Autonomous Taxation on Director Severance Pay Under IRC Article 88 - CAAD Case 163/2017-T

ARBITRAL AWARD

The Arbitrators, Dr. José Poças Falcão (Presiding Arbitrator), Dr. Nuno Oliveira Garcia and Dr. Mariana Vargas (Arbitrators), appointed by the Deontological Council of the Administrative Arbitration Centre (CAAD) to form the Collective Arbitral Tribunal constituted on 22 May 2017, hereby agree as follows:

REPORT

On 8 March 2017, the company A… – Social Participations Management Company, SA, with tax identification number …, represented by company B…, SGPS, SA, with registered office at …, no. … and …, …, …, …-… Amadora and with tax identification number … (hereinafter referred to as Claimant), pursuant to the combined provisions of Articles 2 and 10 of Decree-Law No. 10/2011 of 20 January, which approved the Legal Regime for Arbitration in Tax Matters (RJAT), requested the constitution of a Collective Arbitral Tribunal, with the Tax and Customs Authority (hereinafter AT or Respondent) being the respondent, with a view to declaring the illegality and partial annulment of Corporate Income Tax (IRC) assessment No. 2016…, in the amount of €484,312.27, and of the Statement of Account Adjustment No. 2016…, in the total value of €630,487.72, relating to the financial year 2012, assigning to the claim the economic value of €458,294.08 (four hundred and fifty-eight thousand, two hundred and ninety-four euros and eight cents).

The Claimant further requests the condemnation of the Respondent to pay compensation, should it improperly provide security for suspension of the tax enforcement proceedings No. …2016…, initiated for compulsory collection of the assessment now disputed.

Summary of the Parties' Positions

Of the Claimant:

The Claimant bases the request for partial annulment of the IRC assessment act of the 2012 financial year on the erroneous quantification of taxable income, for which it invokes the reasons set out below:

The disputed assessment was issued by AT on the premise that the indemnities paid in 2012 to four of its administrators, in the amount of €1,238,149.13, should have been subject to autonomous taxation, at the rate of 45%, to be self-assessed by the Claimant in the IRC return for that financial year.

However, the aforementioned administrators, appointed for the three-year period 2011/2013, resigned from their positions by letters dated 12 March 2012, having performed administrative functions for only approximately 14.5 months of the 36 months initially provided for.

In accordance with the provisions of paragraph (a) of Article 88, section 3, of the Corporate Income Tax Code (Código do IRC), only the "expenses relating to the part exceeding the amount of the remuneration that would have been earned by performing those positions of administrator or manager until the end of the contract, in the case of termination of a contract before the end" (quoted above) are subject to taxation.

The monthly remuneration earned by the administrators amounted to €8,826.00 and, having these individuals ceased their functions on 12 March 2012, the payment would be outstanding for at least 25.5 months each, until the end of their respective terms of office: 11.5 from the year 2012 and 14 months from the year 2013.

For this reason, according to the Claimant, only the difference between the amount of indemnities paid to the administrators who resigned from their mandates before the end of the period designated for the performance of functions (€1,238,149.13) and the amount of remuneration to which they would have been entitled until the end of that period (€900,252.00), is subject to autonomous taxation, under IRC.

The disputed IRC assessment should, to that extent, be partially annulled, as well as the corresponding compensatory interest.

Considering that the excess of the amount of indemnities paid to the administrators over the amount of remuneration to which they would have been entitled until the end of 2013 is €339,475.35, only this amount would be subject to autonomous taxation, at the rate of 45%, resulting in tax of €152,763.91, the Claimant requests the annulment of the tax assessed in the amount of €404,403.20.

The Claimant further requests the partial annulment of compensatory interest in the amount of €53,890.88, based on the amount of tax due and its respective calculation period.

In its submissions, the Claimant reiterated the factual and legal arguments set out in the initial petition, advocating for the annulment of the disputed IRC assessment in the proceedings.

Of the Respondent:

Notified pursuant to the terms and conditions provided for in Article 17 of RJAT, AT presented its response and attached the administrative file, to which it referred in full, defending the legality and maintenance of the assessment act that is the subject of this arbitral decision request.

The Respondent did not submit counter-arguments.

II. PRELIMINARY MATTERS

• The Collective Arbitral Tribunal is competent and was regularly constituted on 22 May 2017, in accordance with Articles 2, section 1, paragraph (a), 5 and 6, all of RJAT.

• The parties have legal personality and capacity, are legitimate and are legally represented, in accordance with Articles 4 and 10 of RJAT and Article 1 of Ordinance No. 112-A/2011 of 22 March.

• The proceedings do not suffer from defects that would invalidate it.

• No exceptions were raised that merit consideration.

III. LEGAL REASONING

III.I FACTUAL MATTER

a) Established Facts

The factual matter relevant to the understanding and decision of the case, following critical examination of the documentary evidence attached to the Initial Petition and the Administrative File (PA) forwarded by AT, is established as follows:

• In compliance with Internal Service Order OI2016… of 26 January 2016, of the Tax Office of Lisbon, the company A… – Social Participations Management Company, SA, now Claimant, was the subject of an internal tax inspection action, of partial scope (IRC for the financial year 2012), "essentially motivated by the analysis and verification of the value attributed as compensation in the financial year 2012 (…)" – page 6 of the Tax Inspection Report, hereinafter RIT;

• The Claimant, subject to the normal IRC taxation regime, ceased operations on 23 December 2013 (page 7 of RIT) and cancelled its registration on 26 December 2013 (page 6 of Doc. 9, attached to the Initial Petition), with the company B…, SGPS, SA being the representative of cessation;

• With reference to the financial year 2012, the Claimant submitted two Model 22 IRC declarations, on 31 May and on 29 October 2013, registered under numbers …-2012-…-… and …-2012-…-…, respectively (page 8 of RIT);

• In the first declaration submitted, a tax loss of €1,114,061.72 was determined and a refund of €146,175.45 was made (assessment No. 2013… of 06.06.2013), transferred to the Claimant on 29.07.2013 (Doc. 3, attached to the Initial Petition);

• In Annex A of the Accounting Statement of the financial year 2012, registered in the AT computer system under number …-…-…, the Claimant declared, in section 03-A of the Statement of Results by Nature (Annex A), in field A5008 – personnel expenses, the sum of €1,479,968.05, a value itemized in section 05292-A of the same annex as follows (pages 9 and 10 of RIT):

[Details of personnel expenses breakdown]

• Following clarifications provided by the Claimant, it was established that the indemnities were paid to the employees identified in the table below, due to the termination of their respective contracts, in March 2012 (page 12 of RIT):

[Table with administrator indemnity details]

• The administrators identified in the above table were appointed members of the Board of Directors of the Claimant for the three-year period 2011/2013, in accordance with the resolution of 31 March 2011 and Registration 7, Annotation 22/20110511 (see permanent certificate with access code …-…-… – Doc. 9, attached to the Initial Petition);

• These same administrators sent letters to the Claimant dated 12 March 2012, in which they resigned from their respective positions (Doc. 10, attached to the Initial Petition);

• The cessation of their functions as administrators was registered by Annotation …/… (Doc. 9, attached to the Initial Petition);

• The salaries paid by the Claimant to the administrators identified above, referring to the month of February 2012, based on remuneration of €8,826.00, appear in the receipts reproduced in Docs. 11 to 14, attached to the Initial Petition and in Annexes 11 (E…), 14 (D…), 17 (C…) and 20 (F…), attached to RIT;

• The salaries paid by the Claimant to the aforementioned administrators, with reference to the month of March 2012, based on remuneration of €4,270.65, appear in the receipts reproduced in Annexes 12 (E…), 15 (D…), 18 (C…) and 21 (F…), attached to RIT;

• AT considered the entire amount of €1,238,149.13, paid by the Claimant as compensation for the cessation of functions in March 2012 to the administrators already identified, subject to autonomous taxation, at the rate of 45% (Article 88, sections 13 and 14 of CIRC), having proposed corrections in the amount of €557,167.11, as shown in the table below (page 28 of RIT):

[Table with AT's correction calculations]

• The Claimant did not exercise the right to prior hearing, with the final version of the RIT being notified to company B…, SGPS, SA, in its capacity as representative of its cessation, by letter No. …, of the Tax Office of Lisbon (registration of registered mail RC … PT) of 6 October 2016;

• On 12 October 2016, the correction document No. … for the year 2012 was prepared, on the basis of which the IRC assessment No. 2016 … of 12 December was made, assessments of compensatory interest and default interest reflected in the Statement of Account Adjustment No. 2016…, in the total value of €630,487.72, with voluntary payment deadline of 12 December 2016;

• The Statement of Account Adjustment No. 2016…, dated 14 October 2016, contains the following elements:

• The failure to pay the disputed assessment resulted in the initiation of tax enforcement proceedings No. …2016….

b) Unproven Facts:

It was not proven that the Claimant had provided security for suspension of tax enforcement proceedings No. …2016….

It was not proven that a new professional relationship was created between the administrators in question and the Claimant or any other entity equivalent to it in accordance with section 10 of Article 2 of the Personal Income Tax Code.

III.II THE LAW

As follows from what has been set out above, the correction made by AT is based on section 13 of Article 88 of the Corporate Income Tax Code, according to which:

"Are taxed autonomously, at the rate of 35%:

The expenses or charges relating to indemnities or any other compensation owed not related to the achievement of productivity objectives previously defined in the contractual relationship, when there is a cessation of functions of a manager, administrator or managing director, as well as the expenses relating to the part exceeding the value of the remuneration that would have been earned by performing those positions until the end of the contract, in the case of termination of a contract before the end, regardless of the modality of payment, whether this is paid directly by the taxpayer or whether the responsibilities inherent therein are transferred to another entity" (quoted above, italics added).

It is true that the RIT reports various facts – e.g., shareholding by the administrators,[1] inconsistency in the indication of the date of resignation of the corporate organs, incongruence in the response of the taxpayer during the inspection procedure – but the correction made is based, solely, on the provisions of section 13 of Article 88 of the Corporate Income Tax Code, together with the provision for increased rates set out in section 14 of the same article.

Well then, in this regard, and now at the arbitral stage, the Claimant invokes that a (significant) part of the value of the indemnities paid to the administrators in question relates to the amount that would have been owed to them as remuneration that they would have earned by performing the administrative positions until the end of their respective terms of office. And the Claimant seeks to demonstrate this fact based on the indication of the average monthly remuneration values earned by those administrators.

Now, in accordance with the legal command transcribed above, and given that AT has not been able to contradict the allegation that part of the value of the indemnities to the administrators was justified by the remuneration that they failed to earn by virtue of their resignation, it is difficult to see how the Claimant's argument cannot be accepted.

It is also true that in the Portuguese legal order it is not yet entirely clear what the legislator intended by the provisions of section 13 of Article 88 of the Corporate Income Tax Code; namely: did the legislator intend to presume, for purposes of not reducing taxation, that the indemnity paid to an administrator is based on the time of work that he might have performed for the company before becoming an administrator, and not the time during which he was an administrator? From the letter of the law, it does not appear so.

That is to say, even if it is not an exemplary solution, everything indicates that the Corporate Income Tax Code, in this matter, does not intend to subject to autonomous taxation the indemnities paid to administrators up to the amount in which those indemnities are comprised in the average monthly remuneration values that those administrators failed to earn. That is precisely what appears to result from the expression "the part exceeding the value of the remuneration that would have been earned by performing those positions until the end of the contract" (quoted above).

Furthermore, the interpretation we follow is the one that best conforms to the regime provided for taxation, now in Personal Income Tax, of administrators. Effectively, in accordance with paragraph (a) of section 4 of Article 2 of the Personal Income Tax Code, the part of the indemnity corresponding to the performance of administrative functions is always subject to taxation in full. It is certain that, in this case, AT did not demonstrate that the administrators were not subject to Personal Income Tax in accordance with the aforementioned paragraph (a) of section 4 of Article 2 of the Personal Income Tax Code...

Now, in this case, and in accordance with the established facts, we are not dealing with indemnities related to the achievement of productivity objectives. Moreover, as we have already indicated above, AT has not controverted that the values of the indemnities are justified by the remuneration that those administrators would have been entitled to until the end of their term of office, despite this not being the initial response of the taxpayer during the inspection procedure.

On the other hand, it was also not proven that a new professional relationship was created between the administrators in question and the Claimant or any other entity equivalent to it in accordance with section 10 of Article 2 of the Personal Income Tax Code.

In these terms, it is difficult to see how one can decide in the sense of disregarding what is expressly stipulated in section 13 of Article 88 of the Corporate Income Tax Code, when it refers to the taxation of only the "expenses relating to the part exceeding the value of the remuneration that would have been earned by performing those positions until the end of the contract" (quoted above). It is true that it is incumbent upon the company to calculate the value of the indemnity to be paid, and to reach agreement with the worker or member of the corporate body. And it is also true that this company can always justify the value of the indemnity (or part of it) – as the Claimant does at the arbitral stage (not having done so at the inspection stage) – based on the remuneration that remained unpaid by virtue of the termination of the employment contract or the performance of the function. But even if this is the case, once again it is difficult to see how one can disregard the cited section of section 13 of Article 88 of the Corporate Income Tax Code which, in practice, provides that autonomous taxation of the indemnity exists only from a certain value that is assessed by taking into account the value of the remuneration that would have been owed had the termination of the relationship with the company not occurred.

IV. DECISION

In these terms, this Arbitral Tribunal decides:

a) To fully uphold the Claimant's claim;

b) To declare, consequently, the partial illegality of the Assessment – IRC No. 2016… and of the respective compensatory interest assessment, both requiring correction by annulment, in the amount of €404,403.20 and €53,890.88, respectively;

c) To dismiss the claim for compensation as it was not proven that the Claimant had provided security for suspension of tax enforcement proceedings No. …2016….

d) To condemn AT to pay the costs of these proceedings.

Value of Action

The value of the action is fixed at €458,294.08 in accordance with Article 97-A, section 1, paragraph (a) of the Tax Procedure and Process Code, applicable by virtue of paragraphs (a) and (b) of section 1 of Article 29 of RJAT and section 2 of Article 3 of the Regulation of Costs in Tax Arbitration Proceedings.

Let notification be made.

Lisbon, 7 November 2017

The Arbitrators,

José Poças Falcão
(President)

Nuno Oliveira Garcia
(Arbitrator)

Mariana Vargas
(Arbitrator)

[Text prepared by computer, in accordance with section 5 of Article 131 of the Code of Civil Procedure, applicable by referral of paragraph (e) of section 1 of Article 29 of Decree-Law 10/2011 of 20 January. The drafting of this decision is governed by the 1990 spelling agreement].

[1] It should be noted that, on page 22, reference is made to the fact that all administrators are simultaneously shareholders. However, having all shares the same nominal value (in accordance with the permanent certificate), and in the absence of additional justification by AT, no correspondence is established between the value of the participation and the indemnity that each administrator received by virtue of the resignation. To this regard, AT states, still on page 22 of the RIT that "[f]rom the 2011 Annual Report, there is a document called the Legal Certificate of Accounts, which in the final part (page 19 of annex 23) textually states '(III) The shareholders of the company initiated, at the end of 2011, a negotiation process with the main financial institutions and the Fund being created for sectoral consolidation, such negotiations having been concluded by March 2012, as a result of which there is a promise of transfer of the shareholder position'. If we understand correctly what AT intends to allude to in this regard, it is not therefore a mere correction based on the provisions of sections 13 and 14 of the Personal Income Tax Code, but rather the possible invocation of an abusive situation, with the consequent taxation of the indemnities in the sphere of the administrators. It happens that this is not the route followed by the RIT, nor has AT even brought to the administrative proceedings any type of argument in the sense of disregarding acts allegedly directed at reducing or eliminating taxes that would be owed (see section 2 of Article 38 of the LGT).