CAAD Case 162/2017-T: General Anti-Abuse Clause (CGAA) in IRS Withholding Tax on Income

ENGLISH TRANSLATION

The arbitrators José Baeta de Queiroz (president), Jónatas Machado and Fernando Manuel dos Santos Cardoso, appointed by the Ethics Council of the Administrative Arbitration Center to form the arbitral tribunal, agree as follows:

I. REPORT

1. A… – SGPS, S.A., with registered office in the parish …, …, legal entity number …, covered by the local peripheral service of … (hereinafter, "Applicant" or "A…"), comes, pursuant to Articles 10 and 2, No. 1, subparagraph a), both of Decree-Law No. 10/2011, of 20 January, which establishes arbitration as an alternative means of jurisdictional resolution of conflicts in tax matters (hereinafter "RJAT"), and of Order No. 112-A/2011, of 22 March, to request the constitution of an arbitral tribunal, with the Tax and Customs Authority being the respondent (hereinafter "TA").

2. The Applicant requests an arbitral pronouncement on the legality of the tax acts involving additional assessment of withholding on Personal Income Tax (PIT), identified with number 2015…, of 05.11.2015, issued by the TA, PIT and Statement of Compensatory Interest Assessment No. 2015… and 2015…, relating to the tax period of 2011.

3. The request for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the TA on 08-03-2017.

4. The Applicant did not proceed with the appointment of an arbitrator, so that, pursuant to the terms provided in subparagraph a) of No. 2 of Article 6 and subparagraph b) of No. 1 of Article 11 of the RJAT, the President of the Ethics Council of CAAD appointed the signatories as arbitrators of the collective arbitral tribunal, who communicated acceptance of the appointment within the applicable period.

5. On 05-05-2017 the parties were duly notified of this appointment, and did not manifest an intention to refuse it, pursuant to the combined terms of Article 11, No. 1, subparagraphs a) and b), of the RJAT and Articles 6 and 7 of the Ethics Code.

6. Thus, in accordance with the provision of subparagraph c) of No. 1 of Article 11 of the RJAT, the arbitral tribunal was constituted on 22-05-2017.

7. Duly notified, the TA filed a response in which it defended the lack of merit of the request.

8. On 13-10-2017 the meeting referred to in Article 18 of the RJAT took place, with oral arguments being presented by the parties, who reiterated and developed their respective legal positions.

9. The date of 22 November was fixed for the pronouncement of the final decision.

10. The Applicant seeks a declaration of illegality of the aforementioned assessments, alleging, in summary, that the TA incurred several illegalities:

• First, the TA incurred a violation of law defect due to incorrect interpretation and application of the General Anti-Abuse Rule (GAAR) contained in Article 38, No. 2, of the General Tax Code (LGT), to the extent that this provision does not have the capacity to give rise to tax obligations toward tax substitutes, and should instead be directed at whoever actually obtains the alleged tax advantages. Thus, the disregard for tax purposes of the acts under analysis is not opposable to A…;

• Second, the tax acts suffer from illegality due to incorrect notification of the same to A…, to the extent that full application of Article 38, No. 2, of the LGT to the operations described by the TA requires the conclusion that the duty of withholding at source falls upon B… and not upon the Applicant herein, as will be further explained below;

• Third, the TA incurred a violation of law defect, through violation of the defense guarantees recognized to all citizens in Articles 20 and 268, No. 4, of the Constitution of the Portuguese Republic (hereinafter, "CRP"), to the extent that the right to be heard of all parties linked, directly or indirectly, to the operation disregarded by the TA under the GAAR was not ensured;

• Fourth, the tax acts suffer from illegality due to the fact that the conditions for application of the GAAR are not met;

• Finally, the acts which are the subject of the present request for arbitral pronouncement suffer from a defect of lack of reasoning, through non-compliance with the provisions of Articles 77 of the LGT and 63 of the Code of Tax Procedure and Process (CPPT).

1. For its part, the Respondent came in response to defend the lack of merit, due to lack of grounds, of the arbitral request, alleging, in summary:

• "We are in the presence of a structure, as a set of sequential, logical and planned acts, organized in a unitary manner (linked), with a view to achieving the intended tax objective: to distribute dividends without subjecting them to taxation (…).

• "By means of the sale of shares to A… SGPS, the dividends of B… are made available to shareholders, avoiding withholding at source in a definitive manner and benefiting from the exclusion of taxation provided for in the transitional regime of category G provided in Article 5 of Decree-Law No. 442-A/88, of 30/11 and in the wording as of the date of subparagraph a) of No. 2 of Article 10 of the PIT Code".

II. PRELIMINARY HEARING

The arbitral tribunal has material jurisdiction and was regularly constituted. The parties have legal personality and capacity and benefit from procedural legitimacy, pursuant to Articles 4 and 10, No. 2, of the RJAT and Article 1 of Order No. 112-A/2011, of 22 March.

The TA proceeded with the appointment of its representatives in the proceedings and the Applicant attached a power of attorney, the parties thus being duly represented.

The proceedings do not suffer from nullities, nor are there exceptions or preliminary questions to be decided.

III. FACTUAL MATTERS

III.1. Facts Established as Proven

With respect to the factual matters relevant for the decision of the tribunal, the following facts are considered proven:

a) The Applicant is a partnership management company, established on 03-09-2008, whose corporate purpose is the management of social participations in other companies, as an indirect form of the exercise of economic activities, with capital of € 50,000.00, represented by 50,000 shares with a nominal value of € 1.00 each, whose shareholder structure is composed of:

• C…, holding 46%;

• D…, holding 46%;

• E…, holding 2%

• F…, holding 2%;

• G…, holding 2%;

• H…, holding 2%.

b) Administrators were appointed on the date of constitution of A…, SGPS, C… (president) and D… (secretary); however on 28-02-2011, D… resigned from his duties, and H… was appointed as his replacement, allegedly the daughter of the resigning party. On 02-10-2012 these administrators were reappointed in their positions for the four-year period 2012-2015.

c) In turn "below" the A…, SGPS, SA we have the limited liability company B…, Lda., Tax ID …, which was established on 13 April 1987 with share capital of €4,987.98 (represented by two quotas of € 2,493.99 each), fully paid in cash by the two partners C… and D…, for the exercise of the activity of cladding, export, representation and trade, transformation and recycling of plastic materials and import, export, representation and trade of machines for the plastics industry, with registered office at Street …, No. …, parish of …, municipality of Vila Nova de Gaia.

d) On 19 September 1990 a capital increase of B… was carried out in the amount of € 194,531.18, subscribed in equal parts by each of the aforementioned partners and equally paid in cash, and the registered office was changed to … No. …, …, …, belonging to the parish of …, municipality of …

e) On 24 February 1999, by deed of Capital Increase and Transformation, the share capital of B… was increased again to be set at € 498,797.90, through the subscription, once again made in cash, of € 199,951.92 by each of the partners, and the entry of four new partners (allegedly the children of each of the founding partners), who each subscribed a quota of € 14,963.94; simultaneously the company B… was transformed into a public limited company, with share capital represented by 100,000 shares with a nominal value of € 4.99 each.

f) On 23.12.2008, the A…, SGPS acquired the entire capital of the company B…, for the price of € 8,000,000.00, corresponding to a unit value of € 80.00 per share, distributed as follows:

g) It was agreed, in accordance with the terms of the purchase and sale contract entered into, that the price would be paid in 10 equal and successive annual installments, with the first falling due on 31 December 2009 and the last on 31 December 2018. Thus, in the accounting of A…, SGPS a credit was recognized from the former shareholders of B… in the total amount of € 8,000,000.00.

h) The contractual clause that defined the conditions of that transaction also established the non-incurrence of any interest on this payment plan, and the immediate taking of possession (on 23-12-2008) of all the shares of B… by the B…, SGPS, in accordance with Article 2 of the aforementioned contract.

i) With respect to the agreed price, the aforementioned contract expressly states in its point 3.2 that this was not determined based on balance sheet values, ruling out from the outset the possibility of it being changed as a result of any facts that would affect the value of B… or of the social participations assigned to it.

j) Thus both families, I… and J…, which held direct participation constituted a debt of € 8,000,000.00 in the company that already belonged to them and came to hold an indirect participation of 50% each family.

k) In addition to the participations acquired in B…, the A… also acquired participations in the following companies:

• On 6-8-2009, 16% of the capital of the Company "K… Lda." (hereinafter, "K…"), company established in May 2006;

• On 15-9-2009, 12% of the capital of the Company "L…, Lda." (hereinafter, "L…"), company established in April 2003.

l) The A… was subject to an inspection procedure, initiated under Service Orders No. OI2015…, OI2015…, OI2015…, OI2015… and OI2015…, of general scope covering the tax periods 2011 to 2015.

m) Notwithstanding the arguments contained in the prior hearing submitted, B… was notified, through Letter No. …, of 28.10.2015, of the Tax Inspection Report, which is here given as entirely reproduced, in which the TA concluded that the conditions were met for the application of the GAAR contained in Article 38, No. 2, of the LGT.

n) Additional assessments of withholding on PIT were issued identified with number 2015…, of 05-11-2015 by the TA, PIT and Statement of Compensatory Interest Assessment No. 2015… and 2015…, relating to the period of 2011, whose voluntary payment period ended on 04-01-2016, in the amount of € 402,715.60.

o) The Applicant filed, on 02.05.2016, an administrative appeal of the additional assessment, which was subject to a dismissal decision notified to the Applicant on 07-12-2016, through Letter No. …, of 05-12-2016.

III.2. Unproven Facts

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

III.3. Reasoning on Factual Matters

With respect to factual matters, the tribunal does not have to pronounce on everything that was alleged by the parties; rather, it is its duty to select the facts that matter for the decision and to distinguish the proven facts from the unproven ones (see Articles 123, No. 2, of the CPPT and 607, No. 3 of the Code of Civil Procedure (CCP), applicable by virtue of Article 29, No. 1, subparagraphs a) and e), of the RJAT).

Thus, the facts pertinent to the judgment of the case are chosen and delineated based on their legal relevance, which is established in consideration of the various plausible solutions of the legal question(s) (see previous Article 511, No. 1, of the CCP, corresponding to the current Article 596, applicable by virtue of Article 29, No. 1, subparagraph e), of the RJAT).

Thus, taking into account the positions assumed by the parties, in light of Article 110/7 of the CPPT, the documentary and testimonial evidence and the administrative procedure file attached to the proceedings, the facts listed above were considered proven as relevant for the decision, taking into account that, as stated in the Decision of the TCA-South of 26-06-2014, rendered in case 07148/131, "the probative value of the tax inspection report (...) may have probative force if the assertions contained therein are not impugned".

IV. THE LAW

IV.1. Introductory Considerations

The central question that arises is related to the application to the case of the provision of Article 38, No. 2 of the LGT.

Before entering into the analysis of the rule and the issues that the Applicant raises regarding its application to the specific case, it is useful to trace the reasons for its emergence, and others which, within the scope of comparative law, pursue the same objective.

The problem of tax evasion constitutes one of the most serious threats to the world economy and to the capacity of States to achieve the objectives entrusted to them by international human rights law and constitutional law in the field of realization of social rights. It results in significant losses of revenue for the State and, consequently, in expense at the cost of citizens. If we consider the time, work and money spent in the attempt to avoid taxes and the opportunity costs involved in tax evasion, we conclude that these losses increase dramatically.

For some years now, the problem of tax evasion has been at the center of the agenda of the international community, namely through the Base Erosion and Profit Shifting (BEPS) initiative promoted by the OECD. Within the European Union, the problem has been no less relevant, since Member States depend significantly on the proper functioning of the tax system to fulfill the objectives of the Stability and Growth Pact within the framework of Economic and Monetary Union.

In this context, the "manufacture of factual indeterminacy", consisting among other things in the artificial and contrived creation of added complexity in business transactions, presents itself as a typical instrument of tax evasion capable of producing a multi-level impact.

The legitimacy of a reasonable measure of tax planning by economic agents is not at issue, through the use of the exemptions, deductions, allowances and other tax benefits that the legislator puts at the disposal of taxpayers by understanding that this best pursues its financial, economic and social objectives. When acting in this manner, the taxpayer does nothing illegal, from a purely formal and material point of view. Things are different in abusive planning, when it is sought to reduce taxes in a manner that is "contrary to the spirit of the law". In these cases, it is sought to circumvent the material objectives of the tax system through a merely formalistic and cunning use of tax rules, in a perspective of fraud on the law.

It is in these cases that the insufficiency of a merely literal interpretation becomes apparent, making teleological interpretation important. This aspect is especially important to the extent that, pursuant to Article 103, No. 1 of the Constitution of the Portuguese Republic (CRP) and Article 5, No. 1 of the LGT, the objectives of taxation expand far beyond the simple increase in tax revenues. Assuming a nature of public interest, they include the satisfaction of the financial needs of the State and other public entities so as to enable them, among other things, to effect the socially guaranteed constitutional rights, to promote social justice and equal opportunities and the necessary correction of inequalities in the distribution of wealth and income. The legitimacy of political and tax systems ultimately depends on the pursuit of these objectives.

This explains the development, over recent decades, of anti-abuse tax law doctrines, such as:

a) substance over form;

b) economic substance of the transaction;

c) principal purpose test (PPT);

d) step transaction; or

e) sham transaction.

Together, these doctrines aim at the preservation of the tax base and the combating of abusive tax planning. Their respective content overlaps to a large extent.

These doctrines, initially of jurisprudential origin, ended up serving as the basis, in various countries, for the legislative introduction of general or special anti-evasion rules (General Anti-Avoidance Rules – GAAR; Special Anti-Avoidance Rule - SAAR). The GAARs, known among us as General Anti-Abuse Rules (GAAR) have the advantage of being applicable to all transactions and all taxes, and may act subsidiarily even in relation to a special rule. The objective of these general and special rules is clear: to encourage the payment of taxes and discourage tax evasion. Being able to and should be mobilized autonomously or in combined form, they enable the tax administration and the courts to disregard and recharacterize legal transactions devoid of sufficient economic or commercial substance.

GAARs are deliberately drafted using vague and open concepts requiring active interpretation and application by the tax authorities and courts. They rely on the creation of a certain indeterminacy, capable of discouraging aggressive tax planning and tax evasion. They represent a considerable departure from formal legal reasoning, based on linguistic analysis and the succession of laws over time and the strict guarantee of typicality, certainty and predictability, which has characterized tax law. Certainty and legal security are fundamental to encourage investment and structure business transactions. Although these principles continue to characterize the day-to-day practice of formulation, interpretation and application of tax rules, as required by the rule of law, they do not present themselves as absolute categorical imperatives exempt from a process of balancing.

GAARs rest on the recognition that strict adherence to legal-tax formalism is absolutely unrealistic and quixotic in the face of the nearly infinite possibilities of manipulation of legal forms and aggressive tax planning at national and international levels. The recent intensification and globalization of tax evasion and fraud conduct imposes, in some situations, the assumption of a more realistic, pragmatic and results-oriented attitude on the part of the legislator, the administration and tax courts.

This approach requires that, in cases where it is sought to prevent abusive tax planning, the administration and courts go beyond the limits of linguistic analysis of legal texts and investigation of legislative history and advance to a normative inquiry as to the purposes pursued by tax legislation and the best means to achieve those purposes. The posture of the administration and courts should be practical and rooted in empirical results.

Among us, the TCA-South had occasion to pronounce on the GAAR, having emphasized that "the anti-abuse rules find their 'raison d'être' in the evasive and fraudulent behavior of taxpayers in tax matters and in the need to establish adequate means of reaction in order to guarantee compliance with the principle of equality in the distribution of the tax burden and in the pursuit of the satisfaction of the financial needs of the State and other public entities". In this sense, GAARs express the balancing and proportional weighing of the principle of legal security and protection of confidence – with its requirements of typicality and legality – with other constitutionally protected interests, such as the preservation of the tax base, tax equity and the realization of fundamental rights and social justice. They are also reducible to a constitutionally sound balancing of constitutional values and principles.

IV.2. Article 38, No. 2 of the LGT

It is in the context of these developments that the introduction of a GAAR among us should be understood. It first appeared by virtue of Law No. 100/99 of 22 July, which added a No. 2 to Article 38 of the LGT. There it said:

"The acts or legal transactions are ineffective when it is demonstrated that they were carried out with the sole or principal objective of reducing or eliminating the taxes that would be due by virtue of acts or legal transactions of equivalent economic result, in which case taxation is applied to the latter."

However, the GAAR of Article 38, No. 2 of the LGT was subsequently amended in its wording by law No. 30-G/2000, of 29 December. There it now provides:

"Acts or legal transactions are ineffective for tax purposes when they are essentially or primarily directed, by artificial or fraudulent means and with abuse of legal forms, to the reduction, elimination or temporary deferral of taxes that would be due as a result of facts, acts or legal transactions of identical economic purpose, or to the obtaining of tax advantages that would not be achieved, in whole or in part, without the use of those means, taxation then being carried out in accordance with the applicable rules in their absence and the aforementioned tax advantages not being produced."

In relation to the initial version, the current wording of the GAAR stands out for limiting the ineffectiveness of acts and legal transactions to the tax sphere, while they retain their validity and effectiveness in other domains. Noteworthy is also the elimination of the requirement for demonstration, suggesting a mitigation of the evidentiary standard by the TA. However, Article 63, No. 3, subparagraph b) of the CPPT must be taken into account, where it provides that the statement of reasons for the draft and the decision to apply the GAAR must contain the demonstration that the entry into of the legal transaction or practice of the legal act was essential or primarily directed to the reduction, elimination or temporary deferral of taxes that would be due in the case of a transaction or act with identical economic purpose, or to the production of tax advantages. This latter reference, made in generic terms, points to the irrelevance of the question of who actually obtained the tax advantages. If any of the parties involved in the transaction obtained an undue tax advantage, by not having been contemplated by the tax legislator and having no correspondence with economic substance, it is incumbent upon the TA to consider it ineffective and neutralize the production thereof. This aspect is especially relevant in cases where the advantage is produced and obtained within a group logic.

Article 38, No. 2 of the LGT links the GAAR to a principal purpose test (PPT), formulated by the national legislator as essential or principal purpose, and to the presence of conduct indicating the use of artificial and fraudulent means and abuse of legal forms. The point is that it must be aimed at a) the reduction, elimination or temporary deferral of taxes due by virtue of facts, acts or transactions of identical economic purpose, or b) the production of tax advantages dependent on those means. In either case, taxation is carried out in accordance with the applicable rules in the absence of the acts and means in question, and the aforementioned tax advantages are not produced.

From the exegesis of Article 18, No. 2 of the LGT, it follows that the TA must provide evidential elements that allow it to establish the existence of an artificial and abusive operation according to the intermediate level of scrutiny of preponderance of the evidence or balance of probabilities that in various contexts has been associated with the application of GAARs. This requires a contextual and factual approach to specific cases, simultaneously attentive to the teleology of tax rules and the characteristics and objectives of transactions. Especially important is the analysis of the transaction in its totality, paying attention to all its steps and participants, reserving a particularly demanding scrutiny when it comes to transactions involving partners and companies of the same group. In these cases, the principle of primacy of substance over form admits that certain "grouped" entities may be considered as a single taxpayer.

Ambiguity seems to be the main objective of this type of legislative technique. In drawing up the GAAR of Article 38, No. 2 of the LGT, the tax legislator recognizes the necessity to preserve the tax base and enable the TA and courts to protect the substantive purposes of the tax legislator. The deliberately generated uncertainty in taxpayers leads them not to approach too closely to the line demarcating fraud and tax avoidance, while allowing the GAAR to be sufficiently flexible to follow new transactions generated by the dynamic and accelerated "aggressive tax planning industry" and that the TA and courts fill the gaps in the tax system in unforeseen situations that are conducive to abuses.

The GAAR of Article 38, No. 2 of the LGT does not permit the reduction, elimination, deferral of taxes or the production of tax advantages in cases where the transaction that originated them cannot reasonably be considered as having a main economic purpose and manifests an artificial, fraudulent and abusive use of legal forms. In such cases, the TA has the power/duty to requalify the operation performed and assess the tax in accordance with the applicable rules in its absence and as if the tax advantage had never been produced. In other words, it has the power to rewrite the abusive transaction and assess the taxes that would be due if it had never occurred.

IV.3. Application of the GAAR of Article 38, No. 2 of the LGT to the Specific Case

Having clarified the substantive content of the GAAR of Article 38, No. 2 of the LGT, it is necessary to then scrutinize its application to the specific case as carried out by the TA. This examination is carried out based on the premise that the legal-political decision to introduce a GAAR into the national legal system is systemically incompatible with the adoption, in this context, of a formalist and literalist stance by the instances of jurisdictional control, including tax arbitration.

The TA limited itself to considering ineffective, for tax purposes, the legal transaction of purchase and sale of social participations, without, however, failing to see this transaction as part of a broader scheme. The reorganization of the group through the establishment of A… SGPS is taken into account in the broader framework in which the sale of shares is inserted. This limitation of the ineffectiveness of the legal transactions provided for in Article 38, No. 2 of the LGT to what is strictly necessary to pursue the tax objective pursued by the TA is entirely in accordance with the principle of prohibition of excess or principle of proportionality in the broad sense that should guide the actions of the Administration. Pursuant to Article 7, No. 2 of the Code of Administrative Procedure (CPA), "Administrative decisions that collide with subjective rights or legally protected interests of individuals may only affect these positions to the extent necessary and in terms proportional to the objectives to be achieved."

In order to substantiate its actions, the TA constructs its reasoning from the premise that the inclusion in the liabilities of A… SGPS of a debt of approximately 8 million euros, credited to its partners, for the acquisition of shares in B… held by them, can hardly be plausibly explained in light of a purely economic and business logic. And the truth is that an analysis of the transaction sub judice based on the criteria of primacy of substance over form, economic substance of the transaction and the principal purpose test (PPT), allows acceptance of the reasonableness of the conclusion, supported by the TA, that the essential or predominant purpose of the transaction carried out was to avoid or defer the payment of legally due taxes, namely those that in the case would apply to dividends that should have been distributed but were not. In support of this understanding, the following arguments appear especially relevant and compelling:

a) The transaction in question involved two related companies and the common partners to both; the shares held by the partners in B… were sold to A… SGPS which they also control.

A…, SGPS was established on 3-09-2008 with capital of € 50,000.00 represented by 50,000 shares with a nominal value of € 1.00 each, distributed among:

• 23,000 shares – C…

• 23,000 shares – D…

• 1,000 shares – E…

• 1,000 shares – F…

• 1,000 shares – G…

• 1,000 shares – H…,

having as corporate purpose the management of social participations in other companies.

On 23-12-2008 the contract for the purchase and sale of shares was entered into, by which the shareholders of A…, SGPS sold all shares in B… to A…, SGPS, for the total price of € 8,000,000.00, capital represented by 100,000 shares of € 80.00 each and distributed as follows:

• 44,000 shares – C…

• 44,000 shares – D…

• 3,000 shares – E…

• 3,000 shares – F…

• 3,000 shares – G…

• 3,000 shares – H…

The shares were sold for the aforementioned price of € 8,000,000.00 to be paid by A…, SGPS in 10 equal and successive annual installments, with the first falling due on 31 December 2009 and the last on 31 December 2018, with no interest being charged.

b) The group substantially increased its business volume in recent years; it grew from € 2,435,018.19 in 2009 to € 9,719,136.48 in 2014; B… proved to be a very profitable company with a solid capital structure;

It should be noted that in addition to B… in which A…, SGPS holds 100% of the capital, A…, SGPS is also a holder of participations of 16% of the capital of K…, Lda. and 12% of L…, Lda.

c) The prices practiced in the transmission of social participations were isolated from market vicissitudes; the shares were sold for € 80, with care being taken to mark off the value of the shares from B…'s balance sheet and their respective fluctuations; during the 10-year loan payment period no interest would be charged to A… SGPS, although it immediately took possession of the shares.

This situation was only possible because the holders of the capital were the same.

d) After the transaction, the partners substantially maintained their unchanged position of economic control over the entire corporate structure; the shareholders of B… continued to hold its capital through A… SGPS of which they were holders. The economic position of individual shareholders did not suffer any significant change, which allows questioning the existence of a substantial purpose beyond the reduction or deferment of taxes.

e) The taxes paid by the company and the partners were too low in relation to the growth of the group's business volume; in the period 2009 to 2014, A… SGPS accumulated distributable results of € 6,896,765.64, showing real income and tax-paying capacity, as shown in the table below:

f) From the moment that A… SGPS became the sole shareholder of B…, there was an abrupt change in the dividend distribution policy. The stated objective was to defer taxation to an uncertain future or to the time of liquidation of A…. As the TA argues "with the exception of a distribution of results that occurred in 2007, B… never distributed results and this despite the positive results presented since 2003. Thus only in 2010 does B… begin to allocate results to its sole shareholder and relating to the year 2009." (TA Response, no. 36).

g) Although the individual shareholders had gone many years without receiving dividends, the dividends paid by B… to A… SGPS were used to pay them the debt of 8 million euros. In order for A… SGPS to be able to take advantage of the elimination of double taxation with respect to such profits, the contractual clause that stipulated the year 2008 as the start of payment of the ten annual installments was breached, beginning in the first two years, i.e., 2008 and 2009. To compensate for this delay, the annual installments paid to shareholders in 2011 and 2012 were double the stipulated amount, i.e., €1,600,000.00 in each year, declining in the following years to the agreed values, €800,000.00 annually.

Based on these factual data, it is reasonable to doubt the genuineness of the transaction or arrangement of transactions in question, from the perspective of their respective economic substance. Using a holistic and multifactorial approach to the transaction, which allowed it to see through the forms ("look through"), the TA concluded, in a measured and methodical manner, that the € 8,000,000.00 debt created in favor of the shareholders of A… SGPS was intended, in reality, to "consume" the results which, demonstrating tax-paying capacity and real income, should have been distributed but were not, thereby deferring their taxation. Availing itself of the requalification or recharacterization powers delegated to it by the GAAR of Article 38, No. 2 of the LGT, the TA considered that this was, objectively, a matter of constructive dividends, which should be taxed as such. Note that the so-called constructive or disguised dividends occur more frequently in situations where, by virtue of the capital structure of the companies in question, negotiations between them and their shareholders assume greater informality.

Thus, the TA sought to adapt the tax reality to the economic substance of the transaction. An identical solution would be reached by applying the doctrine of fraud on the law (fraus legis) which in some legal systems operates as a functional equivalent of the GAAR. In the case at hand, the tax fact (i.e. distribution of dividends) is avoided by the non-use of normal legal means through recourse to artificial means devoid of relevant economic effects beyond tax savings with the tax result being the payment of less taxes than those that would be due if normal legal means had been used. The creation of the debt in favor of the shareholders constitutes the simulated transaction, and the distribution of profits is the concealed transaction.

The decision of the TA is far from being erroneous and absurd, and does not represent a departure or abuse of power or an improper exercise of discretion. The considerations set out above reasonably permit the conclusion that the transaction under analysis presents many of the typical elements corresponding to the creation of a fictional market (fictitious market) where partners and/or companies of the same group transact with each other at controlled prices, not subject to the economic tension characteristic of the market and resulting from the healthy competitive distance that it imposes (arms-length principle).

One of the multiple textbook examples of the sham transaction doctrine is precisely that of a distribution of dividends through the creation of a loan from shareholders, an operation that is designated, in circles dedicated to the study of aggressive tax planning, as a dividend-stripping transaction. It is one of many studied modalities of constructive or disguised dividends. For this reason, the present tribunal considers that the TA made legitimate use of the margin of appreciation recognized to it by the GAAR of Article 38, No. 2 of the LGT.

IV.4. Duty of Statement of Reasons

Pursuant to Article 152, No. 1 a) of the CPA, the duty of statement of reasons extends to administrative acts that totally or partially deny, extinguish, restrict or affect in any manner subjective rights or legally protected interests, or impose or aggravate duties, charges, burdens, subjections or sanctions. This duty serves an objective function, of guarantee of legality, transparency, integrity, rationality and controllability of administrative action, and a subjective function, of safeguarding the substantive and procedural rights of defense of the rights and interests of the addressees of the administrative act. In its objective dimension, the duty of statement of reasons must represent the factual presuppositions and the legal rules that gave the act its specific form, so as to allow the injured party its challenge before the competent administrative and judicial authorities.

The act of the TA applying the GAAR is subject to a specific duty of statement of reasons, provided for in Article 63, No. 3 of the CPPT, which necessarily comprises:

a) A description of the legal transaction entered into or of the legal act performed and of the transactions or acts of identical economic purpose, as well as an indication of the rules of incidence that apply to them;

b) The demonstration that the entry into of the legal transaction or practice of the legal act was essential or primarily directed to the reduction, elimination or temporary deferral of taxes that would be due in the case of a transaction or act with identical economic purpose, or to the obtaining of tax advantages.

The best way to assess whether the TA satisfied the requirements of statement of reasons is to see what is stated in this regard in the inspection report that supports the impugned act:

"II. Description of the Legal Transaction Entered Into or Legal Act Performed

The legal transaction in question results from a pre-planned scheme that begins with the sale, by the shareholders of B…, of the social participations they held in that company, to A… SGPS, and culminates in the reimbursement of the credit arising from that transaction, with the aim of avoiding the taxes to be "borne" by the shareholders resulting from the distribution of dividends.

This is a complex set of acts/transactions subject to a global architecture: subscription of the capital of A… SGPS in its entirety by the shareholders of B…, sale of the shares of B… for a price much higher than its nominal value (benefiting from the exclusion of taxation provided for in subparagraph a) of No. 2 of Article 10 of the PIT Code then in force) and the consequent creation of a credit in favor of these at A… SGPS, by which only in its complete view, which we will now describe, is the elusive design detected:

a. On 03 September 2008, the company A… SGPS was established with a share capital of € 50,000.00 (minimum capital required under the provisions of Article 276 of the Code of Commercial Companies), by the same shareholders of B…, and in identical proportion for each of the families holding;

b. Note that the establishment of this SGPS, in itself, cannot be considered an abnormal act, but rather the taking advantage of it for the pursuit of this scheme;

c. On 23 December 2008, the aforementioned shareholders sold all of the capital of B… to A… SGPS, at the price of € 80 per share (when the respective nominal unit value was € 5.00);

i. Note that no justification is presented for the stated price, although care was taken to include in the Contract for Purchase and Sale of Shares entered into, a clause that marks it off from B…'s balance sheet value and completely precludes any possibility of alteration of the same as a result of eventual changes in the value of the transacted company;

d. Without financial resources to pay the amount of € 8,000,000, A… SGPS acknowledges a debt to the shareholders, which they agree to receive over a period of 10 years, without interest, in annual installments of € 800,000, with the first falling due in the year 2008;

i. In fact, A…, established three months before, possessed in its assets, on the date of entry into of the aforementioned contract, only the amount corresponding to the initial share capital - € 50,000 — and had not, however, contracted any financing from banks, its shareholders or third parties, which would have enabled it to carry out this acquisition under normal market conditions;

ii. Only the existence of special relations with the shareholders (such as defined in subparagraphs a) and c) of No. 4 of Article 630 of the Corporate Income Tax Code) enabled the execution of this transaction under such favorable payment conditions (temporal extension for 10 years without any charges) with immediate acquisition of title to the social participations acquired;

iii. In reality, the sellers, in their capacity as former shareholders of B… and, simultaneously, as shareholders of A… SGPS, possessed privileged information regarding the patrimonial situation of both companies involved in the transaction, knowing full well that, by means of this, A… would come to hold the right to receive the profits that had been accumulated by B… for several years and not yet distributed to shareholders;

e. Notwithstanding the positive results presented at least since 2003 (and with the exception of the aforementioned distribution of results to the individual shareholders that occurred in 2007), only in 2010 does B… begin to allocate results to the shareholder (relating to the year 2009) — A… SGPS - on a repeated basis, benefiting from the elimination of double taxation (DTE) referred to in Article 51 of the Corporate Income Tax Code);

i. In the wording given to it by Law No. 55-A/2010, of 31 December — State Budget (in force at the date), this rule stipulates that the following shall be deductible from taxable profit the income corresponding to profits distributed provided, among other things, the following requirement is verified: "the beneficiary entity holds directly a participation in the capital of the company that distributes the profits of not less than 10% and this has remained in its ownership, continuously, during the year prior to the date the profits are made available.

f. Finally, the amounts received by A… as a distribution of results are, from 2011 onwards, used to amortize the aforementioned debts created at shareholders as a result of the sale of the capital parts of B…;

i. However, the taking advantage of the tax exclusion mentioned in the preceding subparagraph obliged the breach of the contractual clause that stipulated as the start year of payment of the ten annual installments the year 2008 during the first two years — 2008 and 2009, a fact for which there exists no other possible justification;

ii. To compensate for this delay, the annual installments paid to shareholders in 2011 and 2012 amounted to € 1,600,000 in each year, declining thereafter, in the following years, to the agreed amount of € 800,000 (see table on page 43).

A diagram of the acts/legal transactions carried out in chronological order is presented below so that the linking of operations can be better understood.

(…)

In a preliminary analysis, we can conclude that we are in the presence of a structure, as a set of sequential, logical and planned acts, organized in a unitary manner (linked), with a view to achieving the intended tax objective: to distribute dividends without subjecting them to taxation at the liberatory rate provided for in subparagraph c) of No. 1 of Article 71 of the PIT Code (years 2011 to 2014), and in subparagraph a) of the same rule (year 2015).

Such acts or legal transactions are embodied in the reimbursement to the shareholders after the distribution of profits by company B… to company A… SGPS (benefiting from the elimination of the DTE referred to in Article 51 of the Corporate Income Tax Code), preceded by the sale of the 100% participations that they held in the share capital of company B…, on 23 December 2008, for the total amount of € 8,000,000.00, to company A… SGPS, in which they hold all participations.

By means of the sale of shares to A… SGPS, the dividends of B… are made available to shareholders, avoiding withholding at source in a definitive manner and benefiting from the exclusion of taxation provided for in the transitional regime of category G provided in Decree-Law No. 442-A/88, of 30/11 and in the wording as of the date of subparagraph a) of No. 2 of Article 10 of the PIT Code.

II. Description of transactions or acts of identical economic purpose

In the case under analysis, the act with identical economic purpose to the payments made to shareholders as reimbursement of debts would be the distribution of dividends to them by company B… — classified as income in category E, pursuant to No. 1 and subparagraph h) No. 2 of Article 50 of the PIT Code - and the withholding at source of such income at the liberatory rate, as stipulated in subparagraph c) of No. 1 of Article 71 of the same Code (for the years 2011 to 2014) and subparagraph a) of the same provision for the year 2015, in accordance with the legal framework that we explain in Chapter III of this Report.

Indeed, since the objective was the withdrawal of profits from company B…. Such an objective could and should have been achieved with the simple distribution of dividends to the shareholders. Instead, a series of legal acts, more complex and expensive, was undertaken, which given the economic reality in concrete, the reasonableness thereof is not demonstrated, which clearly denotes the artificial intention of their use.

No valid reason is to be seen from an economic point of view for the successive accumulation of substantial results over the years by that company without distribution to shareholders (excepting the aforementioned € 500,000 distributed in November 2007, which was taxed in accordance with the law). This fact becomes even more incomprehensible when we are dealing with a very profitable company with a solid capital structure, as is the case with B….

It is evident that, without the use of these means, the beneficiary taxpayers would not avoid taxation, resulting from the transformation of dividends into reimbursement of credit, remaining subject to tax, under general rules, as income of category E of PIT.

By using this structure, it is clear that the shareholders of the identified companies artificially decided to avoid taxation in PIT through the entry into a set of anomalous transactions, thereby achieving identical economic purpose, and thus avoiding taxation in the seat of PIT in the amount of € 1,428,000.00 calculated in accordance with the legal rules indicated below.

III. Indication of Rules of Incidence That Apply to Them

The sanction, provided for in the final part of No. 2 of Article 38 of the LGT, where it states: "taxation then being carried out in accordance with the applicable rules in their absence and the aforementioned tax advantages not being produced", results, then, in the establishment of the rule itself.

Since the transformation of a distribution of dividends into a reimbursement of debt generated by the sale of shares in B… to A… SGPS had no other motivation than to avoid taxation in the seat of PIT, category E/capital in the sphere of shareholders as individual persons, it is incumbent upon the Tax Administration to consider ineffective, for tax purposes, the classification of these income items as reimbursements of debts and to classify them as distribution of dividends, in accordance with subparagraph h) of No. 2 of Article 5 of the PIT Code, subject to the liberatory rate provided for in subparagraph c) of No. 1 of Article 71 of the same statute (for the years 2011 to 2014), and in subparagraph a) of No. 1 of Article 71 (for the year 2015).

We are dealing with the so-called "step by step transactions", involving a succession of acts coordinated with each other, with the law applier operating an integrated treatment, viewing them as a single transaction, leading to a single and final result. Well, when this occurs, the anti-abuse provision can and should be applied at the decisive and final moment which is represented, "in the case at hand", by the receipt of payments by the shareholders as reimbursements of debts by A… SGPS, which would be what would happen in the absence of the composite evasive operation.

In the present case, the interposition of company A… SGPS between the shareholders and company B… – through the transmission carried out and the consequent change of direct ownership to indirect ownership - and its abusive use, had as its objective the withdrawal of profits from B… (benefiting from the aforementioned elimination of DTE) and the transformation of these into reimbursement of the credit generated with the transmission, resulting in the elimination of taxation in the seat of PIT of the principal shareholders of the companies under analysis and identified above, in the periods 2011 to 2015, since without the use of the structure used, they would not benefit from the exclusion of taxation, remaining those flows subject to tax as income of category E of PIT.

Thus, after the sale, B… began the distribution of results and profits to A… SGPS (without taxation, in accordance with Article 51 of the Corporate Income Tax Code), in the amounts of € 821,087.40, € 1,945,813.50, €1,545,547.20, € 920,000.00, € 960,000.00 and € 2,400,000.00, relating to the years 2009, 2010, 2011, 2012, 2013 and 2014 and paid in 2010, 2011, 2012, 2013, 2014 and 2015, with the entirety of the profits transferred — €1,600,000.00, € 1,600,000.00, € 800,000.00, € 800,000.00 and € 800,000.00 (respectively, in 2011, 2012, 2013, 2014 and 2015), subsequently to shareholders as reimbursement of the credit formed with the operation of sale of B….

Note that, following this operation, both families involved came to hold a percentage of the share capital in A… SGPS identical to that they held previously in B… – that is, 50% – such that their relative position remains unchanged, since both family J… and family I… now hold 50% of A… SGPS and therefore, indirectly, 50% of B….

If these amounts had been paid to shareholders in the form of profits, without the structure used, they would be subject to taxation, in accordance with the provisions of Article 5, No. 2, subparagraph h) of the PIT Code, similarly to what occurred in November 2007, when the distribution of results to shareholders — then individual persons — in the amount of € 500,000 took place.

These income items classified as Capital – Category E are subject to withholding at source at the liberatory rate, as results from subparagraph c) of No. 1 of Article 71 of the PIT Code (with the corresponding wording at the date of the facts) and subparagraph a) of No. 1 of Article 71 of the PIT Code (in the wording currently in force for the year 2015), from the moment they are made available to their respective holder, as provided in subparagraph 2) of No. 3 of Article 7 of the PIT Code. The liberatory rates in force in the years 2011 and 2012 were 21.50%, 25%, 26.5%, respectively, and 28% from 2013 onwards, as shown in the following table:

Thus, given that A…SGPS was the company that made the profits available, it will be upon the amounts paid by this to shareholders that withholding at source will apply at the moment of payment, and it would be incumbent upon it to deliver them — by virtue of the provision of No. 1 of Article 98 of the PIT Code — according to the values calculated below and in the periods indicated:

It can be seen, thus, that the TA amply satisfied the formal requirements regarding statement of reasons, which proves to be clear, sufficient and congruent, referring to the facts and the law that justified the proposal, subsequently made a decision through the agreement of the hierarchy of the TA.

Given such statement of reasons, the Applicant became aware of the position of the administration and the reasons why it acted as it did, so as to be able to choose to comply or react, administratively or contentiously, as occurred.

It is a different matter the assessment of the substantial validity of the same statement of reasons, which consists in verifying the absence of errors of fact or law.

This is a matter that the tribunal has already assessed in point IV.3. above.

IV.5. The GAAR and Tax Substitution

In comparative law, the application of the GAAR to situations of tax substitution and withholding tax (witholding tax) constitutes a current and generally accepted practice in the context of combating aggressive tax planning and tax evasion and fraud. It occurs with great frequency precisely in the requalification of various types of transactions as distributions of dividends. As mentioned above, the application of the GAAR requires special attention to transactions subject to a group logic, with the question of who, within the group, ultimately obtains the tax advantages produced being considered irrelevant. For purposes of applying the GAAR, the principle of primacy of substance over form may legitimize the treatment of the group involved in the abusive transaction as if it were a single taxpayer, namely in determining tax-paying capacity, consideration of tax advantages produced and tax exigibility, it not being excluded, in some contexts, the possibility of holding responsible and sanctioning all participants in that transaction.

Under Article 38, No. 2 of the LGT, when the TA considers ineffective for tax purposes acts or legal transactions essentially or primarily directed, by artificial or fraudulent means and with abuse of legal forms, to the reduction, elimination or temporary deferral of taxes that would be due as a result of facts, acts or legal transactions of identical economic purpose, taxation must be carried out in accordance with the applicable rules in the absence of such acts or legal transactions. What is intended in this way is the reconstitution of the current hypothetical tax situation, that is, the tax situation that would exist if the abusive transaction had not been carried out and normal legal means corresponding to the economic reality of profit distribution had been adopted.

In the specific case, the act suited to the economic purpose pursued would be the distribution of dividends to the partners of A… SGPS, with the corresponding withholding at source applicable as tax substitution. This is what results from the synoptic reading of No. 1 and subparagraph h) No. 2 of Article 5 of the PIT Code – which leads to the category of income of category E the profits of entities subject to Corporate Income Tax made available to their respective associates or holders, including advances on account of profits – with Article 71, No. 1, subparagraph c) of the same Code, the withholding at source, definitive in nature, of such income at the liberatory rate of 28%.

Pursuant to Articles 20 and 28, No. 3 and 34 of the LGT and 21 of the PIT Code, the principal responsibility for withholding and the respective delivery lies with the tax substitute. In accordance with these rules, applicable in the absence of the abusive transaction in question, taxation occurs in the sphere of A… SGPS, S.A, in its capacity as tax substitute and principal debtor. The question of who, within the group, obtained the tax advantages produced is irrelevant.

The GAAR of Article 38, No. 2 of the LGT does nothing more than make applicable the regulatory framework in force at the moment of the occurrence of the tax fact, considered in its economic substance, which should ab initio have been applicable to it. The same is based on the premise that the loan contracted from shareholders for the acquisition of the respective shares corresponds to a disguised distribution of dividends, and should be subject to the withholding at source which, according to law, applies to dividends. One cannot, therefore, speak of any violation of the principle of prohibition of retroactivity of tax law enshrined in Article 103, No. 3 of the CRP.

This results in important procedural implications. First, A… SGPS must be heard within a period of 30 days from the notification of the draft of application of the anti-abuse provision to the taxpayer, pursuant to the right to a prior hearing provided for in Article 63, Nos. 4 and 5 of the CPPT. Second, it is the entity that can exercise the right to challenge. Indeed, Law No. 64-B/2011, of 30 December, revoked No. 10 of Article 63 of the CPPT which provided for the figure of an autonomous contentious claim for the application of the anti-abuse rule. Since then, the same has come to be subject to review in the assessment in accordance with the principle of unitary challenge. This very result follows from No. 1 of Article 63 of the CPPT, where it provides that "The assessment of taxes on the basis of the anti-abuse provision contained in No. 2 of Article 38 of the general tax law follows the terms provided in this article."

This means that A… SGPS may challenge the assessment act directed to it, with it not being justified to open up the challenge avenue to all subjects that intervened in the abusive scheme. If in the specific case this would imply A…, S.A., A… SGPS, S.A., C…, D…, E…, F…, G… and H…, in other cases of abusive practices this could imply a multiplicity of corporate structures and individual persons. The assessment of taxes converges with the application of the GAAR and with the procedure provided for in Article 63 of the CPPT.

The allegation by the Applicant that it is not the actual taxpayers who are called into the proceedings but only A… SGPS – in its capacity as tax substitute to whom the withholding of the tax owed is charged – does not appear to be well-founded.

First, the abusive transaction was carried out in a fictional market, involving controlled companies and shareholders holding control. That is, the transaction followed a group logic, marking the intimate legal-economic relationship between all those involved. The principle of primacy of substance over form cannot remain indifferent to this reality, and this cannot fail to have implications at the procedural level.

Second, any procedural difficulties that might eventually arise for a possible right of recourse against the taxpayers who obtained the tax advantage, besides being attributable to all participants in the transaction, can be easily resolved by them in the extrajudicial forum at any time or, possibly, at the time of liquidation of the company.

It is concluded from the foregoing that the TA made no erroneous interpretation of the facts, in considering them to be subsumed by the rule of Article 38, No. 2 of the LGT, which it interpreted and applied correctly; that the notification made to the Applicant is legal, as it is upon it that the obligation to withhold at source falls; that the right to be heard was observed with respect to whom it should be, that is, the Applicant, with no need to respect it with respect to others; and that the challenged act is duly reasoned.

In brief, since none of the illegalities accused by the Applicant are verified, its request cannot succeed.

V. DECISION

In accordance with the foregoing, the present arbitral tribunal decides to find the request for arbitral pronouncement not to have merit, absolving the Respondent, and condemning the Applicant, as the losing party, to bear the costs of the proceedings.

VI. VALUE OF THE PROCEEDINGS

In accordance with the provisions of Articles 306, No. 2, of the Code of Civil Procedure, 97-A, No. 1, subparagraph a), of the CPPT and 3, No. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of the proceedings is set at € 402,715.60.

VII. COSTS

Pursuant to Article 22, No. 4, of the RJAT, the amount of costs is set at € 6,732.00, in accordance with Table I attached to the Regulation of Costs in Tax Arbitration Proceedings.

Let notification be made.

Lisbon, 14 November 2017.

The arbitrators

(José Baeta de Queiroz)

(Jónatas Machado)

(Fernando Manuel dos Santos Cardoso)

[1] Values net of corrections of other nature.