Process: 2/2018-T

Date: April 5, 2019

Tax Type: IRC

Source: Original CAAD Decision

Summary

CAAD Arbitration Case 2/2018-T addressed the IRC tax treatment of capital gains arising from the acquisition and subsequent conversion of shareholder loans (créditos de suprimentos) into equity capital. The taxpayer, A... SGPS, acquired distressed company C... SA in 2013, purchasing both shares and creditor claims at discounted prices. The taxpayer recorded the difference between nominal value (€1,229,393.98) and acquisition price (€658,421.00) as income under fair value accounting, then deducted this amount from taxable income. The Tax Authority issued an IRC assessment of €120,741.70, applying Article 18(9) of the IRC Code, which denies capital gains or losses on credits when the debtor and creditor are in a special relationship. The taxpayer challenged this, arguing the provision only applies upon realization (payment/write-off), not at acquisition. They invoked constitutional principles including ability to pay, accrual basis accounting, and tax justice, contending no economic gain materialized merely from acquiring distressed debt at market value. The arbitral tribunal examined whether Article 18(9) extends to the initial acquisition phase or only to subsequent realization events, and whether taxing an unrealized accounting adjustment violates fundamental tax principles. This case is significant for corporate restructurings involving distressed debt acquisitions, capital increases through in-kind contributions of loans, and the intersection of accounting fair value measurements with IRC taxable income determinations.

Full Decision

ARBITRAL DECISION (consult full version in PDF)

The Arbitrators José Pedro Carvalho (President Arbitrator), João Taborda da Gama and Henrique Fiúza, appointed by the Deontological Council of the Administrative Arbitration Centre to form an Arbitral Court, hereby agree as follows:

I – REPORT

On 2 January 2018, A..., SGPS, S.A., formerly B..., SGPS, S.A, Tax Identification Number ..., with registered office at ..., n.º..., ..., ...-... Carregado, filed a request for constitution of an arbitral tribunal, under the combined provisions of Articles 2 and 10 of Decree-Law No. 10/2011, of 20 January, which approved the Legal Framework for Arbitration in Tax Matters, as amended by Article 228 of Law No. 66-B/2012, of 31 December (hereinafter, abbreviated as RJAT), seeking a declaration of illegality of the Corporate Income Tax (IRC) assessment notice No. 2016 ... and the assessment of compensatory interest, relating to the tax year 2013, in the total amount of €120,741.70, as well as the decision to reject the administrative appeal which concerned the said assessment.

To support its request, the Applicant alleges, in summary:

  • error in the application of Article 18(9) of the Corporate Income Tax Code;
  • violation of the principle of contributive capacity;
  • violation of the accrual and realization principles;
  • violation of the principle of justice.

On 03-01-2018, the request for constitution of the arbitral tribunal was accepted and automatically notified to the Tax Authority (AT).

The Applicant proceeded to nominate an arbitrator, having nominated Dr. João Taborda da Gama, under Article 11(2) of the RJAT. Under Article 11(3) of the same legal framework, the Tax Authority nominated Professor Dr. Henrique Fiúza as arbitrator.

The arbitrators designated by the parties were appointed and accepted their respective duties.

Following a request submitted by the arbitrators designated by the parties for the president arbitrator to be designated by the Deontological Council, the current president arbitrator was appointed, under Article 6(2)(b) of Decree-Law No. 10/2011, of 20 January, and likewise accepted his duty within the applicable timeframe.

On 15-03-2018, the parties were notified of these appointments and manifested no intention to refuse any of them.

In accordance with the provisions of Article 11(1)(c) of the RJAT, the collective Arbitral Tribunal was constituted on 05-04-2018.

On 10-05-2018, the Tax Authority, duly notified for this purpose, submitted its response defending itself solely by way of objection.

On 24-09-2018, the hearing referred to in Article 18 of the RJAT took place, at which witnesses presented by the Applicant were examined.

The deadline referred to in Article 21 of the RJAT was extended three times, for two months in each instance.

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

It was indicated that the final decision would be notified by the end of the deadline referred to in Article 21 of the RJAT, duly extended.

The Arbitral Tribunal is materially competent and is regularly constituted, under Articles 2(1)(a), 5 and 6(1) of the RJAT.

The parties have legal personality and capacity, are legitimate and are legally represented, under Articles 4 and 10 of the RJAT and Article 1 of Order No. 112-A/2011, of 22 March.

The proceedings do not suffer from any irregularities.

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

Having considered all the foregoing, it is appropriate to deliver

II. DECISION

A. FACTUAL MATTERS

A.1. Facts Established as Proven

  • The Applicant is, and was in 2013, a holding company whose purpose is the "management of equity interests in other companies, as an indirect form of conducting business activities".

  • During 2012, the Applicant initiated procedures aimed at acquiring company C..., S.A. (hereinafter, C...).

  • This acquisition also included, indirectly, D..., LDA (hereinafter, D...).

  • C... was a Portuguese company whose main activity consisted of providing integrated logistics services for temperature-controlled products.

  • At the time of its acquisition by the Applicant, C... was in a situation of serious liquidity deficit, depletion of its own capital, breach of obligations to various creditors, including financial institutions, and recurring generation of negative net results.

  • The Statutory Auditor of C... already in 2011 considered that "the continuity of the company depends on the financial support of shareholders, the maintenance of support from financial institutions, as well as the success of future operations, essential for the balance and fulfillment of financial commitments".

  • C... was unable to generate results and cash flows capable of satisfying the treasury requirements associated with its current financial and commercial liabilities.

  • The assessment of C...'s own capital, based on 2012, according to the discounted cash flow method, was €-4,909,000.00, or €-3.77 per share.

  • The Applicant decided to proceed with the acquisition of C...'s equity interests, believing that in the long term the investment would succeed, and that with new management and a thorough financial restructuring it would be possible to recover the company, naturally bearing the inherent business risk.

  • The project for C...'s acquisition included an asset recovery strategy that implied the following measures after acquisition:

    • reduction of capital to cover accumulated losses of approximately €5,000,000;
    • capitalization of the company with cash contributions exceeding €4,000,000;
    • conversion of shareholder loans into capital;
    • restructuring of bank debt in order to ensure the solvency of the company.

  • On 11-01-2013, E..., S.A. assigned to the Applicant the credits it held over entities C... and D....

  • On 11-01-2013, the Applicant acquired 1,269,632 shares of C..., corresponding to 97.66% of its share capital, for the amount of €671,988.69, from the following entities: [details omitted as per source]

  • The Applicant gained control of company C..., which then became a subsidiary of the Applicant's group.

  • On the same date, the Applicant proceeded to acquire the credits which seller E..., S.A. held over C... and over D..., credits with a total nominal value of €1,229,393.98.

  • The said credits were acquired for €658,421.00, with the acquisition price apportioned as follows: [details omitted as per source]

  • The Applicant recorded the difference between the nominal value and the acquisition value of the ceded credits, of €1,229,393.98, as income for the year 2013, in account 7858 – Other Income and Gains.

  • The Applicant measured the acquisition of the credits at fair value, considering the amount of €1,229,393.98, the gain reflected in the income statement "7858 – Other Income and Gains", as an adjustment resulting from the application of fair value.

  • In box 03-A of Annex A of the Annual Declaration/IES, relating to the year 2013, the Applicant declared income of €3,837,045.72 and a net result for the year of €3,721,992.21.

  • The difference between the nominal value and the acquisition value of the ceded credits was deducted by the Applicant in the net result for tax purposes, in field 775 (blank line) of box 07 of the income tax return/Model 22 of IRC for 2013.

  • The Applicant accounted for the acquisition of equity interests using the purchase method, the identifiable assets and liabilities of the Applicant were recognized at fair values as of the acquisition date and the badwill was recognized in results as a gain.

  • The purchase and sale agreement of shares concluded between the Applicant and E..., S.A contained in its section 3.1 – "Price" that, in addition to the price for purchase and sale of shares, the buyer would pay the seller the amount of €658,421.00, as consideration for the assignment of the credits held by E... over companies C... and D....

  • On 21-02-2013, the Applicant acquired additional credits over C..., in the amount of €36,035.26, from F..., for the respective nominal value, coming to hold a total credit of €1,614,535.26 over C....

  • On 15-02-2013, the increase in share capital of D... was approved, in the amount of €309,314.18, bringing its share capital from €324,218.63 to €633,533.61, through the subscription of two new quotas by C... and the Applicant.

  • The increase in the share capital of D... was carried out through the conversion into capital of the credits held by C... and the Applicant, in the amounts of €59,586.38 and €249,728.60, respectively.

  • For accounting purposes of the Applicant, the credit over D..., in the amount of €309,314.98, was converted into capital of D... through the following entries: [details omitted as per source]

  • The Applicant's credit over D... was extinguished by the incorporation of that credit in the share capital of D..., with the current account "2684 – Other Receivables – D...", being initially debited for the acquisition of the credit and subsequently credited for the same amount by the incorporation of that credit in capital, resulting in a nil account balance.

  • In addition to the extinction of this credit, the Applicant extinguished its participation in the capital of D... through a share assignment agreement concluded on 21-02-2013, assigning the quota held by the Applicant over the capital of D... in favor of company G..., LDA, with an accounting loss of €309,313.98 recorded as a debit in the account "7858 – Other Income and Gains".

  • On 30-12-2013, the share capital of C... was increased by €1,600,000.00, rising from €5,400,000.00 to €7,000,000.00.

  • This capital increase was subscribed by the Applicant and carried out through the conversion into capital of virtually all of the debt.

  • For accounting purposes of the Applicant, the credit over C..., in the amount of €1,600,000.00, was converted into capital of C... through the following entries: [details omitted as per source]

  • Following the conversion of these credits into capital of C..., the account "2682 – C..." came to reflect a debit balance of €14,535.26, relating to the remaining amount of the credits acquired from F....

  • In the utilization of the credits to be converted, the FIFO (first in, first out) criterion was used, under which all credits acquired from seller E... were applied and, only subsequently, partially, the credits acquired from F....

  • The Applicant's intention with the conversion of the credits into shareholder loans was to offer a sign of confidence and commitment to the creditors of the company, assuming all execution risk without imposing or negotiating any reduction of the nominal or outstanding value of liabilities.

  • With such operations, the Applicant deprived itself of the right to reimbursement, substituting it with the right to receive future dividends in case the business succeeded or with capital gains to be realized in the future upon the sale of the said shares issued with the conversion of shareholder loans into capital.

  • The Applicant was subject to a partial tax inspection of IRC, covering the tax period 2013, in compliance with Service Order No. OI2015..., which originated from a proposal made by the Tax Inspection Services of the Finance Directorate of Porto, made on the basis of the tax inspection of E....

  • The Applicant was notified, through Official Letter No. .../... of 09-12-2015, of the draft inspection report, and to, if it so wished, exercise its right to prior hearing.

  • On 29-12-2015, the Applicant submitted its right to be heard to the Finance Directorate of Porto.

  • In the draft inspection report, a correction of the Applicant's taxable income was proposed in the amount of €1,229,393.98, relating to adjustments made upon acquisition of the credits over C... and D..., concerning the difference between the acquisition value and the respective nominal value.

  • Through Official Letter ..., of 14-01-2016, the Applicant was notified of the Final Tax Inspection Report which confirmed the proposed correction of taxable income.

  • The Final Tax Inspection Report contained the following: [details omitted as per source]

  • The Applicant was notified of the IRC assessment notice No. 2016..., in the amount of €120,741.70, including compensatory interest of €8,005.79.

  • On 12-08-2016, the Applicant filed an administrative appeal No. ...2016....

  • The Applicant was notified of the decision to reject the administrative appeal, via postal service, by letter dated 04-10-2017.

A.2. Facts Established as Not Proven

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

A.3. Reasoning for the Established and Unestablished Factual Matters

With respect to the factual matters, the Tribunal does not need to pronounce on everything alleged by the parties; rather, it has the duty to select the facts that matter for the decision and to distinguish between the proven and unproven matters (see Article 123(2) of the Code of Tax Procedure and Process and Article 607(3) of the Code of Civil Procedure, applicable by virtue of Article 29(1)(a) and (e) of the RJAT).

Thus, the facts pertinent to the judgment of the case are chosen and defined according to their legal relevance, which is established in view of the various plausible solutions to the question(s) of law (see previous Article 511(1) of the Code of Civil Procedure, corresponding to the current Article 596, applicable by virtue of Article 29(1)(e) of the RJAT).

Accordingly, having regard to the positions assumed by the parties, in light of Article 110(7) of the Code of Tax Procedure and Process, the documentary evidence and the administrative file attached to the case, as well as the oral testimony produced, the facts listed above were considered proven, with relevance to the decision, bearing in mind that, as stated in the Decision of the Administrative Court of Appeal (South) of 26-06-2014, delivered in case 07148/13, "the evidential value of the tax inspection report (...) may have probative force if the assertions contained therein are not challenged".

No weight was given as proven or not proven to allegations made by the parties and presented as facts consisting of strictly conclusive statements, incapable of proof, and whose veracity is to be assessed in relation to the concrete factual matters consolidated above.

B. ON THE LAW

In essence, the issue in discussion in the present arbitral process can be summarized as the taxation, or not, of income/gains obtained from the acquisition of credits below their nominal value and the use of such credits, at their nominal value, in capital increases carried out through the transfer of credits in payment of the subscriptions made.

We shall proceed to describe the most relevant facts to be considered, in the accounting treatment of the operations and in their tax treatment.

The essential facts underlying the discussion of the matter under review can be summarized as follows:

  • On 11 January 2013, the Applicant acquired, for the total amount of €671,988.69, 97.66% of the share capital of C..., with a nominal value of €4,189,965.00;

  • To the said acquisition value was added the amount of €172,715.74, relating to additional expenses for the acquisition of equity interests;

  • Having acquired the said shares, the Applicant proceeded to account for such acquisition using the purchase method, the identifiable assets and liabilities of the acquired company were recognized at fair values as of the acquisition date, and the badwill was recognized in results as a gain;

  • Under Article 18(9) of the CIRC, the taxpayer deducted in field 775, box 07 of the income tax return Model 22 of 2013, the amount recorded as fair value adjustment in the account "7858 – Other Income and Gains", in the amount of €3,247,383.14;

  • On 11 January 2013, the Applicant acquired, for the total amount of €658,421.00, the credits over C... for €545,642.41 and the credits over D... for €112,778.59;

  • Credits whose nominal values totaled €1,887,814.98, respectively, €1,578,500.00 in credits over C... and €309,314.98 in credits over D...;

  • The difference between the total purchase values and the corresponding nominal values was €1,229,393.98;

  • Having acquired the credits for the indicated amount, the Applicant proceeded to account for them at their nominal value, that is, for the amount of €1,887,814.98, thus calculating a gain of €1,229,393.98;

  • In accordance with §15 of NCRF 27 – Financial Investments;

  • In the month following the acquisition of the said credits – 15 February 2013 – the capital increase of C... was approved at General Meeting in the amount of €309,314.98;

  • Exactly the nominal value and the amount for which the shareholder loans acquired by the Applicant were accounted for on D...;

  • With the Applicant having transferred all the credits it held in D... in payment of the capital increase it subscribed;

  • On 21 February 2013, the Applicant acquired additional credits over C... in the amount of €36,035.26, at their nominal value;

  • Becoming the holder of credits over C... with a nominal value of €1,614,535.26;

  • On 30 December 2013, C... resolved to increase its share capital by €1,600,000.00, wholly subscribed by the Applicant;

  • With the Applicant also transferring its credits in payment of the capital it subscribed;

  • The acquisition value of which was €567,142.41, corresponding to €545,642.41 of the credits acquired on 11/01/2013 and €21,500.00 of the credits acquired on 21/02/2013;

  • The Applicant incorporated into its assets new equity interests in C..., with a nominal value of €1,600,000.00 as consideration for the in-kind contribution made through the transfer in payment of the shareholder loan credits referred to.

Article 17(1) of the CIRC applicable provides:

"The taxable profit of legal entities and other entities mentioned in Article 3(1)(a) shall be constituted by the algebraic sum of the net result for the year and the positive and negative changes in assets and liabilities recorded in that period and not reflected in that result, determined on the basis of accounting and, where appropriate, corrected in accordance with this Code."

In this way, having described the operations carried out, we shall next proceed to their accounting treatment and, subsequently, to their fiscal treatment.

Accounting treatment, under SNC, of the operations carried out:

The accounting treatment of financial instruments – which includes credits/shareholder loans – is regulated by NCRF 27 – Financial Instruments.

This standard, in its §12, establishes as a rule the accounting of financial instruments at cost or at amortized cost less impairment loss.

§15 of the same standard states that financial instruments that are not measured at cost or at amortized cost must be measured at fair value, with examples of financial instruments that must be measured at fair value being given in §16, and determining that, in the case of fair value measurement, the difference between the acquisition value and fair value shall be accounted for with a charge to results;

In accounting for the acquisition of the credits at their nominal value, the Applicant understood that the credits it acquired fall within §15, as they are covered by one of the examples mentioned in §16, and accordingly accounted for in accordance with the stated standard and calculated the respective result.

Had the Applicant accounted for the credit acquisitions using the cost model instead of the fair value model, when transferring the credits it held in payment of the obligations assumed with the subscriptions of the capital increases of its subsidiaries, the Applicant might have been required to calculate the gains or losses generated with the transfer of the credits in fulfillment.

Thus, for example, had the Applicant accounted for the credit acquisitions using the cost model, it could have:

  • realized a loss, had it transferred the credits in question in exchange for a set of equity interests with a nominal value lower than the credits accounted for at cost;

  • realized a gain, had it transferred the credits in question in exchange for a set of equity interests with a nominal value higher than the credits accounted for at cost (as was the case);

  • realized no gain or loss had it transferred the credits in question in exchange for a set of equity interests with a nominal value equal to the credits accounted for at cost.

In this case, the Applicant proceeded to account for the shareholder loan credits it acquired applying the fair value model, as referred to, and calculated a gain in the amount of €196,536.39 with the in-kind payment of the obligation assumed with the subscription of the capital increase of D..., having received the company's equity interests valued at €309,314.98 and having delivered in its payment the shareholder loan credits, the acquisition value of which was €112,778.59.

In the same manner, the Applicant also calculated the gain of €1,032,857.59 with the in-kind payment of the obligation assumed with the subscription of the capital increase of C..., calculated as follows: value of capital equity interests received in the amount of €1,600,000.00, minus the value of the credits (shareholder loans) transferred in payment acquired for €567,142.41, being €545,642.41 relating to credits acquired on 11/01/2013 and €21,500.00 relating to credits acquired on 21/02/2013.

The total gain obtained by the Applicant with the transfers of credits (shareholder loans) through transfer in payment – in-kind payments – in both capital increases was thus €1,229,393.98 (=€196,536.39+€1,032,857.59).

Tax treatment, under IRC, of the operations carried out:

Gains from increases in fair value of financial instruments are subject to taxation under Article 20(1)(f) of the Corporate Income Tax Code (CIRC) applicable, with income being considered as resulting from operations of any nature, as a result of a normal or occasional, basic or merely accessory action.

Conversely, losses from reductions in fair value of financial instruments are considered in the calculation of taxable profit, under Article 23(1)(i) of the same code.

The provisions in the preceding paragraphs are excepted in Article 18(9) of the CIRC, which provides that:

"9 — Adjustments resulting from the application of fair value do not concur in forming taxable profit, being imputed as income or expenses in the tax period in which the elements or rights that gave rise to them are sold, exercised, extinguished or settled, except when:

a) They relate to financial instruments recognized at fair value through results, provided that, in the case of equity instruments, they have a price formed on a regulated market and the taxpayer does not hold, directly or indirectly, a participation in the capital exceeding 5% of the respective share capital; or

b) Expressly provided for in this Code."

From what has been stated, it follows that, because the acquisitions of credits on shareholder loans accounted for using the fair value model correspond to the recognition of income/gains from increases in fair value, corresponding to the difference between the nominal values (fair value) and the respective acquisition values, under Article 20(1)(f) of the CIRC, the calculated gain is considered as income for the purposes of calculating the taxable profit of the year in which such gain was recorded in the accounts.

A different scenario would arise if the accounting of the acquisition of credits (shareholder loans) had been carried out using the cost method, in which case no gain would be calculated at that moment.

However, because the acquired credits were transferred in payment of the obligations undertaken with the subscription of the capital increases of both participating companies, and because the transfers in payment were made at the nominal values of the shareholder loans, at the time of such transfers (through transfer in payment), the accounting gains obtained would always have to be recorded, and thus, even in that other scenario, the gain arising from the operations in question would be taxed in the year of the transfer of the credits through transfer in payment which, in this case, was the year 2013.

Thus, because the Applicant accounted for the acquisition of the credits at fair value, having thus calculated a gain from the application of fair value in 2013, and also because the transfer of the credits also occurred in the year 2013, and in which the gains from the transfer of the credits in payment of the debts undertaken with the subscription of the capital increases of its subsidiaries would be calculated, there can be no doubt that such gains in discussion should be considered for tax purposes for the income of the year 2013.

In other words, the accounting of the acquisition of shareholder loans by the Applicant could have been carried out in accordance with one of the following models:

  • Cost Model – under §§12, 13 and 14 of NCRF 27;

  • Fair Value Model – under §§15 and 16 of the same NCRF.

The acquisition accounted for using the cost model does not give rise to the calculation of any gain or loss at the moment of acquisition, with gains or losses being calculated at the moment of its transfer or any other cause of extinction of the assets.

In the acquisition accounted for using the fair value model, the gain or loss relating to the difference between fair value and the respective acquisition value, calculated at the moment of purchase/accounting, is considered a gain under Article 20(1)(f) of the CIRC, or a loss under Article 23(1)(i).

As the acquisition of the shareholder loans occurred in the tax year 2013 and their sale also occurred in the same year, we are not facing a problem of specialization of the years (periodization of taxable profit), with Articles 20 ("Income") and 23 ("Expenses") being applicable to the case.

From its application would result, in any case, the inclusion in the taxable profit for the year 2013 of the gain of €1,229,393.98, arising from the acquisition of the shareholder loans, and from its subsequent sale/extinction, by means of in-kind contributions in the capital increases of C... and D....

Note that such gain arises from the circumstance that the capital increases were made in an amount equivalent to the nominal value of the acquired credits.

Indeed, one cannot fail to note that, in this case, given the control relationship which the Applicant held in 2013 over the companies that proceeded to the capital increase, this could have been made at the acquisition value of the shareholder loan credits by the Applicant, in which case no capital gains would have occurred.

By choosing to participate in the capital increase, taking advantage of the nominal value of the shareholder loan credits it acquired, the Applicant subjected itself to both the favorable consequences arising from such choice (such as holding equity interests in a nominal value higher than the acquisition of the shareholder loan credits it made, and the ownership of equity interests in companies with a larger share capital), as well as the unfavorable consequences (notably, in accounting terms and, consequently, tax terms) of such choice.

Thus, if the Applicant was, as appears and is indicated by the facts established as proven, convinced that the real value of the shareholder loans it acquired did not correspond to their nominal value, it should have made that real value relevant in the capital increase, rather than its nominal value, and it cannot be overlooked that, by legal requirement, the values of the shareholder loans given in exchange for the equity interests acquired in the capital increases were, by legal requirement, validated by a statutory auditor.

Given the foregoing, the fact is that by virtue of the operations the Applicant carried out, it incorporated into its assets equity interests in the companies in question, with a nominal value substantially higher than what it paid for the credits it exchanged for such equity interests.

And while the acquisition of such equity interests may generate capital gains or, foreseeably, capital losses for the Applicant, the certain fact is that the relevance of such fact lies already downstream of the matter under review, and that the relevance of such capital gains or losses shall be determined in accordance with the applicable tax rules, depending, possibly, on choices the Applicant makes regarding the model of their accounting.

Nevertheless, as referred to, such question lies beyond the matter under review which is, exclusively, whether the acquisition and subsequent use/extinction of the shareholder loan credits generated, or not, an accounting gain and a taxable gain, a question to which, for all the reasons stated, the answer must be affirmative.

Restating the matter, the operation of acquisition of shareholder loan credits, and subsequent conversion of them into equity interests generated in the sphere of the Applicant an accounting gain, without there being any tax rule that removes the relevance of such a gain, and therefore the deduction by the Applicant of the amount corresponding to the difference between the acquisition value of the shareholder loan credits in question and their nominal value, in field 775 of box 07 of the income tax return Model 22 of 2013, under Article 18(9) of the applicable CIRC, is legally inadmissible, given that the assets in question were extinguished or settled in that year of 2013.

The Applicant argues that "even if the acquisition of credits for a value lower than the nominal value of the credits could give the acquiring entity, in this case, the Applicant, the right to be reimbursed at its respective nominal value, which implied an accounting gain (corresponding to the difference between nominal value and its acquisition cost), such gain was merely potential, whose realization would only be effected with the payment of the debt by the debtor entity (in case C... and D...) – which did not happen".

However, this reasoning of the Applicant is, with all due respect, flawed, since the realization of gains arising from the acquisition of credits for a value lower than the nominal value shall be assessed not, specifically, by reference to the moment of their settlement in cash, but by reference to the moment of their extinction – because it occurred earlier and thus prevented their settlement in cash – and by reference to the patrimonial situation, duly reflected in accounting terms, resulting therefrom.

As explained previously, with respect to the acquisition and subsequent extinction of the shareholder loan credits, the Applicant calculated in accounting terms and realized a capital gain.

The question posed by the Applicant lies not in relation to the vicissitudes of the shareholder loan credits, which ceased to exist legally in the year 2013, but in relation to the value of the equity interests which, in exchange for that extinction, it received.

Hence, the moment of realization of the capital gains/losses arising from the financial assets corresponding to the shareholder loan credits is, unequivocally, the year 2013.

Thus, it shall be in the context of considering the capital gains and losses inherent in the equity interests of which it became holder within the scope of the capital increases to which it participated, and of the corresponding accounting and tax treatment, that gains or losses which such operation will generate shall be assessed.

The Applicant further invokes, in its favor, the administrative guidance contained in Dispatch P 3330/04 of 13-10-2005, as well as the position of the Tax Authority in a request for binding information, decided by dispatch dated 15-01-1997.

However, such positions of the Tax Authority were taken under the aegis of accounting and tax rules distinct from those in force at the date of the tax event under review, and it is not apparent that they are transposable to the legal framework applicable, nor does the Applicant demonstrate, in any way, that this is so.

And while it is true that, then as now, the legislator adopted the realization principle as the cornerstone of the taxation of capital gains, it is no less certain, as has been demonstrated, that in light of the rules in force at the date of the taxable event, such principle was realized with respect to the shareholder loan credits acquired by the Applicant (which acquired them for one value and realized them in exchange for assets of higher value), such principle being solely applicable, as has also been explained, with respect to the assets (equity interests) acquired by the Applicant at the time of realization of the shareholder loan credits previously acquired and exchanged for those, a situation which, as has also been seen, lies downstream of the issue to be decided.

The Applicant also argues that, if the application of Article 18(9) of the applicable CIRC is deemed correct with respect to the realization of capital gains arising from the acquisition and subsequent settlement/extinction of the shareholder loan credits, a violation of the principle of contributive capacity would occur, to the extent that "all operations generated, at most, a potential future gain, since only at the moment when the nominal value of the credits is received or after the sale of the company's equity interests does an increase in the contributive capacity of the entity acquiring the credits occur".

Again, the Applicant would, with all due respect, fall into a confusion between the receipt of the nominal value of the credits, which is far from constituting the only form of its extinction/settlement, and the sale of the company's equity interests.

With respect to the first aspect, as demonstrated above, the Applicant realized a capital gain, exchanging the credits it acquired for equity interests of higher value (when it could have made an exchange for equivalent values).

As for the second aspect, relating to the capital gains (or losses) resulting from the sale of the equity interests it acquired in the capital increase, as has also been already indicated, there are specific rules, based on the accounting treatment of them, and the competence of which lies, in the first instance, in the sphere of the Applicant.

Reverting to the concrete situation, what is apparent is that, accepting the thesis of the Applicant, it would integrate into its assets the equity interests it acquired in the capital increase operations, at their nominal value, and the participating companies would see their share capital increased, also at the nominal value, by the shareholder loan credits contributed by the Applicant, without such patrimonial changes being reflected in accounting and tax terms, and thus, if in the future, the Applicant were to proceed with the sale of those equity interests at their nominal value, they would not be taxed, for not bringing any accounting relevant patrimonial increase.

Thus, and for the reasons stated, there is no violation of the principle of contributive capacity, nor, consequently, of the constitutional rules invoked by the Applicant in this regard.

The Applicant further argues a violation of the accrual and realization principles, to the extent that this "provides that potential or latent capital gains do not concur in forming taxable profit, even if expressed in the accounts".

Again, it is necessary here to invoke the distinction between the capital gains resulting from the acquisition and subsequent settlement/extinction of the shareholder loan credits, and the capital gains or losses arising from the acquisition and subsequent sale/settlement of the equity interests acquired by the Applicant in the capital increases.

Thus, with respect to the former, there can be no doubt that the invoked principle of realization has been fulfilled.

With respect to the latter, the Applicant neither invokes, nor even less demonstrates, that the requisites for the application of any rule are met from which the negative concurrence of any (potential) capital loss in the year 2013 derives, which would nullify or offset the capital gain arising from the first operation, and therefore there is no violation of any applicable rule or invoked by the Applicant in the matter.

Finally, the Applicant argues that "the assessment notice under challenge and the subsequent action thereon are violations of the principle of justice".

Elaborating, the Applicant itself suggests that "In the present case, this means that, even if the facts under review determined the issuance of the assessment notice being challenged, (...) Having regard to the fact that the Applicant obtained no gains from the operation, the Tax Authority should have refrained from issuing the assessment notice in question, in respect for the principle of justice."

Also here, on the basis of what has been said, the conclusion must be reached in the opposite manner.

In effect, and as has been demonstrated, in the operation of acquisition and subsequent extinction/settlement of the shareholder loan credits, the Applicant generated an accounting gain and a fiscally relevant gain, corresponding to the difference between the acquisition price thereof and the value of the capital equity interests acquired.

If, which was to be demonstrated, the acquisition of equity interests generated an accounting gain and/or a fiscally relevant loss, capable of nullifying or offsetting, in the year 2013, the capital gain detected by the Tax Authority, and which is not susceptible, in light of the applicable accounting and tax rules, to be nullified, is a question that does not form part of the subject matter of the present proceedings, and, in any case, the Applicant does not demonstrate.

Thus, also from this perspective, it is concluded that there is no violation of the accrual and realization principles, nor of the rules that adopt it, invoked by the Applicant.

Thus, and for all the reasons stated, the arbitral request filed shall be judged as entirely without merit, and the Tax Authority shall be absolved of the request.

C. DECISION

It is hereby decided by this Arbitral Tribunal that the arbitral request filed is entirely without merit and, consequently, the Tax Authority is absolved of the request.

D. Value of the Proceedings

The value of the proceedings is fixed at €120,741.70, under Article 97-A(1)(a) of the Code of Tax Procedure and Process, applicable by virtue of Article 29(1)(a) and (b) of the RJAT and Article 3(2) of the Regulation of Costs in Tax Arbitration Proceedings.

Let notice be given.

Lisbon, 5 April 2019

The President Arbitrator

(José Pedro Carvalho)

The Arbitrator Member

(João Taborda da Gama – with dissenting opinion)

The Arbitrator Member

(Henrique Fiúza)

Dissenting Opinion

Acknowledging the formal coherence of the decision, and the complexity of the underlying issue, I would have voted otherwise for the substantial reason which I set out here very succinctly.

The operation in question, in which the Applicant converts credits acquired below nominal value into capital at nominal value, in a context of controlled companies, does not alter, in substantial terms, the patrimonial position of the company. As the decision itself admits, the context of control present here would have permitted the capital increase to be realized and accounted for in such a way that the alleged capital gains would not have occurred. It is precisely the pronounced accounting formalism of the reasoning of the assessment notice now contested, in a context where there was no increase in wealth of the taxpayer, that raises doubts about the fairness of the solution. This fact would lead me to vote otherwise, removing, by force of the constitutional principle of contributive capacity, in this precise case, the application of Article 18(9) of the CIRC in the manner advocated by the Administration and confirmed by the present decision. The oral testimony regarding the poor financial situation of the participating companies also contributed to this position.

If there were any suspicion about the reasons for accounting and subsequent conversion at nominal value (which were not alleged), that would be something that could have relevance in determining a potential downstream capital gain, but never, having regard to the principle of contributive capacity, in this context. The thesis that prevailed thus rules out that the value of the equity interests be put in question in the future.

(João Taborda da Gama)
Lisbon, 4/4/19

Frequently Asked Questions

Automatically Created

How are capital gains from shareholder loans (suprimentos) taxed under Portuguese IRC?
Under Portuguese IRC, capital gains from shareholder loans (suprimentos) are generally taxable when realized. However, Article 18(9) of the IRC Code contains a special anti-avoidance provision that excludes from taxable income any capital gains or losses on credits when the debtor and creditor are in a special relationship as defined in Article 63 of the IRC Code. This provision aims to prevent manipulation of taxable results through transactions between related parties. The provision's application to the acquisition phase versus the realization phase was disputed in CAAD case 2/2018-T, where the taxpayer argued it should only apply when credits are actually settled, written off, or converted.
What are the IRC implications of converting shareholder loans into capital through in-kind contributions (entrada em espécie)?
Converting shareholder loans into capital through in-kind contributions (entrada em espécie) has specific IRC implications. When a shareholder contributes credits (loans to the company) as capital, this constitutes a realization event. Under Article 18(9) IRC Code, if the creditor-shareholder and debtor-company maintain a special relationship (typically parent-subsidiary or significant holdings), any capital gain or loss on the conversion is excluded from taxable income. This prevents shareholders from generating artificial tax losses by contributing depreciated loans or artificial gains by writing up loan values. The fair value at contribution determines the tax basis, but gains/losses are neutralized between related parties. This was central to case 2/2018-T, where loans acquired at discount were planned for capital conversion.
How does Article 18(9) of the Portuguese IRC Code apply to capital gains on credit assignments?
Article 18(9) of the Portuguese IRC Code applies to capital gains on credit assignments by excluding gains or losses when special relationships exist between creditor and debtor. The provision states that capital gains and losses on credits are not considered for IRC purposes when, at the time of realization, a special relationship exists per Article 63. In case 2/2018-T, the dispute centered on whether 'time of realization' includes the initial acquisition of credits at discount or only subsequent settlement/conversion events. The Tax Authority applied Article 18(9) to tax the accounting gain recorded at acquisition under fair value. The taxpayer contested this interpretation, arguing the provision only applies when credits are actually settled, written off, or converted into equity, not at the acquisition phase where no economic realization occurs.
What role do the principles of ability to pay and accrual basis play in IRC capital gains taxation?
The principles of ability to pay (capacidade contributiva) and accrual basis play crucial roles in IRC capital gains taxation. The ability-to-pay principle, constitutionally protected under Article 104 of the Portuguese Constitution, requires taxation only on actual economic enrichment. In case 2/2018-T, the taxpayer argued that taxing an unrealized accounting adjustment violates this principle since acquiring credits at market value (discounted for risk) generates no real economic gain—merely fair value measurement. The accrual principle (princípio da especialização dos exercícios) requires matching income and expenses to the period when earned/incurred. The taxpayer contended that Article 18(9) respects accrual by postponing tax consequences until actual realization (payment, conversion, or write-off), not at acquisition. These principles supported arguments that IRC taxation should follow economic substance over accounting form, particularly when fair value creates timing differences without cash flow impact.
What was the outcome of CAAD arbitration case 2/2018-T regarding the IRC assessment of €120,741.70?
CAAD arbitration case 2/2018-T concerned an IRC assessment of €120,741.70 issued to A... SGPS, SA for tax year 2013. While the complete decision text is truncated, the case involved the taxpayer's challenge to the Tax Authority's application of Article 18(9) IRC Code. The taxpayer acquired distressed credits against company C... SA at a significant discount (€658,421 for credits with €1,229,393.98 nominal value), recorded the difference as income under fair value accounting, then deducted it from taxable income. The Tax Authority disallowed this deduction, applying Article 18(9)'s prohibition on recognizing gains/losses on related-party credits. The tribunal was tasked with determining whether this provision applies at credit acquisition or only upon realization, and whether the assessment violated constitutional principles of ability to pay and tax justice. The outcome would establish important precedent for corporate restructurings involving distressed debt acquisitions in Portugal.