IRC Double Taxation Relief on Distributed Profits

Process: 161/2013-T

Date: March 10, 2014

Tax Type: IRC

Summary

CAAD Arbitral Process 161/2013-T addressed three critical IRC (Corporate Income Tax) issues involving fiscal year 2007 assessments totaling €768,530.35. The taxpayer, a real estate development company, challenged IRC assessments arising from a second internal tax inspection that corrected previously reported tax losses. The central dispute concerned whether distributions from revaluation reserves established under Decree-Law 430/78 qualified for the economic double taxation elimination regime under Article 46 (now Article 51) of the IRC Code. The taxpayer argued that €2,883,297.11 in distributed profits from extinguished revaluation reserves—created when revalued assets were subsequently disposed of—should be deductible as they were subject to actual taxation. The Tax Authority countered that revaluation reserves are non-distributable under fiscal legislation and cannot qualify as 'distributed profits' eligible for double taxation relief. Two procedural challenges were raised: first, whether conducting successive internal inspections on identical subject matter violated the principle of non-repetition of tax inspections; second, whether the statute of limitations was four years (general period) or six years (special period under Article 45(3) LGT) when tax losses are utilized within the shorter timeframe. The Tax Authority defended the second inspection citing Article 63(4) LGT provisions for internal inspections and asserted authorization from the head of service. Regarding limitations, the Authority argued the extended six-year period applies universally to loss carryforward situations regardless of when losses are actually deducted. The arbitral tribunal examined whether formal defects invalidated the assessments and the correct interpretation of economic double taxation elimination rules for distributions originating from fiscal revaluation reserves.

Full Decision

Arbitral Proceeding No. 161/2013-T

Claimant: A..., Lda.

Respondent: Tax and Customs Authority

ARBITRAL DECISION

The arbitrators, Dr. Alexandra Coelho Martins (arbitrator chair), Dr. António Moura Portugal and Dr. Luís Manuel Pereira da Silva (arbitrator members), designated by the Ethics Council of the Centre for Administrative Arbitration (CAAD) to form the Arbitral Tribunal, constituted on 10 September 2013, agree as follows:

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 FACTUAL REPORT
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1.1. The company A..., Lda., Legal Entity No. …, with registered office at Avenue …, …, hereinafter designated as the "Claimant", requested the constitution of the Arbitral Tribunal, in accordance with Article 2, No. 1, paragraphs a) and b), and Article 10, both of Decree-Law No. 10/2011, of 20 January.

1.2. The request for arbitral determination has as its object the annulment of the following tax acts:

(a) Corporate Income Tax assessment No. 2013 ..., which established the tax losses of fiscal year 2007 at € 4,612,816.08;

(b) Corporate Income Tax assessment No. 2013 ..., which established the Corporate Income Tax payable relating to fiscal year 2009 in the amount of € 57,022.72, as a result of the correction of tax losses from 2007; and

(c) Corporate Income Tax assessment No. 2013 ..., which established the Corporate Income Tax payable relating to fiscal year 2010 in the amount of € 706,894.87, also as a consequence of the correction of tax losses from 2007.

1.3. To support this request, the Claimant alleges that the Tax Authority conducted two inspections on the same subject matter (determination of the 2007 fiscal profit), having successively made two different decisions and opened a new inspection procedure without authorization from the head of the service. Circumstances which, in its view, invalidate the tax acts in question, resulting from the second inspection, due to omission of legally required formalities.

The Claimant also considers that the right to make corrections to the taxable base of 2007 and to the amount of losses to be carried forward in subsequent fiscal years has expired, as the general statute of limitations period (of four years) applicable to the specific situation has been exceeded. It argues that since the tax loss was deducted within the four years (standard) of the statute of limitations, the extension of the period (up to six years) provided for in Article 45, No. 3 of the General Tax Law (LGT) is not applicable, resulting in the illegality of the contested assessments.

Finally, it raises incorrect quantification and qualification of the tax event and defect in reasoning. In this context, it considers that the increase to the taxable profit for 2007, in the amount of € 2,883,297.11, and the consequent reduction of the tax loss to be carried forward in that and in subsequent fiscal years, violate the provisions of Article 46 of the Corporate Income Tax Code (current Article 51 of the same Code), as these are distributed profits that were subject to actual taxation, and therefore these income items cannot fail to be deducted in determining its taxable profit for 2007.

It argues that the fact that the distribution of profits in question originated from a revaluation reserve established under Decree-Law No. 430/78, of 27 December, does not deprive it of the nature of distributed profits, given that the revalued assets were subsequently disposed of and, consequently, the reserve associated with the revaluation was extinguished, through transfer to carried forward profits, whereby it became "profit from prior fiscal years". It considers that Decree-Law No. 430/78 refers to forms of utilization of the reserve as such, and not to its realization or extinction.

It requests the annulment of the assessments with the legal consequences, including the annulment of the compensation interest assessed.

1.4. The Respondent filed a Reply and attached the Administrative File (AF). It alleges, firstly, that there are no limits to the conduct of inspection actions of an internal nature, such as those at issue here, for which it invokes the provisions of Article 63, No. 4 of the LGT, in addition to which the final inspection action was preceded by authorization from the head of the service.

Regarding the statute of limitations period, it argues that this cannot be other than the extended period (for the exercise of the right) as provided for by law, which does not establish any distinction for situations in which the taxpayer carries forward losses within a period shorter than the statute of limitations (general), as already endorsed by the Southern Administrative Central Court (TCAS).

Additionally, it considers that the distribution of results was not subject to actual taxation and does not fall within the concept of distributed profit, as it corresponded to a distribution of revaluation reserves created under fiscal legislation and, as such, non-distributable. It further argues that the Claimant did not substantiate or prove the facts relating to the alleged disposal of the revalued assets. It concludes that, for tax purposes, the distribution of results originating from the revaluation reserve established under Decree-Law No. 430/78 cannot be classified under the concept of distributed profits and constitutes taxable income in the sphere of the shareholder, in accordance with Article 20, No. 1, paragraph c) of the Corporate Income Tax Code, to which the mechanism for eliminating economic double taxation provided for in Article 46 (current 51) of this Code is not applicable.

It emphasizes, finally, that the Claimant raised the defect of lack of reasoning without substantiating such allegation in any part and argues for the dismissal of the request for arbitral determination and absolute discharge from the claim.

1.5. On 7 January 2014, the first meeting of the Collective Arbitral Tribunal took place, at the headquarters of CAAD, in accordance with Article 18 of the RJAT. No exceptions were identified, the production of witness evidence and the submission of arguments were dispensed with, and 10 March was set for the pronouncement of the arbitral decision.

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 ISSUES TO BE DECIDED
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There are essentially three issues to resolve:

(a) whether the succession of internal inspection actions (two) on the same subject matter, the same tax, and the same fiscal year is capable of invalidating, due to formal defect, the assessments resulting from the second inspection and which are the subject of the arbitral action;

(b) to determine whether the statute of limitations period, in the case of deduction and carrying forward of losses, is the general period (of four years) or the special period provided for in Article 45, No. 3 of the LGT, that is, the period for the exercise of the right in question (of six years), in the case in which said losses are utilized within the four-year period, as occurs in the situation at hand;

(c) whether the distribution to the Claimant of results (carried forward) that originated from revaluation reserves made under fiscal legislation (specifically, Decree-Law No. 430/78, of 27 December) can be classified under the regime for eliminating economic double taxation of distributed profits provided for in Article 46, No. 1 (current Article 51, No. 1) of the Corporate Income Tax Code.

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 ESTABLISHED FACTS
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With relevance for the assessment and decision on the merits, the following facts alleged by the parties are established as proved:

A) The company A..., Lda., now Claimant, has as its object the construction and sale of buildings (real estate development) – CAE 41200 – and is subject to Corporate Income Tax under the general taxation regime (cf. Second Tax Inspection Report, AF, Part 7 and reasoning of the Hierarchical Appeal decision, AF, Part 8).

B) On 16 July 2002, a contract for the promise to sell was entered into between the Claimant and the promissory sellers, B... and C..., relating to the entirety of the shares representing the capital of the Portuguese limited company D..., Real Estate, S.A., hereinafter referred to as "D...", under the express presupposition that the urban real estate described in the Property Register of … under No. ..., located at Rua ..., parish and municipality of …, registered in the matrix of the parish of … under No. ..., was the property of D... at the time of the transmission of the shares (cf. Second Tax Inspection Report, AF, Part 7 and copy of the promise contract, AF, Part 3).

C) On 30 December 2003, the Claimant acquired all of the capital of D... for the value of € 15,600,000.00 (cf. Second Tax Inspection Report, AF, Part 7).

D) On this date, the urban real estate described in the Property Register of … under No. ..., located at Rua ..., registered in the matrix of the parish of … under No. ..., composed of factory and administrative facilities, was part of the assets of D... (cf. Second Tax Inspection Report, AF, Part 7).

E) The Claimant sold two hundred shares of D... to its managers (cf. Second Tax Inspection Report, AF, Part 7).

F) On 23 December 2004, D..., was transformed into a limited liability company, becoming designated as D... – Real Estate, Lda., with the Claimant holding a participation corresponding to 99.98% of the capital, represented by a quota with the nominal value of € 1,474,000.00, and the other two partners – E... and F... – with a participation of 0.01% each, represented by two quotas of € 500.00 each (cf. Second Tax Inspection Report, AF, Part 7).

G) On 21 December 2005, the Claimant acquired from D... the land previously referred to (paragraph D above), which originated from property registration number ..., for the value of € 25,297,500.00, having recorded the purchase thereof in account 3211701 – merchandise – Land Rua ... (cf. Second Tax Inspection Report, AF, Part 7 and copy of the deed, AF, Part 3).

H) On 28 February 2007, the General Meeting of D... unanimously resolved to distribute to the partners the balance of the Carried Forward Earnings account, which was in the amount of € 3,863,189.03 (cf. Minutes No. 21 of the General Meeting relating to the approval of accounts and distribution of earnings for fiscal year 2006 attached as Doc. 1 to the arbitral request and Second Tax Inspection Report, AF, Part 7).

I) The Claimant, which held a quota representing 99.98% of the capital, received a distribution of € 3,860,569.91 (cf. Minutes No. 21 of the General Meeting relating to the approval of accounts and distribution of earnings for fiscal year 2006 attached as Doc. 1 to the arbitral request and Second Tax Inspection Report, AF, Part 7).

J) The carried forward earnings distributed by D... to its partners in 2007 originated from:

(i) A revaluation reserve in the amount of € 2,885,253.21, created under Decree-Law No. 430/78, of 27 December;

(ii) A revaluation reserve in the amount of € 953,743.01, created under Decree-Law No. 31/98, of 11 February;

(iii) The positive net earnings for 2006, in the amount of € 30,192.81.

(cf. Second Tax Inspection Report, AF, Part 7).

K) The difference between these three items, which total € 3,869,189.03, and the amount distributed, relates to the amount overpaid, by error, by D... in 2006 to its partners, as a distribution of profits (cf. Second Tax Inspection Report, AF, Part 6).

L) The two revaluation reserves [mentioned in paragraphs J), i) and ii)], had been created by a company named G..., from which D... was created by division, with the balance of the two revaluation reserves passing to the latter (cf. Second Tax Inspection Report, AF, Part 7).

M) Such revaluation reserves created by G... related to adjustments made to the construction land, located at Rua ..., parish and municipality of …, registered in the matrix under No. ..., which was disposed of in 2005, in accordance with paragraph G) above (cf. First Tax Inspection Report, AF, Part 1).

N) The Claimant considered that this distribution of the balance of the Carried Forward Earnings account, which it received in the amount of € 3,860,569.91, was classifiable under the provisions of Article 46, No. 1 of the Corporate Income Tax Code (current Article 51, No. 1), having deducted such income in determining the taxable profit for fiscal year 2007 (cf. Tax Inspection Report, AF, Parts 7 and 8, proved by agreement).

O) In fiscal year 2007, and following the aforementioned distribution, the Claimant proceeded to the dissolution and liquidation of D..., which resulted in a declared tax loss of €7,014,413.53 (cf. First Tax Inspection Report, AF, Part 1, and Second Tax Inspection Report AF, Part 7).

P) The Claimant declared this loss in the amended return filed on 29 May 2009, whereby it altered the tax loss declared from € 481,699.66 to € 7,496,113.19 (cf. First Tax Inspection Report, AF, Part 1 and Second Tax Inspection Report PA, Part 7).

Q) The tax losses declared by the Claimant were utilized by it with reference to fiscal years 2008, 2009 and 2010 (cf. proved by agreement).

R) The Claimant was subject to a first internal inspection action, of limited scope – Corporate Income Tax, pursuant to Internal Service Orders OI... and OI2..., relating to fiscal years 2006 and 2007, respectively, which resulted in the First Tax Inspection Report communicated to the Claimant by the Tax Office of …, through Official Letter No. …/…, of 27 May 2010 (cf. First Tax Inspection Report, AF, Part 1).

S) Within this scope, the Tax and Customs Authority corrected the tax losses declared by the Claimant, in the amount of € 7,496,113.19, to the value of € 5,571,387.59, and this reduction in the amount of tax losses was essentially due, in the amount of € 1,915,198.79, to the partial non-acceptance, at 50%, of the deduction by the Claimant of the profits that had been distributed to it (cf. First Tax Inspection Report, AF, Part 1).

T) As grounds for said reduction of tax losses, this First Report mentions that the income distributed to the Claimant came from profits that had not been subject to actual taxation, and therefore, in light of what is stipulated in Article 20, No. 1, paragraph c) of the Corporate Income Tax Code, in conjunction with the provisions of Article 46, No. 11 (current Article 51, No. 10) of the same statute, would have to be added to taxable profit in the proportion of 50% (cf. First Tax Inspection Report, AF, Part 1).

U) The First Tax Inspection Report states (pp. 10-11) on the lack of actual taxation that:

"(…) we can conclude that revaluation reserves created under fiscal legislation associated with land are not effectively taxed, given that these are not subject to depreciation. However, for the calculation of capital gains and losses, the value of the adjustments (updates made) is excluded, not because these are not accepted for tax purposes, but so that the monetary correction coefficients are not applied twice: once by the revaluation under fiscal legislation and another by application of Article 44 of the Corporate Income Tax Code.

Returning to the case in question, as referred to in section III above, these are revaluation reserves created by G..., under the aforementioned legislative diplomas which passed to D... upon the division. These reserves relate to adjustments made to construction land, located at Rua ..., parish and municipality of …, registered in the respective matrix under No. ... and disposed of in fiscal year 2005.

Given that D..., in the year 2005, was classified under the simplified regime provided for in Article 53 of the Corporate Income Tax Code, the profit resulting from the disposal of said land was taxed not by the accounting result (Net earnings = €20,644,926.68), but by the sale value of the land and treated as sale of inventory, applying the coefficient of 0.2 to the sale value, as provided for in No. 4 of Article 53 of the Corporate Income Tax Code. A tax profit of € 5,059,500.00 = €25,297,500.00*0.2 was thus determined, following the intervention of the tax inspection, in accordance with the conclusions report prepared on 03 December 2009.

However, for the revaluation reserve in question to have been taxed, to the Net Result determined by 2005 accounting totaling €20,644,926.68, the adjustments associated with the revaluation reserves of € 3,830,397.58 would still have to be added, resulting in the profit of € 24,475,324.26 (€20,644,926.68 + € 3,830,397.58) and not the profit actually declared and taxed of € 5,059,500.00.

Thus, it is demonstrated that the amount distributed by D..., in the amount of € 3,830,397.58, was not subject to taxation in the sphere of D..., and therefore will have to be taxed in the sphere of A..., by virtue of what is stipulated in paragraph c) of No. 1 of Article 20, in conjunction with the provisions of No. 11 (current 10) of Article 46 (current 51) Corporate Income Tax Code."

V) The Claimant filed a Gracious Petition opposing the correction of the 2007 tax losses resulting from this first inspection action, with the consequent impact on the following fiscal years, and requested its annulment. The Petition was dismissed on 15 April 2011 (cf. AF, Part 6, Gracious Petition proceeding No. ...).

W) The Claimant filed a Hierarchical Appeal, which was entirely granted by Order, dated 4 December 2012, of the Deputy Director-General, legal substitute of the Director-General of the Tax and Customs Authority, who adheres to the terms proposed in Report No. …/2012 of the Directorate of Corporate Income Tax Services (cf. AF, Parts 6 and 7, Gracious Petition proceeding No. ...).

X) According to the cited Report No. …/2012, of 17 September 2012, of the Directorate of Corporate Income Tax Services, which contains the grounds for the Hierarchical Appeal:

"30. The appellant alleges that revaluation reserves never have relevance for the purposes of calculating capital gains resulting from the disposal of the assets to which they relate, since the calculation of tax capital gains is not influenced by the revaluation value of the asset.

In fact, the issue raised by the appellant, regarding the calculation of capital gains and losses, is not relevant to the assessment of the present matter, as is well known, the determination of tax result results from the difference between the realization value minus the charges inherent to it and the historical cost of the asset, corrected by the monetary devaluation coefficient.
To determine the gain or loss, in tax terms, values resulting from revaluation are not taken into account, so the taxpayer's allegation does not allow for inferring the actual taxation of these reserves.
This same issue had already been raised in the petition, being subject to assessment by the Tax Office of …, resulting in Report No. …/2011, which ruled on the accounting and tax classification of revaluation reserves, in force at the time of the facts.
Thus, we will proceed to the classification of revaluation reserves, for the purposes of the provisions of Article 46 (current Article 51) of the Corporate Income Tax Code, keeping in mind understandings already previously issued by this Directorate of Services, sanctioned at a higher level.

On the Accounting Classification

According to accounting directive No. 16/95 'to revalue an asset means to adjust, usually by increase, the amount recorded for it; this increase, after adjusting the corresponding accumulated depreciation, if applicable, gives rise to an excess, not yet realized, to be recorded in equity.
The said Directive provides that revaluation can be made on the basis of the change in the purchasing power of the currency or on the basis of fair value. Establishing in point 3.3 thereof, that the excess obtained as a result of the updating process and recorded in equity cannot serve, from a strictly accounting perspective, as a basis for increasing capital or covering losses.
The revaluation reserve cannot be used to increase capital or cover losses except to the extent that it is realized, with realization considered to occur through use, that is, through depreciation or disposal of the respective assets.
Only the realization, partial or total, of this excess that implies the corresponding transfer to account 59 – Carried Forward Results, will permit the aforementioned applications or others, with this excess, which implies the corresponding transfer to account 59 - Carried Forward Results, able to permit the aforementioned applications or others, with this excess only considered realized through use or disposal of the assets to which it relates (Cf. Point 2.4.).
Accounting Directive No. 16/95 further emphasizes that legislative diplomas that have permitted the so-called fiscal revaluations exceed the fiscal scope and have encroached on the corporate area, by establishing the destination to be given to the revaluation reserve – namely, the coverage of accumulated losses up to the date to which the revaluation relates, and the incorporation in the capital stock of the remaining part.
Indeed, the legislative diplomas that permit the constitution of revaluation reserves under fiscal legislation, particularly Decree-Laws No. 429/78 [430/78] and 31/98, provide that the use of these reserves is only possible for the coverage of accumulated losses up to the date of the revaluation or for increases in capital. On the other hand, these two diplomas establish the consequences in case of improper use of the revaluation reserve.

On Tax Classification

The mechanism for eliminating economic double taxation is provided for in No. 1 of Article 51 of the Corporate Income Tax Code, which permits distributed profits corresponding to income included in the tax base to be deducted, provided that the respective requirements are met, in particular, that the company distributing the profits is subject to and not exempt from Corporate Income Tax. However, current No. 10 of Article 51 of the Corporate Income Tax Code provides that the deduction for economic double taxation, provided for in No. 1, is only applicable when the income derives from profits that have been subject to actual taxation.
As stated in Circular 24/11, the requirement of actual taxation provided for in No. 10 of Article 51 of the Corporate Income Tax Code should be interpreted to require that the income derives from profits that have borne Corporate Income Tax, or another tax on profits that is identical or analogous, and that are not excluded from or exempt from it.
It is further stated in the said Circular that the requirement of actual taxation should be considered met when the company that generated the distributed profits does not benefit from an exemption and such profits originate from income that does not benefit from any exemption or occur, as a result of applicable legislation, permanent disregard of such income for purposes of determining the tax payable.
Additionally, effectively taxed profits should also be considered when there is no tax liability as a result, for example, of the deduction of tax losses, tax deductions, or even timing differences between taxable profit and accounting net result, since such profits derive from income that is included in taxable profit.
Thus, for purposes of assessing the requirement of actual taxation, only the tax charges finally borne are relevant, regardless of the form in which it is collected, making irrelevant the amounts borne as payment on account, special payment on account, withholding at source, or autonomous taxation.

Taxation of 2007 Profits

The distribution of profits made by D... in favor of A... in fiscal year 2007 for the value of € 3,860,569.91, determined by the Inspection Services described above, given the differences between the various components, requires an individualized analysis.
The revaluation reserve established under Decree-Law No. 430/78, results from Nos. 2 and 3 of Article 5 of that legal provision, that the revaluation reserve can be used for coverage of accumulated losses up to 31 December and for increase in capital. On the other hand, non-compliance with the use of the reserve is subject to the application of a fine in an amount equal to 30% of the value of the improperly used revaluation reserve, this being the only effect provided for as a result of non-compliance.
Thus, given the formulation adopted by the legislator, we have that this revaluation reserve, made under fiscal legislation, cannot be used for purposes other than the coverage of losses or increase in capital, and therefore constitutes a non-distributable reserve, cannot, for tax purposes, correspond to the concept of distributed profit, and does not benefit, in the sphere of the shareholder, from the regime for eliminating economic double taxation, provided for in the then Article 46 (current Article 51) of the Corporate Income Tax Code.
With respect to amounts originating from a revaluation reserve created under Decree-Law No. 31/98, that legal provision equally prevents the use of reserves for purposes other than the coverage of losses or increase in capital, under penalty of being considered null for tax purposes. If improper use of the revaluation reserve results in its nullity, for tax purposes, we have that, by application of Accounting Directive No. 16/95, the realization, partial or total, of the reserve may permit its use for coverage of losses, increase in capital, or others. Thus, admitting the distribution of these reserves to the partner, we can admit that this is distributable profit, which was subject to taxation, and therefore the beneficiary of distributed profits can utilize the mechanism for avoiding economic double taxation, provided for in the then Article 46 (current Article 51) of the Corporate Income Tax Code.

It is verified that with respect to this item, the conditions for the deduction, in full, of the amount of € 953,743.01 are met, and it can benefit from the mechanism for avoiding economic double taxation.

In accordance with the concept of "actual taxation of distributed profits" advocated in Circular 24/2011, the requirement of actual taxation provided for in No. 10 of Article 51 of the Corporate Income Tax Code should be interpreted to require that the distributed results derive from profits that have borne Corporate Income Tax, or another tax on profits that is identical, and that are not excluded from or exempt from it.

Thus, the requirement of actual taxation should be considered met, in the sphere of the company generating income, since it is not covered by an exemption regime, nor occurred, as a result of applicable legislation, any permanent disregard of such income for purposes of the tax payable. Thus, the profits distributed by it cannot but be considered effectively taxed for purposes of application of No. 11 of Article 46 (current No. 10 of Article 51) of the Corporate Income Tax Code.

In summary, the correction of the amount of € 3,960,569.91 obtained by A..., as a distribution of results, by considering that the entirety of this amount is equivalent to distributed profits not subject to actual taxation, for purposes of what is provided for in the then No. 11 of Article 46 (current Article 51) of the Corporate Income Tax Code, should not proceed, since the reasoning was based on the assumption that these were distributed profits not subject to actual taxation, which proves to be at variance with what has been set forth above.
Note that if the revaluation reserve is not realized, it is not distributable, and does not fall within the concept of distributed profit, and therefore the regime provided for in the then Article 46 (current Article 51) of the Corporate Income Tax Code will not be applicable.
It should be noted that, in any case, the amounts received by A..., shareholder of H..., constitute a positive component in the formation of its respective taxable profit.
The Tax Office further requests clarification on whether the profits of the period 2006 distributed in 2007, which benefited from the carrying forward of losses from prior periods, can be considered as effectively taxed.
In this regard, Circular 24/2011 was recently issued by the Directorate General of Tax Revenue, which aims to clarify the concept of "actual taxation of distributed profits". And in accordance with point 5 of the said Circular, distributed profits are considered effectively taxed when there is no tax liability as a result, inter alia, of the deduction of tax losses.
Thus, when loss carryforward is effected, we are faced with the mere application of the principle of solidarity among taxation periods, and it cannot be affirmed that there is an absence of actual taxation. Therefore, distributed profits relating to a period in which the mechanism of carrying forward tax losses was used, in accordance with the former Article 47 (current Article 52) of the Corporate Income Tax Code, cannot but be considered effectively taxed for purposes of applying No. 11 of Article 46 (current Article 51).
In summary, we have:

i) With respect to the reserve established under Decree-Law No. 430/78, in the amount of € 2,885,253.21, this cannot be used for purposes other than the coverage of losses or increase in capital, and therefore cannot, for tax purposes, correspond to the concept of distributed profit, and does not benefit, in the sphere of the shareholder, from the regime for eliminating economic double taxation, provided for in the then Article 46 (current Article 51) of the Corporate Income Tax Code. It results from the Inspection Report that the correction made by the Tax Services only corrected 50% of the value of the reserve, considering that this had the nature of distributed profit, not subject to actual taxation.

The revaluation reserve created under Decree-Law No. 430/78, in the amount of € 2,885,253.21, is incapable of being equated to a free reserve, and cannot be used for purposes other than those expressly provided for in the said legal provision, and consequently cannot be equated to distributed profit, and therefore there would be no room for the deduction provided for in Article 46 (current Article 51) of the Corporate Income Tax Code. However, pursuant to paragraph c) of No. 1 of Article 20 of the Corporate Income Tax Code, the amount received originating from this item is subject in full to taxation, and therefore must be integrated into the taxable profit of A..... Recognizing that the correction should have covered the entirety of the income obtained, of € 2,885,253.21.

ii) With respect to amounts originating from the revaluation reserve created under Decree-Law No. 31/98, this legal provision equally prevents the use of reserves for purposes other than the coverage of losses or increase in capital, under penalty of being considered null for tax purposes. If improper use of the revaluation reserve results in its nullity, for tax purposes, we have that, by application of Accounting Directive No. 16/95, the realization, partial or total, of the reserve may permit its use for coverage of losses, increase in capital, or others. Thus, admitting the distribution of these reserves to the partner, we can admit that this is distributable profit, which was subject to taxation, and therefore the beneficiary of distributed profits can utilize the mechanism for avoiding economic double taxation, provided for in the then Article 46 (current Article 51) of the Corporate Income Tax Code.

It is verified that with respect to this item, the conditions for the deduction, in full, of the amount of € 953,743.01 are met, being able to benefit from the mechanism for avoiding economic double taxation.

iii) It is understood in accordance with the concept of "actual taxation of distributed profits" advocated in Circular 24/2011, that the requirement of actual taxation provided for in No. 10 of Article 51 of the Corporate Income Tax Code should be interpreted to require that the distributed results derive from profits that have borne Corporate Income Tax, or another tax on profits that is identical, and that are not excluded from or exempt from it.

In summary, the correction of the amount of € 3,960,569.91 obtained by A..., as a distribution of results, by considering that the entirety of this amount is equivalent to distributed profits not subject to actual taxation, for purposes of what is provided for in the then No. 11 of Article 46 (current Article 51) of the Corporate Income Tax Code, should not proceed, since the reasoning was based on the assumption that these were distributed profits not subject to actual taxation, which proves to be at variance with what has been set forth above.
Pursuant to Nos. 1 and 2 of Article 77 of the LGT, there results the duty of express and unequivocal reasoning of the tax act, to which the Tax Administration is bound in the practice of its acts.
Considering that the tax act of assessment, which is contested here, derives from an inspection action conducted on the taxpayer, whose conclusions are expressed in the final report that identifies and systematizes the facts detected and their tax-legal qualification, in accordance with the provisions of Article 62 of the RCPIT, and that tax acts resulting from the report can be grounded in its conclusions.
It is found in published doctrine on the appropriateness of reasoning "It is a contextual reasoning, that is, materially associated with the decision, with posterior or successive reasoning not being permitted in Portugal, contrary to other legal systems, to request by the interested party, but only the mere communication of the grounds omitted in the notification of the decision, in accordance with the law. The reasoning must, therefore, be contemporary to the act and appear, directly or by reference, in the same formal instrument of decision, without prejudice to the legal possibility of ratification/remedy of the defect of lack of reasoning, and must also be express. (emphasis added)
Given that we are dealing with fiscal year 2007, on this date, the four-year statute of limitations period provided for in No. 1 of Article 45 of the General Tax Law has already expired. However, the taxpayer determined a tax loss in fiscal year 2007, and thus the extension of the statute of limitations period provided for in No. 3 of Article 45 of the LGT applies.

(…)

III – Conclusion and Proposed Decision

In view of the foregoing, it is our opinion that the present hierarchical appeal should be granted, in accordance with what we briefly set forth below:

A) Distribution of Dividends

It seems to me to grant the taxpayer's request, annulling the correction made by the Tax Services, due to inapplicability of No. 11 (current No. 10) of Article 46 (current Article 51) of the Corporate Income Tax Code, to the profits distributed by the subsidiary, in the amount of € 1,915,198.79.

However, proposing the correction to the amount of losses determined in 2007, by adding to the taxable result of A..., the benefit relating to the distribution of results originating from the revaluation reserve, in the amount of € 2,885,253.213, established under Decree-Law No. 430/78, of 27 December, which should be constituted as taxable income, in accordance with the provisions of paragraph c) of No. 1 of Article 20 of the Corporate Income Tax Code, to which the mechanism for eliminating economic double taxation provided for in current Article 51 of the Corporate Income Tax Code is not applicable.

A... determined in the taxation period of 2007 a tax loss, deducted in the periods of 2008 and 2009, and therefore the six-year statute of limitations period is still running, which results from the conjunction of No. 3 of Article 45 of the LGT, with No. 1 of Article 46 of the Corporate Income Tax Code (numbering and wording in force at the time of the facts), and therefore it will be proposed to open a new service order to correct the omissions of the taxpayer." (cf. AF, Parts 6 and 7).

BB) The correction of the 2007 tax losses resulting from the First Inspection Report was annulled (proved by agreement).

CC) On 28 January 2013, Internal Service Order OI..., of limited scope – Corporate Income Tax, was issued, relating to fiscal year 2007, which resulted in the Second Tax Inspection Report, communicated to the Claimant by Official Letter No. …/…, dated 2 April 2013 (cf. AF, Parts 7 and 8), in which it is concluded:

"In summary, the Corporate Income Tax Services Directorate concludes that the correction of the amount of € 1,915,198.79, made by considering that the income obtained by A..., as a distribution of results, in the amount of € 3,830,397.58, is equivalent to distributed profits not subject to actual taxation, for purposes of what is provided for in the then No. 11 of Article 46 (current 51) of the Corporate Income Tax Code, should not proceed, since the reasoning was based on the assumption that these were distributed profits not subject to actual taxation, which proves to be at variance with what is mentioned in Circular 24/2011.

(…)

However, a correction was verified to be made to the tax losses determined in 2007, of the benefit relating to the distribution of results originating from the revaluation reserve, in the amount of € 2,883,297.11 (€2,885,253.21*€ 1474,000.00/€1475,000.00), established under Decree-Law No. 430/78, of 27 December, which should constitute taxable income, in accordance with the provisions of paragraph c) of No. 1 of Article 20 of the Corporate Income Tax Code, to which the mechanism for eliminating economic double taxation provided for in current Article 51 of the Corporate Income Tax Code is not applicable.

(…)

The proposed correction is duly grounded in the response to the hierarchical appeal filed by the taxpayer, through Report No. …/2012, issued by the Corporate Income Tax Services Directorate (…)" (cf. AF, Part 8).

DD) Following this second internal inspection action relating to fiscal year 2007 and the Second Tax Inspection Report, corrections were made to the Claimant – increase to the 2007 taxable profit of € 2,883,297.11 – which are at the origin of the contested assessments, identified below:

(a) Corporate Income Tax assessment No. 2013 ..., of 8 April 2013, which established the tax losses for fiscal year 2007 at the value of € 4,612,816.08;

(b) Corporate Income Tax assessment No. 2013 ..., of 10 April 2013, which established the Corporate Income Tax payable, relating to fiscal year 2009, in the amount of € 57,022.72, as a result of the correction of the 2007 tax losses; and

(c) Corporate Income Tax assessment No. 2013 ..., of 10 April 2013, which established the Corporate Income Tax payable, relating to fiscal year 2010, in the amount of € 706,894.87, also as a consequence of the correction of the 2007 tax losses.

(cf. statements of Corporate Income Tax assessment attached with the request for arbitral determination and AF, Parts 7 and 8).

EE) On 8 July 2013, the Claimant filed the request for constitution of the Arbitral Tribunal (cf. electronic request in the CAAD system).

```
 FACTS NOT ESTABLISHED
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There are no facts with relevance to the decision on the merits that have not been established.

```
 REASONING REGARDING FACTUAL MATTERS
```

The established facts were based on critical analysis of the documents discriminated above, which were not challenged by the parties, and the contents of the administrative file attached to the proceedings.

It should be noted that in the Reply Articles (point 83), the Respondent alleges that the Claimant did not substantiate the facts relating to the operation of disposal of fixed tangible assets that had been revalued in 1978, seeming to ignore that the very Tax Inspection Report itself, produced following the first internal inspection action to which it was subject, states that the revaluation reserves originally created in the sphere of G... (and transferred in the context of a division operation to D...) related to land, specifically to construction land located at Rua ..., Matosinhos, registered in the matrix under No. ..., which was disposed of by D... to the Claimant in 2005 in accordance with the deed attached (paragraphs G), M) and N) of the statement of facts).

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 ON THE MERITS
```

6.1. The Principle of Non-Repeatability of Inspections and Its Inapplicability to Internal Inspections

The first issue under examination comes down to whether the internal inspection procedure is covered by the principle set forth in Article 63, No. 3 of the LGT (current No. 4) relating to the prohibition of two successive inspection procedures, when we are dealing with an identity of facts, tax, taxation period, and the same taxpayer.

The cited rule of the LGT provides that "the procedure of inspection and the duties of cooperation are appropriate and proportional to the objectives being pursued, with there being able to be more than one external fiscalization procedure with respect to the same taxpayer or tax-obligated party, tax, and taxation period only by means of decision, grounded on new facts, by the head of the service, except if the fiscalization aims merely at confirmation of the assumptions of rights that the taxpayer invokes before the tax administration and without prejudice to the determination of the tax situation of the taxpayer by means of inspection or inspections directed at third parties with whom the taxpayer maintains economic relations". (emphasis added)

From the literal element, it can be derived that the limitation on succession of procedures refers only to external fiscalization procedures, which Article 13 of the Supplementary Tax Inspection Procedure Rules (RCPIT) characterizes as that in which inspection acts are carried out, wholly or partially, in "facilities or dependencies of taxpayers or other tax-obligated parties or third parties with whom they maintain economic relations or in any other location which the administration has access to" (paragraph b)), by contrast with the internal procedure, in which inspection acts are carried out "exclusively in the services of the tax administration through formal and consistency analysis of documents" (paragraph a)).

Indeed, the meaning established in the literal interpretation leads us to the exclusion of this type of inspection procedure [internal] from the provision of Article 63, No. 3 of the LGT, not resulting in the prohibition of its repetition, it being presumed that the "legislator […] knew how to express his intention in appropriate terms" (cf. Article 9, No. 3 of the Civil Code).

This solution is understandable, as the main objective of the provision delimiting the tax authority powers of the Tax and Customs Authority is to prevent "the same taxpayer or tax-obligated party from being overburden with the inconveniences that external fiscalization actions are likely to cause them", as noted by Diogo Leite de Campos, Benjamim Silva Rodrigues and Jorge Lopes de Sousa, Annotated and General Tax Law, 4th edition, Encontro da Escrita, 2012, p. 271, in line with the principle of proportionality expressly adopted by Articles 5 and 7 of the RCPIT.

Now, internal inspections carried out exclusively within the Tax and Customs Authority "through formal and consistency analysis of documents", unlike external ones, do not entail the disturbance and interference in the sphere of taxpayers that are inherent to the practice of external inspection acts. The internal procedure contains fewer requirements in terms of guarantees of the taxpayers inspected, taking on a less formal and faster character, given its characteristics less intrusive in the life and commercial activity of the taxpayers inspected.

The two types of tax inspection procedures thus exhibit important differences in regime, being worthy of note, in particular, the suspension of the statute of limitations period for the right to assess which is provided for during "the conduct of external inspection acts, being sufficient for this that the taxpayer be notified of the beginning of the procedure", in accordance with Article 46, No. 1 of the LGT, a suspension that does not occur in cases of internal inspection – cf. Nuno de Oliveira Garcia, Rita Carvalho Nunes, "External Tax Inspection and the Relevance of Material Acts of Inspection", in Public Finance and Tax Law Review, Year IV, No. 1, March 2011, p. 249-268.

Another difference concerns the specific regime set forth in Article 36 of the RCPIT, according to which the inspection procedure is continuous and must be completed within a maximum period of six months, only being able to be extended by two further periods of three months, combined with its Article 64, whose applicability is limited to the external inspection procedure as stated in Arbitral Decision, proceeding No. 14/2012-T, cited above.

The interpretation supported by the literal element corresponds to the ratio of the rule (Article 63, No. 3 of the LGT) by reflecting enhanced protection of taxpayers in the case of external procedure, given its increased potential for harm.

Thus, absent new facts, taxpayers should not be subject to a second external inspection action. As for internal inspections, not being reflected in the practice of material acts of fiscalization with taxpayers (for otherwise, they should be qualified as external), the reason underlying the principle of non-repeatability (of external inspection actions) does not apply, and the restriction of internal inspection procedures could even represent an excessive and inhibitory limitation to the exercise of the fiscalization attributions of the Tax Administration.

In this sense, António Lima Guerreiro states that the "said principle of non-repeatability is applicable only to external inspections, not including, thus, internal inspections which may be repeated as many times as necessary" – cf. General Tax Law Annotated, Rei dos Livros, 2001, p. 293.

In the specific situation, it is manifest that we are dealing with two internal inspection procedures, both formally, as they were classified as such in the respective service orders – OI2... and OI ... [which relate to fiscal year 2007, of limited scope (Corporate Income Tax), relating to the same facts (distributed results originating from revaluation reserves created under fiscal legislation)] –, and from a substantive point of view, as no allegation has been made that any acts were carried out outside the services of the Tax and Customs Authority to obtain the relevant elements (cf. on the possibility of discrepancy between the formal classification of the inspection and reality, Nuno de Oliveira Garcia and Rita Carvalho Nunes, "External Tax Inspection and the Relevance of Material Acts of Inspection", in Public Finance and Tax Law Review, Year IV, No. 1, March 2011, p. 254; Arbitral Decision rendered in proceeding No. 14/2012-T, of 29 June 2012 and Decision of TCAS, proceeding No. 5303.12, of 10 July 2012).

As stated above, there does not exist a principle prohibiting successive internal inspections or non-repeatability of internal inspections, and therefore it is concluded that the alleged formal defect of "omission of legally required formalities" has not occurred.

Neither should the requirement (as the Claimant did) that the second procedure be preceded by a decision of the head of the service (based on new facts) be invoked. This requirement is provided for in Article 63, No. 3 of the LGT for a different situation: that of succession of (two) external inspections, and therefore is not applicable to the case under analysis.

However, it can be said that it is clearly evident from the chain of facts that the second Internal Service Order for fiscal year 2007 is a direct consequence of the decision (to grant) the Hierarchical Appeal, which proposes further corrections to the Corporate Income Tax of the Claimant, in accordance with Report No. …/2012 (cf. paragraph AA of the statement of facts). A decision taken by the Deputy Director-General, in the capacity of legal substitute of the Director-General of the Tax and Customs Authority, that is, by the head of the service (cf. paragraph Z of the statement of facts).

Another point is that the inspection procedure and the assessment procedure are distinct from one another, even though the former has a preparatory or ancillary character to the latter, and not all defects of the procedure necessarily produce effects on the validity of the assessment (cf. Decisions of the Supreme Administrative Court – "STA", proceeding No. 955/07, of 27 February 2008, and proceeding No. 103/08, of 4 June 2008).

It is equally noted that the successive adoption of two different decisions on the same subject matter, embodied in distinct assessment acts, with different legal grounds, is not contrary to law, contrary to what the Claimant seems to contend, as nothing prevents the Administration, following the issuance of an invalid act, from revoking it, provided it observes the legally determined periods, as occurred in the situation at hand, and replacing it with another (cf. Articles 138 and 141 of the Code of Administrative Procedure – "CPA").

This possibility is, moreover, required by the principle of legality, as otherwise, facing any defect of the tax act, following its annulment, the Tax and Customs Authority would not be able to redo that act (naturally purged of the respective invalidating defects) even if that act were materially due (or to the extent it were) in light of the norms of tax incidence.

The legal system must ensure the possibility of redefining the tax-legal situation of the taxpayer on the part of the Tax and Customs Authority until the expiration of the statute of limitations period for the right to assess, and to this, the principle of legal security and certainty does not oppose, as this principle cannot be preventative of taxation, if the material presuppositions of incidence are validly verified, and has as its scope the stability of tax situations which is achieved through another route, that of the consecration of a reasonable time limit for the exercise of the rights of the tax creditor, in this case the mentioned statute of limitations period.

For the reasons set forth, the defect of omission of legal formalities raised by the Claimant does not hold.

6.2. Statute of Limitations for the Right to Assess

The Claimant invokes that the general statute of limitations period for the right to assess, of four years, provided for in Article 45, No. 1 of the LGT, according to which "the right to assess taxes expires if the assessment is not validly notified to the taxpayer within four years, when the law does not fix another", has expired, and therefore the Tax and Customs Authority did not have the right to proceed with the alteration of the tax profit for fiscal year 2007 in April 2013 (the date to which the tax assessment acts relate). In summary, the tax acts would be illegal, due to expiration of the right to assess that occurred on 31 December 2011.

To conclude in this manner, the Claimant excludes the application of Article 45, No. 3 of the LGT (in conjunction with Article 46, No. 1 of the Corporate Income Tax Code (current Article 52, No. 1)), which provides that: "In the case of loss carryforward having been effected, as well as any other deduction or tax credit, the statute of limitations period is that for the exercise of that right", that is, the special extended period of six years in force at the time of the facts.

In summary, the Claimant makes a restrictive reading of the scope of application of the cited Article 45, No. 3 of the LGT, which implies that this would only cover situations in which tax losses had been utilized beyond the ordinary statute of limitations period (as mentioned above, of four years), a circumstance that did not occur in the specific case, as the tax losses were utilized within that general statute of limitations period, that is, in fiscal years 2008, 2009 and 2010, being entirely consumed in the latter year.

The Claimant relies on the position of Diogo Leite de Campos, Benjamim Silva Rodrigues and Jorge Lopes de Sousa, Annotated and General Tax Law, 4th edition, Encontro da Escrita, 2012, p. 190, which is presently as follows: "Pursuant to No. 3, the statute of limitations period, in the case of loss carryforward, is coincident with the period for the exercise of that right. That period is 6 years for the Corporate Income Tax and 5 years for the Individual Income Tax (Article 46 of the Corporate Income Tax Code and Article 54 of the Individual Income Tax Code).

If the taxpayer deducts the losses within a period of less than four years, or if the legal period is less, it can be sustained that this is the statute of limitations period, by analogy with what is provided for in No. 3; or the general period is applied (…)". (emphasis added)

In this sense, it seems to incline likewise, Ricardo da Palma Borges, (cf. presentation made to the Portuguese Tax Association on 28 February 2013), who considers inconclusive the literal element of Article 45, No. 3 of the LGT, in particular due to the lack of clarity of the expression "loss carryforward" and considers the deduction of losses as optional, a subjective right of the taxpayer (by contrast with an automatic and mandatory deduction).

He concludes that "the statute of limitations period for the right to assess is counted prospectively from the base year whether profits or losses have been determined" (a position with which we agree) and that "the statute of limitations period for the right to assess will only be different depending on whether profits or losses have been determined in base year 0 if these are not deducted within 4 years" (a position with which we do not agree).

The condition that the Claimant introduces, and that some doctrine supports, that tax losses be, or have to be, utilized beyond the ordinary statute of limitations period, in order for the scope of the provision of Article 45, No. 3 of the LGT to apply and to conclude for the applicability of the extension of the period, has no support in the text of the rule.

The mentioned Article 45, No. 3 of the LGT does not consecrate that condition nor postulate such a distinction, satisfying itself with the positive requirement of loss carryforward having been effected ("in the case of loss carryforward having been effected"). The Claimant's understanding thus presupposes a distinction that was not manifested by the legislator, i.e., that the 4-year period in loss carryforward has been exceeded. Additionally, not only are no reasons discerned for why the interpreter should distinguish, but it appears that the introduction of that additional requirement, lacking support and legal framework, would violate the principle of legality, since expiration of rights integrates the substantive regime of the tax credit (cf. Article 103, No. 2 of the Constitution of the Portuguese Republic – "CRP").

Moreover, the institute of expiration or fixed-term periods, as a rule, does not attribute effects to the conduct of the rights holder. As Vaz Serra emphasizes "Statute of limitations periods, as they forego consideration of the negligence of the rights holder, run even if no negligence is attributable to the latter". And in another passage, "the law in fixing expiration does so for objective reasons of legal security, without attention to the negligence or inertia of the rights holder, attending only to the need to define with brevity the legal situation" – cf. "Expiration and Statute of Limitations", in Bulletin of the Ministry of Justice, Nos. 105, 106 and 107, 1961 (pp. 177 and 178).

In accordance with the understanding advocated, the Decision of the TCAS, in proceeding No. 2857/09, of 22 January 2013, is reviewed:

"(…) both in the initial wording, as well as in the one introduced by L. 55-B/2004 of 30.12. (State Budget for 2005), the same [Article 45, No. 3 of the LGT] aims to establish specific statute of limitations period in the hypothesis of having effected loss carryforward (and/or any other deduction or tax credit), establishing the rule of equivalence to the period for the exercise of that right of carryforward. In another formulation, No. 3 of Article 45 LGT, similar to the preceding Nos. 1 and 2, merely provides, for a determined universe of cases, a statute of limitations period for the right to assess, without any determination at the level of its calculation, such that from its content only the principle of equal duration of the periods established in the laws of the diverse taxes, for exercising eventual loss carryforward (…) recorded in the operation of each tax and the statute of limitations period of the corresponding assessment can be withdrawn. For example, in the field of Corporate Income Tax, currently (2), losses recorded by taxpayers may be deducted, carried forward, during 6 years/taxation periods, such that it follows that, also, it is 6 years, instead of the 4 years of the general rule, the competent statute of limitations period for the right to assess of that tax, in situations of this kind. In sum, No. 3 of Article 45 LGT constitutes the establishment, by law, of a period of expiration with duration different from the normal period, imposed in its No. 1 and as it is established to be possible, in the respective final segment.

Embraced this reading and breadth of the legal provision under analysis, it follows obviously, by consequence, to affirm that, in cases of effected loss carryforward, the calculation of the competent statute of limitations period for the right to assess must be processed in strict compliance with the common rules, applicable to all periods of tax expiration, positivized in No. 4 of the same Article 45 LGT.

Thus, for periodic taxes such as Corporate Income Tax, the statute of limitations period, casually relevant, must be, always, counted "from the end of the year in which the tax event occurred".

That is, situations of loss carryforward do not presuppose any kind of specificity at the level of the form of computing the statute of limitations period, determined by correspondence with the period of permission of the exercise of the possibility of deferred deduction." (emphasis added)

Equally, Counselor Joaquim Gonçalves emphasizes that:

"The rule now contained in No. 3 of Article 45 of the LGT implies that the statute of limitations period be, in the case of having effected loss carryforward, coincident with the period for the exercise of that right. Which is understandable.

The maximum period for the exercise of loss carryforward is, currently, 6 years for Corporate Income Tax (wording given to Article 46 of the Corporate Income Tax Code, by No. 1 of Article 3 of DL No. 18/97, of 21/; see also Article 6, No. 1 of DL No. 14/98, of 28/1) and 5 years for Individual Income Tax (Article 54 of the Individual Income Tax Code).

However, it remains open to question whether the general 4-year period or the period for the exercise (specifically) of the right to carryforward applies when the taxpayer proceeds to deduct losses within a period of less than four years: on the one hand, Nos. 2 and 3 of the article configure themselves as deviations from the general rule contained in No. 1; on the other hand, if the general period only applies when the law does not fix another (No. 1), it does not seem to be the case, as here a new period is fixed, equivalent to that for the exercise of carryforward. In any event, we hold that the statute of limitations period for the assessment will, in these cases, be the maximum period abstractly considered in law for the exercise of the deduction – 6/5 years – and not the concrete period actually used for that purpose. Especially because, in certain cases, the maximum period for carryforward is less than the general period of expiration, as occurs in the hypothesis provided for in No. 3 of Article 54 of the Individual Income Tax Code" – cf. by the author "Expiration in the Face of Tax Law", in Fundamental Issues of Tax Law, Lisbon, Vislis, 1999, p. 244. (emphasis added)

As well as António Lima Guerreiro, General Tax Law – annotated, Lisbon, Rei dos Livros, 2000, p. 215, according to whom:

"The third special statute of limitations period is that of the actual exercise of loss carryforward, which case it coincides with the legal period for carryforward.

Only in the case of carryforward (on the institute, which aims to mitigate the negative effects derived from the need to periodize taxable profit, see Freitas Pereira, "Periodization of Taxable Profit", in "Tax Science and Technique, number 349, pg. 47) having been actually exercised – and not mere non-exercised faculty of said right – the statute of limitations period for the right to assess coincides with the carryforward, as provided for in number 3 of this article." (emphasis added)

In view of what was set forth above, it is concluded that the right to assess would only expire on 31 December 2013, and therefore the statute of limitations defect raised by the Claimant does not exist.

6.3. Error in Presuppositions (Quantification and Qualification of Tax Event) and Defect in Required Reasoning

a) On the Defect of Reasoning

The allegation of the defect of reasoning is not substantiated by the Claimant, which merely enumerates it as a basis for the annulment of the assessments.

The jurisprudence of the Supreme Administrative Court ("STA") advocates that reasoning is a relative concept that varies as a function of the legal type of act, aiming to respond to the clarification needs of the taxpayer, allowing it to know the reasons, of fact and of law, that determined its practice and why it was decided in one direction and not another, and can be succinct and by reference, provided that the primary function of making known the cognitive and evaluative process of the act is ensured.

The factual and legal grounds on which the tax acts in crisis are based are expressly stated in the second Tax Inspection Report and in Report No. …/2012, of the Directorate of Corporate Income Tax Services, which, by express reference, is an integral part thereof. Such grounds, regardless of whether one agrees with them, are intelligible and permit a normal recipient to apprehend the decisional reasoning, the causes and the sense of the decision, in observance of the provisions of Article 77 of the LGT and Article 125 of the CPA (cf. Decisions of the STA, proceeding No. 42180, of 20 November 2002, and proceeding No. 46796, of 14 March 2001).

It is verified that the tax acts of correction (reduction) of losses and Corporate Income Tax assessment observe the parameters of reasoning legally required, with the invoked defect of reasoning being unfounded.

A different question is that of the Claimant's disagreement regarding the grounds of the assessments which are stated in the Tax Inspection Report and the cited Report No. …/2012, which is analyzed below. In this case, one would be faced with the defect of error as to presuppositions of fact or error as to presuppositions of law and not of reasoning (in this sense, see the Decision of the Collective Arbitral Tribunal, of 16 November 2012, proceeding No. 86/2012-T CAAD).

b) Error in Presuppositions

The correction made by the Tax and Customs Authority is based on the understanding that the distribution to the Claimant of carried forward earnings deriving from revaluation reserves subject to the regime of Decree-Law No. 430/78, of 27 December, is not classifiable under the concept of "distribution of profits" and, consequently, cannot be classified under the regime for eliminating economic double taxation of distributed profits provided for in Article 46, No. 1 of the Corporate Income Tax Code (current Article 51, No. 1 of the same statute), and therefore the amount in question could not have been deducted in the determination of the results of fiscal year 2007.

The advocated non-application of the discipline of Article 46, No. 1 of the Corporate Income Tax Code stems from the chain of a set of premises. These are:

ü That revaluation reserves created under Decree-Law No. 430/78 can only be utilized for two purposes, the coverage of accumulated losses up to 31 December 1976 and the increase in capital, in conformity with the provisions of Article 5 of the respective regime, and therefore constitute non-distributable reserves;

ü That non-distributable reserves cannot, for tax purposes, correspond to the concept of distributed profit;

ü And that they cannot benefit, in the sphere of the shareholder, from the regime for eliminating economic double taxation.

Let us begin with the analysis of the revaluation regime established by Decree-Law No. 430/78, which in its Article 5 provides:

"1 – The accounting movements inherent to revaluation are recorded by debit and credit to a sub-account named "Revaluation reserve – Decree-Law No. 430/78.

2 – The revaluation reserve can be used, wholly or partially, for coverage of accumulated losses up to 31 December 1976 that have not been compensated by later profits obtained up to the date to which the revaluation relates.

3 – Except as provided in the preceding number and in the case of company dissolution, the revaluation reserve can only be used, in the part that should not be transferred to the earnings account, in accordance with the following article, for an increase in capital."

As a consequence of non-compliance (with the provisions of No. 3 of Article 5 above), Article 11 of Decree-Law No. 430/78 provides for punishment "with a fine equal to 30% of the value of the improperly used revaluation reserve".

This legal provision is inserted in a historical context of inflation in which "The holding of non-monetary assets, that is, assets whose value in terms of purchasing power is maintained despite inflation (land, equipment, inventory), when recorded at acquisition cost, is necessarily undervalued in subsequent fiscal years" and "Its real value is not correctly reflected in the balance sheet" – see in this respect Maria Teresa Barbot Veiga de Faria and Maria dos Prazeres Rito Lousa, "The Revaluation of Elements of Fixed Assets of Companies, in Notebooks of Tax Science and Technique, No. 148, DGCI, 1986, p. 15.

In accordance with the cited authors "the net increase resulting from revaluation is credited to a reserves account – revaluation reserve –, the use of which normally is only authorized for incorporation in capital stock or for coverage of accumulated losses. Regardless of whether or not there is taxation of the reserve, its distribution is never permitted, as such a procedure would have contradicted the very logic underlying the correction method" (ob.cit. p.20).

The objective pursued was therefore that the value resulting from the revaluation would remain retained in the company and not be distributed to the partners (at least while the gain that the revaluation reserve anticipated was not realized) and, if improperly done, a high penalty corresponding to 30% of the value of the reserve utilized outside the intended scope would fall on the taxpayer.

It should be noted that the realization of the reserve (considering that the same occurs through use, that is, through recovery or disposal of the respective assets), implies the mandatory transfer of the revaluation reserve to carried forward earnings, by virtue of Accounting Directives Nos. 16 and 28, the first of 1995 and the second of 2003, issued by the Accounting Standards Commission, whose bindingness derives from Articles 2 and 17 of Decree-Law No. 367/99, of 18 September, which establishes the rules for the organization and operation of the Accounting Standards Commission (CNC).

In fact, the realization, wholly or partially, of the reserve made in "the wake of fiscal statutes" implies the corresponding transfer to account 59 "Carried Forward Earnings – Regularization of Excess" (points 2.4 and 3.3 of Directive No. 16/95). Equally, Directive No. 28 – Income Taxes refers in its example to the transfer of a legal revaluation reserve to the earnings account insofar as it is realized. An accounting operation (debit of the account "56 – revaluation reserves", by counterpart of account "59 – carried forward earnings") that applies to any type of revaluation.

Only after this transfer can the results be applied and utilized, following what comes to be resolved in the general meeting, in particular for coverage of losses or increase in capital.

In these terms, the realization of the revaluation reserve, in particular by virtue of the disposal of the underlying asset (read well, revalued), implies an accounting operation of transfer of the revaluation reserve to carried forward earnings, as stipulated in binding rules, those provided for in Accounting Directive No. 16, and does not collide with the discipline contained in Decree-Law No. 430/78, as, in our understanding, the same [accounting operation] by itself does not configure a use or an application of the reserve which, as just emphasized, will only be concretized with a possible resolution of the general meeting that decides on the application of those results.

Concluded that the accounting reclassification is in accordance with law, the subsequent distribution to the partners of the results (carried forward) proceeding from the revaluation reserve could, however, prove to be contrary to the regime established by Decree-Law No. 430/78, in that this expressly prohibits the use or application of this reserve for purposes other than those of coverage of losses prior to the constitution of the reserve or of increase in capital.

Without prejudice to what was said above, which confirms the first premise from which the Tax and Customs Authority departed – that the revaluation reserve with the nature of legal reserve should be utilized for coverage of losses and for inclusion in capital – the truth is that from this cannot be concluded that, being such reserves realized and being correctly accounted for as carried forward earnings, they cease to correspond to profits and that their subsequent distribution (even if possibly illegal) is not classifiable under the regime of Article 46, No. 1 of the Corporate Income Tax Code, in the sphere of the beneficiary [the Claimant].

On the other hand, it is to be recalled, from the outset, that the statute that institutes this reserve expressly provides for the possibility of non-compliance by taxpayers and establishes the corresponding legal consequence. Where the hypothesis of non-compliance occurs, the taxpayer is subject to a sanctionary regime that imposes, for such conduct, a significant fine of 30% of the value of the improperly used revaluation reserve, in the sphere of the entity to whom the non-compliance is attributable (in this case, D... and not the Claimant, without prejudice to the latter holding 99.98% of the capital thereof).

The legal effects of non-compliance, provided for in the very regime of revaluation, thus correspond to the application of a sanction determined by reference to the value of the non-compliance, in the proportion of 30%. That burden is the penalty for the improper anticipation of seeking to distribute to partners an actual result from a merely potential gain (the said revaluation reserve), which was reprehensible for violating the principle (meanwhile abandoned) of the inviolability of capital stock.

Moreover, Corporate Income Tax is a direct tax that applies to the income accrual of all legal entities of public or private law with registered office or effective management in Portuguese territory. Taxation applies to the economic reality constituted by profit, with accounting, as an instrument of measurement and information of that reality, called upon to play an essential role (see Article 17, No. 1 of the Corporate Income Tax Code).

If, accounting-wise, the revaluation reserve has been transformed into a result, it is because there was effectively a result stemming from a realization event, with respect to which it made (every) sense to associate the revaluation reserve. In the silence of the law (whether the special law governing revaluation, or the general law, i.e., Corporate Income Tax Code), and following the interpretive maxim that the legislator has established the most correct solutions, it is required to conclude that the distribution of carried forward results cannot fail to be characterized as a distribution of profits for purposes of Corporate Income Tax, of which the Claimant was beneficiary and whose possible illegality, should it be verified, would always have occurred in the sphere of another entity other than the Claimant.

It being doubtful of such illegality, as if we ponder, there would be no justifying reason for different tax treatment to be given to a distribution of profits stemming from a gain inherent to the sale of an immovable property that had not been revalued, as opposed to the same gain (determined and quantified in the same manner) stemming from an immovable property meanwhile legally revalued. Such discrimination does not appear to have reason to be. What appears that the legislator sought to guard against, after all, with the limitations to the use of the revaluation reserve contained in Decree-Law No. 430/78 was the premature distribution of a result not yet realized, and which, in the limit, could even never come to be realized (in that circumstance, the revaluation reserve would never be extinguished).

In the specific situation, the revaluation reserve was realized, following the sale, in 2005, of the revalued asset (land, not recoverable therefore) located at Rua ... in …, and therefore the same, by correct application of the accounting norms as seen above, was transferred to carried forward results. The allocation of results to the partners and as concerns the Claimant cannot fail to be characterized as a distribution of profits.

Being a distribution of profits and the other presuppositions of Article 46, No. 1 of the Corporate Income Tax Code being met, the same is classifiable under the regime for eliminating economic double taxation of distributed profits.

The truth is that the extinction of the revaluation reserve, by way of increase in "carried forward results" followed by the distribution of the same, could not have as a consequence the non-application of a regime (that for eliminating economic double taxation), with respect to which the entire completion of all presuppositions is verified (as these are profits subject to actual taxation), when the statute governing the reserve and, as well, the Article 46 itself of the Corporate Income Tax Code do not prescribe it anywhere.

It should be further noted that in its reply (points 66 and following) the Tax and Customs Authority considers that, in addition to not being able to characterize as a distribution of profits [the allocation of results to the Claimant], the same would not have been subject to actual taxation (in the sphere of D...) and therefore one of the requirements of the regime of Article 46 would not have been met (which would determine, per se, its disregard at 50%).

This conclusion ignores (or does not understand) the decision to grant the Hierarchical Appeal filed by the Claimant (when the assessment effected following the first internal inspection to which it was subject) which clearly concludes that the "requirement of actual taxation should be considered met, in the sphere of the company generating income, since it is not covered by an exemption regime, nor occurred, as a result of applicable legislation, any permanent disregard of such income for purposes of the tax payable. Thus, the profits distributed by it cannot but be considered effectively taxed for purposes of application of No. 11 of Article 46 (current No. 10 of Article 51) of the Corporate Income Tax Code" in an interpretation based on Circular 21/2011 which clarifies the concept of actual taxation of distributed profits.

It was the Tax and Customs Authority itself that, following this its decision, proceeded (as incumbent upon it) to annul the first correction to the 2007 tax losses, a decision that was consolidated and that constitutes res judicata, and therefore it is incomprehensible the position now assumed in the reply articles based on the ground of actual taxation.

Furthermore, the Tax and Customs Authority comes to contest that the revaluation reserve had been realized, characterizing the Claimant's allegation as "merely theoretical defense without the Claimant having even substantiated the facts in which allegedly the operation is translated", when it is manifest that such facts are not only substantiated – it is the sale of an identified piece of land, with the Claimant having attached a copy of the corresponding notarial deed – but the same are highlighted in the first Tax Inspection Report, which makes express reference to them and recognizes that the revaluation reserves related to adjustments made to the construction land, located at Rua ..., in … (cf. Article 76 of the LGT on the probative value of official information).

In view of the foregoing, it is concluded in this matter that the Claimant has reason, as we are in the presence of distributed profits that meet the presuppositions of application of Article 46, No. 1 (current Article 51, No. 1) of the Corporate Income Tax Code, and the tax acts of correction (reduction) of losses and Corporate Income Tax assessment for the years 2007, 2009 and 2010 should be annulled due to violation of law through error in presuppositions, with the legal consequences, including the annulment of the corresponding compensation interest and the consideration of the losses declared by the Claimant.

Whereupon the parties agree in this Arbitral Tribunal to declare the request for declaration of illegality and annulment of the above-identified Corporate Income Tax assessment and compensation interest acts as well-founded, with the legal consequences.

The value of the case is fixed at 763,917.59, in accordance with the provisions of Articles 3, No. 2 of the Regulation of Costs in Tax Arbitration Proceedings (RCPAT), 97-A, No. 1, paragraph a) of the Code of Tax Procedure (CPPT) and 306 of the Civil Procedure Code (CPC).

The amount of costs is fixed at Euro 11,016.00, under Article 22, No. 4 of the RJAT and Table I attached to the RCPAT, to be borne by the Tax and Customs Authority, in accordance with the provisions of Articles 12, No. 2 of the RJAT and 4, No. 4 of the RCPAT.

Notify the parties.

Lisbon, 10 March 2014

The Arbitrators,

Dr. Alexandra Coelho Martins

Dr. António Moura Portugal

Dr. Luís Manuel Pereira da Silva

Text prepared by computer in accordance with Article 131, No. 5 of the Civil Procedure Code, applicable by reference from Article 29, No. 1, paragraph e) of Decree-Law No. 10/2011, of 20 January, with blank verses and reviewed.

The text of this decision is written in the old Portuguese orthography.

Frequently Asked Questions

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What are the rules for eliminating economic double taxation on distributed profits under Article 46 (now Article 51) of the Portuguese IRC Code?

Article 46 (now Article 51) of the Portuguese IRC Code establishes the regime for eliminating economic double taxation on distributed profits. This mechanism allows companies receiving dividends to deduct them from taxable income when such profits have already been subject to actual taxation at the distributing entity level. The key requirement is that the distributions must qualify as 'distributed profits' that were previously taxed. In this case, the dispute centered on whether distributions originating from revaluation reserves created under Decree-Law 430/78 constitute 'distributed profits' eligible for this regime. The taxpayer argued that once revalued assets were disposed of and the reserve transferred to retained earnings, they became taxable profits qualifying for double taxation relief. The Tax Authority maintained that revaluation reserves established under fiscal legislation are non-distributable by nature and fall outside Article 46's scope, constituting taxable income under Article 20(1)(c) of the IRC Code without the double taxation elimination mechanism.

Does the principle of non-repetition of tax inspections apply to internal inspections by the Portuguese Tax Authority?

The principle of non-repetition of tax inspections (irrepetibilidade das inspeções) generally prohibits conducting multiple inspections on the same taxpayer for the same tax and taxable period. However, this principle does not apply to internal inspections conducted by the Portuguese Tax Authority. According to Article 63(4) of the General Tax Law (LGT), internal inspection actions—those conducted through analysis of documents and information available to the tax administration without direct contact with the taxpayer—are not subject to the limitations on repetition that apply to external inspections. In Process 161/2013-T, the Tax Authority successfully argued that conducting two successive internal inspections on the determination of fiscal year 2007 profits did not violate legal formalities, as internal inspections face no statutory limits on repetition. The Authority also claimed that the second inspection was authorized by the head of the service, addressing the taxpayer's procedural objection regarding lack of proper authorization.

What is the statute of limitations for the right to reassess corporate income tax (IRC) when tax losses are carried forward under Article 45(3) of the LGT?

Article 45(3) of the Portuguese General Tax Law (LGT) establishes a special statute of limitations period for situations involving the deduction and carryforward of tax losses. The central question in this case was whether the applicable period is the general four-year limitation or the extended six-year period tied to the duration of the right to utilize losses. The taxpayer argued that since the 2007 tax losses were deducted within the standard four-year period, only the general limitation period should apply to reassessments. The Tax Authority countered that the special six-year period applies universally to all loss carryforward situations under Article 45(3) LGT, regardless of when the taxpayer actually utilizes those losses. This interpretation was supported by previous jurisprudence from the Southern Administrative Central Court (TCAS). The extended period recognizes that tax loss corrections impact not only the original year but also subsequent fiscal years where losses are carried forward and deducted, requiring a longer timeframe for the Tax Authority to verify and correct initial loss determinations that affect multiple tax years.

Can the Tax Authority open a second inspection on the same taxable period without authorization from the head of the tax service?

Portuguese tax law distinguishes between internal and external tax inspections regarding authorization requirements and procedural limitations. For external inspections involving direct taxpayer contact, the principle of non-repetition generally prohibits opening a second inspection on the same subject matter without specific justification and proper authorization. However, for internal inspections—conducted through document review without taxpayer interaction—Article 63(4) of the General Tax Law establishes that there are no statutory limits on conducting successive actions. In Process 161/2013-T, the taxpayer challenged the second inspection on procedural grounds, alleging lack of authorization from the head of the tax service. The Tax Authority responded that: (1) internal inspections are not subject to repetition restrictions, and (2) the final inspection action was indeed preceded by authorization from the competent hierarchical superior. The distinction is critical because internal inspections allow the Tax Authority greater flexibility to review and correct previous determinations based on information already in its possession, without the procedural safeguards required for external audits that involve taxpayer burden.

How does the CAAD assess the legality of IRC assessments resulting from corrections to reported tax losses in subsequent fiscal years?

The CAAD (Centre for Administrative Arbitration) assesses the legality of IRC assessments resulting from corrections to reported tax losses by examining both procedural and substantive dimensions. Procedurally, the tribunal verifies whether the Tax Authority complied with statutory requirements for inspection actions, including authorization formalities, observation of limitation periods, and respect for taxpayer rights. Substantively, CAAD analyzes whether the corrections are legally and factually supported, examining the proper qualification of income, deductions, and loss carryforwards under IRC Code provisions. In Process 161/2013-T, the assessment focused on: (1) whether successive internal inspections violated formal requirements; (2) whether the four-year or six-year statute of limitations applied to loss corrections under Article 45(3) LGT; and (3) whether the substantive correction—denying economic double taxation elimination for distributions from revaluation reserves—correctly interpreted Article 46 (now 51) of the IRC Code. The tribunal's role includes determining if the Tax Authority properly proved facts supporting the corrections, whether the legal reasoning was adequate, and whether the quantification of adjusted taxable income and resulting tax liabilities was correct. Loss carryforward corrections require particular scrutiny as they affect multiple fiscal years through cascading adjustments.

IRC Double Taxation Relief on Distributed Profits & Tax Inspection Non-Repetition Principle | CAAD 161/2013-T

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IRC Double Taxation Relief on Distributed Profits & Tax Inspection Non-Repetition Principle | CAAD 161/2013-T

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