CAAD 198/2018-T: Deductibility of Financial Charges on Supplementary Contributions Under Article 23 CIRC

ARBITRAL DECISION

The arbitrators Dr. Alexandra Coelho Martins (presiding arbitrator), Prof. Dr. Paulo Nogueira da Costa and Dr. Jesuíno Alcântara Martins (member arbitrators), appointed by the Ethics Council of the Administrative Arbitration Centre ("CAAD") to form the present Arbitral Tribunal, constituted on 4 July 2018, agree as follows:

Report

A..., S.A., a commercial company registered under the single registration number at the Commercial Registration Office and collective person identification number..., with registered office at ..., no...., ..., Vila Nova de Famalicão, hereinafter referred to as the "Claimant", submitted a request for constitution of a Collective Arbitral Tribunal and for arbitral pronouncement, pursuant to articles 2, no. 1, paragraph a), 3, no. 2 and 10 et seq., all of the Legal Framework for Arbitration in Tax Matters ("RJAT"), approved by Decree-Law no. 10/2011, of 20 January, having as its object the partial annulment of the tax acts for assessment of Corporate Income Tax ("IRC") and inherent compensatory interest, issued under numbers 2017... and 2017..., respectively, relating to the tax year 2013, in the total amount of €134,295.15, embodied in the statement of account reconciliation number 2017....

The Tax and Customs Authority ("AT") is the respondent.

As grounds for the request, the Claimant alleges a defect of form and error in matters of fact and law, in the latter case, by erroneous interpretation and application of the provisions of article 23, no. 1 and no. 2, paragraph c), of the IRC Code and by violation of the principle of taxation on real profit.

Regarding the defect of form, the Claimant contends that the elements of the AT's reasoning reveal insufficient consistency to justify the fiscal disallowance of the expenses in question and the inference that these were not incurred in its [the Claimant's] interest, and therefore the duty provided for in article 268, no. 3 of the Constitution ("CRP") was not fulfilled.

With respect to substantive defects, the Claimant maintains that it is not possible to establish a direct causal link between the bank financing it contracted, whose interest expenses were fiscally disallowed by the AT, and the provision of unpaid supplementary and ancillary services to its subsidiaries, all of which are 100% owned.

In this context, the AT did not demonstrate that the supplementary services were referable to acts foreign to the economic activity of the Claimant and disregarded part of the corporate object thereof, which expressly provides for the acquisition of equity interests, as well as the concrete development of the activity of managing these interests, and therefore did not satisfy the burden of proof imposed on it under article 74, no. 1 of the General Tax Law ("LGT") and article 342 of the Civil Code.

On the other hand, according to the Claimant, the method used by the AT to determine the financial expenses allegedly related to the supplementary and ancillary services is illegal and arbitrary, as it is based on erroneous assumptions and merely applies to the average balance (accumulated) of the loans granted by the Claimant the same proportion of financial expenses that it bears in the loans it contracted, in addition to an error in quantification, as it only took into account the financing recorded in account 25 and not the bank overdrafts recorded in account 12.

For the Claimant, the application of such ratio to the global balance of all investments recorded as loans granted, and not merely to the supplementary and ancillary services provided in 2013, also amounts to penalizing the 2013 tax year based on facts occurring in previous tax years, the correction of which was already barred from the AT by the expiry of the limitation period provided for in article 45 of the LGT.

Additionally, even if the financial expenses whose deductibility was denied were attributable to loans contracted by the Claimant to finance its investees, these would be indispensable in light of article 23 of the IRC Code, as they fall within its object (acquisition of equity interests), concrete activity (management of these interests) and corporate purpose (profit).

The Claimant states that the financing of its financial assets was motivated by justifiable business reasons, aimed at providing the subsidiary companies with the means to meet their matured commitments and discharge their obligations, avoiding situations of insolvency that would have serious consequences for the Group and for the Claimant, namely reputational risk and alarm among creditors, particularly banking creditors. Ensuring the maintenance and viability of the subsidiaries also made it possible to subsequently dispose of these or their assets at a favorable time, with a return to the Claimant, in the form of future profits or capital gains.

This is also, according to the Claimant, the understanding of doctrine and jurisprudence on the matter, which considers indispensable the expenses incurred in the interest of the company, i.e., incurred within the scope of the activities arising from its corporate purpose, understanding as such not only productive activities, but also the management of any income-generating assets, from which future economic benefits may flow, an attribute inherent to the very accounting concept of an asset.

The Claimant advocates that, by disallowing the fiscal deduction of incurred expenses that fell within its business activity, the AT departed from the principle of taxation on real income, a principle contained in article 104, no. 2 of the CRP.

It concludes with the partial illegality of the IRC assessment and the assessment of compensatory interest relating to the 2013 tax year. It attached 20 (twenty) documents and requested witness examination.

The request for constitution of the Arbitral Tribunal was accepted by the President of the CAAD and followed its normal course, namely with notification to the AT on 27 April 2018.

In accordance with articles 5, no. 3, paragraph a), 6, no. 2, paragraph a) and 11, no. 1, paragraph a), all of the RJAT, the Ethics Council of the CAAD appointed as arbitrators of the Collective Arbitral Tribunal the signatories hereto, who communicated their acceptance of the task within the applicable period.

The parties, duly notified of this appointment, did not object, in accordance with the combined provisions of articles 11, no. 1, paragraphs b) and c) and 8 of the RJAT and 6 and 7 of the CAAD Code of Ethics.

The Collective Arbitral Tribunal was constituted on 4 July 2018, as communicated by the President of the Ethics Council of the CAAD.

On 24 September 2018, the Respondent filed its reply and attached the administrative file ("PA").

With respect to the alleged defect of form, the Respondent contends the sufficiency of the reasoning of the assessment acts. On the substantive defects, it argues that the notion of indispensability must be interpreted according to the concrete corporate object and the activity actually exercised, which in this case consists of the textile industry business. It advocates that the provision of ancillary and supplementary services by the Claimant to its investees does not constitute an act of the normal and ordinary activity of the former, nor is it indispensable for the generation of income in its sphere, or for the maintenance of the income-generating source. These services benefit directly the activity pursued by the investees and do not concern the Claimant or its activity.

Finally, the Respondent argues for the maintenance of the impugned act, since the expenses in question cannot be accepted as a fiscal expense in light of article 23 of the IRC Code, concluding with the dismissal of the request for arbitral pronouncement and absolution of the claim. It requested the waiver of witness examination.

On 19 October 2018, the Tribunal determined the use of evidence produced in the context of arbitral proceedings no. 298/2017-T and determined the examination of witnesses with respect to matters not covered thereby.

On 15 November 2018, the aforementioned hearing took place, in which a statement from the Claimant's certified accountant, B..., was heard, with the remaining witnesses being dispensed with, one from the Claimant and another from the AT.

The Tribunal notified the parties for successive written submissions and extended the deadline for delivery of the decision by two months, pursuant to article 21, no. 2 of the RJAT, which was again extended on 1 March 2019.

The Claimant and Respondent submitted submissions maintaining, in essence, the arguments contained in the request for arbitral pronouncement and the reply, respectively.

Procedural Matters

The Tribunal was duly constituted and is competent ratione materiae, given the nature of the subject matter of the proceedings (cf. articles 2, no. 1, paragraph a) and 5 of the RJAT).

The request for arbitral pronouncement is timely, as it was submitted within the period provided for in paragraph a), no. 1, of article 10 of the RJAT.

The parties have legal personality and capacity, have standing and are duly represented (cf. articles 4 and 10, no. 2 of the RJAT and article 1 of Ordinance no. 112-A/2011, of 22 March).

The proceedings do not suffer from any defects, and no exceptions have been raised.

Reasoning

Findings of Fact

The following facts, relevant to the decision, merit consideration:

A. A..., S.A., the Claimant herein, is a public limited company registered since 1966 for the exercise of the principal activity of "finishing of yarn, textiles and textile articles" (CAE 13303) and the secondary activities of "preparation and spinning of linen and other textile fibers" (CAE 13105), "weaving of silk-type yarn and other textiles" (CAE 13203) and "bleaching and dyeing" (CAE 13301), constituting a taxpayer covered by the general IRC tax regime – cf. Tax Inspection Report ("RIT") attached as document 2 with the request for arbitral pronouncement ("ppa") and also with the PA.

B. The corporate object of the Claimant consists in "the exercise of the textile industry, being able to operate any other branch of industrial or commercial activity that the General Assembly decides and is permitted by law, to establish or acquire other factories, to establish branches or subsidiary offices" and, furthermore, "to acquire equity interests in other limited liability companies, regardless of their corporate object, and likewise, to acquire equity interests in companies regulated by special laws and in business combinations" – cf. document 5 attached with the ppa (Articles of Association – article 3).

C. The Claimant heads, as a parent company, a vertically integrated textile industrial Group, within which it holds and manages, among other financial assets, the interests of the companies listed below, held by it at 100% (subsidiaries):

• C..., S.A. ("C...");
• D..., S.A. ("D...");
• E..., S.A. ("E...");
• F..., S.A. ("F..."); and
• G..., Lda. ("G...")

– cf. witness testimony and RIT.

D. The industrial Group of which the Claimant is the parent company encompasses the activities of production and marketing of textiles, divided among the subsidiaries, covering the various phases of the value chain (from spinning, weaving, finishing, dyeing), clothing manufacture and retail sales (to the public), with the Claimant responsible for overall management – cf. documents 6 to 17 attached with the ppa, relating to permanent certificates of the said companies, with mention of their corporate object, and respective financial statements and accounts (2013), and witness testimony.

E. The Claimant's activity is predominantly directed at the international market, in which it commercializes the majority of its production, and also encompasses direct marketing to the public through the investees, aimed at increasing its productive activity – cf. witness testimony, RIT and documents 14 and 15 attached with the ppa.

F. In 2013, the Claimant contributed funds to the subsidiary companies, through supplementary and ancillary services subject to the supplementary services regime, namely without accrual of interest, in the following amounts:

• C... - €20,000.00;
• D... - €25,000.00;
• E... - €502,000.00;
• F... - €5,000.00;
• G... - €2,282,000.00;

– cf. RIT.

G. The financial situation of the said companies was, at the date of the facts, considerably deteriorated, lacking liquidity to meet their pecuniary obligations, and lacking capacity to obtain financing from external entities – cf. documents 9, 11, 13, 15 and 17 attached with the ppa and witness testimony.

H. It was foreseeable that if any of the Group companies were declared insolvent, such circumstance would produce the following effects in the sphere of the Claimant and of contamination to the entire Group:

• Reputational damage;
• Loss or disposal at low value of relevant assets, namely real property assets held in companies C... and F..., and financial interests held by E...;
• Immediate deterioration of relations with banking creditors

– cf. witness testimony.

I. The supplementary and ancillary services provided by the Claimant were intended to provide the said subsidiaries with financial resources to satisfy their matured obligations and current expenses and to avoid the negative consequences that would arise from the insolvency of those entities for the Claimant and for the other entities of the Group of which it is the parent company – cf. witness testimony.

J. The Claimant was, in 2013, a heavily leveraged company, with liabilities recorded in the accounts (in account #25) exceeding €70 million, being heavily dependent on banking – cf. witness testimony.

K. In 2013, C... was in a state of inactivity, and thus did not generate revenues. However, it held significant real property assets that entailed various expenses, such as maintenance, IMI (real property tax) and insurance costs, among others. It thus needed to be financed – cf. document 9 attached with the ppa and witness testimony.

L. Despite C... being inactive, it was in the Claimant's interest to maintain the company for subsequent sale of its real property assets at a favorable time, with improvement in market conditions and increase in transaction values – cf. witness testimony.

M. In 2013, E... was also in a state of inactivity, and thus did not generate revenues. In that year, despite being inactive, this company presented a negative operating result of approximately half a million euros, largely due to the recognition of adjustments in its financial interests. Despite the company being inactive, E... concentrated equity interests in various companies belonging to the A... Group. Given its inability to generate the means to pay its matured debts, it needed to be financed – cf. document 11 attached with the ppa and witness testimony.

N. In 2013, F... was in a state of inactivity, and thus did not generate revenues. However, it held significant real property assets that entailed various expenses for their maintenance. It thus needed to be financed – cf. document 13 attached with the ppa and witness testimony.

O. In 2013, G..., the company that held the Group's retail stores, presented a deteriorated economic and financial situation that culminated in the accounting of net results exceeding half a million euros in losses. It needed to be financed to continue its activity and to achieve economic and financial recovery. Its maintenance was important as a sales point – wholesale and retail – of the textile products manufactured by the A... Group – cf. document 15 attached with the ppa and witness testimony.

P. In 2013, D..., a company that was systematically in a deficit situation, no longer generated revenues, but continued to have expenses: accumulated debts, taxes and general expenses. It needed to be financed as it did not generate funds to pay its debts. At the end of that year, it was decided to close it (dissolution and liquidation) – cf. documents 17 and 18 attached with the ppa and witness testimony.

Q. The AT carried out an external tax inspection action of the Claimant, covering the 2013 tax year, of partial scope (IRC), under the service order no. OI2017..., to monitor the indispensability of the financial expenses incurred – cf. RIT.

R. As a result of this inspection action, the Claimant was notified of the draft tax inspection report to exercise the right of hearing on the proposed corrections to the taxable IRC matter, and chose not to do so – cf. RIT.

S. The AT maintained the corrections contained in the draft, proceeding with the notification, by letter dated 29 November 2017, of the final Tax Inspection Report ("RIT"), which was subject to a favorable opinion from the Head of the Finance Department Division of ..., dated 28 November 2017, concluding:

• An increase to the taxable IRC matter declared by the Claimant, for the year 2013, of financial expenses in the amount of €428,349.67, considered non-deductible for tax purposes under article 23 of the IRC Code, relating to loans contracted by the Claimant whose funds were assigned, as ancillary/supplementary services, without compensation, to subsidiary companies;

• The correction (reduction) of the capital loss determined in the liquidation and distribution of a subsidiary company (D..., S.A.), in the total amount of €10,106,474.95, which is not the subject matter of the present arbitral proceedings – cf. RIT.

T. The RIT contains the following grounds for the correction of the tax deduction of the financial expenses at issue (referred to in paragraph a) above) – cf. RIT:

"III. – DESCRIPTION OF FACTS AND GROUNDS FOR CORRECTIONS THAT ARE PURELY ARITHMETIC IN NATURE FOR TAXABLE MATTER

III.1. – Financing Expenses

Through an analysis of accounting records, it was verified that, during the year 2013, the taxpayer made the following movements debited to sub-accounts of account 41-Financial Investments:

• In sub-account 41130000 FIN.INV – LOANS GRANTED-SUBSIDIARIES, relating to the following entities:

C... SA, NIPC..., the social capital of which was held, in 2013, at 100% by the taxpayer:

(amounts in EUR)

D... SA, NIPC..., the capital of which was held in 2013 and until its dissolution and liquidation, on 2013-12-27, at 100% by the taxpayer:

(amounts in EUR)

Following the liquidation of D... SA, the taxpayer recognized fiscally a capital loss of 15,951,942.19 EUR, having reduced the amount attributed in the distribution, 8,057.81 EUR, from the amount of ancillary services made in that year.

• In sub-account 41230000 FIN.INV – LOANS GRANTED-ASSOCIATE INVESTMENTS, relating to the following entity:

E... S A, NIPC..., the social capital of which was held, in 2013, at 100% by the taxpayer:

(amounts in EUR)

During the year 2013, the value corresponding to the accumulated Ancillary Services was converted into social capital of the company.

• "41410000 FIN.INV – EQUITY INTERESTS – OTHER COMPANIES", relating to the following entity:

F... SA, NIPC..., the social capital of which, in 2013, was held at 100% by the taxpayer:

(amounts in EUR)

• "41420000 FIN.INV – LOANS GRANTED–OTHER COMPANIES", relating to the following entity:

G... SOLE PROPRIETOR LDA, NIPC..., the social capital of which, in 2013, was held at 100% by the taxpayer:

(amounts in EUR)

Regarding the deliberations on ancillary and supplementary services in the investee companies, the following was determined:

C... SA, NIPC ...

On 2013-12-20, the General Assembly of company C... SA met, minutes no. 54, through which the representative of the sole shareholder A... SA proposed and approved the "(…) formalization of the constitution of Ancillary Services, in cash, gratuitously, statutorily subject to a regime identical to that provided for in articles 211 to 213 of the Commercial Companies Code, in the total amount of €20,000.00 (twenty thousand euros), already previously delivered to the company", to meet "(the needs arising from the activity currently developed by the company, in the course of the year 2013, (…) having, for this purpose, delivered to the company, during the year the amount of 20,000.00 (twenty thousand euros))" (Annex I, with three pages).

D... SA, NIPC ...

On 2013-12-23, the General Assembly of company D... SA met, minutes no. 33, through which the representative of the sole shareholder A... SA proposed and approved an "(…) increase in capital to €15,960,000.00 (fifteen million, nine hundred and sixty thousand euros)", to allow the company to meet its commitments, so as to be in a position to proceed with the dissolution and liquidation project, through the conversion of all ancillary services already constituted in the amount of 9,289,000.00 EUR and the cash entry in the amount of 4,271,000.00 EUR (Annex II, with three pages).

In this minutes, the approval of the 2013 ancillary services in the amount of 25,000.00 EUR was implicit.

E... SA, NIPC ...

In the minutes numbered 75 of the General Assembly of E... S A, held on 2013-11-04, there is a deliberation approved by the sole shareholder A... SA, on the formalization of the constitution of ancillary services, which emphasizes that, given the needs arising from the activity developed, "(…) in the course of this year the sole shareholder A... S A, not only was prepared to deliver, but did so during the year and up to the present date the amount of €502,000.00 (five hundred and two thousand euros) to the company for the constitution of Ancillary Services, which now must be formalized. In this context, the representative of the sole shareholder A... S A proposed and immediately approved the formalization of the constitution of Ancillary Services, in cash, gratuitously, statutorily subject to a regime identical to that provided for in articles 211 to 213 of the Commercial Companies Code, in the said amount of €502,000.00 (five hundred and two thousand euros) already previously delivered to the company." (Annex III, with two pages).

F... SA, NIPC...

On 2013-12-20, the General Assembly of company F... SA met, minutes no. 65, through which the representative of the sole shareholder A... SA proposed and approved "… the formalization of the increase in Ancillary Services, in cash, gratuitously, statutorily subject to a regime identical to that provided for in articles 211 to 213 of the Commercial Companies Code, in the amount of €5,000.00 (five thousand euros), already previously delivered to the company", to meet "(the needs arising from the activity currently developed by the company, in the course of the present year 2013)" (Annex IV, with two pages).

G... SOLE PROPRIETOR LDA, NIPC ...

On 2013-12-23, the General Assembly of G... SOLE PROPRIETOR LDA met, at that date denominated G..., LDA, and minutes no. 67 were drawn up, in which the deliberation on the formalization of the performance of supplementary services in the total amount of 2,225,165.91 EUR made by the sole member A... SA was approved, to meet "(…) the needs arising from the activity developed by the company, in the course of this year the sole member A... SA, was prepared to constitute Supplementary Services, having, for this purpose, delivered to the company during the year 2013, the amount of €2,225,165.91 (two million, two hundred and twenty-five thousand, one hundred and sixty-five euros and ninety-one cents) which must now be formalized". In due course, the value of supplementary services was corrected to 2,282,000.00 EUR, a correction that became an integral part of the respective minutes. (Annex V, with two pages).

From the content of the aforementioned minutes and the documents supporting the accounting entries analyzed, it follows that, during the year 2013, the taxpayer:

• made ancillary services to its subsidiaries C... SA, D... SA, E... SA and F... SA, in the global amount of 543,943.96 EUR, and in relation to these decided, as regards interest, remuneration and restitution, to apply the regime identical to that of supplementary services provided for in articles 211 to 213 of the Commercial Companies Code, such that ancillary services did not accrue interest nor were remunerated in any way, with restitution being envisaged only when the net situation of the investee companies would permit.

• made supplementary services to its subsidiary G... SOLE PROPRIETOR LDA in the amount of 2,282,000.00 EUR.

In all minutes it is stated that the constitution of ancillary and supplementary services by the taxpayer in favor of its investees occurred to meet needs arising from the activity developed by those companies.

In addition to these companies, the taxpayer had made, in the past, loans to company J... SA, NIPC..., with registered office at ..., ..., V.N.FAMALICÃO, the capital of which is held at 100% by the taxpayer, having this made, during the year 2013, the repayment of the amount of 50,000.00 EUR.

According to note 5.2 of the Annex to the Balance Sheet and Statement of Results, on 2013-12-31, the loans granted by the taxpayer to its investees amounted to 9,974,201.97 EUR, taking into account the amounts determined in the previous period plus the movements that occurred in the period and considering the incorporation of some of the loans into capital as is demonstrated:

(amounts in EUR)

On 2013-12-31, the taxpayer had recorded in the SNC account "25 – Financing Obtained", the total credit value of 71,133,057.52 EUR, as determined by the analytical trial balance at the end of the period, distributed among the following financing entities:

(amounts in EUR)

By resorting to financing loans, the taxpayer incurred the following expenses:

1. Interest

On 2013-12-31, the financial expenses with loans obtained, recorded in SNC accounts "69111000 – GPF – BANK LOANS INTEREST", "69116000 – GPF – COMMERCIAL PAPER INTEREST", "69117000 – GPF – FACTORING INTEREST", "69118000 – GPF – CONFIRMING INTEREST" and "69180000 – GPF – OTHER INTEREST", amounted to 5,318,548.81 EUR, as determined by the movements and balances extracted from the analytical trial balance and bank statements.

1. Banking Services

The banking services associated with these loans obtained, in the year 2013, recorded in the SNC account "62270001 – FSE – BANKING SERVICES", amounted to 1,404,271.20 EUR, as determined by the movements and balances contained in the analytical trial balance and bank statement.

1. Stamp Duty

Additionally, the stamp duty on financing supported by the taxpayer in the year 2013, accounted for in the SNC account "68120002-IND.TAX – STAMP DUTY", amounted to 654,020.49 EUR, as determined by the movements and balances extracted from the analytical trial balance and bank statement.¹

¹ From the stamp duty amount accounted for in this sub-account, the amounts of the entries "STAMP DUTY REAL PROPERTY INCOME", "STAMP DUTY CAPITAL INCOME" and "STAMP DUTY-MINISTRY OF ECONOMY (TAXES)" were disregarded.

Thus, in the year 2013, the expenses with financing accounted for and deducted by the taxpayer were as follows:

(amounts in EUR)

It remains, then, to assess the legality of the financial expenses and stamp duty arising from the resort to external capital intended to finance both the activity of the taxpayer and the provision of unpaid supplementary and ancillary services to its investees.

Article 23 of the IRC Code (CIRC) constitutes a general clause in which the rules of deductibility of expenses for tax purposes are laid down to provide that "(…) expenses are considered those that are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the income-generating source (…)", in the wording at the date of the facts.

The notion of indispensability to which the rule refers has been the subject of heated debate. According to António Moura Portugal, "Doctrine has chosen two requirements as essential for the accounting cost to be accepted as a tax cost: proof (justification) and indispensability. To these, we understand to add a third, normally not autonomized, which is the connection to gains subject to tax…"²

² António Moura Portugal, The Deductibility of Costs in Portuguese Tax Jurisprudence, Coimbra Editora, January 2004, page 108

In an analysis of the content of article 23 of the CIRC, Tomás de Castro Tavares, maintains that "various requirements are isolated that govern the fiscal deductibility of business costs: first, as a basic presupposition, there must be an economic expense, that is, the assumption as a counterpart to the acquisition of any production factor. Then, that the referred deduction from income is not precluded by an express legal provision. Third, certain formal requirements determine adequate proof of the negative components of income. Finally, a relationship of causality (indispensability) is required between the expenses and the profits or with respect to the maintenance of the income-generating source".³ According to the same author, "the legal notion of indispensability is thus cut out, from an economic-business perspective, by direct or indirect fulfillment, of the ultimate motivation of contribution to the obtaining of profit. Indispensable costs are equivalent to expenses incurred in the interest of the company or, in other words, in all acts abstractly subsumed in a profit profile. This aim purposefully brings together, economic and fiscal categories, through a primarily logical and economic interpretation of legal causality. The indispensable expense is equivalent to any cost incurred in order to obtain income and that represents an economic decline for the company".⁴

³ Tomás de Castro Tavares, On the Relationship of Dependence between Accounting and Tax Law in Determining the Taxable Income of Legal Entities: Some Reflections at the Level of Costs, Science and Technical Tax, no. 396, 1999, page 113

⁴ Tomás de Castro Tavares, cited work, page 136

Thus, it can be inferred that the fiscal deductibility of the cost depends on a causal and justified relationship with the activity exercised by the company. Outside the concept of indispensability are acts that do not conform to the corporate purpose.

This same understanding is shared by the aforementioned António Moura Portugal, who interprets indispensability as a function of the corporate object and the activity developed by the company itself, emphasizing that "Indispensability must thus be assessed on the basis of a positive judgment of subsumption in corporate activity, which, by nature, should not be controlled by Tax Law, which should not interfere, much less assess the business decisions of the taxpayer. Only this conception is in accordance with the principles of freedom of business management and, at the same time, respects specific interests of tax law (which are the basis of the express limitation made to the deductibility of certain expenses).

Indispensable costs are thus equivalent to expenses incurred in the interest of the company. The fiscal deductibility of the cost must depend only on a justified relationship with the productive activity of the company and this indispensability is verified 'whenever – by operation of the theory of specialty of legal entities – the corporate operations are inserted in its capacity, by subsumption to its respective corporate purpose and, especially, whenever they connect with the obtaining of profit even if in an indirect or mediate manner".⁵

⁵ António Moura Portugal, cited work, pages 115 and 116

This same position is held by author Vitor Faveiro⁶, considering that the "tax concept of indispensability of costs must be related to the elements and data economic or integral aspects of the object of each situation, costs being able to be subject to direct correction, pursuant to article 23 of the CIRC, only when these are facts which, by their nature and univocity, objectively evidence themselves as foreign to the object and to the economic and management purpose of the company".

⁶ Vitor Faveiro, The Status of the Taxpayer, Coimbra Editora, 2002, page 848

Thus, indispensability must be interpreted according to the concrete corporate object and the activity actually exercised.

It is therefore necessary to assess whether the expenses in question are indispensable for the realization of the productive activity of the taxpayer.

Now, the activity of the taxpayer consists of the "exercise of the textile industry, being able to operate any other branch of industrial or commercial activity that the General Assembly decides and is permitted by law, to establish or acquire other factories, to establish branches or subsidiary offices", in accordance with point ONE of article 3 of the company's Articles of Association (Annex VI, with one page). Point TWO of the same article adds that "the company may also acquire equity interests in other limited liability companies, regardless of their corporate object, and likewise, acquire equity interests in companies regulated by special laws and in business combinations".

In these terms, it cannot be considered that the provision, by the taxpayer, of ancillary and supplementary services to its investees, gratuitously, with a view to financing the activity of these, constitutes an act of its normal and ordinary activity, since that financial effort benefits directly the activity pursued by the investees themselves, and are not indispensable for the generation of its income or for the maintenance of its income-generating source.

Thus, it is concluded that the financial expenses and stamp duty in question are not associated with external capital obtained for exclusive allocation to the activity exercised by the taxpayer, which consists of the exercise of textile industry and, consequently, to the generation of income derived therefrom.

In light of the foregoing, it appears that the taxpayer financed itself with financial institutions by contracting loans for which it bore financial expenses and stamp duty (through an analysis of the accounts it was not possible to identify which specific loans were allocated to the provision of ancillary and supplementary services), applying a portion of that financing in the provision of unpaid ancillary and supplementary services to its investees, and therefore the portion of the financial expenses and stamp duty corresponding to that portion does not constitute an expense with fiscal relevance in the sphere of the taxpayer.

It is therefore necessary to quantify the weight of the financing expenses corresponding to the financial effort made by the taxpayer to finance its investees.

Through extracts from current accounts of the sub-accounts of financing obtained and financing granted, the average balance of third-party loans and the average balance of loans to third parties were determined, respectively, for the year 2013, the supporting maps of which are filed in the taxpayer's individual file.

Thus, and considering that they are not indispensable for the generation of the taxpayer's income pursuant to article 23 of the CIRC, the following financing expenses are not accepted:

(amounts in EUR)

Pursuant to article 67 of the CIRC, in the wording at the date of the facts, in conjunction with article 192 of Law no. 66-B/2012, of 31/12, the taxpayer increased, in field 748 of form 07 of the tax return model 22, the amount of 1,114,756.62 EUR relating to financing expenses supported, and therefore, taking into account that a partial correction was already made, the amount of 428,349.67 EUR will be increased to the declared taxable result. […]"

U. The Claimant was notified of the IRC assessment statements and respective compensatory interest issued by the AT, as a result of the inspection procedure relating to the 2013 tax year, in the following manner:

• IRC assessment issued under number 2017..., dated 6 December 2017, in the total amount of €134,295.15, including €1,535.93 in compensatory interest, as per assessment (of interest) number 2017...;

• Statement of account reconciliation number 2017..., in the total amount of €12,939.83, with payment deadline fixed on 18 January 2018 – dated 11 December 2017

– cf. Document 1 attached with the ppa.

V. The Claimant proceeded to pay, by bank transfer with a "value date" of 8 January 2018, the total amount due, evidenced in the statement of account reconciliation number 2017..., resulting from the IRC assessment and compensatory interest aforementioned which are the subject matter of the proceedings and which, after account reconciliation (offsetting), amounted to €12,939.83 – cf. Document 3 attached with the ppa.

X. In disagreement with the above-identified IRC assessment and compensatory interest acts – with the exception of the component relating to the correction of the capital loss determined as a result of dissolution and liquidation of a subsidiary company, which are not part of the subject matter of this action – the Claimant submitted to the CAAD, on 17 April 2018, the request for constitution of the Collective Arbitral Tribunal that gave rise to the present proceedings of impugnation of these acts.

Motivation

The relevant facts for the judgment of the case were selected and delineated based on their legal relevance, in light of plausible solutions to questions of law, in accordance with the combined application of articles 123, no. 2, of the Tax Code of Procedure and Process ("CPPT"), 596, no. 1 and 607, no. 3 of the Code of Civil Procedure ("CPC"), as provided for in article 29, no. 1, paragraphs a) and e) of the RJAT.

With respect to proven facts, the arbitrators' conviction was based on critical analysis of the documentary evidence attached to the proceedings, the positions taken by the parties, and the witness testimony produced.

The witness statements were objective, consistent and demonstrated direct knowledge of the reported facts.

FACTS NOT PROVEN

It was not proven that the bank financing contracted by the Claimant was related to the ancillary and supplementary services provided to its subsidiaries, a point on which the AT itself states in the RIT that: "through an analysis of the accounting records, it was not possible to identify which specific loans were allocated to the provision of ancillary and supplementary services".

With relevance to the decision, there are no other alleged facts that should be considered as not proven.

On the Law

The essential question in dispute is the deductibility (for tax purposes) of financial expenses associated with the provision of unpaid ancillary and supplementary services, by the Claimant to its subsidiaries, and their classification under the criterion of indispensability of expenses provided for in article 23, no. 1 of the IRC Code.

2.1. Defect of Reasoning

The Claimant invokes that the reasoning of the AT, contained in the RIT, is insufficient to justify the disallowance of financial expenses, as well as its basic premise that the provision of ancillary and supplementary services was not made in the interest of the Claimant and solely in that of the subsidiaries, constituting a defect of lack of reasoning.

Indeed, as provided in article 77, no. 1 of the LGT, the decision of the procedure must always be reasoned, and, as provided in article 153, no. 2 of the Code of Administrative Procedure ("CPA"), "[a] lack of reasoning is equivalent to the adoption of grounds which, due to obscurity, contradiction or insufficiency, do not concretely clarify the motivation of the act".

However, this Tribunal cannot adhere to the Claimant's thesis, taking into account the nature of the formal defect of lack of reasoning.

The duty to provide reasoning serves the primary function of enabling the recipient of the act to understand the reasons underlying the decision, to make known its cognitive and evaluative process, allowing the control of its validity through analysis of its respective presuppositions and access to contentious protection. Reasoning is a relative concept that varies depending on the type of legal act and aims to respond to the needs for clarification of the taxpayer, allowing it to know the reasons, of fact and law, that determined its adoption and why the decision was made in one sense and not another (cf. Opinion of the Supreme Administrative Court ("STA"), of 2 February 2006, case no. 1114/05[1]).

It is considered that an act is sufficiently reasoned whenever it contains the contextual indication of the reasons of fact and law that allow its normal recipient to understand the decision-making reasoning, the causes and the sense of the decision (cf. Opinion of the STA, of 14 March 2001, case no. 46796) and a normal recipient, when faced with it, may become aware of the reasons that sustain the decision (cf. Opinion of the STA, of 20 November 2002, case no. 42180).

Having reviewed the arbitral proceedings, it is verified that the Inspection Report contains the arguments, of fact and law, on which the AT based the correction of the Claimant's taxable IRC matter, which concern the understanding that the assignment of funds, gratuitously, to investee companies, even if held entirely (at 100%), as occurs in the present situation, is not realized in the interest of the taxpayer, the Claimant herein, but of third parties (the investee companies) and, for that reason, the corresponding financial expenses are not fiscally deductible in its sphere [of the Claimant], not meeting the requirement of indispensability contained in article 23, no. 1 of the IRC Code, in the version applicable at the date of the facts (2013).

These arguments were well understood by the Claimant, which against them presented its extensive counter-arguments.

The Claimant understood the facts and the framework advocated by the AT, understood its meaning and scope, such that the invocation of the defect of lack (insufficiency) of reasoning raised by the Claimant is unfounded.

Another question is whether the Claimant disagrees with the reasoning because it does not consider the presuppositions of taxation portrayed therein to be demonstrated or verified. However, this is not about assessing the formal defect of lack of reasoning, but the substantive validity of the tax act, which is assessed below.

2.2. Substantive Defects. Article 23, no. 1 of the IRC Code

2.2.1. Burden of Proof. Failure to Demonstrate the Presuppositions of the Assessment

The IRC correction being challenged is based on the connection, which the AT invokes, between the financial expenses incurred by the Claimant in 2013 with loans contracted from third parties, exceeding €70 million, and the partial allocation of the funds underlying those loans to ancillary and supplementary services to the Claimant's subsidiaries, in the approximate amount of €2.8 million.

However, it is the AT itself that ends up acknowledging the impossibility of identifying "which specific loans were allocated to the provision of ancillary and supplementary services". Thus, it appears that there is no support for the conclusion that the AT draws, without demonstrating, that a portion of the financing obtained was applied in the provision of unpaid ancillary and supplementary services to the investee companies.

The Claimant is therefore correct when it alleges that it is not possible to establish a direct causal link between bank financing and the services provided and that the AT did not demonstrate the presuppositions of its action, as was incumbent upon it, in accordance with the provision of article 74, no. 1 of the LGT, according to which "the burden of proof of facts constituting the rights of the tax administration or of taxpayers rests on whoever invokes them", in implementation of the general principle enshrined in article 342, no. 1 of the Civil Code.

Thus, the IRC assessment acts and the corresponding compensatory interest, in the impugned portion, suffer from a defect of violation of law, given the failure to demonstrate the presuppositions of application, and are, for that reason, voidable.

2.2.2. Indispensability or Necessary Connection of Expenses with Activity

Furthermore, even if some connection had been demonstrated between the loans contracted from third parties, generating the financial expenses partially disallowed by the AT, and the contribution of funds to the Claimant's subsidiaries, such circumstance would not mean that the attribution of ancillary and supplementary services constituted an act foreign to the economic activity of the Claimant, to its interest and corporate purpose and, consequently, that the corresponding expenses incurred were not indispensable for the realization of income subject to tax or for the maintenance of the income-generating source.

It is worth recalling that, at the date of the facts, the legal configuration of the relationship between expenses and the purpose of obtaining or generating income subject to tax expressly appealed to the criterion of indispensability, pursuant to article 23, no. 1 of the IRC Code, which is partially transcribed:

"Article 23

Expenses

1 – Expenses are considered those that are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the income-generating source, namely:

a) […];

b) […];

c) Of a financial nature, such as interest on foreign capital applied in the operation, discounts, premiums, transfers, exchange rate differences, expenses with credit operations, debt collection and issuance of bonds and other securities, redemption premiums and those resulting from the application of the effective interest method to financial instruments valued at amortized cost;

[…]"

The application of the concept of indispensability as a delimiting condition of fiscal deductibility in IRC has given rise to some divergences which, over the years, have been resolved through case law and promoted, jointly with doctrine, greater specification of this concept.

As Saldanha Sanches points out, it is "in the aforementioned concept of indispensability that the essential problem lies regarding the consideration of business costs and which rests on one of the main points of distinction between the cost actually incurred in the collective interest of the company and what may result solely from the individual interest of a shareholder, of a group of shareholders or of the company as a whole, which cannot, therefore, be considered a cost", adding that "the requirement of indispensability of costs for the formation of profits must be assessed by criteria of economic rationality in light of statutory objectives" – "The Limits of Tax Planning", Coimbra Editora, 2006, p. 215-216.

It is now relatively consensual that the implementation of the general clause of indispensability of expenses does not imply a judgment of opportunity and merit on their realization.

Such notion, as contained in the reasoning of the Opinion of the STA (en banc), of 15 June 2011, case no. 49/11 – must be interpreted as "an indeterminate concept requiring case-by-case fulfillment, as a result of an economic business perspective analysis, in the perception of a relationship of economic causality between the assumption of a cost and its realization in the interest of the company, taking into account the corporate object of the commercial entity in question, being prohibited to the Tax Administration actions that place in crisis the principle of freedom of management and autonomy of the will of the taxpayer".

In this way, the "Administration can only exclude expenses not directly precluded by law under strong motivation that convinces that they were incurred beyond the corporate objective, that is, in the pursuit of another interest than the business, or, at least, with clear excess, deviating, in light of the needs and objective capacities of the company", as advocated by the Opinion of the STA, of 29 March 2006, case no. 1236/05.

Which means, in the explanation of the Opinion of the STA, of 30 November 2011, case no. 107/11, that "the indispensability between costs and profits must be assessed on the basis of a positive judgment of subsumption in corporate activity: indispensable costs will be equivalent to expenses incurred in the interest of the company (…). As a rule, therefore, the fiscal deductibility of the cost depends, only, on a causal and justified relationship with the activity of the company (…). Indispensability cannot, however, be assessed in light of criteria of opportunity and merit. And outside the concept of indispensability will remain only acts that do not conform to the corporate purpose, those that do not fit in the interest of the company, above all because they do not aim at profit."

In this way, the understanding is rejected that indispensability amounts to the requirement of a necessary and direct relationship of causality between expenses and income (rather, costs and profits) – as confirmed by the Opinions of the STA of 24 September 2014, case no. 779/12; of 15 November 2017, case no. 372/16; and of 28 June 2017, case no. 627/16.

This latter judgment considers "definitively removed a purposive view of indispensability (as a requirement for costs to be accepted as tax costs), according to which a relationship of cause and effect would be required, of the type conditio sine qua non, between costs and profits, such that only costs in relation to which it is possible to establish an objective connection with profits could be considered deductible" – cf. Opinion of the STA, case no. 627/16.

The connection should therefore be made between the expenses and the activity developed by the taxpayer. "In general, then, fiscal deductibility depends, only, on a causal and justified relationship with the productive activity of the company" (TOMÁS CASTRO TAVARES, On the Relationship..., loc. cit., p. 136.). In other words, only costs that do not have a causal and justified relationship with the productive activity of the company will not be indispensable." – cf. Opinion of the STA, case no. 627/16.

The restrictive understanding of indispensability was much criticized by doctrine, and on this point, see Tomás de Castro Tavares, "On the Partial Relationship of Dependence between Accounting and Tax Law in Determining the Taxable Income of Legal Entities: Some Reflections at the Level of Costs", Science and Technical Tax no. 396, October-December 1999, p. 131 to 133, and "The Deductibility of Costs under IRC", Tax no. 101/102, January 2002, p. 40, and António Moura Portugal, "The Deductibility of Costs in Portuguese Tax Jurisprudence", Coimbra Editora, 2004, p. 243 et seq.

The development of case law and doctrine thus established the generic causal relationship of the expense to the activity as a whole (surpassing the strict expense-income nexus) and emphasized the rejection of the evaluation, by the Administration, of the correctness, convenience or opportunity of the decisions of corporate entities.

2.2.3. The Unremunerative Assignment of Funds to Related Entities and the Concept of "Productive Activity"

The case law of the STA has considered fiscally irrelevant, that is, non-deductible, the financial expenses incurred to meet the financial needs of companies in the same Group, which are not charged to the beneficiary entities, opening an exception, when loans or supplementary services of holding companies to the companies they hold are at issue, taking into account their specific corporate object, as noted in the following excerpt from the Opinion of the STA, of 28 February 2018, case no. 1206/17:

"The Supreme Administrative Court has understood that, when a holding company is at issue, financial expenses relating to credit obtained for the holding company to make gratuitous loans to the companies it holds will be accepted as a tax cost.

The corporate object of management of equity interests means that a company acquires or disposes of equity interests of another company and exercises commercial activity, using solely and exclusively the power of decision over 'the life of the investee company' that the value of the shares it holds may confer. That is, if the investee company is to acquire shares in another company, if it is to contract loans to make such acquisitions, the holding company has the power to agree, voting in favor of such decisions. This falls within the corporate object of a holding company."

With respect to another type of companies, it is argued that "[in] light of art. 23 of the CIRC, the costs with interest and stamp duty of bank loans contracted by a company and applied in the gratuitous financing of its associate companies are not to be considered fiscally relevant – Opinion of the STA, of 30 November 2011, case no. 107/11, (in the same sense, see the Opinions of 30 November 2011, case no. 171/11; of 20 May 2009, case no. 1077/08; and of 7 February 2007, case no. 1046/05).

According to this case law, the expenses provided for in article 23 of the IRC Code must respect the taxpayer company itself and the respective activity must be developed by it, not by other companies. In this sense, see Opinion no. 1046/05 aforementioned:

"Otherwise, how could the exercise of the activity of one company be attributed to another with which it had some relationship. The amounts in question correspond to interest on bank loans contracted by the appellant and applied in the gratuitous financing of an associate company.

Such sums are not, therefore, directly related to any activity of the taxpayer entered in its corporate object, which is the manufacture of tiles and not the management of equity interests or financing of risk companies, nor do they even report, albeit indirectly, to its activity.

On the other hand, these are not interest on foreign capital applied in the operation itself, those indeed provided for as costs in paragraph c) of no. 1 of article 23 of the CIRC.

The mere possibility of being able to have future gains resulting from the application of those capital in its associate company does not by itself determine that such investments may be classified under the concept of tax costs because for that it was necessary that such expenses be indispensable for the realization of profits or gains subject to tax or for the maintenance of the income-generating source. And such indispensability is far, in this case, from having been demonstrated."

The conception according to which the obtaining of funds by a company, followed by their gratuitous assignment to an investee, does not constitute, without more,