CAAD Case 174/2018-T: IRC Deductibility of Financing Costs Under Article 23 CIRC – Loan Interest Expenses

ARBITRAL DECISION

The Arbitrators José Pedro Carvalho (Presiding Arbitrator), Jorge Bacelar Gouveia and José Joaquim Monteiro Sampaio e Nora, designated by the Deontological Council of the Administrative Arbitration Centre to form an Arbitral Tribunal, hereby agree on the following:

ARBITRAL DECISION (consult full version in PDF)

I – REPORT

On 5 April 2018, A... Lda., NIPC..., with registered office at Rua..., no...., ..., room..., ...-... Lisbon, filed a request for constitution of an arbitral tribunal, under the combined provisions of articles 2 and 10 of Decree-Law no. 10/2011, of 20 January, which approved the Legal Regime of Arbitration in Tax Matters, as amended by article 228 of Law no. 66-B/2012, of 31 December (hereinafter, briefly referred to as RJAT), seeking the declaration of illegality of the additional IRC assessment act no. 2016..., in the amount of €75,339.32, as well as the decision of tacit dismissal of the hierarchical appeal no. ...2017... filed against the dismissal of the administrative complaint no. ...2017... lodged against the said additional IRC assessment.

To substantiate its request, the Claimant alleges, in summary, the occurrence of a defect consisting of violation of law by error as to the factual and legal premises, in that, in short:

• the irregularities in determining the taxable result derived from the erroneous interpretation and qualification of balances and accounts of the Claimant, because the AT (Tax Authority) considered that the Claimant contracted bank loans to meet the needs of its associates, when in fact the Claimant contracted bank loans to meet its own treasury needs;

• The Claimant did not abuse the institute of deductibility of expenses through the inclusion of costs with the pursuit of third-party interests;

• It follows from the foregoing that the cost in question is indispensable, since it is related to the company's activity and that the expenses were incurred solely and in the interest of the company, wherefore they should be fiscally accepted as a cost pursuant to section c) of article 23(1) of the CIRC (Corporate Income Tax Code).

On 6 April 2018, the request for constitution of the arbitral tribunal was accepted and automatically notified to the AT.

The Claimant did not proceed to appoint an arbitrator, whereby, under the provisions of section a) of article 6(2) and section a) of article 11(1) of the RJAT, the President of the Deontological Council of CAAD designated the signatories as arbitrators of the collective arbitral tribunal, who communicated acceptance of the assignment within the applicable period.

On 29 May 2018, the parties were notified of such designations and did not manifest any intention to refuse any of them.

In accordance with the provisions of section c) of article 11(1) of the RJAT, the collective Arbitral Tribunal was constituted on 18 June 2018.

On 6 September 2018, the Respondent, duly notified to that effect, submitted its defence solely by way of challenge.

Under the provisions of sections c) and e) of article 16 and article 29(2), both of the RJAT, the holding of the meeting referred to in article 18 of the RJAT was dispensed with.

Having been granted a period for the submission of written submissions, these were submitted by the parties, pronouncing on the evidence produced and reiterating and developing their respective legal positions.

It was indicated that the final decision would be notified by the end of the period provided for in article 21(1) of the RJAT.

The Arbitral Tribunal is materially competent and is properly constituted, pursuant to articles 2(1)(a), 5 and 6(2)(a) of the RJAT.

The parties have legal personality and capacity, are legally entitled and are properly represented, pursuant to articles 4 and 10 of the RJAT and article 1 of Ordinance no. 112-A/2011, of 22 March.

The proceedings are not affected by nullities.

Thus, there is no obstacle to the consideration of the case.

Everything considered, it is therefore necessary to deliver:

II. DECISION

A. FACTUAL MATTER

A.1. Facts Established as Proved

The Claimant was incorporated on 3 July 1979 and has as its purpose the trade in hardware and toys, carrying out various buying and selling operations with other companies.

The Claimant is, and was in 2012, subject to the general regime for IRC purposes, with organized accounting.

On 18 April 2013, the Claimant filed the IRC Model 22 Declaration, relating to the fiscal year 2012, in which it determined a taxable profit of €74,647.09.

In the fiscal year 2012, the Account "2783 – Associated Companies" presented a balance of €952,642.17, divided as follows:

• "B..., Lda.", with a balance of €804,780.00;

• "C..., Lda.", with a balance of €112,528.00;

• "D..., S.A.", with a balance of €33,568.00;

• "Other" with a balance of €2,068.00.

These balances result from loans granted by the Claimant to associated companies, with agreement of deferred payments over time and with forgiveness or without stipulation of interest.

In the fiscal year 2012, a balance of €2,617,131.18 was recorded in account 21 – "Customers", as follows:

• "C..., Lda." with a balance of €1,987,420.29;

• "D... S.A." with a balance of €433,309.34;

• "B..., Lda." with a balance of €196,401.45.

These balances corresponded to commercial buying and selling operations of goods and products, embodied in the corresponding invoices, issued in accordance with legal requirements.

The Claimant carried out normal commercial buying and selling operations with such entities.

The Claimant agreed to installment payment and without interest of the amounts owed.

In relation to the company "C..., Lda.", the amount of €6,475,372.73 has already been settled to the Claimant between 1997 and 2012, and that of the balances evidenced in customer accounts in 2012, in the amount of €2,099,947.92, the company settled the amount of €652,311.36, these payments occurring fundamentally during 2016 and 2017, as per the table below:

With respect to the company B... Lda, of the balances evidenced in customer accounts in 2012, in the amount of €1,000,879.08, the company settled the amount of €927,966.46, these payments occurring in 2016 and 2017, as per the table above:

The Claimant resorted to financing with third-party capital to finance its activity:

• from banks and from shareholders, recorded in the SNC 25 sub-account (financing obtained), in a total of €6,575,741.41;

• from suppliers, recording in the suppliers account (221110099 supplier D..., S.A.), a total of €126,000.00.

In the fiscal year 2012, the Claimant incurred charges with loans obtained, recorded in account 69 – Financing charges and losses, in the amount of €450,035.45.

The Claimant did not obtain any income from the credit granted.

The accounts of loans obtained and related suppliers presented together average monthly balances of €6,297,591.60 and, on the other hand, the accounts of loans granted and related customers present average monthly balances of €3,491,787.81.

The loans obtained had an average monthly cost of €37,319.61 and the credits granted obtained no income.

If the Claimant had not resorted to financing, it would have entered into a liquidity shortage, given the outstanding flow in its commercial accounts.

The Claimant was the subject of an internal inspection action, following Service Order no. OI2015..., relating to the fiscal year 2012.

The Claimant was notified of the Draft Inspection Report and to, if it wished, exercise its right to be heard.

On 28 November 2016, the Claimant was notified of the Final Tax Inspection Report, which proposed the following corrections:

• Correction to the taxable matter in the amount of €248,148.63 resulting from non-deductible financial charges;

• Correction to the tax due, under autonomous taxation, in the amount of €419.98.

In the Final Tax Inspection Report, the following is stated, in summary:

[Content of inspection report summary not fully reproduced in original]

On 28 November 2016, the Claimant was notified of the additional IRC assessment act no. 2016....

Following the assessment notice and the absence of payment by the Claimant, tax enforcement proceedings no. ...2017... were instituted.

The Claimant provided as guarantee a mortgage on a property, in the amount corresponding to €95,652.48.

On 17 March 2017, the Claimant filed an administrative complaint against the said assessment act.

On 6 October 2017, the Claimant was notified of the decision dismissing the administrative complaint.

On 8 November 2017, the Claimant filed a hierarchical appeal.

Until the date of submission of the arbitral request, no decision had been rendered regarding the hierarchical appeal, whereby the Claimant presumed its tacit dismissal.

A.2. Facts Established as Not Proved

1- That the balances mentioned in accounts 27 ("Associated Companies") result from normal commercial operations.

2- The justification for the balances of accounts 21 ("Customers") is the lack of payment capacity of the customers.

3- The company "C..., Lda" represented a crucial commercial relationship, since it sold products of the Claimant that had less rotation and, as such, greater difficulty in selling, thus allowing a greater reduction in the Claimant's stock.

4- The Claimant contracted loans to meet its own treasury needs.

A.3. Reasoning of the Factual Matter Proved and Not Proved

Regarding factual matters, the Tribunal does not have to pronounce on everything alleged by the parties; rather, it has the duty to select the facts that matter for the decision and to discriminate between proved and not proved matters (cf. article 123(2) of the CPPT and article 607(3) of the CPC, applicable by virtue of article 29(1)(a) and (e) of the RJAT).

Thus, the facts relevant to the judgment of the case are chosen and delineated according to their legal relevance, which is established in light of the various plausible solutions to the legal question(s) (cf. previous article 511(1) of the CPC, corresponding to the current article 596, applicable by virtue of article 29(1)(e) of the RJAT).

Thus, having regard to the positions taken by the parties, in light of article 110(7) of the CPPT, the documentary evidence and the Administrative Record attached to the case, the facts listed above were considered proved, with relevance to the decision, taking into account that, as stated in the Judgment of the TCA-South of 26 June 2014, rendered in case 07148/13[1], "the probative value of the tax inspection report (...) may have probative force if the assertions contained therein are not challenged."

The facts established as not proved are due, essentially, to the absence or insufficiency of evidence regarding them.

Thus, the fact established as not proved under no. 1 was specifically challenged by the Respondent in point 13 of the Respondent's reply, it being certain that the Claimant admits, in point 42 of the initial petition, that "loans granted" are at issue, without, anywhere, justifying and duly sustaining the business rationale for such "loans."

As for the fact established as not proved under no. 2, it is likewise the subject of specific challenge by the Respondent, in points 14 et seq. of the reply, and no evidence available corroborates it.

The same applies, mutatis mutandis, to the facts established as not proved under nos. 3 and 4, insofar as no available evidence permits asserting, beyond any reasonable doubt, that they correspond to reality.

No findings of proof or non-proof were made regarding allegations made by the parties and presented as facts, consisting of assertions that are strictly conclusive, incapable of proof, and whose truthfulness is to be assessed in relation to the concrete factual matter consolidated above.

B. LAW

The question at issue in the present arbitral action is identified with the question widely already discussed both in arbitral proceedings and in the superior courts of the administrative and tax jurisdiction, relating to the deductibility of financial expenses attributable to non-remunerated financing granted by IRC taxpayers.

The starting point for the assessment of any question that presents itself to be decided relating to the matter in question should be, as formulated in the Judgment of the STA of 4 June 2014, rendered in case 01763/13, that "the relevance or lack thereof of certain expenses as exercise costs would always have to be seen concretely, case by case, in function of the peculiar business context in which they develop and the purposes they pursue."

It is in this context, therefore, that the analysis and legal-tax framing of the situation sub iudice should be carried out.

Having stated this, "it constitutes consolidated case law of the STA that in light of article 23 of the CIRC, financial costs with interest on bank loans contracted by a company and applied to free financing of associated companies are not to be considered as fiscally relevant"[2].

Indeed, repeatedly, the STA has affirmed that "In light of article 23 of the CIRC, financial costs with interest and stamp duty on bank loans contracted by a company and applied to free financing of associated companies are not to be considered as fiscally relevant."[3] and that "The financial charges borne by the claimant arising from supplements and additional contributions made to associated companies free of charge cannot be considered as fiscally deductible costs, as they are not indispensable for the realization of the claimant's income subject to tax or for its maintenance as a source thereof, under article 23 of the CIRC in the wording in effect at the time of the facts, not being the claimant an SGPS nor being covered by the group taxation regime."[4]

In light of such case law, and of the facts established as proved, no other conclusion can be reached than that the financial charges attributable to the financing recorded by the Claimant in accounts 27 ("Associated Companies") cannot, in light of article 23 of the CIRC, be qualified as deductible costs, as the AT considered, in operating the corrections that the Claimant contests in the present arbitral action.

Indeed, apart from the existence of non-remunerated loans granted by the Claimant to entities associated with it, including an individual, its partner, and the necessity for the Claimant to bear financial charges, by way of deprivation of financial resources channeled to such loans, nothing more is ascertained that would permit, in light of the criterion of business necessity that should guide the deductibility of expenses incurred by IRC taxpayers, to conclude that financial charges necessary for the obtaining of income subject to that tax, or for the maintenance of the source producing such income, are at issue.

Indeed, in light of the facts established as proved, and to nothing else is it lawful for this Tribunal to have regard, the loans in question, granted to associated entities, present themselves as liberalities of the Claimant (whose deductibility is expressly prohibited by article 24(a) of the CIRC, as a concretization of the general criterion of article 23(1) of the CIRC), without legal framework for their deductibility being achieved.

Thus, and in light of the foregoing, there is nothing to censure in the tax act sub iudice, insofar as it operates corrections regarding the amounts recorded by the Claimant in accounts 27 ("Associated Companies").

As for the corrections operated by the AT regarding the financial charges that it attributed to the amounts recorded by the Claimant in accounts 21 ("Customers"), these appear to lack foundation.

Indeed, as is established as proved and is not contested by the Respondent, the amounts in question corresponded to commercial buying and selling operations of goods and products, embodied in the corresponding invoices, issued in accordance with legal requirements, it being the case that the Claimant carried out with such entities normal commercial buying and selling operations, and agreed to installment payment without interest of the amounts owed.

Now, this type of operations, in which an economic operator agrees that a customer of his proceed to the payment of debts on terms, and without the payment of interest, plainly constitute normal operations in the business context, the financial cost of such facilities granted to customers being a component of the cost of the products or services that are sold by the supplying company.

Indeed, and equally plainly, the granting of payment facilities by economic operators to their respective customers is a competitive advantage as against their competitors, and, as such, is of an eminently business nature, and should not and cannot, in light of positive law, be subject to fiscal censure.

This conclusion shall not be hindered by the circumstance, pointed out by the Respondent, that "This fact, however, constitutes a way for customers to finance themselves, insofar as they can carry out their activity without the corresponding financial expenditure."

While what the Respondent points out is certain, no less certain is what the same recognizes, that the "amounts (...) recorded in account 21 of the accounting, have underlying the supply of goods to customers, through the sale without obligation of immediate payment," as well as that this constitutes a normal commercial practice, and one in which the financial costs borne by the supplier with such choice necessarily integrate the cost of the goods or services supplied, being an option that is legitimate and entirely justifiable from a business standpoint, always when, and if, there are no indices of fraud or tax avoidance present.

At issue, therefore, is not the circumstance, ventured by the Respondent, that "those customers of the Claimant are being financed," but rather that such financing is justifiable on business grounds assessable in light of the criteria relevant for the purposes of article 23 of the CIRC, on which the corrections operated by the AT are based, and against which the Claimant rises, not being perceived, in light of the reasoning concretely elaborated by the AT, in what manner "the amounts involved and the period of deferral of payment" can justify any other legal-tax framework, particularly insofar as they point out, nor does the AT derive therefrom, that any fraudulent or avoidance action is at issue.

In this context, such costs cannot be considered other than as incurred "in the pursuit of the corporate purpose (...) and/or maintenance of the source producing income."[5]

In the terms set forth, and in light of the reasoning above, there must be considered founded the corrections relating to the financial charges attributable to the amounts recorded in accounts 27 ("Related Entities"), in the value of €952,642.17 (in addition to the correction relating to autonomous taxation in the value of €419.98, not contested by the Claimant), and unfounded the corrections relating to the same type of charges attributable to the amounts recorded in accounts 21 ("Customers"), in the value of €2,617,131.18, by error in the factual premises, and consequent error of right.

C. DECISION

In these terms, this Arbitral Tribunal decides to declare the arbitral request partially upheld and, in consequence:

• Partially annul the additional IRC assessment act no. 2016..., in the amount of €75,339.32, as well as the decision of tacit dismissal of the hierarchical appeal no. ...2017... filed against the dismissal of the administrative complaint no. ...2017... lodged against the said additional IRC assessment, insofar as it relates to the disregard as expenses of the financial charges attributed to the amounts recorded by the Claimant in accounts 21 ("Customers"), in the amount of €2,617,131.18;

• Declare not upheld, maintaining the tax acts referred to, in the remaining part;

• Condemn the parties for the costs of the proceedings in the proportion of their respective defeat, fixing the amount of €664.00, charged to the Claimant, and the amount of €1,784.00, charged to the Respondent.

D. Value of the Proceedings

The value of the proceedings is fixed at €75,339.32, pursuant to article 97-A(1)(a) of the Code of Tax Procedure and Process, applicable by force of sections a) and b) of article 29(1) of the RJAT and article 3(2) of the Regulation of Costs in Tax Arbitration Proceedings.

E. Costs

The arbitration fee is fixed at €2,448.00, pursuant to Table I of the Regulation of Costs in Tax Arbitration Proceedings, to be paid by the parties, in the proportion of their respective defeat, fixed above, since the request was partially upheld, pursuant to articles 12(2) and 22(4), both of the RJAT, and article 4(4) of the said Regulation.

Let notification be made.

Lisbon, 17 December 2018

The Presiding Arbitrator

(José Pedro Carvalho)

The Arbitrator Member

(Jorge Bacelar Gouveia)

The Arbitrator Member

(José Joaquim Monteiro Sampaio e Nora)

[1] Available at www.dgsi.pt, as is the remaining case law cited without mention of provenance.

[2] Judgment of the TCA-South, of 12 December 2013, rendered in case 06826/13.

[3] Judgment of the STA of 30 January 2011, rendered in case 0107/11.

[4] Judgment of the STA of 19 April 2017, rendered in case 0925/16.

[5] Judgment of the STA of 19 April 2017, rendered in case 0925/16.