IRC Tax Deductibility of Business Expenses: CAAD Arbitration Case 198/2017-T

ARBITRAL DECISION

The arbitrators Dr. Jorge Manuel Lopes de Sousa (arbitrator-chair), Dr. Maria Cristina Aragão Seia and Dr. Cristiana Maria Leitão Campos, appointed by the Ethics Council of the Centre for Administrative Arbitration to form the Arbitral Tribunal, constituted on 28-06-2017, agree as follows:

1. Report

A… LDA, NIPC…, with registered office at Rua …, n.º…, …, …, …, …-…, Lisbon (hereinafter referred to as "A…" or "Claimant"), submitted, pursuant to articles 2.º and 10.º of Decree-Law n.º 10/2011, of 20 January (Legal Framework for Tax Arbitration, hereinafter referred to only as RJAT), a request for arbitral pronouncement in which the TAX AND CUSTOMS AUTHORITY is required.

The Claimant requests:

– the annulment of the acts carried out by the Tax Authority regarding Corporate Income Tax (IRC) assessments for the years 2013 and 2014, identified by assessment notices n.º 2016 … and n.º 2016…, for failure to hold a hearing with the taxpayer before the assessment;

– if not so understood, the said assessments should be annulled, on the grounds that the expenses which the AT considered as non-deductible should be considered as proven;

– if not so understood, which is not admitted, the assessments of compensatory interest mentioned therein should be annulled.

The request for constitution of the arbitral tribunal was accepted by the CAAD President and automatically notified to the Tax and Customs Authority on 24-03-2017.

Pursuant to the provisions of article 6.º, n.º 2, paragraph a) and article 11.º, n.º 1, paragraph b) of the RJAT, as amended by article 228.º of Law n.º 66-B/2012, of 31 December, the Ethics Council appointed as arbitrators of the collective arbitral tribunal the signatories, who communicated their acceptance of the appointment within the applicable time limit.

On 17-05-2017, the parties were duly notified of this appointment, and neither manifested any intention to refuse the appointment of the arbitrators, in accordance with article 11.º, n.º 1, paragraphs a) and b) of the RJAT and articles 6.º and 7.º of the Ethics Code.

Thus, in accordance with the provisions of article 11.º, n.º 1, paragraph c) of the RJAT, as amended by article 228.º of Law n.º 66-B/2012, the Arbitral Tribunal was constituted on 28-06-2017.

The Tax and Customs Authority submitted a reply defending the non-acceptance of the request.

On 24-10-2017, a meeting was held for the production of witness evidence, at which it was decided that the proceedings would continue with written submissions.

The Parties presented their submissions.

The Arbitral Tribunal was duly constituted.

The Parties are duly represented, have legal personality and capacity and are legitimate (articles 4.º and 10.º, n.º 2, of the same statute and article 1.º of Ordinance n.º 112-A/2011, of 22 March).

The proceedings are not affected by nullities and no exceptions were raised.

2. Facts

• The Claimant is registered for the exercise of its main activity of real estate development, CAE 41100, since 02.01.2008 and also for the exercise of two secondary activities – other consulting, scientific, technical and similar activities and lease of real estate;

• With reference to the period of 2013 and 2014, inspection actions were promoted under service orders n.º OI2016… and OI2016… issued by the Tax Inspection Services of the Lisbon Tax Office, pursuant to article 46.º of RCPITA (Complementary Framework for Tax and Customs Inspection Procedures);

• Such service orders were issued to verify and check the operations underlying the payments made, in the years in question, in the context of VAT and IRC, to non-resident entities subject to privileged tax regime, namely the aforementioned B…, with registered office in Hong Kong (hereinafter referred to as "B…");

• In the years under analysis, the Claimant, in the exercise of its activity, sold 34 units of lots … and …, corresponding to two developments located at Rua … and Rua … in Lisbon, to 32 citizens of Chinese nationality and 2 of Angolan nationality;

• These sales were carried out at values superior to the property value of the real estate, and were related to the possibility of foreign citizens obtaining special authorization to reside (the so-called Gold Visa) in the event of acquisition of real estate valued at or above 500,000 euros;

• In the course of the inspection procedure, it was verified that, although the sale values of the units were considerably higher (sometimes about double) than the determined property values, the profit obtained was almost entirely absorbed by expenses for supplies and external services provided by B…;

• When questioned about this matter, the Claimant justified this fact on the basis of the situation in the real estate sector in the country at that time, and the financial constraints in which it found itself, leading to the sale of the real estate on the terms proposed to it;

• Specifically, the Claimant stated that these expenses referred to advertising and marketing expenses, carried out by B…, for the acquisition of clients residing in the People's Republic of China;

• Such statement – regarding the nature of the services provided – is consistent with the description on the invoices, as well as with the entry made in the General Accounting Trial Balance (accounts 62215 and 62216);

• In the inspection actions, a Tax Inspection Report was drawn up, which is part of the administrative file, the content of which is reproduced here, referring in particular to the following:

III. DESCRIPTION OF FACTS AND GROUNDS FOR PURELY ARITHMETIC CORRECTIONS

III.1 IRC

III.1.1 Changes to Taxable Income - Non-Deductible Expenses

In the fiscal years 2013 and 2014, the operations carried out by A… corresponded to the sale of real estate located in Lisbon to Chinese citizens, for which it incurred expenses recorded in the SNC account "Advertising and Propaganda", sub-account "Specialized Works", referring to the marketing services of company B…, with registered office in HONG KONG, in the respective amounts of 82,300.00 euros and 2,582,254.00 euros.

These advertising and "marketing" expenses, which are reflected in the accounting of A…, will not be accepted tax-wise, for the following reasons, given that they assume relatively high values and were paid to a non-resident entity outside the national territory. In accordance with tax regulations, A… is not entitled to deduct them for purposes of determining fiscal result.

III.1.1.1 - Legal and Tax Framework

Article 23.º, n.º 1 of the IRC Code, in the version applicable in 2013, establishes the general conditions that expenses must meet to be tax-deductible:

"Article 23.º Expenses

1 — Expenses are those which are demonstrably indispensable for the achievement of income subject to tax or for the maintenance of the productive source, namely:"

Three essential requirements are thus required for expenses incurred to be valued and accepted tax-wise: proof (justification), indispensability, and the connection to income subject to taxation.

The first requirement relates to the effectiveness of the actual incurrence of expenses, which consists of various forms of documentary support for accounting entries, that is, their documentary evidence.

The second requirement makes the tax deductibility of the expense dependent on a justified relationship with the productive activity of the company, and this indispensability occurs when such charges are connected with the generation of profit.

The third requirement that comprises the general clause of deductibility of expenses, as formulated by the IRC Code, is the requirement of connection to "income subject to taxation or the maintenance of the productive source". It follows from the general principle of article 23.º of the IRC Code that expenses incurred by the taxpayer, to be tax-deductible, must be limited either to the generation of income subject to taxation or to the maintenance of the productive source.

The requirement of proof is met if it is based on documentary evidence such as, for example, invoices or contracts;

However, the general principle of deductibility of expenses is subject to an exception in the case of payments to non-resident entities in Portugal and located in privileged tax jurisdictions, as a way to prevent the erosion of the tax base.

Thus, with a view to combating international tax evasion and fraud and in order to restrict the use of tax havens, the Portuguese legislator chose to introduce into our legal order, measures generically designated as anti-abuse, through specific clauses in the law.

In this context, article 65.º of the IRC Code provides as follows, applicable in 2013:

"Article 65.º

Payments to non-resident entities subject to a privileged tax regime

1 – Amounts paid or owing, in any form whatsoever, to natural or legal persons resident outside the Portuguese territory and subject therein to a clearly more favourable tax regime are not deductible for purposes of determining taxable profit, save if the taxpayer can prove that such charges correspond to operations actually carried out and do not have an abnormal character or an excessive amount.

2 – A natural or legal person is deemed to be subject to a clearly more favourable tax regime when the territory of their residence is included in the list approved by ordinance of the Minister of Finance or when they are not subject therein to an income tax identical or analogous to IRS or IRC, or when, regarding the amounts paid or owing mentioned in the preceding number, the amount of tax paid is equal to or less than 60% of the tax that would be due if the said entity were considered resident in Portuguese territory.

3 – For purposes of the preceding number, taxpayers must have and, when requested by the Directorate-General for Taxation, provide evidence of the tax paid by the non-resident entity and the calculations made to determine the tax that would be due if the entity were resident in Portuguese territory, in cases where the territory of residence of the same is not included in the list approved by ordinance of the Minister of Finance.

4 – The proof referred to in n.º 1 must take place following notification of the taxpayer, made with a minimum notice of 30 days.

5 - The provisions of the preceding numbers also apply to amounts paid or owing indirectly, in any form whatsoever, to the same natural or legal persons, when the taxpayer has or should have knowledge of the destination of such amounts, such knowledge being presumed when there are special relationships within the meaning of n.º 4 of article 63.º between:

a) The taxpayer and the natural or legal persons resident outside the Portuguese territory and subject therein to a clearly more favourable tax regime; or

b) The taxpayer and the mandatary, fiduciary or interposed person who makes the payment to the natural or legal persons referred to in the preceding paragraph."

For its part, article 23.º-A added to the IRC Code by Law n.º 2/2014 of 16 January, which republished this Code, and applicable in 2014, provides:

"Article 23.º-A Non-deductible charges for tax purposes

1 – The following charges are not deductible for purposes of determining taxable profit, even when accounted for as expenses of the tax period:

r) Amounts paid or owing, in any form whatsoever, to natural or legal persons resident outside the Portuguese territory and subject therein to a tax regime identified by ordinance of the member of Government responsible for the finance area as a clearly more favourable tax regime, save if the taxpayer proves that such charges correspond to operations actually carried out and do not have an abnormal character or an excessive amount.

...

7- The provision of paragraph r) of n.º 1 also applies to amounts indirectly paid or owing, in any form whatsoever, to natural or legal persons resident outside the Portuguese territory and subject therein to a clearly more favourable tax regime, when the taxpayer has or should have knowledge of their destination, such knowledge being presumed when there are special relationships, within the meaning of n.º 4 of article 63.º, between the taxpayer and the said natural or legal persons, or between the taxpayer and the mandatary, fiduciary or interposed person who makes the payment to the natural or legal persons.

8 - The Tax and Customs Authority notifies the taxpayer for the production of the proof referred to in paragraph r) of n.º 1, and for this purpose a period of not less than 30 days must be set.

These rules clearly aim to combat a type of evasive or fraudulent operations, by means of payments in favour of non-resident entities established in privileged tax jurisdictions, in order to transfer income generated and located in Portugal to places with more favourable tax regimes, with reduced or non-existent taxation, and traditionally reluctant to cooperate in the provision of information for tax purposes.

The establishment of these rules immediately determines the general principle of non-deductibility of expenses incurred with this type of payments, establishing, however, a saving clause, which operates through the reversal of the burden of proof, directing it to the taxpayer, to whom it will fall to cumulatively comply with two conditions, in which case, if it does so, the expenses will be admissible for purposes of determining fiscal result:

• The expenses correspond to actual operations;

• They do not have an abnormal character or an excessive amount.

This is a dual proof obligation that will fall on the taxpayer to produce, which must, in the first place, demonstrate that the expenses materialized in actual acts, not sufficing the mere formal existence such as contracts, invoices and bank transfers, and, in the second place, that these expenses are not abnormal or excessive, which may operate through comparison with comparable market situations in a context of perfect competition.

In this regard, part of the judgment handed down on 19/02/2015, in case 08126/14 at the Central Administrative Court of the South (TCAS), which tried a case of payment to non-resident entities subject to a privileged tax regime, is transcribed, highlighting the importance of proof demonstration, to the detriment of form, the summary of which is transcribed:

With regard to proof of the veracity of the operation, it will not be sufficient to exhibit written documents, namely contracts concluded between the parties, as these are presumed to be simulated, nor the demonstration of payment of the price, since that is not in dispute. What must be the object of proof is rather the effective provision of services, or the receipt of a loan, that is, the commercial fact that gave rise to the payment of the same price that appears as a cost to be deducted in the context of IRC. As for proof of the absence of abnormal or excessive character of the expenses, this must involve demonstrating that the contract, whose veracity has been proven, is balanced. For this purpose, the taxpayer must demonstrate what the real importance of the advantages gained by the said contract is, such as proving that the charges established constitute the fair remuneration of these advantages, in particular through comparison with the costs of similar services on the market."

In the absence of proof of these requirements, it is concluded that the expenses in question are not deductible and the consequent increase of their amounts in fiscal result.

The production of this proof should be made by the taxpayer before the AT, presenting to it the means of proof of the effectiveness of the expense and of the normal and non-excessive character, to whom will fall the duty of its appraisal with a view to forming an administrative judgment on the validity of the payments.

This is therefore a legislative solution in which the "burden of proof" is reversed to the taxpayer, in which, by force of the provisions referred to, in the field of payments to entities domiciled in territories of low taxation, the presumption of truthfulness of the taxpayer's statements contained in n.º 1 of art. 75.º of the General Tax Law is excluded, according to which "the declarations of taxpayers presented in accordance with the terms provided by law, as well as the data and calculations entered in their accounts or books, are true and made in good faith, when these are organized in accordance with commercial and tax legislation". And if the taxpayer fails to produce such proof, the expense is not tax-accepted, and the taxable income is increased for tax purposes.

(i) As to the existence of a more favourable tax regime

First, it must be determined whether the privileged tax jurisdiction is encompassed in the provision of n.º 2 of article 65.º applicable in 2013, and paragraph r) of n.º 1 of article 23-A, in force for the fiscal year 2014, both of the IRC Code.

Now, in the specific case of HONG KONG, this is the jurisdiction listed in n.º 31 of Ordinance n.º 292/2011, applicable in the years under analysis of 2013 and 2014, so for the situation in question and for both years, the single prerequisite of inclusion in the list approved by ordinance of the Minister of Finance is relevant in common.

That is, ascertaining that amounts are being paid to an entity, in this case B…, resident outside the Portuguese territory and located in a jurisdiction included in the said Ordinance, the condition is met that determines the verification of the prerequisite for subsumption in the concept of clearly more favourable tax regime.

(ii) As regards the requirement for actual performance of operations

It is incumbent upon the taxpayer to demonstrate that operations involving payments to non-residents subject to a more favourable tax regime were actually carried out. This reversal of the burden of proof materializes in the demonstration of the effectiveness of the performance of the operation which, if not supplied, implies that the charges resulting therefrom are not deductible.

Now, from documentary analysis it was found that the taxpayer (inspected entity) has the deeds of purchase and sale of the real estate and the "Framework Agreement" and further:

— Invoices issued by the said service provider; and

— Means of payment of the invoices through bank transfers.

However, although this set of documents provides the operation with the fulfilment of formal requirements, it lacks substantial proof, a gap that was not filled for the following reasons;

— It was not shown that any action, advertising campaign or equivalent, concrete and effective, was carried out by the said service provider company aimed at the sale of units;

— That if there had been any, the same was appropriate and directed to the objective, that is, in the event that it had been carried out it was intended to attempt to sell units or instead any other product;

— Proof that the service was in reality provided by means of the presentation, in particular, of market prospecting studies, investment advantages, marketing campaigns, since no evidence of the same was presented on paper, recordings, video, computer support, digital or any other support;

— And even if the physical evidence of the work carried out were displayed, it would still be necessary to demonstrate the adequacy of each of them to the requirements of article 23.º of the IRC Code;

— And that, beyond the contract, no exchange of any correspondence or contacts with the alleged service provider was shown, connected with the services that it allegedly intermediated.

It is not enough, therefore, to have the existence of contract, invoices or bank transfers: it is necessary to have evidence of a whole set of actions, activities or concrete advertising campaigns, that is, of complementary justifying elements to the tax-relevant documentation, without which well-founded doubts remain about the actual performance of the operations that the invoices purport to represent.

In sum, there is no proof whatsoever of the actual performance of advertising services by the company based in HONG KONG.

Now, noting that pursuant to the legislation already cited, it is incumbent upon the taxpayer to demonstrate the material evidence that supports the fact that such services were provided, and it having failed to do so, this requirement of deductibility is not met.

(III) As to abnormal character

In this regard, it is concluded that, the taxpayer not having produced any material proof that would allow for the assessment of the intrinsic nature of the expense, or its consistency with the business activity, it is not possible to assess its normal character in relation to the activity carried out.

That is, if the taxpayer failed to prove the substance of the expense, it is not possible to assess whether what is characterized as advertising and commissions has a normal character in relation to the activity carried out.

Here too the taxpayer failed to comply with the burden imposed upon it by law.

(IV) As to excessive amount

For the assessment of this characteristic, that is, whether the payments are adequate to the actual value of the services provided, it appears that the "cost-benefit ratio will be appropriate, the condition being considered met if the revenues compensate the respective expenses, that is, that future revenues are such that they justified the respective charge, except in cases where the attempt to penetrate other markets was not successful and the service inherent to the expense was actually carried out.

That is, despite the gross marketing margins being positive, they are absorbed by expenses for supplies and external services relating to "marketing" paid to the advertiser or to commissions paid to the commission agent located in HONG KONG.

Now, in situations involving human intervention with studies, projects, or advertising as in the matter at hand, the taxpayer should have in file elements that would allow assessing the appropriateness of the amount to the purpose and enabling the assessment of any excess, in particular:

• identification of human resources involved, hours applied and hourly rates per consultant;

• evidence of meetings, "surveys";

• travel;

• whether those who carried out the work have professional experience;

• whether budgets were requested on the national or international market for comparative purposes and, if so, why the budget of an entity resident in a privileged tax jurisdiction was preferred over others with other locations.

There would also be a factor of great relevance the knowledge and identification of the capital holders of the "off-shore" entity to ascertain whether they are independent in relation to the company in question, as relevant elements to dispel the presumption of untruthfulness of the expense, unless proven otherwise, which it is incumbent upon A… to produce.

It was also incumbent upon A… to prove that the operations did not have an abnormal character, and as is public knowledge, this action implies the payment to the real estate company of a commission which is usually 5% of the sale value of the real estate, which in some cases may be lower and reach 3%, or be higher and reach 6%. (the commission paid in 2013 was 16% and in 2014 there were commissions of 15% to 21%)

Here too it is concluded that, the A… not having produced any proof that there is no excess in the amount of advertising, this requirement is considered as not met.

Conclusion:

The burden that tax law requires for accepting as deductible payments to non-residents, when located in low taxation jurisdictions, was not met, divided cumulatively by the following requirements: -

• The production of proof of the actual performance of advertising;

• The production of proof of the normality of the payment;

• The production of proof that the amount is not excessive.

Therefore, it is concluded that, the A… not having complied with the burden of proof enshrined in the provisions of articles 65.º and 23.º-A of the IRC Code, the expenses relating to the payments in question are tax-disallowed in the fiscal years 2013 and 2014. In light of the foregoing, it is concluded that the elements presented by the taxpayer are insufficient to ascertain that the charges correspond to operations actually carried out and that they do not have an abnormal character or an excessive amount, as provided for in articles 65.º (for 2013) and 23.º-A (for 2014) of the IRC Code.

III.1.1.3 Amendment to Taxable Result

Thus the determination of fiscal result is as follows:

[TABLE STRUCTURE PRESERVED]

Given that in previous years fiscal losses are recorded, these are deductible pursuant to article 52.º of the IRC Code, and thus their adjustment is made in 2013 and 2014.

The deduction permitted in 2013 cannot exceed the amount corresponding to 75% of the respective taxable profit, pursuant to n.º 2 of article 52.º of the IRC Code. Therefore, taking the corrected taxable profit, we have: 21,841.75€ x 0.75 = 16,381.31 euros, which is the limit of fiscal losses to be deducted.

In this case it can deduct the 16,381.31 from 2011. For 2014 it can deduct the remaining losses from 2011: 70,600.28 euros plus the 80,088.44 euros from 2012, which totals € 150,688.72 euros. In 2015 there are no more losses to deduct.

The corrected taxable income is presented as follows:

[TABLE STRUCTURE PRESERVED]

• The VAT on all invoices of the fiscal years 2013 and 2014 constitutes a tax-accepted expense in the context of IRC, an acceptance that does not put in crisis the disregard of the expense with the corresponding advertising. This occurs because, the company having carried out VAT self-settlement, and deduction depending on the framework of the activity, as it is limited to exempt sales without right to deduction, it has the prerogative of reflecting it in expenses of the period. The self-settlement operation is connected with the payment made to a non-resident, whose mere act is not in question, by application of the localization rules of operations provided for in article 6.º of the VAT Code, without assessing the substance, normal character or excess of the amount paid. That is, the act of payment to a non-resident subsumes the operation in the provision of paragraph a) of n.º 6 of article 6.º of the VAT Code, without directly resulting from this a validation of expense proof requirements, this one effected in another context and specifically in income tax.

III.1.2 - Correction to Tax

III.1.2.1 - Autonomous Taxation

The non-proof of the expenses mentioned in the preceding chapter also has as a consequence autonomous taxation at the rate of 35%, in accordance with the provisions of n.º 8 of article 88.º of the IRC Code.

This provision provides the following for the fiscal years 2013 and 2014:

Article 88.º Autonomous taxation rates

3 — Expenses corresponding to amounts paid or owing, in any form whatsoever, to natural or legal persons resident outside Portuguese territory and subject therein to a clearly more favourable tax regime, as defined in accordance with the Code, are subject to the regime of n.º 1 or n.º 2, as the case may be, with the applicable rates being, respectively, 35% or 55%, save if the taxpayer can prove that they correspond to operations effectively carried out and do not have an abnormal character or an excessive amount.

Since the taxpayer did not proceed with the proof mentioned above, and the expenses in question were not accepted tax-wise as an expense of the period, they are subject to autonomous taxation at the rate of 35%, in accordance with the provisions of n.º 1 and n.º 8 of article 88.º of the IRC Code. Therefore, we have:

Fiscal year 2013:

82,300.00 X 0.35 = 28,805.00 euros

Fiscal year 2014:

2,582,254.00 x 0.35 = 903,788.90 euros

III.1.2.2 - Withholding Tax

The company presented forms Model 21-RFI signed and stamped by the actual beneficiary of the payments, as well as tax residence certificates issued in their name, validated by the Hong Kong tax authorities, whereby it complies with the withholding exemption requirements provided for in article 98.º of the IRC Code (see Annex 6.).

It is noted from the outset that the institute of withholding or exemption, in compliance with these formal requirements, does not contend with the disregard of the expense, since the operation of withholding consists only in the application of a taxation rate to an amount paid to a non-resident, and which constitutes income in their sphere, in which the mere act of payment is not in question given that the monetary outflow has in fact occurred, but which is not dependent on the tax acceptance or not of the expense, this one dependent on compliance with legal requirements.

III.1.3 - Summary of Corrections

The inspection procedures aimed to evaluate compliance with the tax duties of A…, and it was found that payments occurred to a non-resident entity subject to a privileged tax regime, specifically HONG KONG, and as such qualified by inclusion in Ordinance n.º 292/2011 of 08/11.

Given that this type of payment may occur with the intent to carry out evasive or even fraudulent operations, given that they are made in favour of entities established in a privileged tax jurisdiction, in order to transfer income generated and located in Portugal to places with more favourable tax regimes, with reduced or non-existent taxation, the IRC Code has established a specific anti-abuse rule intended to combat these practices.

Thus, in a first line of analysis, for an expense to be deductible, it must comply with the requirements of the general deductibility clause inherent in n.º 1 of article 23.º of the IRC Code. However, amounts paid or owing to natural or legal persons resident outside the Portuguese territory whose territory of residence are not deductible as expenses for tax purposes (the last two prerequisites apply only in 2013):

A) Is included in the list approved by ordinance;

B) They are subject therein to a clearly more favourable tax regime - exempt from IRS or IRC or

C) The tax is equal to or less than 60% of what would be due in Portugal (15%=60% x 25%).

However, a saving clause was provided for, that is, the charges may be deductible if the following requirements are cumulatively met:

A) The taxpayer proves the effectiveness of performance of the operations;

B) They do not have an abnormal character or an excessive amount.

The taxpayer having failed to proceed with this proof, the expenses in question are not accepted tax-wise as expenses of the period, being subject to autonomous taxation at the rate of 35%, in accordance with the provisions of n.º 1 and n.º 8 of article 88.º of the IRC Code, this taxation being burdened by 10 percentage points in 2013, given that a fiscal loss was presented.

Autonomous taxation was also carried out by applying the rate of 35% to 2013 and 2014, with the tax owing being 28,805.00 euros in 2013 and 903,788.90 euros in 2014.

• Following the inspection action, IRC assessments n.ºs 2016 … and 2016 …, for the fiscal years 2013 and 2014 respectively, were issued (documents n.ºs 1 and 2 attached with the request for arbitral pronouncement, whose contents are herein reproduced);

• B… carried out advertising, promotion and disclosure activities in Chinese territory of the real estate of the Claimant which led to the acquisition of the same by Chinese citizens;

• B… held conferences and seminars on the advantages and benefits of living in Portugal in various cities in China;

• B… assisted Chinese citizens in obtaining visas for entry and stay in Portugal;

• B… accompanied Chinese citizens in traveling to Portugal for visits to the real estate;

• B… paid travel, accommodation and food expenses, as well as other expenses related to their stay and visits to the Claimant's real estate;

• B… provided interpreter services by contracting translators to accompany Chinese citizens in Portuguese territory;

• B… hired drivers to transport Chinese citizens in Portugal, namely between the airport and the hotel, foreign and border services, banks and restaurants and the main tourist attractions in Portugal;

• Accompanied Chinese citizens in opening bank accounts in Portugal;

• After the acquisition of the real estate, B… assisted Chinese citizens in decorating the real estate and in connecting electricity, gas and water to the acquired real estate;

• B… provided legal services to said Chinese citizens, hiring lawyers;

• The Claimant undertook to pay B… remuneration for each real estate sold to a buyer indicated by that company;

• The Claimant entered into 33 deeds and sales of real estate to Chinese citizens indicated by B…;

• The Claimant made the payments to B… to which it had committed itself;

• There were hundreds of potential clients garnered by B… who did not complete any acquisition of real estate, situations in which the Claimant made no payment to that entity;

• B…, initially, required commissions of 15% on the value of real estate sold and, later, commissions higher than 20% and 25%;

• The Claimant had to accept the conditions demanded by B…, as there was enormous difficulty in selling real estate to national citizens in the years 2013 and 2014 and it was in a situation of economic distress, as under normal conditions it should have sold the real estate by 2010 (5 years after the beginning of the construction process) and, not having sold them, had to continue to bear banking charges, with significant aggravation of interest, which during the period provided for the construction process were approximately € 93,000 in 2006, € 144,000 in 2007, € 176,000 in 2008, € 223,000 in 2009 and € 300,000 in 2010, and were later aggravated, becoming approximately € 520,000 in 2011, € 600,000 in 2012, € 483,000 in 2013, and € 486,000 in 2014;

• In the situation of urgent need to find buyers for the real estate, the Claimant had no possibility of discussing the respective value of the commissions demanded by B…, as there was no one else who provided the service of customer acquisition that it provided, at the sale prices that the Claimant wished to obtain;

• The commissions of B… were added to the prices of the real estate desired by the Claimant, so did not affect its profit margin;

• In January 2014, the Claimant company increases the price of the units by 5% in order to "accommodate" the increase in commission;

• The manager of the Claimant exchanged hundreds of emails with B…;

• It was the advantages arising from the said "GOLD VISAS" that were advertised by B… on the Chinese market and led to the acquisitions of the real estate referred to in the proceedings;

• Beyond the commercial relations respecting the sale of the real estate;

• The Claimant associated itself with other companies in the customer acquisition program that B… organized, so that a dimension of the number of real estate that interested this company would be reached;

• B… acts in various countries, such as Canada, Malta, Spain and Portugal, being a company specialized in attracting Chinese clients for investments in programs like Golden Visa;

• The Claimant was not placed, in the context of the right to be heard, with the possibility of compensatory interest being assessed;

• On 23-03-2017, the Claimant submitted the request for arbitral pronouncement that gave rise to the present proceedings.

2.1. Facts Not Proven

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

2.2. Reasoning of the Decision on Facts

The facts were considered as proven on the basis of documents contained in the administrative file and those attached with the request for arbitral pronouncement and also on the basis of testimony given at the hearing by G…, H…, I…, J…, K…, L… and M…, which confirmed the generality of the facts alleged by the Claimant, as referred to in paragraphs l) to hh) of the facts.

All witnesses appeared to testify with impartiality and with knowledge of the facts they referred to.

As to the lack of prior hearing on the assessment of compensatory interest, the Draft Tax Inspection Report was not attached to the proceedings, but the Tax and Customs Authority does not dispute the Claimant's statement that no reference was made to it in that draft, instead defending that "such exercise would be dispensable to exercise autonomously as the tax owed in default and the respective interest are directly related".

Furthermore, the Tax Inspection Report also makes no reference to compensatory interest, including in section I.1.3 of the "SUMMARY MAP OF CORRECTIONS RESULTING FROM INSPECTION ACTION", specifically intended to indicate "Amounts Subject to Interest" (page 6/46 of the Tax Inspection Report, on sheet 7 of the administrative file).

3. Law

3.1. Issue of Pretermission of Right to Be Heard as to Compensatory Interest

The Claimant attributes to the assessment in question a defect of pretermission of the right to be heard before the assessment of compensatory interest.

The Draft Tax Inspection Report was not attached to the proceedings, not being part of the administrative file, nor was the respective notification.

In any case, it is the Tax and Customs Authority that must prove that it carried out notification for exercise of the right to prior hearing, so the hypothetical doubt about the content of the notification for exercise of the right to be heard must be valued procedurally against the Tax and Customs Authority.

However, in the case in question, as referred to in the reasoning of the decision on facts, it is to be considered proven that the draft Tax Inspection Report that was notified to the Claimant for exercise of the right to be heard contained no reference to compensatory interest, nor does the Tax Inspection Report.

However, the Tax and Customs Authority argues that exercise of the right to be heard would be dispensable because "the subjection to interest flows directly and automatically from the law, as provided for in article 102º of the IRC Code and article 35º of the General Tax Law" and "the tax owed in default and the respective interest are directly related".

Article 60.º of the General Tax Law provides as follows:

Article 60.º

Principle of Participation

1. The participation of taxpayers in the formation of decisions concerning them may be effected, whenever the law does not provide otherwise, by any of the following means:

a) Right to be heard before assessment;

b) Right to be heard before total or partial rejection of requests, complaints, appeals or petitions;

c) Right to be heard before the revocation of any benefit or administrative act in tax matters;

d) Right to be heard before the decision to apply indirect methods, when there is no tax inspection report;

e) Right to be heard before the conclusion of the tax inspection report.

2 - Hearing is waived:

a) In the case of assessment being made on the basis of the taxpayer's declaration or the decision on the request, complaint, appeal or petition being favorable to the taxpayer;

b) In the case of assessment being made ex officio, on the basis of objective values provided for by law, as long as the taxpayer has been notified to present the missing declaration, without having done so.

3 - Having the taxpayer been previously heard in any of the phases of the procedure referred to in paragraphs b) to e) of n.º 1, hearing before assessment is waived, except in the case of invocation of new facts about which the taxpayer has not yet had the opportunity to pronounce themselves.

1. The right to be heard must be exercised within the time limit set by the tax administration in a registered letter sent for that purpose to the taxpayer's tax residence.

2. In any of the circumstances referred to in n.º 1, for purposes of exercise of the right to be heard, the tax administration must communicate to the taxpayer the draft decision and its reasoning.

3. The time limit for the exercise orally or in writing of the right to be heard is 15 days, and the tax administration may extend this period up to a maximum of 25 days depending on the complexity of the matter.

4. New elements raised during hearing of taxpayers must be necessarily taken into account in the reasoning of the decision.

The right to be heard has its roots in the Constitution, being postulated by article 267.º, n.º 5, of the Constitution of the Portuguese Republic, which provides that "the processing of administrative activity shall be the subject of special legislation, which shall ensure the rationalization of the means used by the services and the participation of citizens in the formation of decisions or deliberations concerning them".

However, as follows from this rule, the Constitution does not regulate the regime of the right to be heard, relegating to the "special legislation" the definition of the terms in which such right shall be exercised, terms in which various factors may be taken into account, including those of an economic and feasibility nature.

It is in this context that n.º 3 of article 60.º of the General Tax Law, invoked by the Tax and Customs Authority in the present proceedings, provides for situations in which prior hearing before assessment is waived.

In the case at hand, it is not disputed in the present proceedings that paragraph a) of n.º 1 of article 60.º of the General Tax Law guarantees taxpayers the right to be heard before assessment, which results from the express provision of this rule, so the issue to be assessed is reduced to determining whether we are in a situation in which hearing before assessment is waived by n.º 3 of the same article.

This n.º 3 waives the right to be heard before assessment if the taxpayer has been previously heard in any of the phases of the procedure referred to in paragraphs b) to e) of n.º 1, except in the case of invocation of new facts about which the taxpayer has not yet had the opportunity to pronounce themselves.

In the case in question, the Claimant had the opportunity to exercise the right to be heard on the basis of the Draft Tax Inspection Report, which is a situation that can be framed in paragraph e) of n.º 1 of article 60.º of the General Tax Law, so, in principle, we are in a potential situation of application of the waiver of the right to be heard before assessment.

Therefore, the need to ensure the right to be heard before assessment can only result from the exception provided for in the final part of n.º 3, that is, from the invocation therein of facts about which the taxpayer has not yet had the prior opportunity to pronounce themselves.

Examining the Tax Inspection Report it is concluded that the Claimant should not have been given the opportunity of compensatory interest being assessed, as no reference is made to them, including in the place intended to indicate the amounts that are subject to interest.

On the other hand, contrary to what the Tax and Customs Authority argues, the assessment of compensatory interest does not flow directly and automatically from the law.

In fact, both article 102.º, n.º 1, of the IRC Code and article 35.º of the General Tax Law, invoked by the Tax and Customs Authority, make the requirement of compensatory interest dependent on assessment being delayed "by a fact imputable to the taxpayer".

Objective responsibility is exceptional, occurring only in cases specified by law (article 483.º, n.º 2, of the Civil Code) and, therefore, it should be understood that, for purposes of responsibility for compensatory interest, there is a "fact imputable to the taxpayer" only when a judgment of censure can be formulated in relation to the conduct of the taxpayer themselves.

In this line, the Supreme Administrative Court has consistently understood that the imputability required for accountability for payment of compensatory interest depends on the existence of fault on the part of the taxpayer. [1]

Therefore, the requirement of compensatory interest that was effected in the assessments in question contains an implicit judgment on the imputability to the Claimant of the delay in the assessments, which constitutes invocation of new facts, for purposes of article 60.º, n.º 3, of the General Tax Law.

Thus, we are not in a situation of waiver of prior hearing as to compensatory interest, so the lack of prior hearing constitutes pretermission of legal formality, which justifies the annulment of the assessments, pursuant to article 163.º, n.º 1, of the Code of Administrative Procedure, subsidiarily applicable, by force of the provision of article 2.º, paragraph c), of the General Tax Law.

The request for arbitral pronouncement is therefore granted as to this defect.

3.2. Issue of Deductibility of Expenses Relating to Payments to B…

The Tax and Customs Authority did not accept the deductibility of the Claimant's expenses relating to payments to B…, on the grounds of articles 65.º of the IRC Code, in the version of Law n.º 64-B/2011, of 30 December (in force in 2013) and 23.º-A of the same Code, in the version of Law n.º 2/2014, of 16 January (in force in 2014), which provide as follows, in what is relevant here:

Article 65.º

Payments to non-resident entities subject to a privileged tax regime

1 – Amounts paid or owing, in any form whatsoever, to natural or legal persons resident outside Portuguese territory and subject therein to a clearly more favourable tax regime are not deductible for purposes of determining taxable profit, save if the taxpayer can prove that such charges correspond to operations actually carried out and do not have an abnormal character or an excessive amount.

2 – A natural or legal person is deemed to be subject to a clearly more favourable tax regime when the territory of their residence is included in the list approved by ordinance of the Minister of Finance or when they are not subject therein to an income tax identical or analogous to IRS or IRC, or when, regarding the amounts paid or owing mentioned in the preceding number, the amount of tax paid is equal to or less than 60% of the tax that would be due if the said entity were considered resident in Portuguese territory.

3 – For purposes of the preceding number, taxpayers must have and, when requested by the Directorate-General for Taxation, provide evidence of the tax paid by the non-resident entity and the calculations made to determine the tax that would be due if the entity were resident in Portuguese territory, in cases where the territory of residence of the same is not included in the list approved by ordinance of the Minister of Finance.

4 – The proof referred to in n.º 1 must take place following notification of the taxpayer, made with a minimum notice of 30 days.

(...)

Article 23.º-A

Non-deductible Charges for Tax Purposes

1 - The following charges are not deductible for purposes of determining taxable profit, even when accounted for as expenses of the tax period:

(...)

r) Amounts paid or owing, in any form whatsoever, to natural or legal persons resident outside Portuguese territory and subject therein to a tax regime identified by ordinance of the member of Government responsible for the finance area as a clearly more favourable tax regime, save if the taxpayer proves that such charges correspond to operations actually carried out and do not have an abnormal character or an excessive amount.

The territory of Hong Kong was included, in 2013 and 2014, in the "list of countries, territories and regions with privileged tax regimes, clearly more favourable", which is contained in Ordinance n.º 292/2011, of 8 November, which amended Ordinance n.º 150/2004, of 13 February.

Following notification for that purpose, the Claimant submitted various documents for proof of operations carried out by B….

However, the Tax and Customs Authority understood that the amounts of payments to B… are not deductible, for the following reasons, in summary:

– "It is not enough, therefore, to have the existence of contract, invoices or bank transfers; it is necessary to have evidence of a whole set of performance of actions, activities or concrete advertising campaigns, that is, of complementary justifying elements to the tax-relevant documentation, without which well-founded doubts remain about the actual performance of the operations that the invoices purport to represent". "In sum, there is no proof whatsoever of the actual performance of advertising by the company based in HONG KONG";

– "the sales were directly carried out by A… to Chinese clients, without intermediaries, although bearing and paying expenses for advertising invoiced by a single company designated B…, with registered office in HONG KONG, whose values reach 16% in 2013 (82,300.00 euros) and 15%, 16%. 19%, 20% and 21% in 2014 (2,582,254.00 euros), percentages which are considered as high in relation to the value of the units";

– "Now, in situations involving human intervention with studies, projects, or advertising as in the matter at hand, the taxpayer should have in file elements that would allow assessing the appropriateness of the amount to the purpose and enabling the assessment of any excess, in particular:

• identification of human resources involved, hours applied and hourly rates per consultant;

• evidence of meetings, "surveys";

• travel;

• whether those who carried out the work have professional experience;

• whether budgets were requested on the national or international market for comparative purposes and, if so, why the budget of an entity resident in a privileged tax jurisdiction was preferred over others with other locations";

– "there would also be a factor of great relevance the knowledge and identification of the capital holders of the "off-shore" entity to ascertain whether they are independent in relation to the company in question";

– "it was also incumbent upon A… to prove that the operations did not have an abnormal character, and as is public knowledge, this action implies the payment to the real estate company of a commission which is usually 5% of the sale value of the real estate, which in some cases may be lower and reach 3%, or be higher and reach 6%. (the commission paid in 2013 was 16% and in 2014 there were commissions of 15% to 21%)"

3.2.1. Proof of Performance of Operations

It resulted from the evidence produced that a global activity of acquisition of Chinese citizens for the purchase of real estate of the Claimant was carried out by B… in the years 2013 and 2014.

This activity of acquiring clients included actions of advertising and disclosure in China about the advantages and benefits of acquiring real estate in Portugal, payment of travel, accommodation and food expenses, as well as other expenses related to their stay and visits to the Claimant's real estate, assistance to Chinese citizens in obtaining visas for entry and stay in Portugal and their accompaniment in visits to the real estate, hiring of drivers to transport Chinese citizens in Portugal, namely between the airport and the hotel, foreign and border services, banks and restaurants and the main tourist attractions in Portugal.

In the context of this client acquisition activity, B… provided interpreter services by contracting translators to accompany Chinese citizens in Portuguese territory, accompanied Chinese citizens in opening bank accounts in Portugal, after the acquisition of the real estate, B… assisted Chinese citizens in decorating the real estate and in connecting electricity, gas and water to the acquired real estate and provided legal services to said Chinese citizens, hiring lawyers.

There are no justified doubts about the performance of this activity, not only because commercial documentation and correspondence exchanged between the Claimant and B… relating to these activities were submitted, but also because the evidence produced at the hearing by those who had direct contact in Portugal with these activities so demonstrated.

Moreover, the fact, which is not disputed, that the Claimant sold a large quantity of real estate to Chinese citizens is indirect, but convincing, proof that there was an efficient client acquisition activity, since without this it is not possible to understand how they could have known that the Claimant had real estate for sale. On the other hand, the fact that B…'s remuneration was only paid if as a result the sales were completed, ensures that there were no payments that did not have underlying client acquisition activity.

For this reason, it is not justified that it not be considered proven that the expenses incurred by the Claimant with payments to B… correspond to operations actually carried out.

In this context, it appears manifestly unjustified to require, as proof of the effectiveness of the activity carried out by B…, the "identification of human resources involved, hours applied and hourly rates per consultant", the "evidence of meetings, "surveys"; "whether those who carried out the work have professional experience", since, in addition to being information that will normally not be accessible to those who contract a foreign company for client acquisition services, there will be little concern for the purchaser when it comes to payments that are made only on the basis of results.

It must even be said that the requirement of "identification of human resources involved" and the determination of their professional experience in an activity with the dimension described is beyond the limits of reasonableness, as, in its literal terms, it will include the identification of all those who provided airplane transport services, services in restaurants and hotels, taxi drivers, etc.

Thus, it is to be considered proven that the payments correspond to operations actually carried out.

3.2.2. Proof of Non-Abnormality and Non-Excessiveness

Concerning the normality of payments for the provision of client acquisition services for the acquisition of real estate, this appears evident, as this is an activity of provision of regulated services, precisely with regard to real estate (Decree-Law n.º 69/2011, of 15 June) and, as any activity of a professional nature, is remunerated. What would constitute abnormality would be the provision of services free of charge to the Claimant, with B… bearing the expenses of the activity.

As to the amount of commissions, this relates to the requirement of "non-excessiveness" and not to that of "non-abnormality" for purposes of those articles 65.º and 23.ºA of the IRC Code.

To decide whether or not there is excessiveness, one cannot take as terms of comparison the percentages of commissions that the Tax and Customs Authority says are normally charged by real estate companies, between 3% and 5%, as the activity carried out by B… is not limited to what is normally carried out in real estate mediation, which does not involve expenses of the order of those proven to be borne by B… (payment of travel, accommodation, food, transport, interpreters, etc.).

On the other hand, the assessment of the requirement of non-excessiveness should be carried out taking into account the situation of the taxpayer, seeking to determine whether the payment should be considered excessive, from its perspective, in the context in which it has to decide to pay for the services.

From this perspective, payment would be excessive when it is demonstrated that the taxpayer could obtain what the same service for a lesser amount.

It follows from the evidence produced that the Claimant intended to sell the real estate as quickly as possible, as it was envisaged that the construction and sale process of the real estate would be completed by 2010, five years after the beginning of the construction process, and it had not yet managed to sell them by 2013 and 2014, due to the economic and financial crisis situation affecting Portugal.

The evidence produced is also to the effect that the Claimant could not obtain the acquisition of clients with payment of commissions lower than those to B…, which did not accept them, nor from other service providers for client acquisition, as none provided it with clients who would pay the sale prices that the Claimant wished to obtain for itself.

In these circumstances, the payment cannot be considered excessive, as it is justified by the need to obtain client acquisition services and the absence of alternative at a lower price.

The reasonableness of the payments made to B… is further reinforced by the fact that the Claimant was not affected by the payments it made to it, as it only paid when it completed the sale of the real estate and what it paid to B… was added to the sale price that the Claimant itself set and wished to obtain for itself.

Based on the foregoing, it is concluded that the Claimant proved that the payments made to B… were neither abnormal nor excessive.

Thus, it is concluded that the assessment act for the fiscal year 2013 is affected by the defect of violation of article 65.º, n.º 1, of the IRC Code and the assessment act for the fiscal year 2014 is affected by the defect of violation of article 23.º, n.º, paragraph r), of the IRC Code in their respective versions that were in force in those years.

The assessments of compensatory interest are based on the assessments of IRC, and thus are affected by the defects affecting these.

3.3. Issues of Prejudiced Knowledge

Proceeding the request for arbitral pronouncement by defect of violation of law, which provides effective protection of the Claimant's interests, knowledge of the other issues raised is prejudiced as being useless (article 130.º of the Code of Civil Procedure).

4. Decision

On these grounds, the Arbitral Tribunal agrees to:

– Judge the request for arbitral pronouncement well-founded;

– Annul the IRC assessments and compensatory interest n.º 2016 … and n.º 2016 … .

5. Value of the Proceedings

In accordance with the provisions of article 306.º, n.º 2, of the Code of Civil Procedure and 97.º-A, n.º 1, paragraph a), of the Tax Procedure Code and 3.º, n.º 2, of the Regulations for Costs in Tax Arbitration Proceedings, the value of the proceedings is fixed at € 1,519,643.60.

6. Costs

Pursuant to article 22.º, n.º 4, of the RJAT, the amount of costs is fixed at € 20,196.00, in accordance with Table I attached to the Regulations for Costs in Tax Arbitration Proceedings, to be borne by the Tax and Customs Authority.

Lisbon, 21-11-2017

The Arbitrators

(Jorge Manuel Lopes de Sousa)

(Maria Cristina Aragão Seia)

(Cristiana Maria Leitão Campos)

[1] In this regard, reference may be made to the following judgments of the Supreme Administrative Court:

– of 20-3-1996, case n.º 020042, published in Appendix to the Official Journal of 13-3-1998, page 1067;

– of 2-10-1996, case n.º 200605, published in Appendix to the Official Journal of 28-12-1998, page 2707;

– of 18-2-1998, case n.º 022325, published in Appendix to the Official Journal of 8-11-2001, page 553;

– of 3-10-2001, case n.º 025034, published in Doctrinal Judgments of the Supreme Administrative Court, n.º 492, page 1615, and published in Appendix to the Official Journal of 13-10-2003, page 2080;

– of 29-1-2003, case n.º 01647/02, published in Appendix to the Official Journal of 25-3-2004, page 164;

– of 12-3-2003, case n.º 026800, published in Doctrinal Judgments of the Supreme Administrative Court, n.º 506, page 219 and published in Appendix to the Official Journal of 25-3-2004, page 545;

– of 19-11-2008, cases n.ºs 0325/08 and 0576/08;

– of 11-3-2009, case n.º 961/08.