473,566.83) and part of the value of the loan contracted with Bank C… were used for the acquisition of the entire equity stake in D…, whose acquisition price amounted to €118,522,228.97, as per the statement of accounts of the Claimant as of 31/12/2007;

B) As per Documents 6 and 11 attached, the acquisition value of €118,522,228.97 corresponds to the value of the (only) asset of D… (the commercial center A…) – whose market value was, according to an appraisal made by independent entity F…, €171,677,000.00 (see Doc. 11) –, to which was deducted the value of a bank debt of €55,000,000.00 (see Docs. 6 and 11) and added minor balance sheet adjustments;

C) As per the balance sheet of the Claimant as of 31/12/2007, the 100% stake in the capital of D… was acquired by the Claimant for the aforementioned amount of €118,522,228.97, which was paid using the two loans referred to above (with B… and Bank C…).

Despite the wording of the loan agreement entered into between the Claimant and B… pointing to the direct purchase of property A… (and not to the indirect acquisition, through acquisition of the entire equity stake in D…), owned by D…, the values recorded in the Claimant's accounts (and which were not challenged) do not permit the conclusion that the said loan was intended for the acquisition of said property. On the contrary: only by adding the value of the loan granted by B… to the Claimant to the value (of part) of the loan granted by Bank C… could the Claimant (as it effectively came to be able to) acquire the entire capital of D…, since the value total of the latter loan (€90,670,000.00) would be insufficient to materialize the operation of acquisition of D… (€118,522,228.97).

It should further be noted that, had the acquisition of the said property occurred directly, through recourse to the loan granted by B… (as follows from the argumentation of the Respondent), there should be (and there is not) an accounting trail (namely, at the level of available assets) of such significant value in the sphere of the Claimant (€69,473,566.83) – since the transaction did not materialize. But, as stated, this does not occur. On the contrary, all the accounting documents end up confirming that the (real) intention underlying the agreement entered into between the Claimant and B… was to make possible the indirect acquisition of the property through the direct acquisition of the entire equity stake in D…. If the (real) intention had not been the latter (but rather to acquire the property directly), then one would also have to conclude that the amount loaned by B… was, by itself, insufficient for such purpose (as can be read above, the market value of the property was, according to an appraisal made by independent entity F…, €171,677,000.00: see Doc. 11 attached to the file).

By the foregoing, it is concluded that the aforementioned loan was intended (in its entirety and in conjunction with part of the loan contracted with Bank C…) for the acquisition of the entire equity stake in D…. And, thus being, the deduction of charges relating to these loans by the Claimant does not configure (nor is it demonstrated that it had as objective) the duplication of charges that was invoked by the AT, nor, consequently, the also alleged "[subversion] [o]f the objectives [...] of neutrality and combating tax evasion, pursued by the fiscal transparency regime."

V.2)

The Respondent alleges, in this regard, that, "given the purpose of the financing of €69,473,566.83 [«for acquisition of the property 'Commercial center and shopping park designated A…', which is property of D…, whose shares were acquired by A…»], it should be noted, as provided in the respective agreement, and was duly demonstrated in the inspection report, the provisions of Article 23.º of the CIRC were not complied with, therefore the corresponding financial charge, in the amount of €5,120,780.68, was not considered an expense of the fiscal year for tax purposes, having been added to the taxable result for 2012". It further adds that "the Claimant requested a financing of €69,473,566.83, which generates financial charges of €5,120,780.68, for acquisition of a property that indirectly is already its own and with respect to which it already bears the corresponding charges by virtue of the 100% stake it holds in D…".

However, as was noted in V.1), the financing requested from B… was not intended for the acquisition of the property owned by D…, but was rather intended for the acquisition of the entire shares representing the capital of D…. It is not, consequently, reasonable to understand – as does the Respondent – that the aforementioned financing aimed at the acquisition of a property that was already owned by the Claimant (as stated, the acquisition of D… was only possible through recourse – together with another – to this financing and exhausted, by itself, the need to acquire the property held by D…).

The Respondent further understands, echoing the Inspection Report (see Doc. 6), that "such charges are not indispensable for the realization of income subject to tax or for the maintenance of the income source, pursuant to Article 23.º of the CIRC". It further adds that, "in the situation sub judice, doubt arises regarding the existence of a direct connection between the financial charges borne by the Claimant and the realization of income or gains subject to tax, for reason the application of the fiscal transparency regime to the subsidiary company, the income that contributed to the determination of the taxable income imputed to A… are offset by the expenses borne by this, with the financial charges for acquisition of the property".

The Respondent is also not correct here, for two reasons:

A) Because, as was noted previously, there is no deduction of financial charges related to the acquisition of the property, but rather to the acquisition of the entire equity stake in D…; and

B) Because the operations in question (the loans contracted by the Claimant with B… and bank C… – Branch in Portugal) generated financial charges that were borne by the Claimant within the scope of its object and activity, not resulting therefrom any indication (nor has evidence been presented to the effect) that the expenses resulting therefrom did not have the potential to positively influence the income or gains of the Claimant, or that they did not aim at the realization of the company's purposes (bearing in mind the broad margin of discretion permitted to corporate activity under the principles of freedom of economic initiative and fiscal neutrality). It should be noted that these conditions – expenses, actually or potentially, adequate to the obtaining of income or gains (or indispensable to the maintenance of the company's productive source), and identification of the operation with the activity that is developed by the taxpayer – are essential to assess the indispensability of the expenses in question in light of Article 23.º of the CIRC.

It should further be noted that the economic results of the operations in question are not a requirement to be considered for purposes of fiscal acceptance thereof.

In the same sense as has been expounded herein, see, for example, the following rulings and arbitral awards:

  • "In the understanding that doctrine and jurisprudence have come to adopt for purposes of ascertaining the indispensability of a cost (see Article 23.º of the CIRC in the version in force in 2001), the AT cannot scrutinize the soundness and appropriateness of the economic decisions of company management, under penalty of intruding on the freedom and autonomy of management of the company. Thus, a cost or loss will be accepted for tax purposes if, in a judgment reported to the moment it was incurred, it is adequate to the productive structure of the company and to the obtaining of profits, even if it proves to be an unfruitful or economically ruinous economic operation, and the AT can only disregard those that do not fall within the scope of the taxpayer's activity and were incurred, not in the interest of this, but for the pursuit of extraneous objectives (when it is to be concluded, in light of the rules of common experience, that it did not have the potential to generate income). [...]. [the] requirement of a necessary and direct causal relationship between costs and income has long [been] rejected by doctrine and jurisprudence." (Supreme Administrative Court Award of 28/6/2017, proc. 0627/16);

  • "[...] the concept of indispensability of costs is an indeterminate concept, with jurisprudence having taken on its substantiation, but in a case-by-case manner, with no concrete definition emerging from such labor. But such indeterminacy does not permit the Tax Administration to determine its relevance under the criterion of its reasonableness or even necessity or convenience. [...] The power that the Industrial Contribution granted to DGCI in Article 26.º of CI and which permitted it to reject the deductibility of certain costs ceased to exist. The rule according to the CIRC is that correctly recorded expenses be fiscal costs. As also stated in the same ruling … «the criterion of indispensability was created by the legislator not to permit the Tax Administration to meddle in company management by dictating how it should apply its means but to prevent the fiscal consideration of expenses that, even if recognized as costs, do not fall within the scope of the company». Rui Duarte Morais argues, in Notes on IRC, Almedina Coimbra, 2007, p. 87, that the cost must be considered indispensable whenever the charge that originates it derived from «a genuine business motivation – the understanding of the partners and/or managers of the company, the only ones to whom it falls to decide on corporate interest». Following, moreover, António Moura Portugal who, in The Deductibility of Costs in Portuguese Tax Jurisprudence, Coimbra Publisher, 2004, pp. 133 et seq., holds that «indispensability must be interpreted according to the corporate object. The use of the reasonableness criterion as a basis for limiting quantitatively the charges incurred by taxpayers is no longer tolerable. Indispensability should be assessed from a positive judgment of subsumption in corporate activity which by nature should not be scrutinized by Tax Law and should certainly not evaluate the business decisions of the taxpayer. Indispensable costs thus correspond to expenses incurred in the interest of the company. The fiscal deductibility of the cost must depend only on a justified relationship with the productive activity of the company and this indispensability occurs whenever through the operation of the theory of the specialty of legal entities the corporate operations fall within its capacity by subsumption to its corporate purpose and especially since they connect with the obtaining of profit even if in a direct or indirect manner»." (Supreme Administrative Court Award of 5/11/2014, proc. 0570/13);

  • "The legal interpretation of the concept of «indispensability», at the time provided in Article 23.º of the CIRC, has been, as doctrine and jurisprudence show, equated to costs incurred in the interest of the company; to expenses borne within the activities deriving from its corporate purpose. Only when the expenses result from decisions that do not meet such requirements should they be disregarded. Now, having corporate entities a corporate purpose or objective defined in their bylaws, with a view to the realization of the end for which such collective entities are formed – the obtaining of a surplus to be divided among the partners – then the management acts that contribute to such end must constitute the activity of the companies. The productive activity should not be understood in a restrictive sense, but rather in a broad sense, meaning activity related to an income-producing source of the entity bearing the expenses. [...]. [...] the «activity» of a company is not exhausted, as sometimes seems to emerge from some interpretations, in the set of operational acts. «Activity» is also the set of operations that have the purpose of making investments or the disposition of assets, the acquisition of financial stakes and their subsequent disposition, the application of liquidity in investments or short-term securities and their management, the receipts and payments resulting from operational and non-operational income and expenses, and many others not expressly mentioned here. The management of companies has, in essence, as its purpose to obtain a surplus from the use of assets that are held by economic-business entities. Such assets are, even through their classification under normative-accounting provisions, divided into different types: tangible fixed assets/immobilized (e.g., machines dedicated to production), intangible assets (e.g., manufacturing patents), financial assets (e.g., equity stakes), non-current assets held for sale (e.g., machine that is no longer used in production and is intended to be sold in the short term), inventories/stock (e.g., raw materials) and so on. Constituting this vast array of assets the means that management has at its disposal to generate income and surplus, it is natural that the purchase of physical assets for investments and their eventual disposition (disinvestment), the purchase and sale of equity stakes, the application of liquidity, the receipts and payments of activity, all this is part of what are considered normal or appropriate acts of company management." (Arbitral Award of 8/4/2017, proc. 480/2016-T);

  • "Article 23.º, no. 1, of the CIRC establishes the rule that «expenses are considered those that are proven to be indispensable for the realization of income subject to tax or for the maintenance of the income source». [...]. According to Tomás Tavares, «the legal notion of indispensability is thus cut out from an economic-business perspective, by fulfillment, direct or indirect, of the ultimate motivation for the obtaining of profit. Indispensable costs equate to expenses incurred in the interest of the company or, in other words, in all acts abstractly subsumable in a profitable profile. (...) Indispensability subsumes itself to any and all acts performed in the interest of the company... The legal notion of indispensability thus represses acts contrary to the company's purpose, not inserted in corporate interest, above all because they do not aim at profit»." (Arbitral Award of 6/12/2016, proc. 341/2016-T).

For all the foregoing, the substantiation of the impugned additional assessment incurs in error of fact and law, the Claimant being correct.

It is therefore appropriate to proceed with the present arbitral petition, with the consequent annulment of the additional IRC assessment no. 2016…, the respective account settlement demonstration no. 2016…, and the compensatory interest, relating to IRC for 2012.

V.3)

The Claimant combines with the petition for annulment of the additional assessment at issue in the present proceedings, the request for condemnation of the AT to payment of compensatory interest for the undue payment of the tax act in question.

Pursuant to Article 43.º, no. 1, of the LGT, compensatory interest is due when it is established, in an administrative appeal or judicial challenge, that there was error attributable to the services from which resulted payment of the tax debt in an amount higher than legally due.

It is, therefore, a necessary condition for the attribution of said interest the demonstration of the existence of error attributable to the services.

To that effect, see, for example, the following ruling: "The right to compensatory interest provided for in no. 1 of Article 43.º of the LGT [...] depends on it having been established in the proceedings that the act is affected by error in the factual or legal assumptions attributable to the AT." (Supreme Administrative Court Award of 30/5/2012, proc. 410/12).

In the case at hand, it is manifest that, following the illegality of the impugned additional assessment, for the reasons pointed out previously, the conditions for the right to compensatory interest are met.

Although the judicial challenge process is essentially a process of mere annulment – as provided in Articles 99.º and 124.º of the CPPT – it can issue a condemnation of the tax administration to payment of compensatory interest.

On the other hand, there is entitlement to reimbursement of the tax paid by the Claimant, by force of the provisions in Articles 24.º, no. 1, para. b), of the RJAT and 100.º of the LGT, as such is essential to "restore the situation that would have existed if the tax act that is the subject of the arbitral award had not been performed".

This was also the understanding of the arbitral tribunal constituted under proceeding no. 48/2013-T, where requests for reimbursement and condemnation to payment of compensatory interest were also at issue. That tribunal concluded that: "The request for constitution of an arbitral tribunal has as its corollary that it is in the arbitral process that the legality of the exigible debt will be discussed, therefore, as results from the express wording in no. 1 of said Article 117.º of the CPPT, it is also the arbitral process that is appropriate to consider the petition for compensation for undue guarantee."

Applying the doctrine of that ruling, it is considered that the Claimant now has the right to compensatory interest, on the amount indebtedly paid, pursuant to Article 43.º, nos. 1 and 3, para. c), of the LGT and Article 61.º of the CPPT.

Compensatory interest is due and calculated on the basis of the amount indebtedly paid, until its full reimbursement to the Claimant, at the legal rate, pursuant to Articles 43.º, nos. 1 and 4, and 35.º, no. 10, of the LGT, Article 61.º of the CPPT and Article 559.º of the Civil Code and Ordinance no. 291/2003, of 8 April (without prejudice to any subsequent changes to the legal rate).

VI – DECISION

The Tribunal Arbitral hereby decides:

  • To find the present arbitral petition well-founded and, as a consequence, to annul the additional IRC assessment for 2012 that is impugned;

  • To find the petition well-founded also with regard to the payment of accrued and accruing compensatory interest, calculated at the maximum legal rate, until effective and full payment.

VII – Value of the Cause

The value of the proceedings is set at €203,738.54 (two hundred three thousand seven hundred thirty-eight euros and fifty-four cents), pursuant to Article 32.º of the CPTA and Article 97.º-A of the CPPT, applicable by force of Article 29.º, no. 1, paras. a) and b), of the RJAT, and Article 3.º, no. 2, of the Ordinance on Costs in Tax Arbitration Proceedings (RCPAT).

VIII – Costs

Costs to be borne by the Respondent, in the amount of €4,284.00, pursuant to Table I of the RCPAT, and in fulfillment of Article 12.º, no. 2, and Article 22.º, no. 4, both of the RJAT, and pursuant to Article 4.º, no. 4, of the said Ordinance.

Let notice be given.

Lisbon, 31 October 2017.

The Arbitrators,

(Maria Fernanda dos Santos Maçãs)

(Miguel Patrício)

(Luís Miranda da Rocha)

Text prepared by computer, pursuant to the provisions of

Article 131.º, no. 5, of the CPC, applicable by remission of Article 29.º, no. 1, para. e), of the RJAT.

The drafting of the present award is governed by the spelling prior to the Orthographic Agreement of 1990.

Frequently Asked Questions

Automatically Created

What is the indispensability requirement for cost deduction under Article 23 of the Portuguese IRC Code?
Under Article 23 of the Portuguese IRC Code, cost deductibility requires that expenses be indispensable for generating taxable income or maintaining the income source. This means costs must have a direct and necessary connection to the company's business activity. The expense cannot be merely convenient or optional but must be essential to the company's operations. In case 133/2017-T, the dispute centered on whether interest on loans used to acquire an equity stake met this indispensability requirement, with the Tax Authority arguing the costs represented a duplication of financing related to the same underlying property.
How did the CAAD arbitral tribunal rule on the additional IRC assessment for the 2012 tax year in case 133/2017-T?
The excerpt provided does not include the tribunal's final decision in case 133/2017-T. The document shows the procedural history, parties' arguments, and witness examination scheduled for September 22, 2017, with a deadline of November 2, 2017, for rendering the award. The claimant challenged an additional IRC assessment of EUR 203,738.54 for 2012, seeking annulment of corrections totaling EUR 5,120,780.68 in disallowed interest expenses. To determine the tribunal's ruling, the complete arbitral award would need to be consulted.
What procedures apply when challenging an additional IRC tax assessment through CAAD tax arbitration in Portugal?
To challenge an additional IRC assessment through CAAD arbitration in Portugal, taxpayers must file a request for constitution of an arbitral tribunal pursuant to Decree-Law 10/2011 (RJAT). The process includes: (1) filing an arbitral petition identifying the contested assessment; (2) appointment of arbitrators by the CAAD Deontological Council; (3) constitution of the tribunal; (4) the Tax Authority's response with administrative file; (5) evidentiary proceedings including potential witness examination; (6) written arguments from both parties; and (7) issuance of the arbitral award within the statutory deadline. The tribunal may waive hearings if unnecessary but must allow parties to request oral proceedings.
Can a company deduct business costs under IRC if the Portuguese Tax Authority (AT) disputes their necessity?
Yes, companies can deduct business costs under IRC even when the Portuguese Tax Authority disputes their necessity, provided the expenses meet the indispensability requirement of Article 23 CIRC. The burden of proof typically falls on the taxpayer to demonstrate the costs were essential for generating taxable income or maintaining the income source. Taxpayers can challenge AT's disallowances through administrative appeals or CAAD arbitration. In case 133/2017-T, the claimant argued its financing costs were indispensable because the loans funded a legitimate corporate acquisition that concentrated economic activities in a single business unit, with each entity maintaining distinct operational activities and separate income streams.
What evidence is required to prove cost deductibility under the indispensability principle in Portuguese corporate tax law?
To prove cost deductibility under the indispensability principle in Portuguese corporate tax law, taxpayers must provide evidence demonstrating: (1) a direct causal link between the expense and revenue-generating activities; (2) the business purpose and economic rationale for the expenditure; (3) documentation such as contracts, loan agreements, and financial statements; (4) operational evidence showing how the expense contributes to business operations; and (5) distinction between the taxpayer's activities and those of related entities to avoid claims of duplication. In case 133/2017-T, the claimant presented loan agreements, account statements, witness testimony, and arguments showing each entity performed distinct operational activities with separate income and costs related to the commercial center.