IRC Depreciation of Own-Use Property and Autonomous Taxation: CAAD Arbitration 204/2015-T

ARBITRAL AWARD

I – REPORT

1. The taxpayer "A..., S.A.", Tax Number ... (hereinafter "Claimant") submitted, on 20 March 2015, a request for establishment of a Collective Arbitral Tribunal, under the terms of the combined provisions of articles 2, 5, 6 and 10 of Decree-Law no. 10/2011, of 20 January (Legal Regime of Arbitration in Tax Matters, hereinafter "LRAM"), in which the Tax and Customs Authority (hereinafter "TCA" or "Respondent") is required.

2. The Claimant seeks an arbitral decision on the rejection decision of the gracious complaint concerning the Corporate Income Tax (IRC) assessment for the 2010 tax year – based on the illegality of this assessment act issued following a tax inspection action, which the Claimant seeks to have annulled.

3. The request for establishment of the arbitral tribunal was accepted by the Honorable President of CAAD and automatically notified to the TCA on 23 March 2015.

4. Under the terms of article 6, no. 2, paragraph a) and article 11, no. 1, paragraph b) of the LRAM, as amended by article 228 of Law no. 66-B/2012, of 31 December, the Deontological Council appointed the arbitrators of the Collective Arbitral Tribunal, who communicated acceptance of the assignment within the applicable deadline, and notified the parties of this appointment on 15 May 2015.

5. The Collective Arbitral Tribunal was constituted on 8 June 2015; it was regularly constituted and is materially competent, in light of the provisions of articles 2, no. 1, paragraph a), 5, 6, no. 1, and 11, no. 1, of the LRAM (as amended by article 228 of Law no. 66-B/2012, of 31 December).

6. Under the terms of articles 17, nos. 1 and 2 of the LRAM, the TCA was notified on 8 June 2015 to submit a response.

7. The TCA submitted its response on 14 July 2015, raising exceptions and alleging the total lack of merit of the Claimant's request. The TCA attached to its response the preceding administrative file.

8. The Arbitral Order of 2 August 2015 notified the Claimant to submit, if it so wished, a response to the exceptions raised by the TCA.

9. The Claimant submitted on 14 September 2015 that response to the exception raised by the TCA.

10. The Arbitral Order of 3 October 2015 dispensed with the meeting provided for in article 18 of the LRAM, granted the parties a deadline for final submissions and set 2 December 2015 as the deadline for rendering and notification of the award.

11. Following this, the Claimant submitted its submissions on 20 October 2015, and the Respondent submitted its counter-submissions on 3 November 2015.

12. By arbitral order of 29 November 2015, the initially set deadline was extended, exercising the power provided for in article 21, no. 2 of the LRAM, with the new deadline becoming 21 December 2015.

13. The proceedings do not suffer from defects that impede consideration of the merits of the case, once the exception raised by the Respondent has been resolved.

14. The TCA proceeded with the appointment of its representatives in the proceedings and the Claimant attached a power of attorney, with the Parties thus being duly represented.

15. The Parties have legal personality and capacity and have standing, under the terms of articles 4 and 10, no. 2, of the LRAM and article 1 of Ordinance no. 112-A/2011, of 22 March.

II – LEGAL GROUNDS: FACTUAL MATTERS

II.A. Facts Considered Proven

a) The Claimant filed its model 22 IRC declaration for the 2010 tax year on 31 May 2011.

b) The Claimant, which for IRC purposes is classified under the general taxation regime, had at that date its accounts consolidated within the consolidation perimeter of B....

c) On 2 June 2011 the Claimant filed a 1st amended declaration, in which tax to be recovered in the amount of €294,867.88 was determined.

d) On 20 April 2012 the Claimant filed a 2nd amended declaration, from which resulted an assessment note in which it determined, beyond tax to be recovered in the amount of €294,867.88, a reportable tax loss of €13,766,461.38.

e) The TCA initiated on 6 September 2012 an external inspection action for the 2010 tax year of the Claimant.

f) On 12 December 2012 the Claimant was notified of the draft inspection report, in which corrections to IRC were proposed.

g) The Claimant exercised its right to be heard, contesting the proposed corrections.

h) On 28 December 2012 the Claimant was notified of the final inspection report, which determines the application of corrections in IRC, in a total amount of €672,027.55 (= €485,674.66 for owner-occupied real estate, €14,532.40 for transition adjustment, €53,200.00 for job creation, €15,000.00 for non-deductible donations, €18,015.65 for donations – increase, €2,297.40 relating to Policy 14, €16,034.24 for capital gains on real estate, and €71,868.00 for corrections to the transfer value of real estate rights), plus tax shortfall in the amount of €199,458.86 for autonomous taxation.

i) The Claimant received on 9 January 2013 the additional assessment no. 2013... and the respective statement of account adjustment no. 2013..., relating to the 2010 tax year, with a total amount payable of €211,109.43, which was paid by the Claimant on 5 March 2013.

j) From the assessment resulted that the balance of reportable tax losses was corrected to €13,094,433.83.

k) On 9 July 2013 the Claimant filed a gracious complaint of the aforementioned 2010 IRC assessment, disagreeing with the corrections relating to owner-occupied real estate (€485,674.66) and autonomous taxation (€199,458.86).

l) On 28 November 2014 the Claimant was notified of the draft rejection of the complaint.

m) On 23 December 2014 the Claimant was notified of the rejection decision of the gracious complaint.

n) There is pending litigation in the Tax Court of Lisbon, challenging the IRC assessment for the 2008 tax year, filed by the now Claimant on 29 January 2013 (no. .../13...BELRS).

II.B. Facts Considered Not Proven

Based on the documentary evidence made available in the proceedings and consensually accepted by the parties, there are no unproven facts that are relevant to the decision of the case.

III – LEGAL GROUNDS: SUBSTANTIVE LAW

III.A. Position of the Claimant

a) The Claimant seeks the annulment of the additional assessment no. 2013... and the respective statement of account adjustment no. 2013..., relating to the 2010 tax year, from which resulted a total amount payable of €211,109.43.

b) The Claimant maintains that, under article 102 of the Tax Procedural Code (CPPT) and article 10, 1, a) of the LRAM, the request for establishment of the arbitral tribunal is timely, given that it was only on 23 December 2014 that it was notified of the rejection decision of the gracious complaint, and therefore 90 days had not yet elapsed when on 20 March 2015 it submitted the present request for establishment of a Collective Arbitral Tribunal.

c) As it had done in the gracious complaint, the Claimant concentrates its request on only two corrections: 1) those relating to owner-occupied real estate (in the amount of €485,674.66) and 2) autonomous taxation on bonuses and variable remuneration paid to managers and administrators (in the amount of €199,458.86).

d) As regards the corrections relating to owner-occupied real estate, the amount of €485,674.66 results from adjustments already made in the inspection action itself, with corrections both in favor of the Claimant and in favor of the State, based on the conviction that the Claimant would not have proceeded: 1) neither with the transition adjustments claimed by the adoption, from the 2008 tax year onwards, of the standards of International Accounting Standards (IAS); 2) nor with depreciation in the 2010 tax year; 3) nor with the weighting of depreciation made in calculating capital gains and losses for that period.

1. Everything centers, therefore, on the question of the adequacy and legality of the accounting procedures adopted by the Claimant in the 2008 and subsequent tax years, under the terms of the transition regime that led to the adoption of International Accounting Standards (IAS) by insurance companies subject to the supervision of the Portuguese Institute of Insurance (ISP) – an evolution in the Chart of Accounts for Insurance Companies (CAEC), from Regulatory Standard no. 7/94, of 27 April, to Regulatory Standard no. 4/2007-R, of 27 April (amended by Regulatory Standard no. 20/2007-R, of 31 December).

2. The crucial point is that the Claimant disagrees with the attribution of tax relevance to accounting depreciation of owner-occupied real estate of those insurance companies.

3. According to the Claimant, in applying the relevant regulatory framework, fair value assessment of owner-occupied real estate was carried out, based on assessments made by independent experts, subject to impairment tests to determine any loss of value – the choice of the cost model provided for in IAS 16.

4. Based on this procedure, already in the 2008 transition adjustment, having recorded a negative equity variation, the Claimant made no adjustment to IRC taxable income as it considered such adjustments fiscally irrelevant.

5. In the 2010 tax year, reinstatements and depreciation of owner-occupied buildings were recognized accounting-wise and added to the IRC taxable base (in the amount of €739,238.10), but were offset by losses from the sale of real estate, resulting in a capital loss with a total value of €11,046,134.28.

6. Given the succession of CAECs, until the end of 2007, depreciation of real estate, regardless of their respective classification, was not accepted for purposes of determining the fiscal result of companies under ISP supervision; and for that reason, until that date the Claimant valued all its real estate, including owner-occupied real estate, at its market value (calculating capital gains by the difference between realization value and acquisition value, the latter updated by the applicable coefficients).

7. Only from 1 January 2008 onwards, with the application of the transition regime that would ultimately be fixed by Decree-Law no. 237/2008, of 15 December, was the Claimant able to record real estate, including owner-occupied real estate, as "tangible fixed assets" subject to reinstatements and depreciation. Only with this new regime did fiscal reinstatements and depreciation begin to be relevant for purposes of determining capital gains and losses on the sale of these assets.

8. In these terms, it is the Claimant's understanding that the sale of owner-occupied real estate acquired before 1 January 2008 cannot lead to the determination of capital gains and losses considering accumulated depreciation since the date of acquisition – because, from its perspective, such a regime can only apply to the sale of real estate acquired after 1 January 2008, under penalty of incurring retroactivity, violating taxpayer security and legitimate expectations.

9. Furthermore, the Claimant notes the fact that, in the case of insurance companies, such retroactivity would be factually impossible, given the circumstance that they were only required to subject their real estate to depreciation from the 2008 tax year onwards (although in this case integration into a corporate group allowed depreciation from the time of the parent company's transition to IFRS, which occurred in 2004).

10. On the other hand, the Claimant argues that the TCA defends an incorrect point of view by seeking to subject the "cost model" to a single regime, insofar as it associates it with the reflection, in the balance sheet, of historical acquisition value – a single regime that is not imposed by the new accounting standards (namely IFRS 1 in its section 16), and is only suggested by a non-mandatory circular from the ISP.

11. Being so, the Claimant argues that it is being denied, by the TCA, an option that is recognized by IFRS 1 – namely that of accounting for reinstatements of owner-occupied real estate only from the date of transition to the new accounting standards (as the Claimant actually did for purposes of reporting its consolidated accounts, from 2004 onwards).

12. And, it adds, if for accounting purposes there was no obligation on the Claimant to retroactively calculate depreciation to the date of acquisition of the real estate, it does not seem acceptable that such an obligation would arise solely for tax purposes.

13. Decisive, in the Claimant's understanding, is that not only does no legal provision impose the solution that the TCA adopts for tax purposes, but also nothing prevented the Claimant from proceeding as it did: determining capital gains exclusively at the time of sale by subtracting the (corrected) acquisition value from the realization value, without opting for adjustment for tax purposes, exercise by exercise.

e) As regards the corrections relating to autonomous taxation on bonuses and variable remuneration paid to managers and administrators (insofar as they represent a portion exceeding 25% of annual remuneration and exceed €27,500 – article 88, 13, b) IRC), in the total amount of €199,458.86, the Claimant alleges the existence of an error on the part of the TCA, resulting from the fact that such bonuses and variable remuneration were paid to their beneficiaries only in the 2011 tax year.

1. In the Claimant's view, the legal framework (specifically article 88, 13, b) of the IRC) makes it unequivocal that this concerns taxing remuneration actually paid, whereby payment is a prerequisite of the tax incidence – being the only ground compatible with the notion of autonomous taxation.

2. If this is so, the taxable event subject to autonomous taxation arises from a situation in which a payment occurred, not being satisfied by its accounting recognition, its determination. Autonomous taxation occurs expense by expense, notwithstanding its aggregate collection together with IRC; and in the case at hand, article 88, 13, b) of the IRC does not provide for remuneration "determined or paid," but only "paid."

3. Furthermore, if these bonuses and remuneration relating to 2010 but only paid in 2011 were to be taxed, there would be double taxation, as bonuses and variable remuneration relating to 2009 were subjected to autonomous taxation in 2010.

4. Furthermore, the amounts considered by the TCA would be inflated, given that they disregard bonuses and variable remuneration paid to managers and administrators of the Claimant, not for work performed for it, but for work performed in other Group companies... Now these amount to €235,000.00, whereby the taxable base will be reduced from €569,882.46 to €334,882.46, with corresponding partial annulment of the correction made by the TCA.

f) The Claimant seeks, in sum, the annulment of the flagged corrections, that is, of the additional assessment and respective compensatory interest, with the consequent correction of the balance of reportable losses and the reimbursement of tax unduly paid – all accrued with indemnifying interest in its favor.

g) In response to the exception raised by the Respondent, the Claimant argues:

1. As to timeliness, that the deadline provided for in the LRAM was respected, and that what is truly at issue is the rejection decision of the gracious complaint – it merely happening that there are no autonomous or distinguishable defects attributable solely to such decision, whereby it is challenged for confirming the defects of the corrections and the additional IRC assessment for 2010, object of that gracious complaint.

i. In sum, the decision in the gracious complaint is challenged as a confirmatory act of the assessment act – by maintaining the illegality of that assessment, indeed retaking the reasoning already used in the corrections and additional assessment.

ii. Therefore, it is inevitable that that assessment, and the corrections underlying it, remain as the mediate object of the present proceedings.

iii. In any event, the Claimant invokes articles 265, 2 of the CPC and 29 of the LRAM to request alteration/expansion of the request, introducing into it a new point i): "i) Declaration of illegality of the rejection decision of the gracious complaint now challenged which confirmed the legality of the 2010 IRC assessment above better identified, by virtue of violation of law, under the terms and with the grounds above better explained."

1. As to lis pendens, that the prerequisites of article 581 of the CPC are not met, especially because in the judicial challenge what is at issue exclusively is the 2008 assessment, whereas in the present arbitral proceedings what is at issue exclusively is the 2010 assessment, there being thus two requests and two distinct grounds of action.

h) In its written submissions, the Claimant essentially retakes the argument already presented in its initial petition.

1. The Claimant insists on its disagreement regarding the application, to real estate acquired before 1 January 2008, of the regime established by Decree-Law no. 237/2008, particularly by what that implies in terms of retroactivity of the regime.

2. The Claimant further insists that the position expressed by the TCA is therefore especially detrimental to the insurance sector, by disregarding the fact that at the time of acquisition of the real estate it was not possible to depreciate those assets, that reinstatements never had relevance for tax purposes, and that only from 2008 onwards was there a transition to a depreciation regime that accounting-wise had been available to them from 2004 onwards.

3. And the Claimant again maintains that the situation derives from the inconsistency between accounting and tax regimes that occurred because of the transition to international accounting standards (IAS/IFRS).

4. As to autonomous taxation on bonuses and variable remuneration paid to managers and administrators, in its final submissions the Claimant maintains the thesis that taxation should only occur in 2011, the year in which those bonuses and variable remuneration were paid.

III.B. Position of the Respondent

a) In its response, the Respondent begins by presenting exceptions: 1) timeliness; 2) lis pendens.

b) As to timeliness, the TCA observes that the Claimant identifies as the object of its request the legality of the additional IRC assessment, and the entire request is harmonious with that object.

1. However, argues the TCA, such object affects the timeliness of the request, given that it had been far exceeded, on 20 March 2015 when it was presented, the 90-day deadline established in article 10, 1 of the LRAM – a deadline that, under the terms of article 102, 1 and 2 of the CPPT, began the day following 9 January 2013, the date of the additional assessment no. 2013....

2. In fact, emphasizes the TCA, the request is not directed at annulment of the express rejection of the gracious complaint filed by the Claimant – when it could have been, by an extensive interpretation of article 2, 1, a) of the LRAM that is peacefully accepted in doctrine and case law, regarding the possibility of challenging "in the second instance" (by express rejection of gracious complaint) the tax act.

3. The Claimant's request is unequivocally directed at direct challenge of the assessment acts.

4. With the Tribunal's powers of cognition limited by the request (the "principle of the request"), there is no way to go beyond it so as to disregard timeliness.

5. Thus, concludes the Respondent, it should be absolved of the instance, under the terms of article 278, 1, e) of the CPC, applicable by force of article 29, 1, e) of the LRAM.

c) As to lis pendens, the TCA points out the fact that in several points of the initial petition, the Claimant acknowledges that there is pending litigation in the Tax Court of Lisbon, challenging the IRC assessment for the 2008 tax year (no. .../13...BELRS), filed on 29 January 2013, which concerns the same claim in the present action.

1. Accordingly, lis pendens would occur, constituting a dilatory exception in the second of the proceedings, which is the arbitral one.

2. The Arbitral Tribunal would be prohibited from knowing the merits of the case, and the instance should follow with absolution under the terms of articles 576, 1 and 2 and 577, i) of the CPC applicable by force of article 29, 1, e) of the LRAM.

d) As regards the corrections relating to owner-occupied real estate, the TCA retakes the explanations and arguments of the Tax Inspection Report, noting that, beyond corrections favorable to the Claimant, the increase to the IRC taxable base in the amount of €1,313,110.43 results from the difference between the capital loss determined by the Claimant (€4,551,951.08) and that determined by the Tax Inspection (€3,238,840.65).

1. Taking into account the negative equity variation determined by the Tax Inspection, and taking into account the 5-year adjustment provided for by Decree-Law no. 237/2008 and subsequent legislation, it was considered that the negative variation to be considered in the 2010 tax year would be €380,495.40 (changed to €381,840.70 after exercise of the right to be heard at the end of the Tax Inspection).

2. In response to the Claimant's arguments on retroactivity, the TCA interprets article 12 of the General Tax Law (LGT) in light of the distinction of degrees of retroactivity, arguing that this is not here a first degree or authentic retroactivity, but rather an attenuated retroactivity, or third degree, without injury to taxpayer security or confidence – because this concerns, in the taxation of income, complex facts of successive formation, confronted with an extensive change in accounting regulations and their tax implications.

3. On the other hand, the TCA recalls that the fact that the Claimant began to prepare its accounts in accordance with IAS/IFRS from 2004 could not have tax relevance, given that this was only admitted from Regulatory Standard no. 4/2007-R, of 27 April and subsequent standards, and in particular from Decree-Law no. 237/2008, of 15 December – whereas until then article 14 of Decree-Law no. 35/2005, of 17 February applied, which expressly imposed maintenance, even if in parallel, of "traditional" accounting for tax purposes (in this case, the CAEC contained in Regulatory Standard no. 7/1994, of 27 April).

4. That is, the accounting procedure adopted by the Claimant from 2004 onwards only in 2008 had tax consequences.

5. On the other hand, the TCA emphasizes the fact that the Claimant itself acknowledges that the transition adjustments at issue "were not relevant for tax purposes," which in its view is equivalent to admitting that it did not apply the transition regime for adapting the rules for determining taxable profit for insurance companies, defined by Decree-Law no. 237/2008, of 15 December, and specifically its article 2, 4 which mandates the application of the tax regime of depreciation and amortization, and capital gains and losses, to owner-occupied real estate, classified as "tangible fixed assets," and no. 12 of the same article 12, which extends the regime over 5 tax years from 2008.

6. From the TCA's perspective, the Claimant's argument that it does not accept retroactive depreciation to the date of acquisition of real estate "for tax purposes" is equivalent to the statement that it seeks to consolidate an option of disregard of tax relevance that was not legitimate and could not have occurred.

7. Indeed, the accounting options that may have opened with the transition period had no correspondence in the tax realm, as there the IRC, Regulatory Decrees nos. 2/90 and 25/2009 and Decree-Law no. 237/2008 imposed a valuation criterion based on the historical cost model for purposes of applying the regime of depreciation and amortization, and capital gains and losses.

8. Reacting to this situation, the correction applied was limited to giving it the treatment necessary to prevent "lost depreciation," resorting to the concept of "minimum depreciation or amortization quotas," in the framework of article 2, 12 of Decree-Law no. 237/2007 and article 5 of Decree-Law no. 159/2009.

9. With the classification of owner-occupied real estate of insurance companies as "tangible fixed assets," they came to be considered "fixed assets," subject to the respective tax regime of depreciation and reinstatement and deductibility for tax purposes.

10. And that was the path adopted in the corrections applied, preventing that their disregard violated the principle of periodization, or specialization of exercises, of depreciation and reinstatement, and avoiding a temporal attribution of gains and losses exclusively to the year of sale of the real estate.

11. For those reasons the TCA concludes that the corrections are legal and follow the regime of article 46, 2 of the IRC.

12. The TCA further insists that the absence of a specific transition regime necessarily means that the tax treatment granted to capital gains and losses is what results from the general regime in effect at the time of the occurrence of the facts, without exceptions, the Claimant not being able to claim differentiated treatment from that applied to all companies in the sector.

e) As regards the corrections relating to autonomous taxation on bonuses and variable remuneration paid to managers and administrators, the TCA argues that there was no violation of article 88, 13, b) of the IRC, because it completely disagrees with the idea, conveyed by the Claimant, that the fact on which autonomous taxation is based would be actual payment, and not its accounting recognition or the determination of relevant profit (or tax loss).

1. Indeed, autonomous taxation is part of the factuality of which the taxable reality of a given tax year is composed, and cannot be extracted from it, merely because it is considered separately in a calculation that applies to the value recorded as an expense of the companies.

2. In truth, argues the TCA, it is not the remuneration paid that is object of taxation, but the expense or charge that was recorded, and revealed fiscally, in the very tax year – as results from the reading of article 88, 13, b) of the IRC (in which the expression "paid" appears only to identify the beneficiaries).

3. It is not, therefore, a matter of taxing consumption, expenses, or cash movements – but only the expense or charge that, by the will of the taxpayer itself, is transformed into a taxable event.

4. Moreover, an expense or charge that is taxed regardless of its payment and receipt – because already before that it is relevant for determining the taxable profit of the companies (as can be seen in parallel provisions in articles 18, 1, 23 and 88 of the IRC). The legal framework resulted, and results, only in the obligation to make the amounts available to the beneficiaries by the end of the following taxation period (under penalty of reversal of the expense), which reinforces this understanding.

5. Nothing thus prevents autonomous taxation from fitting fully within the regime of specialization of exercises, periodization of taxable profit, integrating itself in the exercise in which they were recorded.

6. In the TCA's view, the relevant taxable event therefore occurred in 2010 and is in that year that it should be considered – as was the case by effect of the corrections now challenged.

7. Furthermore, there was an obligation on the Claimant to recognize accounting-wise that expense still in 2010, and that was done, assuming tax relevance insofar as it contributed to determining taxable profit for 2010: which would be inconsistent if autonomous taxation should only occur in 2011.

f) In its counter-submissions, the Respondent maintains the essential of the arguments already developed in its response.

1. By way of novelty, there is only the argument that, should the exception of lis pendens not proceed, then the instance should be suspended until final judgment of the judicial challenge action, under the terms of article 272, 1 of the CPC, given the prejudicial nature of what will be decided in that judicial challenge with respect to what is at issue in the present proceedings (particularly what concerns transition adjustments).

2. In everything else, the TCA maintains that the additional assessment, the underlying corrections (and therefore the rejection of the gracious complaint) do not suffer from the defects that the Claimant attributes to them.

III.C. Questions to be Decided

III.C.1 Exceptions

III.C.1.A Timeliness

The TCA is not correct. On one hand, the rejection of the gracious complaint is a confirmatory act of the assessment, whereby the only way to challenge it is to attack the act that confirms it, there being nothing autonomous in the very decision of the complaint that could be the distinct object of a challenge. On the other hand, it appears reasonable the expansion of the request that the Claimant makes in its response of 14 September, because in a certain sense it is merely the clarification of what was, not properly implicit, but perhaps inadequately emphasized in the initial petition – and thus that deficiency is remedied.

The exception thus does not prevail.

III.C.1.B Lis Pendens (or alternatively, Prejudicial Nature)

The TCA is not correct. The request and ground of action of the judicial challenge and of the present arbitral proceedings are quite distinct – the 2008 assessment is not the 2010 assessment.

Perhaps perceiving this, the TCA comes, in the counter-submissions, to request suspension of the instance until final judgment of the judicial challenge action, on the ground that there will be prejudicial nature of the decision of that judicial challenge with respect to what is at issue in the present proceedings. But in truth, beyond the differences in requests and grounds of action, it does not appear that the decision of the judicial challenge is indispensable for the arbitral tribunal to know of the merits of the present case and to be able to decide – all the more because it may reach that decision before that reached in the judicial challenge.

The exception thus equally does not prevail.

III.C.2 On the Merits

III.C.2.A Regime of Owner-Occupied Real Estate

a) As to the difference of perspectives regarding the corrections relating to owner-occupied real estate made by the TCA, the difference results from the Claimant understanding that for owner-occupied real estate acquired before the new tax regime came into effect (2008) the new tax rules do not apply, with the TCA understanding the contrary.

b) The principal legislation at the basis of those tax alterations is Decree-Law no. 237/2008, which makes reference in particular to Regulatory Standard no. 4/2007-R, of 27 April, which altered the accounting regime of insurance companies. In fact, in the preamble to Decree-Law no. 237/2008 one can read:

"The accounting regime applicable to insurance companies subject to the supervision of the Portuguese Institute of Insurance was recently subject to significant alterations, by force of Regulatory Standard no. 4/2007-R, of 27 April, amended by Regulatory Standard no. 20/2007-R, of 31 December, which approved the new Chart of Accounts for Insurance Companies (CAEC), which came into mandatory effect from the 2008 tax year. The new CAEC adopts International Accounting Standards (IAS), with the exception of International Financial Reporting Standard (IFRS) 4, with respect to which, by virtue of its transitional character, only the principles of classification of the type of contracts entered into by insurance companies are adopted, with the rules and principles established in legislation and prudential regulation continuing to apply to the recognition and measurement of liabilities resulting from insurance contracts. In this context, similarly to what already occurs with respect to entities subject to the supervision of the Bank of Portugal obliged to apply Adjusted Accounting Standards (AAS), a transition regime is established for adaptation of the rules for determining taxable profit, provided for in the Corporate Income Tax Code (IRC) and complementary legislation, to the new accounting regulation applicable to the insurance sector."

Article 1 of this decree-law (transcribed below) expressly states that the transition regime to adapt the rules for determining taxable profit applies to all entities obliged to apply the Chart of Accounts for Insurance Companies approved by the Portuguese Institute of Insurance. Now the Claimant was covered by this legal provision and, consequently, the tax effects resulting from it in IRC apply to it.

"Article 1
Subject Matter

1 – This decree-law establishes a transition regime for adaptation of the rules for determining taxable profit, provided for in the Corporate Income Tax Code, abbreviated as IRC Code, and complementary legislation, to the new accounting regulation applicable to the insurance sector.

2 – The regime provided for in this decree-law applies to all entities that are obliged to apply the Chart of Accounts for Insurance Companies, approved by the Portuguese Institute of Insurance."

In turn, in no. 12 of article 2 of the aforementioned decree-law that transition regime is established:

"12 – The effects on equity resulting from the first-time adoption of the Chart of Accounts for Insurance Companies approved by Regulatory Standard no. 4/2007-R, of 27 April, in its current wording, which are considered fiscally relevant under the terms of the IRC Code with the adaptations provided for in this regime, resulting from the recognition or non-recognition of assets or liabilities, or from changes in their respective measurement, contribute, in equal parts, to the formation of taxable profit corresponding to the tax year beginning in 2008 and to the four subsequent tax years" (our emphasis).

d) Of the emphasized parts we must particularly note the word "contribute." In our opinion its meaning is unequivocal: the companies covered by this norm must consider, in recognizing an asset (in this case, a tangible fixed asset as regards owner-occupied real estate as they came to be classified for accounting purposes), the tax impact of that change during a period of five years, beginning in 2008. It is not an option, but rather an obligation.

Consequently, and given that no transition regime was established for real estate acquired prior to 1 January 2008 (the date from which that decree-law produced effects, as is clear from its own wording), the tax effects in IRC with respect to their holding or sale will be strictly equal to those of other tangible fixed assets.

e) The Claimant states that companies in the sector would be strongly penalized by the adoption of the new accounting rules with tax effects, defending their non-application because of that impact of its retroactive effects for owner-occupied real estate acquired before 2008.

Through the construction of an example, we will attempt to show that this measure, although not fiscally neutral because of the opportunity cost of money over time (which includes the variation in price levels), is not so prejudicial to companies obliged to change the tax regime of owner-occupied real estate, being more prejudicial the greater the intensity of monetary correction.

• Suppose that owner-occupied real estate had been acquired by an insurance company in 2000 for €500,000 (construction value only) and had been sold in 2010 for €300,000.

• Under the previous tax regime for owner-occupied real estate of insurance companies, a capital loss (300,000 – 500,000 x 1.27) = -335,000 would have been determined, in euros, by the use of the monetary devaluation coefficient contained in Ordinance no. 785/2010.

• In accordance with the tax regime that came to apply from 2008 and assuming an annual reinstatement rate of 2%, we would have the following effects:

• 1st Determination of a negative equity variation (tax) of 2% x 500,000 x 1, that is, -€90,000, to be divided over 5 years (-€18,000 each) from 2008, inclusive.

• 2nd Determination of a capital loss for tax purposes in 2010 of:

300,000 – (500,000 – 2% x 500,000 x 10) x 1.27 = -€208,000

• 3rd If we compare in absolute values the two situations, the new tax regime would allow a total deduction of €298,000 (€90,000 + €208,000) and the previous tax regime a total deduction of €335,000.

• 4th If there had been no inflation in the period in question, the two tax regimes would have enabled a total deduction very close, with the difference deriving from the inability to depreciate the tangible fixed asset in the year of its sale.

Under the previous regime, the capital loss for tax purposes would have arisen in 2010 at the value of -€200,000 (300,000 – 500,000 x 1).

Under the regime currently in effect, there would be obtained the aforementioned negative equity variation of -€90,000 (between 2008 and 2012) and a capital loss for tax purposes in 2010 of €(300,000 – (500,000 – 500,000 x 0.02 x 10) x 1), that is, -€100,000. The total deduction would be -€190,000.

The difference of €10,000 would correspond to the value of annual depreciation (2% x 500,000), in this case that relating to 2010. It should be noted also in this regard that the difference could be only 1/12 of that amount if the company accounted for depreciation on a monthly basis.

f) Precisely to not be prejudiced relative to the previous tax regime of real estate held by insurance companies for own use, the Claimant not only did not consider, in 2010, one-fifth of the negative equity variation for tax purposes that applied under the transition regime contained in Decree-Law no. 237/2008, of 15 December, but also disregarded the very depreciation of 2010 of this type of tangible fixed asset. One of the arguments was that Regulatory Decree 25/2009 states in no. 1 of its article 1 that "Elements of the asset subject to depreciation... may be subject to depreciation or amortization."

We consider that this article should be read in conjunction with other provisions of the IRC and of Regulatory Decree 25/2009, of 14 September, to have a complete perception of this question. The reading of the first part of article 29 of the IRC, which is transcribed, is imperative:

Article 29
Depreciable or Amortizable Elements

1 – Depreciation and amortization of elements of the asset subject to depreciation are accepted as expenses, considering as such:

a) Tangible fixed assets and intangible assets;

…

Consideration should also be given to no. 3 of article 1 of Regulatory Decree 25/2009, of 14 September, which is presented below:

3 – Depreciation and amortization are only accepted for tax purposes if recorded as expenses in the same taxation period or in previous taxation periods.

From the joint reading of these provisions it results that, on one hand, the word "may" mentioned above is used by way of contrast with cases in which they may not (those which, a contrario, do not suffer loss of value through their use or passage of time). It is not, therefore, an option (may, if taxpayers so wish); it is instead a distinction between those that will be fiscally accepted and those that will not be. And, once recorded, those that will be accepted for tax purposes (unless a contrary provision of the IRC – see article 34 – or of Regulatory Decree 25/2009, of 14 September, does not permit it), in accordance with no. 3 of this regulatory decree.

g) The corrections made by the TCA are therefore correct as to the taxation of owner-occupied real estate, and this, in sum, by the conjunction of the following factors:

1. The Claimant was obliged to consider the negative equity variation caused by the change in classification (and measurement) of owner-occupied real estate over 5 years, beginning in 2008, and it did not.

2. From the moment that it began to include owner-occupied real estate as tangible fixed assets and recorded them as such, the depreciation of each period, namely that of 2010, came to be accepted for tax purposes and provided that they did not exceed legal limits, being lost if recorded below the minimum rate (defined for IRC purposes as half of the maximum). The disregard for tax purposes of depreciation fiscally accepted under the applicable legislation, as the Claimant practiced it, does not appear legitimate in light of the applicable regime on reinstatement and amortization.

3. It is true that the Claimant, as with other companies in its line of business, suffered losses in determining the capital loss for tax purposes in 2010 of owner-occupied real estate, due to monetary devaluation between the date of acquisition of the sold real estate and the date of its sale (2010). However, tax law did not address this question – it being necessary to acknowledge that faced with a change in criterion it is not always possible to avoid all collateral damage.

4. Concluding on this question: all corrections that the TCA made with respect to 2010 have backing in the tax regime applicable at the time.

III.C.2.B Autonomous Taxation on Bonuses and Variable Remuneration

a) As is concluded in analyzing the positions of the Claimant and the TCA, the fundamental divergence concerns the moment of emergence of autonomous taxation on bonuses and variable remuneration relating to managers and administrators. At a second level, the Claimant questions the very value of the base that was considered by the TCA for application of the autonomous taxation rate.

b) As to the fundamental divergence, we will develop our position on this particular autonomous taxation, starting with its framing in IRC taxation.

c) In IRC, there is a portion that is calculated on the basis of taxable income, as defined in article 15 of the IRC, but for which the calculation of taxable profit or loss for tax purposes must be made (being null if a loss for tax purposes is determined). Another wholly distinct portion is that corresponding to autonomous taxation, on which there was even, in a relatively recent past, much doctrinal divergence on its own consideration as an integral part of IRC (which is now clarified in light of the most recent wording of the IRC).

d) The path that the tax legislator considered most appropriate for calculating taxable profit (a reductive expression since it can be determined, for tax purposes, both as profit and as loss) was to take accounting elements as the starting point for calculating the taxable base in IRC, as, being those mandatory by law, it thus disposes of an objective basis for the effect. Thus, except for provisions to the contrary contained in the IRC or, possibly, in other tax legislation on such matters, accounting criteria are considered good provided they respect the accounting standards they must follow. In the sequence of the principle of economic periodization (also designated as the accrual principle), article 18 of the IRC expressly provides that "income and expenses, as well as other positive or negative components of taxable profit, are attributable to the taxation period in which they are obtained or incurred, regardless of their receipt or payment, in accordance with the regime of economic periodization."

e) Let us take these concepts in the case of expenses or payments, as these will be the terms that may be related to the autonomous taxation under analysis, to which we will still add another concept, that of expenses, which appears in article 88 of the IRC in some of its paragraphs.

An example is that of a tangible fixed asset. When a transaction occurs (purchase of the good), an expense occurs (financial flow, based on the transaction, in which the legal element is relevant), that tangible fixed asset then being recorded in the Assets of the legal entity. By turn, payment (cash or treasury flow) may or may not occur, in whole or in part, simultaneously with the expense (financial flow). The expense (economic flow) is what does not occur at those moments: it will be recognized accounting-wise as the good suffers wear through its use over its useful life, with the accounting mechanism used for the effect being depreciation.

f) In sum: in determining the taxable base for IRC purposes (strictly speaking, of taxpayers that exercise principally an activity of a commercial, industrial, or agricultural nature and that have therein headquarters or effective management, or, for non-residents, that have a permanent establishment in Portugal), what count are income (which include gains) and expenses (which include losses) and not receipts or payments. And expenses? Those do not count except as expenses.

For example, the purchase of merchandise is an expense that, as such, is not relevant for determining the result of the period, its expense occurring at the moment it is sold. Now an expense of representation is simultaneously an expense and an expense, although for purposes of determining taxable profit it counts only as an expense.

g) As to autonomous taxation, whose genesis can be found in Australia and New Zealand, where it arose as a tax autonomous to that of taxation of the income of legal entities, in Portugal the tax legislator opted for its inclusion in IRC. Autonomous taxation in IRC can be classified into two types with respect to the impact of their base on the very determination of taxable profit: those relating to undocumented expenses and "expenses corresponding to amounts paid or owed, for any reason, to natural or legal persons resident outside Portuguese territory and submitted thereto to a clearly more favorable tax regime, as defined under the Code, unless the taxpayer can prove that they correspond to effectively carried out operations and do not have an abnormal character or an exaggerated amount" (cf. no. 8 of art. 88 of the IRC, the emphasis being ours), cases in which not only does autonomous taxation exist but the expenses are also not deductible as expenses; already the other situations of subjection to autonomous taxation do not suffer a double incidence as they are deductible for purposes of determining taxable profit.

h) And what will be the logic of autonomous taxation given that we are truly taxing expenses/expenses/payments and not a result? Certainly to tax situations that have escaped another seat of taxation.

For example, that purpose is very evident if autonomous taxation is applied to charges incurred with light passenger cars when there was no subjection to PIT, only because there was no written agreement in the person about the user of that vehicle.

i) Before we analyze the autonomous taxation of bonuses or other variable remuneration, we note that in the various points of article 88 of the IRC the expressions used vary: expenses (for example, in no. 1 regarding undocumented expenses), charges made or incurred (in no. 2, concerning, for example, light passenger cars), deductible charges (no. 9, concerning, for example, subsistence allowances), expenses corresponding to amounts paid or owed (no. 8, referred to above), expenses or charges relating to bonuses and other variable remuneration paid (paragraph b) of no. 13, precisely that of autonomous taxation at issue in this Process) and profits distributed by entities subject to IRC to taxpayers who benefit from total or partial exemption (no. 11).

j) A note also on the wording of autonomous taxation introduced with a limited temporal validity to the financial sector in the same year it was introduced in no. 13 of article 88: article 90 of Law no. 3-B/2010, of 28 April, which established that

"Expenses or charges relating to bonuses and other variable remuneration, paid or determined in 2010 by credit institutions and financial companies, to administrators or managers, when these represent a portion exceeding 25% of annual remuneration and have a value exceeding (euro) 27,500 are subject to autonomous taxation in IRC at the unique rate of 50%" (our emphasis).

k) Part of no. 13 of article 88 of the IRC is now transcribed, as it came to appear precisely from 1 January 2010:

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

a) …

b) Expenses or charges relating to bonuses and other variable remuneration paid to managers, administrators or managers when these represent a portion exceeding 25% of annual remuneration and have a value exceeding (euro) 27,500, except if their payment is subject to the deferral of a portion not less than 50% for a minimum period of three years and conditional on the positive performance of the company over that period." (our emphasis).

l) The disagreement on the temporal application of this autonomous taxation between the Claimant and the TCA resides precisely in the reading they make of this norm: whereas the Claimant bases its argument that the autonomous taxation is owed in the year of payment of the bonuses and other variable remuneration on the expression "paid," the TCA bases its position that the autonomous taxation should arise in the period in which the charges were recorded, that is, on the expression "expenses or charges," making the connection with determining the taxable profit for that same year.

m) We conducted an exercise of drafting wording that would unequivocally meet the position adopted by the TCA in this dispute:

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

a) …

b) Expenses or charges relating to bonuses and other variable remuneration paid or determined to managers, administrators or managers when these represent a portion exceeding 25% of annual remuneration and have a value exceeding (euro) 27,500, except if a portion of payment not less than 50% is deferred for a minimum period of three years and is conditional on the positive performance of the company over that period."

In this case, it would become unquestionable that, despite doing the "matching" between income and expenses for purposes of calculating taxable profit (those personnel charges concerned the work performed by those members of the corporate bodies in that year and, consequently, were associated with the generation of income for that year), a lack of full temporal coincidence between autonomous taxation and the portion of IRC relating to the application of the rate to taxable income was admitted if a significant portion of payment (at least 50%) could occur at a moment along a period relatively distant from the moment of generation of the charge associated with that payment.

This wording would adopt the reasoning underlying two of the situations already reported: that of exceptional autonomous taxation with limited temporal validity to the financial sector through article 90 of Law no. 3-B/2010, of 28 April (interestingly the same legal instrument that introduced no. 13 of article 88 of the IRC) and the provision contained in no. 8 of article 88 of the IRC itself regarding certain expenses with residents in "tax havens," where the expression "paid or owed" appears.

n) We conducted the inverse exercise of drafting wording that would unequivocally support the Claimant's position:

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

a) …

b) Expenses or charges relating to bonuses and other variable remuneration when paid, typically in the very year or the following year, to managers, administrators or managers when these represent a portion exceeding 25% of annual remuneration and have a value exceeding (euro) 27,500, except if their payment is subject to the deferral of a portion not less than 50% for a minimum period of three years and conditional on the positive performance of the company over that period."

o) The Claimant is correct on this point, in sum, and for the following reasons:

1. The current wording of paragraph b) of article 13 is not clear as to the connection between expenses and payment in the temporal aspect. It may possibly suffer from an assumption that will not always be verified, which is that of temporal coincidence (and in the year of recording personnel charges) between the emergence of the expense and its payment. However, at that same time an autonomous taxation similar to this arose (applicable to the same reality but to the financial sector and on an extraordinary basis) in which the legislator was clear in stating that taxation occurred based on the recording of the expense, whether or not there was payment.

2. Now if the legislator wanted to ensure the same effect for the autonomous taxation here in question, it could have drafted identical wording, which it did not.

3. The type of argument used by the Respondent thus does not hold, that it must coexist in time the charge related to autonomous taxation and the autonomous taxation itself; moreover, the second part of no. 13 of article 88 of the IRC provides precisely the contrary.

4. Nor is the argument of the Respondent understood that the expression "paid" appears only to "identify the beneficiaries." If one removed the expression "paid" and placed only "Expenses or charges relating to bonuses and other variable remuneration of managers, administrators or managers" would not the beneficiaries be identified in the same way? One presumes that the legislator used the most appropriate expressions, whereby, if the expression "paid" was placed there (and not another, such as "paid or determined/owed"), it is because it wanted to make payment the relevant element in these situations.

p) The matter relating to the base value to be considered for purposes of this autonomous taxation is thus affected.

IV. INDEMNIFYING INTEREST

The Claimant requests the reimbursement of the amount of €211,109.43, paid on 5-3-2013 relating to the act of additional IRC assessment no. 2013... and respective statement of account adjustment, plus indemnifying interest, at the legal rate, under the terms of article 43 of the LGT and 61 of the CPPT.

In accordance with the provision of paragraph b) of article 24 of the LRAM, the arbitral decision on the merits of the claim for which no appeal or challenge is available binds the tax administration from the expiration of the deadline provided for appeal or challenge, with this, in the exact terms of the procedural nature of the arbitral decision in favor of the taxpayer and until the expiration of the deadline provided for voluntary execution of judgments of tax courts, to "reestablish the situation that would have existed if the tax act object of the arbitral decision had not been performed, adopting the acts and operations necessary for the effect," which is in harmony with that provided for in article 100 of the LGT [applicable by force of the provision in paragraph a) of no. 1 of article 29 of the LRAM] which establishes that "the tax administration is obliged, in case of total or partial success of complaint, judicial challenge or appeal in favor of the taxpayer, to the immediate and full reconstitution of the legality of the act or situation object of the dispute, including the payment of indemnifying interest, if applicable, from the expiration of the deadline for execution of the decision."

Although article 2, no. 1, paragraphs a) and b), of the LRAM uses the expression "declaration of illegality" to define the competence of the arbitral tribunals operating in CAAD, making no reference to condemnatory decisions, it should be understood that its competencies comprehend the powers that in judicial challenge proceedings are attributed to tax courts, this being the interpretation that aligns with the sense of the legislative authorization on which the Government based itself to approve the LRAM, in which it proclaims, as a first guideline, that "the tax arbitration proceeding should constitute an alternative procedural means to the judicial challenge proceeding and to the action for recognition of a right or legitimate interest in tax matters."

The judicial challenge proceeding, although essentially a proceeding for annulment of tax acts, admits the condemnation of the Tax Administration in the payment of indemnifying interest, as can be inferred from article 43, no. 1, of the LGT, in which it is established that "indemnifying interest is owed when it is determined, in gracious complaint or judicial challenge, that there was error attributable to the services from which results payment of the tax debt in an amount greater than that legally owed" and from article 61, no. 4 of the CPPT (in the wording given by Law no. 55-A/2010, of 31 December, to which corresponds no. 2 in the original wording), which "if the decision that recognized the right to indemnifying interest is judicial, the deadline for payment is counted from the beginning of the deadline for its voluntary execution."

Thus, no. 5 of article 24 of the LRAM, in stating that "payment of interest is owed, regardless of its nature, under the terms provided for in the general tax law and in the Tax Procedure and Process Code" should be understood as permitting recognition of the right to indemnifying interest in the arbitration proceeding.

In the case at hand, it is manifest that, following the illegality of the assessment act, there is ground for reimbursement of the tax, by force of the aforementioned articles 24, no. 1, paragraph b), of the LRAM and 100 of the LGT, as this is essential to "reestablish the situation that would have existed if the tax act object of the arbitral decision had not been performed."

As regards indemnifying interest, it is also clear that the illegality of the act is attributable to the Tax and Customs Administration, which, on its own initiative, performed without legal support.

One is faced with a defect of violation of substantive law, embodied in error in the legal premises, attributable to the Tax Administration.

Consequently, the Claimant is entitled to the requested indemnifying interest, under the terms of article 43, no. 1, of the LGT and article 61 of the CPPT, calculated on the amount unduly paid (€211,109.43).

Thus, the Tax and Customs Authority should execute the present award, under the terms of article 24, no. 1, of the LRAM, determining the amount to be reimbursed to the Claimant and calculating the respective indemnifying interest, at the legal subsidiary rate on civil debts, under the terms of articles 35, no. 10, and 43, nos. 1 and 5, of the LGT, 61 of the CPPT, 559 of the Civil Code and Ordinance no. 291/2003, of 8 April (or legislation that replaces it).

Indemnifying interest is owed from the date of payment (5-3-2013) until that of processing of the credit note, in which they are included (article 61, no. 5, of the CPPT).

IV. DECISION

In view of all the foregoing, this Collective Arbitral Tribunal decides:

– to uphold the requests for declaration of the illegality of the additional IRC assessment no. 2013... and respective statement of account adjustment no. 2013...;

– to annul the aforementioned assessment and statement of account adjustment;

– to uphold the request for reimbursement of the amount paid corresponding to the aforementioned assessments (€211,109.43) and to condemn the Tax and Customs Authority to reimburse it to the Claimant;

– to uphold the request for payment of indemnifying interest and to condemn the Tax and Customs Authority to pay it to the Claimant, calculated on the amount to be reimbursed, from the date of payment (5-3-2013), until that of processing of the credit note, in which they are to be included (article 61, no. 5, of the CPPT), at the legal rates in effect until payment, under the terms of article 559 of the Civil Code and Ordinance no. 291/2003, of 8 April (or legislation that replaces it).

– to condemn the Tax and Customs Authority to pay the costs of the present proceeding.

VALUE OF THE PROCEEDING

In accordance with the provision in article 306, no. 2, of the CPC and 97-A, no. 1, paragraph a), of the CPPT and 3, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of the proceeding is set at €211,109.43.

COSTS

Under the terms of article 22, no. 4, of the LRAM, the amount of costs is set at €4,284.00, under the terms of Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, charged to the Respondent Tax and Customs Authority.

Lisbon, 22-12-2015

The Collective Arbitral Tribunal

José Poças Falcão
(President)

Fernando Araújo

Luís Janeiro