CAAD 143/2018-T: Reverse Merger Financing Costs Deductibility Under Article 23 CIRC – IRC Tax Ruling

ARBITRAL DECISION

The arbitrators Judge Counselor Dr. Fernanda Maçãs (arbitrator-president), Doctor Tomás Cantista Tavares and Dr. Jorge Carita (arbitrators-members), appointed respectively by the Deontological Council of CAAD, by the Claimant and by the Respondent to form the Arbitral Tribunal, agree as follows:

1. Report

A..., SA, NIPC..., with registered office at ..., ..., ..., Lisbon (hereinafter A... or Claimant) filed a request for constitution of a collective arbitral tribunal, in accordance with the combined provisions of Articles 2, paragraph 1, subparagraph a) and 6, paragraph 2, subparagraph b) of Decree-Law No. 10/2011, of 20 January (Legal Regime of Arbitration in Tax Matters, hereinafter LRAT), in which the Tax and Customs Authority (hereinafter TCA) is named as respondent, seeking the declaration of illegality of the assessment of Corporate Income Tax and compensatory interest and default interest for 2013, in the amount of €532,708.54 (no. 2016...; 2016...; 2016...) – see documents no. 2 to 4 attached with the Initial Petition.

The request for constitution of the arbitral tribunal was accepted by the President of CAAD and proceeded with its normal processing.

The collective arbitral tribunal was constituted on 12/6/2018.

The TCA responded, by way of objection, defending that the request should be ruled unfounded.

The meeting under Article 18 of the LRAT was waived as unnecessary.

The Claimant exercised the right to respond regarding the request filed by the Respondent to refer the case back to the Court of Justice of the European Union for a preliminary ruling.

The Respondent submitted arguments, noting that "There is pending before CAAD the arbitral case no. 144/2018-T in which A..., S.A. is the Claimant, within the scope of which the exact same question of fact and law to be decided in these proceedings is discussed and which concerns the non-deductibility, in accordance with Article 23 of the Corporate Income Tax Code, of expenses with banking finance operations and shareholder loans." and that "on 22 November 2018 the Arbitral Tribunal delivered a decision ordering the preliminary reference of the case to the Court of Justice of the European Union".

The Respondent considers that "the present instance should be suspended until a decision is rendered in the preliminary reference case no. C-751/18, in accordance with the provisions of Articles 269, paragraph 1, subparagraph c), and 272, paragraph 1, of the Code of Civil Procedure, applicable by virtue of Article 29, paragraph 1, subparagraph e), of the LRAT."

The Claimant, in exercise of the right to respond, pronounced on that request, which was denied by Arbitral Decision of 22 February 2019.

The arbitral tribunal was duly constituted and is materially competent, as provided in Article 2, paragraph 1, subparagraph a) and Article 4, both of the LRAT.

The parties have legal personality and legal capacity, are legitimately party to the proceedings and are represented (Articles 4 and 10, paragraph 2, of the same statute and Articles 1 to 3 of Ordinance No. 112-A/2011, of 22 March).

The proceedings are not affected by nullities and there is no obstacle to consideration of the merits of the case.

2. Facts

2.1. Proven Facts

The following facts relevant to the decision are considered proven:

a) The Claimant was established in 1997 and is engaged in activities in the transport sector, specifically in road freight transport with home delivery.

b) The Claimant was wholly held by B..., SGPS, SA (NIPC...).

c) In December 2010, B... transferred 100% of the capital of the Claimant to the company C..., SA (NIPC...) – an entity controlled 100% by the Company D..., SGPS, SA (NIPC...), which in turn is wholly held by the Fund E....

d) C... was established in September 2010 and its purpose was the provision of administrative services and support to transport companies.

e) E... is a venture capital entity, dedicating itself (generally through companies it controls) to the acquisition of equity participations and control of companies, with a view to capital appreciation through improved management quality and, consequently, increased investor remuneration.

f) C..., SA, to complete the purchase of A..., financed itself through: i) Shareholder loans granted by shareholder D..., SGPS, SA, of €13.6 million, at a rate of 15% per annum; ii) Bank loans (borrowed from ...) of €23 million, with tranche A, of €19.5 million, destined for the purchase of the share capital of the Claimant.

g) In September 2011 (with accounting effects as of 1/1/2011), C... (the merged company) merged into A... (the surviving company), through global transfer of the assets and liabilities of the merged company to the surviving company – an operation commonly referred to as reverse or inverted merger.

i) Following the merger, the Claimant (surviving company) assumed (i) all debts of F... and (ii) the charges (interest) incurred by F... with the Bank and the shareholder – which in 2013 amounted to €3,036,897.93, distributed as follows: Interest payable to G...: €709,666.15; management fee to G...: €32,842.11; stamp duty: €28,386.53; shareholder loan interest: €2,266,006.14.

j) In venture capital activities (developed by the Fund E...), it is customary for the purchase of the shares of the company being acquired to be effected by a special purpose vehicle established for that purpose (in this case, F...) and then to promote merger with the operational entity (A...) – normal or inverted – to: (i) reduce administrative costs; (ii) meet banking requirement (place the debt in the same legal entity that owns the assets).

k) The TCA does not accept the tax deduction of these charges (interest) and consequently promoted the assessment that is the subject of this arbitral proceeding, based on Article 23 of the Corporate Income Tax Code.

L) The Claimant filed a Gracious Objection against the contested assessment, which was wholly denied expressly – and following such denial, the Claimant filed the present arbitral request.

M) The Claimant adhered to the special payment regime called PERES, in the modality of 150 installments, to proceed with the payment of the contested assessment (Corporate Income Tax and interest) – document no. 9, attached with the Initial Petition.

2.2. Unproven Facts

There are no facts relevant to consideration of the merits of the case that have not been proven.

2.3. Rationale for Establishment of Facts

The proven facts are based on documents submitted by the parties, on their consensus (also regarding documents, amounts and payment dates), on official information and other documentation contained in the administrative proceedings.

3. Legal Issues

3.1. Question to be Decided

As accepted by the parties, the question raised in these proceedings concerns only the tax treatment to be given to interest and other charges borne in 2013 by A..., relating to loans (from shareholders and third parties [banking]) contracted for the purchase of the capital of A... itself and which the Claimant came to bear by virtue of and as a consequence of the merger with its shareholder C... (which originally incurred these obligations).

In the opinion of the TCA, as expressed in the rationale of the assessment (and denial of the Gracious Objection), such interest and charges would not be tax-deductible, in accordance with Article 23 of the Corporate Income Tax Code (in the wording and numbering at the date of the facts), because they are not indispensable for the obtaining of income or the maintenance of the income-producing source (and are not applied in operations).

For the Claimant, conversely, such interest and charges would be tax-deductible, by fulfilling the requirements inherent in Article 23 of the Corporate Income Tax Code.

As follows from the rationale of the assessment (and other documents attached to the proceedings), the question to be decided does not concern, even incidentally, any correction of transfer pricing in the interest owed to the shareholder (Article 63 of the Corporate Income Tax Code), nor the application of the General Anti-Abuse Clause (Article 38, paragraph 2, of the General Tax Code or Article 73, paragraph 10, of the Corporate Income Tax Code) for possible abusive arrangement of operations with exclusive or preponderant tax intentions, in abuse of legal forms (borrowing [and resulting interest] to purchase capital followed by merger of companies, so that the profitable operational entity bears these charges and reduces its annual taxable profit).

3.2. Applicable Law

According to Article 23 of the Corporate Income Tax Code (in the wording and numbering at the date of the facts), costs or expenses are considered those:

"1. [...] which are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the income-producing source, in particular: (...)

c) Of a financial nature, such as interest on foreign capital applied in operations [...], expenses with credit operations [...]";

Furthermore, with the merger of companies "the merged companies are extinguished [...], with their rights and obligations transferring to the surviving company" (Article 112, subparagraph a), of the Commercial Companies Code).

3.3. Arguments of the Parties

The rationale of the assessment (and the Respondent's answer and other statements of the TCA during the proceedings) invokes, in summary, that the interest borne by A... after completion of the merger (and as a consequence of this operation) relating to financing originally contracted by C..., SA directly for the acquisition of the capital of A... do not merit the qualification of "indispensable" for the obtaining of income or maintenance of the income-producing source: following the merger, they no longer finance the acquisition of the participations (and are not applied in operations); there would have to be, in each year in which interest is recorded, a balancing between the financial charges borne and the income and existence of the asset; such interest would not be linked to the normal activity of the claimant and the associated asset does not exist and would not contribute in the future to taxable income.

The Claimant advocates, conversely, that the interest borne in 2013 by A... is indispensable for the obtaining of income or maintenance of the income-producing source, and is therefore to be qualified as a tax-deductible expense, under Article 23 of the Corporate Income Tax Code. The interest is borne by A... in the conduct of its activity; the loans (and consequently the interest arising from them), when originally incurred (by C..., SA), were applied in operations and were indispensable for income and maintenance of the income-producing source – and if they were so at the initial moment, they must be so for ever, whatever subsequent modifications occur (even with the merger); the merger, among its normal effects, leads to the economic and tax result of these proceedings; the merger is an operation permitted by commercial and tax law and the TCA, in the rationale of the act, does not invoke any alleged abuse of the merger operation, in accordance with Article 38, paragraph 2, of the General Tax Code. The non-acceptance of this expense for tax purposes would imply a violation of the Merger Directive (Directive 2009/133/EC of the Council) which recognizes absolute tax neutrality to these corporate restructuring operations.

3.4. Decision

The arbitrators analyzed all the arguments presented by the parties (in all written submissions and documents presented during the proceedings), as well as the arguments and analysis of prior arbitral decisions on the subject – in fact explained by the parties – but always mindful of the (minor) particularities of the case ("each case is a case").

Indeed, several arbitral decisions (for example, in cases 14/2011-T and 87/2014-T) refused the tax deduction of interest borne by the surviving company post-merger, relating to financing contracted by the merged company pre-merger for the purpose of acquiring the share capital of the future surviving company. Conversely, there are many other arbitral decisions, for example, in cases 101/2013-T, 42/2015-T (here in a non-inverted merger, but the considerations are the same), 92/2015-T and 93/2015-T, 108/2015-T, 537/2016-T, 120/2018-T and 607/2018-T, which pronounced themselves in the opposite sense, accepting the deduction of these financial charges, considering them manifestly indispensable for the obtaining of income or for the maintenance of the income-producing source.

The arbitrators weighed all the arguments of the parties and the content of all the aforementioned decisions and decided to annul the contested assessment. They considered that this interest and charges borne by the Claimant fulfill the requirements inherent in Article 23 of the Corporate Income Tax Code to justify their tax-deductibility, based on the arguments explained below. And, adhering to the content of decision 537/2016-T which, with all due respect, they reproduce hereinafter, they annul the assessment at issue in this proceeding.

Beginning of transcription of Decision No. 537/2016-T – adapted to the factual circumstances of this proceeding.

"Let us begin with FOUR notes of clarification, entirely undisputed, which help to define the scope of the decision.

First, and as already mentioned, the subject matter of these proceedings is limited solely to the application of Article 23 of the Corporate Income Tax Code to the interest borne in 2013 by A..., relating to loans (from shareholder and third parties) contracted for the purchase of the capital of A... itself and which the Claimant bears by virtue of and as a consequence of the merger with its shareholder C..., which originally incurred these debts.

As a second point – relevant to the decision – it is necessary to keep in mind the content of the Decision of the Superior Administrative Court of 2/12/2011, case 0865/11 (in a case of spin-off and merger).

That decision established that the tax notion of merger (subject to tax neutrality) is broader than the legal definition in the Corporate Income Tax Code which required, at the time, the legal formalism of attributing to the respective shareholders titles representing the share capital of the other entity. There is tax neutrality in the merger operation regulated by commercial law, even if it does not involve attributing to shareholders titles representing capital – as happens, symptomatically, among other cases, in the situation of inverted merger. That is: the Superior Administrative Court equated in tax terms inverted and non-inverted mergers, recognizing tax neutrality of both operations, even though they do not involve the attribution of shares to shareholders.

This jurisprudence illuminates the decision of these proceedings: it is an established fact that mergers, inverted or non-inverted, possess the same legal regime, both within commercial law and in tax matters, namely as regards tax neutrality regime described in Articles 73 et seq. of the Corporate Income Tax Code. That is, the merger operation described in commercial law – whether inverted or not – merits the same treatment and regime for tax law: both as regards tax neutrality (deferral of taxation of income associated with these merger operations); and in general, regarding the tax consequences, direct or indirect, arising therefrom.

There is not, so to speak, a first-class merger – non-inverted – with tax neutrality and in general tax acceptance of the provisions imposed by commercial law; and a second-class merger – the inverted one – where these provisions would or would not be verified or would be verified more sporadically and exceptionally.

Nothing of the sort: there exists only the merger operation, encompassing inverted and non-inverted, exactly with the same tax legal regime, and with the same and exact reasons for the various tax consequences associated with it.

This means, looking at the case of these proceedings, that the legal answer is the same, whether or not there is an inverted merger. The regime for tax acceptance of the interest in question has the same framework, considerations and solution, whether the merger was non-inverted (with the incorporation of A... into C...) or in the case of inverted merger chosen by the parties. Nor does there even need to exist an additional rationale by the claimants to explain why they chose one and not the other. That falls within the total freedom of the parties, which the interpreter must respect, on the assumption, obviously, of there being a true and real merger – and this is an established fact in the proceedings, as no one questions it.

The third point has to do with the merger regime from a legal and commercial law perspective. A merger (inverted or not) does not resemble, in economic terms, a liquidation of companies. Here, the legal and economic disappearance of a company occurs, because it has exhausted its purpose or corporate interest.

In merger, conversely, legal disappearance is not associated with economic death of the enterprise, which continues, although restructured, in the company resulting from the merger, both from the perspective of the company (continuation of activity) and from the perspective of shareholders (equal commitment to those activities). The merged company is extinguished, undoubtedly; but all rights and obligations are transmitted to the surviving Company, which continues the activity of the "deceased" (Article 112, subparagraph a), of the Commercial Companies Code). There is a legal modification, with economic continuity (Decision of the Superior Administrative Court of 13-04-2005, delivered in case 01265/04 and Decision of the Court of Appeals of the South of 17-04-2012, delivered in case 04172/10, available at www.dgsi.pt).

The fourth point – accepted by the parties – has to do with the peaceful acceptance, expressed and implied, of the deduction of these financial charges if the merger had not occurred, by compliance with the requirements of Article 23 of the Corporate Income Tax Code. Here, a company (C...) to acquire an asset (share capital of A...), as a means of conducting its activity and seeking profit, must finance itself with third parties (banks and shareholders), bearing over time the inherent annual financial charges associated with financing. No one questioned – and we believe correctly – that prior to the merger, from the perspective of C..., we were in the presence of interest on foreign capital applied in operations (Article 23, paragraph 1, subparagraph c), of the Corporate Income Tax Code).

Well:

The question of these proceedings is thus whether the merger – inverted or not – changes this state of affairs; whether the interest, once accepted in tax terms (peacefully), ceases to be so after the merger, due to subsequent non-compliance with the requirements of Article 23 of the Corporate Income Tax Code (general requirement of indispensability and special requirement of application in operations).

The answer, as we have stated, goes in the direction of tax deduction of such interest, even after the merger, now in the sphere of the Claimant, for three main arguments, explained below – and keeping in mind the previous considerations.

THE FIRST concerns the analysis of the literal text of Article 23, paragraph 1 of the Corporate Income Tax Code: the deduction of financial charges requires that "interest on foreign capital be applied in operations." And everyone agrees that at the initial moment, the credit obtained (from banks and shareholders) was applied in operations, with the acquisition of the participation in the Claimant, by C..., SA – falling within the conduct of its activity and pursuit of profit.

Then a merger occurs, according to the legal rules of commercial law – whether inverted or not (as seen, the standard for the specific case is the same). With that operation, it cannot be said that foreign capital ceased to be applied (financing continued) and remain dedicated to operations, now restructured by legal effects of the merger (transmission of rights and obligations to the surviving company). That is: there is no diversion of financing, with abusive intent, in the sense that it now serves the favoring of interests outside the enterprise, for example, in the benefit of a shareholder. Nothing of the sort: what occurs is merely the production of the normal economic effects of the merger, consented to and imposed by commercial law, and it is impossible to conclude that the effects of that operation, following the strict dictates of commercial law, result in the protection of interests other than the corporate interest, merely to abusively benefit third parties to the merger operation. This interpretive result would be a true contradiction in terms, because it would amount to admitting that commercial law, in regulating the merger (inverted or not) would permit results that would violate the protection of interests safeguarded by that legal discipline.

In sum: if the interest was fiscally accepted prior to the merger (because foreign capital was applied in operations), then it will also be so after the merger (inverted or not), which merely followed the rules of commercial law, of transmission of all rights and obligations of the merged company, because after the merger, they continue to be considered interest on foreign capital applied in operations.

THE SECOND argument considers the similar situation (identical to these proceedings) in which, whether or not there is a subsequent merger, the Company decided to forego the purpose of the investment (because it was not profitable), but obviously had to maintain the financing that provided the financial means for the investment.

Let us suppose that company X buys a high-value machine to pursue a new activity – and finances itself with the Bank to buy it and will pay €100,000 in interest over 10 years (and at the end will have to amortize the capital). Now imagine that the company concludes, at the end of the 4th year, that this activity is not profitable, because there is no market for the products produced by the machine, so it decides to abandon production and the machine is shut down and "abandoned." Of course it will have to continue to pay the annual interest of €100,000. But will such interest, from the 5th year on, not be deductible from taxable income, by arguing that they are not applied in operations or that they are not indispensable for income or maintenance of the income-producing source?

Well, such charges will remain deductible, despite the disappearance – through a business decision – of the purpose for which the foreign capital that remunerated it was applied. The foreign capital was applied in operations at the initial moment – giving rise to productive investment. And that is sufficient and adequate to justify the tax deduction of the interest arising therefrom, regardless of future business vicissitudes of that investment. The financial charges remain deductible, even though the investment proved unsuccessful or revealed itself as a bad business or an unsuccessful business decision – because, and this is what matters, the foreign capital was linked to an investment that at the initial moment was applied in operations.

And if this is so, regardless of the occurrence of any merger (but with economic disinvestment), it will be so with even greater propriety in case of merger, where, as we have seen, there is not a subjective decision of any disinvestment, but only the objective transmission of rights and obligations, by legal effect of that institute of commercial law.

Of course, the previous considerations could be confronted – in tax terms – and this is the THIRD argument, with the existence of a series of operations purposely arranged to provide an undesired tax result, of abusive tax savings, translated in an acquisition of equity participations with use of financing, immediately followed by merger (inverted or not) with the purpose of abusively reducing the taxes to be paid in the following years by the operational and profitable company (due to the effect of the financial charges that had been borne for its acquisition). We are not saying that such abuse occurred in the case of these proceedings. What is important to stress is that the TCA, in the rationale of the tax act, did not invoke this argumentative arsenal to justify the assessment, in substitution or cumulatively with Article 23 of the Corporate Income Tax Code. Despite suspecting the temporal and chronological arrangement of the operations and the "tax savings" ensured by the deduction of the interest from the financing of the acquisition of A... from the operational income of A... (post-merger), it did not support tax correction under Article 38, paragraph 2, of the General Tax Code or Article 73, paragraph 10, of the Corporate Income Tax Code or even Article 63 of the Corporate Income Tax Code (invoking an excessive quantification of interest among companies in special relations). And the judge, in tax litigation, must focus on the subject matter of the proceedings, as defined by the rationale, under penalty of illegal post-hoc rationale and interference with the executive power's duty.

And, to conclude, Article 23 of the Corporate Income Tax Code does not constitute an anti-abuse norm, which could be used in substitution of Article 38, paragraph 2, of the General Tax Code, Article 73, paragraph 10 of the Corporate Income Tax Code or Article 63 of the Corporate Income Tax Code. Each norm has different prescriptive content – and Article 23 of the Corporate Income Tax Code does not function as a substitutive anti-abuse norm for those other provisions. Article 23 of the Corporate Income Tax Code limits its scope of action to the non-tax deduction of expenses thus recorded, but which, when incurred (or investments made) do not fall within the economic interest of the Company, but serve interests outside the company, of administrators or third parties. Let us suppose that a Company bears the interest of a financing contracted by it to make an investment solely for the private benefit of a shareholder or administrator (and this is not recharacterized as income in kind of the individual). Or that it finances with the bank to deliver this financial amount to a third party, without any consideration, outside the group or outside its corporate purpose. In such cases, the interest that it will bear with those funds is not tax-deductible because they were not (ab initio and forever) applied in the conduct of the Company's operations.

The case of these proceedings is totally different. The foreign capital was applied in operations; and should it be intended to invoke that all operations would be recharacterized as an abusive scheme of arrangement of operations, even if lawful from the civil law perspective, to obtain a tax benefit – which in some passages of the inspection is what is implied – then the rationale would not have to rely on the institute of Article 23 of the Corporate Income Tax Code but, as already explained, on other institutes at the disposal of tax law to attempt to achieve such corrective result.

The argument presented is sufficient to proceed to the annulment of the contested assessment. It is therefore not necessary to explore the other arguments presented by the objecting party (repercussion of tax neutrality of the merger operation on the deduction of financial charges arising from loans transmitted through neutral merger) and which arise from other legal proceedings (financial assistance).

End of transcription of case 537/2016-T

The Respondent also requested the suspension of the instance (with opposition from the Claimant), with immediate referral of the present case to the Court of Justice of the European Union, insofar as the disputed matter concerns the application of the Merger Directive (Directive 2009/133/EC of the Council), as was indeed indicated by the Claimant in its Initial Petition, and following the decision in another arbitral case with similar subject matter (deduction of interest after inverted merger), namely case 521/2017-T.

The Tribunal decided, as seen, to annul the assessment – and in this segment of the decision, the Award never concerns itself with any hypothetical violation of community law norms and rights. An interpretation of Article 23 of the Corporate Income Tax Code was advocated that does not create tax distortions to the merger operation with tax neutrality: the interest was deductible pre-merger and continues to be tax-deductible after the merger (just as it would be if this restructuring operation had not occurred). Therefore, the interpretation of Article 23 of the Corporate Income Tax Code, as advocated in this arbitral award, can never result in an obstacle to tax neutrality of the merger, whatever the meaning and scope of that tax neutrality indicated by Community Law. The request for preliminary ruling therefore fails.

Finally, the Claimant requested, in addition to annulment of the contested assessment, that the TCA be ordered to return the tax paid under Decree-Law No. 67/2016 (PERES), increased by statutory indemnity interest.

Article 43, paragraph 1, of the General Tax Code provides that indemnity interest is due in favor of the taxpayer when it is determined in judicial objection (and arbitral action is included in that legal provision, by coherence and unity of the legal system) that there was error attributable to the services resulting in payment of a tax debt superior to that which was due.

Now, this is what occurs in these proceedings. The TCA, in producing the additional Corporate Income Tax assessment – now annulled – resulted in the taxpayer's payment of tax, ultimately undue and required only due to error attributable to TCA services (which effected an illegal tax assessment).

Therefore, meeting the requirements of Article 43 of the General Tax Code, the TCA must proceed to the payment of indemnity interest, at the statutory rate, from the moment of payment by the taxpayer until full reimbursement to the taxpayer of the tax it paid (see also Article 24 of the LRAT and Article 100 of the General Tax Code).

5. Decision

In accordance with what has been stated, this Arbitral Tribunal agrees:

1. To rule as founded the request for declaration of illegality of the contested assessment of Corporate Income Tax and Compensatory and Default Interest for 2013, in the amount of €532,708.54 (document no. 2016...; no. 2016...; no. 2016...)

And, consequently:

1. To order the reimbursement to the claimant of the Corporate Income Tax for 2013 already paid by it under the Regime provided in Decree-Law No. 67/2016;

2. To order the TCA to pay indemnity interest to the Claimant, at the statutory rate, on the amounts referred to in the previous item, from the moment of each payment until full reimbursement.

6. Value of Proceedings

In accordance with Article 97-A, paragraph 1, subparagraph a), of the Tax Procedure and Process Code and Article 3, paragraph 2, of the Costs Regulation in Tax Arbitration Proceedings, the value of the proceedings is fixed at €532,708.54

Let notification be made.

Lisbon, 25 February 2019

The Arbitrators

Fernanda Maçãs (Arbitrator-President)

Tomás Cantista Tavares (Arbitrator-Member)

Jorge Carita (with dissenting opinion)

(Text prepared by computer, in accordance with Article 131, paragraph 5 of the Code of Civil Procedure, applicable by reference of Article 29, paragraph 1, subparagraph e) of the Legal Regime of Arbitration in Tax Matters)

DISSENTING OPINION

With all due respect for the position that prevailed in this Collective Arbitral Tribunal, I dissent from the present Decision, as I have done in previous cases involving the same facts and the same legal question, which I do in the following terms:

I – The Facts

1. At issue is the denial of the Gracious Objection presented against the additional Corporate Income Tax assessment and respective compensatory and default interest, relating to the tax year 2013, which resulted in an amount payable by the Claimant of €532,708.54.

2. Companies involved:

a) Claimant – A...S.A.

b) D... SGPS, S.A – Sole shareholder of the Claimant;

c) C..., S.A.[1] – Company extinguished due to merger through incorporation into the Claimant (had been established on 24 September 2010, within the scope of the Fund, having as sole shareholder C... SGPS, S.A., which in turn was 100% held by the Fund).

1. Contracts:

A) Shareholder loan agreement entered into on 28.12.2010.

C... grants to the Claimant, by way of shareholder loan, the sum of €13,600,000.00.

Purpose: – To allow the Claimant to strengthen the financial means of C... S.A.

B) Financing agreement with G... (Bank) entered into on 28.12.2010.

Purpose – To finance the payment of the price of the purchase and sale agreement entered into on 28.12.2010.

Seller: B... SGPS S.A (sole shareholder of the claimant).

Buyers: C... S.A. and F... S.A.

Shares transferred: A... (Claimant), H... and I....

Tranche A of this loan, in the amount of €19,500,000.00 was intended for the acquisition of the Claimant's shares by C....

Reimbursement of Borrowed Capital: 20 successive quarterly installments – Starting 28.03.2011, all in the amount of €821,052.63 – last installment: 28.12.2015 - €3,900,000.00.

1. Clause 20, paragraph 3

It was agreed between G... (Bank) and the borrowers (C... S.A. and F...) – including C... – that these would merge with the acquired companies (including the Claimant), within a maximum period of 24 months.

1. Complementary Data

Between 2010–2011, the Claimant participated in this corporate reorganization operation, which ended with the acquisition of its indirect control by an Investment Fund.

1. Date of establishment of the Claimant: 20.09.1997

Activity – Road freight transport with home delivery.

Had as sole shareholder until December 2010: B... SGPS

From December 2010 onwards the Claimant came to be controlled by the Fund

Initial Structure of Participations

E...
|
D...
|
C...
|
A...

1. In summary:

Origin of funds with which C..., acquired all the share capital of the Claimant:

A) €13,600,000.00 – Shareholder loans granted by its sole shareholder D... (interest rate 15%).

B) €19,500,000.00 – Loan granted by G... (Interest rate 6%).

1. On 30 June the Merger Plan was deposited, in the modality of global transfer of assets and liabilities of the merged company (C... – sole shareholder of the Claimant) to the surviving company (Claimant).

That transmission naturally includes all the shares that the merged company (C...) holds in the surviving company (Claimant).

Following the merger, the Claimant assumed in full, and by legal effect, the charges arising from the financing contracted by C..., with the Bank and its sole shareholder (D...).

1. Expenses borne by the Claimant in 2013, after the acquisition of itself:

1. As a result of the inspection action, the TCA disregarded the tax effects, in accordance with Article 23, subparagraph c) of the Corporate Income Tax Code, of these charges and added the amount of €3,036,897.93 to the value of losses declared for the tax year 2013 (€1,113,074.70), with the Claimant presenting a taxable profit of €1,923,823.23, from which resulted a tax to be paid of:

Tax - €532,708.54
Compensatory Interest - €43,773.35
Default Interest - €34.42
Total - €576,516.31

II – The Law

1. The Claimant alleges, in summary, in the words of the Respondent in its Answer that, "… by means of merger through incorporation, the surviving company (Claimant) assumed, by the sole effect of law and immediately, all the assets of the merged company, including the right to deduct the expenses that had an economic causal nexus with the activity of the merged company before the merger." (Answer, Article 20, page 5).

2. The Claimant concentrates its criticisms of the TCA's position on two main aspects.

It states that the TCA:

a) "ignores the rationale underlying the merger operation";

b) the position of neutrality that tax law assumes, disrespects European law, as well as constitutional principles of fiscal management freedom, neutrality of tax law and taxation on actual income.

1. Rationale of the Merger Operation.

The Claimant undertakes the defense of the leveraged buy-out or simply LBO, as an inviolable technique, whose effects and consequences no one can challenge.

It starts from the premise that the merger through incorporation, whose legality is accepted by the TCA itself, "corresponds to the exercise of private autonomy and was motivated by legitimate interests or valid economic reasons, must be interpreted in the specific context in which it is inserted because it constitutes a typical procedure of venture capital transactions involving leveraged buyouts (LBO)" (See Article 56 of the Initial Petition, page 13)

That is – we say – a company that develops a lucrative commercial activity, as the generator of resources, releasing considerable financial means, agrees with the shareholders who want to buy it, that they buy it for a considerable value, but that it is not worth worrying about the costs of the acquisition, because, in the end, it is the company itself that will bear them.

That is: "can my shareholders indebt themselves at will to buy me, because I will then assume these costs and the tax authority will also accept them as a tax cost!!!

And this does not happen by chance, it is arranged from the start[2].

1. And it is still curious that the Claimant says that all of this results from the natural consequences of merger through incorporation, when they themselves chose that modality for this scheme (there is no need to apply the General Anti-Abuse Clause, it is enough to disregard the costs).

Ah, I almost forgot – It was a requirement of the Creditor Bank (See Article 60 of the IP)

Well, in this modern era, the financial capacity no longer counts, the risk, the liquidity, the soundness of those who indebt themselves to buy, but curiously of those who are bought (See Article 61 of the IP), or rather of those who indebt themselves to be bought.

It is called "negotiating freedom," where no one can interfere, much less the Tax Authority.

It is curious when the Claimant states that: – "… the mechanism chosen for its realization is not essentially or mainly connected with tax reasons…" (See Article 62 of the IP).

Well, it is clear that if the interest here in question were not to be considered a tax cost, they would have to find another "procedure" inspired by great "negotiating freedom," and which, in the same way, would never be connected with tax reasons.

1. The defense of the inverted merger made in these terms by the Claimant is not without curiosity:

"The inverted merger (or reverse merger) constitutes a modality of merger accepted in the corporate law field – where the principle of private autonomy prevails – whose effects are recognized by tax law, namely for purposes of application of the neutrality regime, with restrictions to tax neutrality of mergers of this type being related to the underlying motivations, which cannot have as objective tax evasion but rather be dictated by valid economic reasons, including among these tax-related reasons."

1. And thus, we pass to the tax neutrality of the merger and to the assessment of the indispensability of the expenses.

Indeed, the TCA understands that "Therefore, the expenses incurred with such financings cannot be considered indispensable for the pursuit of the business activity conducted by the Claimant, because it became impossible to establish any economic causal nexus between them and the obtaining of income or the maintenance of the income-producing source of the entity bearing them;"

And on the other hand:

"But it is not clear what is the legal basis on which the consideration (see Articles 109 and 151 of the arbitral petition) rests that the special tax regime applicable to the merger entails the automatic transposition to the sphere of the surviving company (beneficiary) of the tax treatment conferred, in the sphere of the merged company, on expenses borne with the transferred liabilities (or assets);"

Revealing this conclusion:

"Indeed, as already noted, the incorporation by the Claimant of the company that was its sole shareholder and the consequent delivery of all its social shares to company D... resulted in the charges borne with the liabilities contracted for the acquisition of those participations, following the merger, coming to be inserted in a different corporate context."

1. Next the TCA, after referencing the essence of the outlines of the tax neutrality regime associated with the merger (Article 77 of the Response), concludes that Directive 2009/133/EC does not regulate the deductibility of financial charges, so the position defended by the TCA in this situation does not constitute any disrespect for European law, so the deductibility of financial charges should be treated in accordance with the normatives of national law, that is, in accordance with the provisions of paragraph 1 of Article 23 of the Corporate Income Tax Code (See Articles 78 and 80 of the Response), although it ends up requesting the Preliminary Ruling referral to the CJEU.

2. The Claimant understands that such referral should not be made.

In these situations, the corporate effects are not denied, the assumption of rights and duties, inherent to mergers, even if inverted, with transmission of assets and liabilities, of the parent company, to the subsidiary, with the subsidiary incorporating the parent, although in an authentic "parricide in the feminine."

But the Claimant insists much on this technique.

What is not valid is to carry along with the merger, regarding its tax consequences, the regime of neutrality and Community Directives, the obligation to continue to consider as tax costs, interest, only because they already were, and such consequence result from all the natural processing of the merger.

It is therefore abusive to consider that an expense that has an economic causal nexus with the activity of the merged company before the merger – has to maintain that nexus after the merger, when the realities, before and after, are completely different (See Article 91 of the IP, page 21)

It is as if they took a photograph before and one after, to verify the differences when there is no doubt that they exist.

And the Claimant states:

"The realization of the merger is equally relevant in that the foreign capital to which the financial charges deducted by the surviving company (Claimant) are linked and which are at the genesis of the controversy were wholly applied at a moment prior to the operation, given that the funds borrowed by the bank and the sole shareholder were intended for and were actually used in the acquisition of all the capital of the surviving company (Claimant) by the merged company (C...)." (See Article 92 of the IP page 21)

Just because the capital was applied before the merger does not mean that the interest borne after the merger has to have/maintain the same tax treatment, when the realities are so distinct, before and after the merger.

It is also important to note that the jurisprudence cited and transcribed by both parties has natural contradictions among themselves and is far from being absolutely unanimous.

I transcribe in this respect the dissenting opinion of the undersigned in case 120/2017-T:

"I dissented because the arguments to support the thesis of the non-indispensability of the costs relating to the price that a company pays to acquire itself did not convince me.

But I recognize myself in the first wave of Arbitral Decisions (Cases 14/2011-T, 87/2014-T) and in the same way in the more recent dissenting opinions (Cases no. 92/2015-T, 93/2015-T and 88/2016-T) that could not envision the absolute indispensability of such expenses, borne with respect to an asset, the ownership of itself, unfortunately disappeared upon merger given its very nature.

It becomes evident that in all these decisions participated some of the best specialists in tax law currently collaborating with CAAD.

I cannot understand how in a company that revealed in the 2008 tax year modest monthly financial costs, it comes, after a reverse merger operation of a group (in addition to everything that was done before to get there), to bear almost €10 million in the first year, which the Tax Authority has to continue to accept as deductible for tax purposes, in the following years and as regards 2012, given this Tribunal's decision.

It is remarkable the finding of the evolution of the Claimant's taxable income before the merger and after the merger, as is well stated in the Tax Inspection Report and which is transcribed here:

And paying the interest owed on the loans contracted by the "mother" to buy the "daughter" and accepting it for tax purposes as a cost of the daughter, is exactly the same as buying raw material to manufacture and sell metal scraps and waste!!!

Everything happens, indeed, as if the activity of the Claimant were its own acquisition, as the TCA says in other cases where the same situation is at issue, or rather, the costs "concern its Self-acquisition."

And everyone knows that this is indeed the case and that it is proper, it is inherent to any leveraged buyout (LBO) acquisition, which constitutes a mechanism used to make inadmissible costs into tax efficiency. (There is no need to apply the CGAA, it was enough not to accept these interest as a cost).

And let it not be said either that the character of indispensability of costs should be assessed when the debt is contracted, completely forgetting the moment when the interest is actually borne (goodbye principle of exercise specialization, and not to mention the always necessary causal nexus between costs and income).

Indeed, I find it difficult to accept that interest contracted by a company to acquire another company in which it itself came to be incorporated can come to be accepted for tax purposes.

And if I have no doubt that at the moment the debt was contracted the respective charges were a cost for tax purposes, I do have doubts that they can continue to be so after the (inverted) merger and that moreover there be those who understand that if they were in that moment, in which they were contracted "they have to be so for ever…" (position of the Claimant in Case no. 88/2016-T, page 7), regardless of changes that may occur, including the merger, even more so inverted (no one doubts that the merger is an operation provided for in law and here the application of a CGAA is not at issue, but rather the application of Article 23 of the Corporate Income Tax Code).

How can it be stated that "… the interest expenses in question correspond to foreign capital that was applied in the conduct of the entity bearing them" (Case no. 88/2016-T, page 9), when they served for third parties to acquire precisely the company that currently bears them.

It is hard for me to understand!!! I confess.

It would be the same as within the scope of a corporate restructuring, covered by the tax benefits in Article 60 of the Fiscal Benefits Statute, which includes an inverted merger, after the IMT, IS exemptions, etc., if the interest of an identical indebtedness were to continue to be considered as a tax cost of the subsidiary company that incorporates the mother who bought it.

How can it be claimed that the foreign capital was applied in the conduct by the surviving company, when it did not buy the share capital of any other company!!!

It is said that it is important to ascertain "… the actual and concrete allocation of the financing of which the borne interest 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 intends to deduct fiscally, …, the interest and other associated charges that it bore." (Decision cited, pages 11/12)

But what is the doubt?

Did the financings not serve to pay the price of acquisition of the Claimant by the company that came to be incorporated in it. The interest arises from the indebtedness of third parties, with the debt having been contracted before the merger.

In this way, the company is paying to its own shareholders (or part of them, depending on the merger exchange ratio) the price of acquisition of its own shares.

In the CAAD proceedings that I analyzed and that are dissected in the present Decision, I cannot therefore fail to subscribe to the Dissenting Opinion subscribed by Dr. António Brás Carlos (Case no. 88/2016-T), namely when he expresses his disagreement with respect to the thesis of the prolongation of the existence of the surviving company.

For its part, the factual summary there made lays bare the purpose of the entire operation, naturally raising questions as to whether the interest borne can continue to have tax relevance in the post-merger period.

Categorical is point 8 of this dissenting opinion, which I transcribe here, with all due respect:

"8. All steps of the operation are inserted in the same 'unity of intention and action' and are, from the beginning, solely directed to the objective referred to in the previous number. An objective that is foreign to the corporate interest of the Claimant, the financing and payment of the concomitant charges not being necessary for its activity, nor indispensable for the pursuit of its specific corporate interest materialized in the production of its income subject to tax or in the maintenance of its generating source. The obligation to pay the charges under analysis was never, from the outset, contracted in the corporate interest of the Claimant, and it is clear to me that, following the merger, it could not come to be considered that such financings were indispensable for it for purposes of paragraph 1 of Article 23 of the Corporate Income Tax Code."

Dr. António Brás Carlos is right when he states in the final summary (point 10) that the decision at issue in that case does not respect, but rather openly contradicts, the jurisprudence of the Superior Courts (SAC/Court of Appeals).

"10. Consequently, having present the above stated, the charges relating to those loans, borne by the Claimant, do not fulfill the requirement of indispensability to which paragraph 1 of Article 23 of the Corporate Income Tax Code refers, because, in summary:

a) They do not relate to the activity conducted by it (Decision of the Superior Administrative Court, case 171/11);

b) The expenses corresponding to interest borne by a surviving company by virtue of the acquisition of foreign capital by the merged company to acquire 100% of the shares of the first, are not indispensable for this company (surviving company), because they were not constituted in its corporate interest, and thus are not necessary for the pursuit of its corporate purpose (Decision of the Superior Administrative Court, case 164/12 and Decisions of the Court of Appeals of the South, case no. 5327/12 and case no. 8137/14);

c) There is no causal nexus between such expenses and its income or gains, explained in terms of normalcy, necessity, congruence and economic rationality (Decision of the Court of Appeals of the South, case no. 6754/13);"

It is equally important to take into account in this context the Dissenting Opinion of Prof. João Menezes Leitão in Cases no. 92/2015-T and 93/2015-T.

Here is reiterated the reference to the jurisprudence of the Tax Courts that hold that "the costs (…) cannot fail to relate, from the outset, to the taxpaying company itself. That is, for a given amount to be considered a cost of that company it is necessary that the respective activity be conducted by it itself, not by other companies" (Decision of the Superior Administrative Court of 30.05.2012, Case 0171/11).

It is therefore extensive the analysis of the jurisprudence that, making proper use of the reading of the principle of indispensability of costs, results from its application the non-indispensability of those at issue in such Decisions (92/2015-T and 93/2015-T)

"… that such expenses do not relate to the activity conducted by the taxpaying company itself, lack relation with the activity pursued by the taxpayer, were not incurred in the interest of the enterprise, in the pursuit of its respective activities, are foreign to the enterprise's activity, it is not possible to discern in them any causal nexus with the income or gains, explained in terms of normalcy, necessity, congruence and economic rationality, were incurred beyond the corporate objective, that is, in the pursuit of another interest other than the corporate one." (emphasis mine). Is that not enough!!!

I also have to agree with Prof. Menezes Leitão when he states that:

"… by assuming the indicated financing costs, the Claimant is obliged to divert resources extracted from its assets, which should be destined to the pursuit of its activity and the realization of its corporate purpose, to the payment of the debt and the financial charges relating to the acquisition of the equity participations in its capital by others." (pages 62 and 63 of the Decision)

With application ipis verbis to the case in these proceedings!!!

And if the company does not have financial support to bear charges of that amount (millions in interest) and enters into an insolvency process?!!

"Accordingly, the said financial costs do not fit within the definition of costs and losses (expenses) for purposes of determining taxable profit, since the assumption of the charges in question was determined by corporate motivations within a policy of particular interests dictated by the responsible parties of the interlinked companies and that concerns only them, and accordingly, such costs should not be deemed indispensable, in harmony with the provisions of Article 23 of the Corporate Income Tax Code".

For which reason I cannot accompany the learned decision delivered.

The well-founded Report of the Tax Authority deserved a better destiny."

Finally, a few small notes on the text specific to the Decision delivered in this Case.

• In subparagraph i) of the Proven Facts it is given as proven only the transmission of liabilities, without any reference to the transmission of assets, and if later it is invoked that all of this is very characteristic of the merger, then by the merger "the merged companies are extinguished […], with their rights and obligations transmitting to the surviving company" (Article 112, subparagraph a), of the Commercial Companies Code). (with emphasis ours)

Therefore, I do not see how not to also give as proven that the rights are likewise transmitted, but to third parties, not the Claimant.

I could, for example, conclude the final part of this subparagraph i) with the following:

", without the assets having been transmitted to it."

Then, probably, in this case we are not in the presence of a merger, because the Rights were not transmitted to the surviving company, only the Liabilities.

• With due respect, I do not agree that the Directive recognizes absolute tax neutrality to these corporate restructuring operations, as is stated on page 7, penultimate line of the Decision.

What the Directive does to these and other operations is to say what is not taxed so that there can be neutrality. But it is not absolute and is manifestly relative.

• On page 11, 1st paragraph, after stating that:

"The merged company is extinguished, undoubtedly; but all rights and obligations are transmitted to the surviving Company, which continues the activity of the 'deceased'," does not fully correspond to reality, for the reasons already stated in i) of this note.

First, because all liabilities are transferred, but not all rights (the shares and the rights they represent go to third parties and are not transferred to the Claimant).

Second, because the merged company ceases to conduct the activity of the surviving company, which was "provision of administrative services and support to transport companies," with there being no evidence in the proceedings of this fact.

Unless it is also considered as such the administrative services that it provides to itself and in support of its own activity, because regarding support to third companies, after the merger, there is no record of this fact in the proceedings.

• When it is said on page 12, 2nd paragraph that the interest was applied in operations, it is important to consider that after the merger the operations are not the same.

• In the 1st paragraph of page 13 it is again stated that the "transmission of all rights and obligations of the merged company…," when in reality the only rights (shares) that were at the origin of the only liabilities (interest) assumed, were not transmitted. This reality is in a way and with all due respect, obscured in the Decision and should not be.

• Page 13, 3rd paragraph.

The example given with respect to the machine does not help to reinforce my modest position regarding this matter. As follows.

Interest on a loan intended to buy a machine that is later "abandoned."

This situation is completely different from what happens in our case.

Here, the shares of the Claimant, property of "C...", do not disappear, they were transmitted to third parties.

That is, there is a third entity that will benefit in the future from the distribution of dividends of the Claimant, or will obtain a capital gain when it resells them.

The shares were not "abandoned."

They are even in good hands and will be very profitable.

They were not "shut down."

They are very much alive and valuable.

But we have a better example.

The D... SGPS, S.A. holding the final entirety of the share capital of the Claimant and creditor of the interest on the shareholder loans, which effected in the company merged into the Claimant (C...) and which this (Claimant) assumed as its charge, decides to contract a bank loan to address the increase of share capital of its subsidiary (Claimant/A...), which was materialized.

With such a loan it bears interest of €100,000 a year.

As the Claimant has still not distributed dividends, D... has difficulty bearing that charge.

Easy!!!

It promotes an inverted merger with the Claimant, which incorporates it and the interest in question, which was already a tax cost, continues to be so, but now of the only company among all of these that were called to intervene in this proceeding (some created from scratch for this purpose), that generates profits and possesses liquidity – the Claimant. Always and only the same!!!

And thus, such fund E... becomes the sole shareholder of the Claimant, a Claimant that pays the following interest:

• To the Bank that financed the merged company so that it itself would be bought;
• Ceases to pay itself, because it incorporates the company that was creditor of such interest, the shareholder loan interest;
• To the Bank that financed its sole shareholder to address its share capital increase.

Reasons for which I cannot accompany the learned decision rendered in the scope of this proceeding.

(Jorge Carita)

[1] C..., which had as corporate purpose – "Provision of administrative services and support to transport companies." Began activities on 24.09.2010 and was extinguished through merger registered on 1.09.2011, not reaching a full year of the exercise of its activity of provision of services.

[2] I do not know why I did not think of this sooner, as I would have created a special purpose vehicle, bought... before they destroyed it, the energy companies and the insurance companies, before the Chinese took over, and ..., before the French made thousands of euros with it.

Well, if the purchase of ..., effected by my personal Holding, would be paid by ... itself, that of ..., of ..., of ..., by each one of them, and that of ..., precisely by ... itself and one avoids the hassle of the French always increasing airport fees…