Process: 205/2017-T

Date: October 10, 2017

Tax Type: IRS

Source: Original CAAD Decision

Summary

CAAD Process 205/2017-T addresses the application of the tax neutrality regime to a share exchange operation under Portuguese IRS law. The taxpayer exchanged a 60% quota in C... SGPS (nominal value €3,750) for shares in B..., which increased its capital by €1,339,895 based on a certified accountant's valuation. The Tax Authority denied tax neutrality under Article 73(10) of the IRC Code (via Article 10(11)(a) CIRS), arguing the taxpayer failed to prove two critical requirements: (1) continuation of tax valuation of new participations at the value of old ones, and (2) valid economic reasons beyond tax deferral. The Authority emphasized that while the old quota had a nominal value of €3,750, the capital increase used the appraised value of €1,339,895, evidencing that the taxpayer's participation jumped from €1,000 to €1,340,895—incompatible with maintaining historical tax values. The taxpayer contended the operation had legitimate business purposes and that the Tax Authority failed to substantiate its anti-abuse allegations with concrete evidence. The case highlights the burden of proof requirements for corporate restructuring operations claiming tax neutrality, particularly the need to demonstrate that tax deferral is not the principal objective and that participations are valued consistently for tax purposes at historical cost rather than fair market value.

Full Decision

ARBITRAL AWARD

The arbitrators José Baeta de Queiroz (arbitrator-president), Manuel Pires and Paulo Nogueira da Costa (arbitrators members), designated by the Deontological Council of the Administrative Arbitration Center, agree as follows:

I – REPORT

A... (hereinafter "Claimant"), holder of Tax Identification Number No...., divorced, resident at Street ..., ..., No. .... ...-.... ..., came, pursuant to articles 2, No. 1, paragraph a), and 10 of the so-called Legal Framework for Tax Arbitration (RJAT), which is part of Decree-Law No. 10/2011, of January 20, to the constitution of a collective arbitral tribunal and to submit a request for arbitral award, with a view to the annulment of the decision of partial rejection of the administrative complaint presented against the assessment of Personal Income Tax (IRS) No. 2016..., referring to the period of 2015, as well as the respective assessment of compensatory interest No. 2016..., and the subsequent assessment No. 2017..., in the amount of € 192,943.48.

The AUTHORITY FOR TAX AND CUSTOMS (hereinafter referred to only as "Respondent") is the respondent.

The request for constitution of the arbitral tribunal was accepted by His Excellency the President of CAAD and automatically notified to the Respondent on 31-03-2017.

Pursuant to the provisions of paragraph a) of No. 2 of article 6 and paragraph b) of No. 1 of article 11 of Decree-Law No. 10/2011, of January 20, as amended by article 228 of Law No. 66-B/2012, of December 31, the Deontological Council of CAAD appointed as arbitrators of the collective arbitral tribunal those identified above, who communicated acceptance of the assignment within the applicable period.

On 18-05-2017, the Parties were duly notified of this appointment, and did not express the will to refuse the appointment of the arbitrators, pursuant to the provisions of article 11, No. 1, paragraphs a) and b) of the RJAT, combined with articles 6 and 7 of the Deontological Code.

In accordance with the provisions of paragraph c), of No. 1, of article 11 of the RJAT, the Arbitral Tribunal was constituted on 02-06-2017.

The Claimant alleges, in summary, the following:

There is no basis whatsoever for applying the specific anti-abuse clause, provided for in No. 10 of article 73 of the Corporate Income Tax Code, by virtue of paragraph a) of No. 11 of article 10 of the Personal Income Tax Code;

The TA did not manage to demonstrate that the operation of exchange of social shares was not motivated by valid economic reasons;

The operation of exchange of social shares did not have as its main or principal objectives tax evasion;

The TA restricts itself to making abstract considerations in the justification regarding the economic effects of the operation;

Therefore, it is appropriate to promote the annulment of the act of partial rejection of the administrative complaint, as well as the IRS assessments underlying it, with all legal consequences.

The Respondent presented a reply, in which it defends itself by objection, alleging, in the sense of the non-merits of the request for arbitral award, in summary, the following:

The regime of fiscal neutrality in the context of corporate restructuring operations under the CIRC seeks only not to levy taxation on capital gains that more resemble potential capital gains, not containing, however, an exemption from capital gains, only a deferral of their taxation to the moment of their effective realization;

The application of the (special) regime of fiscal neutrality depends on the parties continuing to value the new participations, for tax purposes, at the value of the old ones;

The Claimant alleges that he continued to value, for tax purposes, the new social share (of B...), at the value of the old social participation (in C...), but does not present any evidence that allows proving the alleged;

The capital of B... was increased by the value of the quota of C..., as it was evaluated by the Certified Public Accountant, according to the report attached at pages 16 et seq. - at € 1,339,895 and not at € 3,750 which was its nominal value - whereby the Claimant went from holding a single quota worth € 1,000 to holding a single quota worth € 1,340,895.00;

It is not foreseen, therefore, how it could have been considered that the parties (in the present case, only one: the Claimant, holder of both participations) continued to value the new participations, for tax purposes, at the value of the old ones;

What the documents in the Administrative Proceedings prove is that such value of the old participation in C... disappeared, giving rise to a new participation in B... in the value of € 1,339,895, which, added to the previously held by the Claimant, of € 1,000, results in a new single quota worth € 1,340,895.00;

The proof of the requirements (in the first place, as already addressed, the continuation of the valuation of the new participations at the value of the old ones, but also the valid economic reasons) falls to the Claimant, who did not manage to make it in the procedure, nor does he manage to make it still;

Contrary to what the Claimant alleges, the Administration did not fail to point out grounds for the lack of the requirement "valid economic reasons," stating categorically that such factual elements were not demonstrated, in light of the elements made available by the Claimant;

In the case sub judice, the fiscal advantage of the deferral of taxation is the only economic reason indisputably verified;

Therefore, the decision should be upheld regarding the exclusion of the situation sub judice from the special regime of fiscal neutrality, due to lack of proof of the requirements legally stipulated for the granting of the benefit of the deferral of taxation.

The Parties presented final written pleadings, in which they reiterate, in essence, the arguments set forth in the initial request and in the reply.

II – DECISION ON PRELIMINARY MATTERS

The tribunal is competent and is regularly constituted.

The Parties enjoy legal standing and capacity, are legitimate as to the request for arbitral award and are duly represented, pursuant to the provisions of articles 4 and 10 of the RJAT and article 1 of Ordinance No. 112-A/2011, of March 22.

No exceptions were raised and no defects are verified, therefore it is necessary to decide on the merits.

III. MERITS

III. 1. FACTUAL MATTER

§1. Proven Facts

The Tribunal considers the following facts proven:

C... SGPS, Lda. (hereinafter C...), is a commercial company, registered under collective person number ..., which is engaged in the management of social participations of other companies as an indirect form of the exercise of economic activities;

The capital of C... corresponded, in 2015, to the nominal value of € 6,250.00, with the Claimant holding a quota at the nominal value of € 3,750.00, representing 60% of the respective capital;

On 29-09-2015, the Claimant incorporated the commercial company B..., collective person No....;

As the corporate purpose, B... pursues the provision of consulting services for business and management, provision of scientific consulting services in the health area, the research and development of services, products and technologies in the health area, as well as training services, teaching, conferences and seminars in said area;

The capital of B..., as of the date of its incorporation, corresponded to the nominal value of € 1,000.00, being held entirely by the Claimant;

By deed of 30-10-2015, the capital of said company B... was increased, in the amount of € 1,339,895.00, through the contribution of the quota that the claimant herein held in company C..., at the nominal value of € 3,750.00;

The capital of B... thus went from € 1,000 to € 1,340,895.00;

The valuation of said quota of C..., at € 1,339,895.00, was carried out by a Certified Public Accountant, based on the equity of C... as of the date of the exchange, in accordance with the report drawn up in accordance with the provisions of article 28 of the Commercial Companies Code;

The Claimant submitted on 26-05-2016 a model 3 declaration of IRS for the year 2015, without annex G, from which resulted a tax value payable of € 5,948.68;

When a divergence was noted, the Claimant submitted the replacement declaration No. ...-2015-...-...;

The TA notified the Claimant of the IRS assessment No. 2016..., in the amount of € 384,491.73, of the assessment of the respective compensatory interest No. 2016..., in the amount of € 4,589.45, as well as the Account Settlement Statement No. 2016..., from which resulted the amount payable of € 378,507.05, all relating to the year 2015;

The Claimant submitted an administrative complaint, processed under No. ...2016..., through which he requested, as the main relief, the annulment of said IRS assessment and the respective compensatory interest;

The decision on the administrative complaint was notified to the Claimant through an official letter dated 20-12-2016, registered on 21-12-2016 under No. RD...PT;

The TA rejected the main request of the Claimant, through which he requested the annulment of the totality of the IRS assessment and the respective compensatory interest;

The TA granted the subsidiary request filed, recognizing that C... meets the material requirements to be considered a micro-enterprise, pursuant to Decree-Law No. 372/2007, of November 6;

In execution of the partial grant, the TA issued the assessment No. 2017..., in the amount of € 192,943.48;

§2. Facts Not Proven

The Claimant failed to prove, through objective elements, that the new participations (in B...) continued to be valued, for tax purposes, at the value of the old ones (in C...).

§3. Reasoning on Factual Matter

Regarding the factual matter proven and not proven, the Tribunal's conviction was based on the free assessment of the positions assumed by the Parties in relation to facts, in the Administrative Proceedings and the content of the documents attached to the case, not disputed by the Parties.

III.2. LEGAL MATTER

§1. Issue to be Decided

The central issue to be decided in this proceeding is whether to the situation sub judice the special regime of fiscal neutrality, provided for in articles 73 and following of the Code of Income Tax on Legal Entities (CIRC), by virtue of article 10, No. 8 and following of the Code of Personal Income Tax (CIRS) could be applicable.

§2. Assessment of the Issue to be Decided

Articles 73 and following of the CIRC contain the legal rules of the so-called special regime of mergers, spin-offs, contributions of assets and exchanges of social shares.

Regarding the special regime applicable to exchanges of social shares, article 77, No. 1 of the CIRC specifically provides as follows:

"The attribution, as a result of an exchange of social shares, such as this operation is defined in article 73, of the securities representing the capital of the acquiring company, to the shareholders of the acquired company, does not give rise to any taxation of the latter if the same continue to value, for tax purposes, the new social shares at the value assigned to the old ones, determined in accordance with what is established in this Code".

Article 77, No. 2 of the CIRC, for its part, provides as follows:

"The provisions of the preceding number are only applicable provided that the following conditions are cumulatively verified:

a) The acquiring company and the acquired company are resident in Portuguese territory or in another Member State of the European Union and fulfill the conditions established in Directive No. 90/434/CEE, of July 23;

b) The shareholders of the acquired company are persons or entities resident in the Member States of the European Union or in third States, when the securities received are representative of the capital of an entity resident in Portuguese territory."

In the case sub judice, an exchange of social shares occurred, as results from the subsumption of the operation carried out to the definition contained in No. 5 of article 73 of the CIRC, therefore it is important to determine whether it is in conditions to benefit from the special regime of fiscal neutrality, as the Claimant sustains.

For this purpose, the provision contained in No. 8 of article 10 of the CIRS is relevant, worded as follows:

"In the case where there is an exchange of social shares under the conditions mentioned in No. 5 of article 73 and No. 2 of article 77 of the Income Tax Code, the attribution, as a result of that exchange, of the securities representing the capital of the acquiring company to the shareholders of the acquired company does not give rise to any taxation of the latter if the same continue to value, for tax purposes, the new social shares at the value of the old ones, determined in accordance with what is established in this Code, without prejudice to the taxation relating to amounts in money that may eventually be attributed to them".

As has already been mentioned above, we are faced with an exchange of social shares, as defined in No. 5 of article 73 of the CIRC.

Nor are there any doubts regarding the verification of the requirements defined in No. 2 of article 77.

However, it follows from the factuality given as proven and not proven that there is not verified, in the case sub judice, the requirement that the shareholders of the acquired company (in the present case, the now Claimant) continue to value, for tax purposes, the new social shares at the value of the old ones (cf. above No. 14).

On the contrary, what was proven was that the increase of the capital of B... was made through the contribution of the quota that the Claimant held in company C..., at the nominal value of € 3,750.00, and which was valued by Certified Public Accountant in the amount of € 1,339,895.00, whereby the capital of B... went from € 1,000 to € 1,340,895.00 [cf. above No. 13, paragraphs e), f), g) and h)].

Therefore, the Claimant cannot benefit from the special regime of fiscal neutrality, by virtue of not verifying one of the legal requirements required for that purpose.

In this way, it is not relevant to know who is responsible for proving the verification of the legally fixed requirements for the application of the regime of fiscal neutrality, since the Respondent made proof of the non-verification of one of the requirements for the application of said special regime of taxation.

That is, even if it were understood that the burden of proof fell to the Respondent, the truth is that such proof was made.

It also lacks relevance to the decision on the merits of the case to know what the motivations underlying the operation of exchange of social shares were.

IV – DECISION

In these terms, and with the grounds set forth, this Arbitral Tribunal decides to judge unfounded the request for arbitral award and to absolve the Respondent of the claims.

V - VALUE OF THE PROCEEDING

In accordance with the provisions of article 306, No. 2, of the Civil Procedure Code and 97-A, No. 1, paragraph a), of the Code of Procedure and Tax Process (CPPT) and 3, No. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of € 192,943.48 is fixed for the proceeding.

VI – COSTS

Pursuant to article 22, No. 4, of the RJAT, the amount of costs is fixed at € 3,672.00, pursuant to Table I annexed to the Regulation of Costs in Tax Arbitration Proceedings, to be borne by the Claimant.

Let notice be given.

Lisbon, 10/10/2017

The Arbitrators

(José Baeta de Queiroz)

(Manuel Pires)

(Paulo Nogueira da Costa)

Frequently Asked Questions

Automatically Created

What is the tax neutrality regime for share exchanges under Portuguese IRS law?
The tax neutrality regime for share exchanges under Portuguese IRS law, governed by Article 73 of the IRC Code and applicable to individuals via Article 10(11)(a) of the CIRS, allows deferral (not exemption) of taxation on capital gains arising from exchange of shareholdings in corporate restructuring operations. The regime requires: (1) parties must continue to value new participations at the historical tax value of the old participations (not fair market value), and (2) the operation must be motivated by valid economic reasons beyond tax advantages. This prevents immediate taxation on unrealized gains, postponing taxation until actual disposal of the replacement shares.
When can the Tax Authority apply the specific anti-abuse clause under Article 73(10) of the IRC Code to share exchange operations?
The Tax Authority can apply the specific anti-abuse clause under Article 73(10) of the IRC Code (incorporated into IRS via Article 10(11)(a) CIRS) when a share exchange operation lacks valid economic reasons and has tax evasion or avoidance as its main or principal objective. The Authority must demonstrate that: (1) the taxpayer failed to maintain the historical tax valuation of participations (i.e., used fair market value rather than cost basis for the exchanged shares), and (2) the operation was primarily motivated by obtaining tax deferral benefits rather than legitimate business purposes. However, the burden of proving the requirements for tax neutrality (valid economic reasons and proper valuation continuity) falls on the taxpayer claiming the benefit.
What must the Tax Authority prove to deny the tax neutrality regime in a share exchange (permuta de partes sociais)?
To deny the tax neutrality regime in a share exchange, the Tax Authority must prove the taxpayer failed to meet statutory requirements. Specifically: (1) the taxpayer did not continue valuing new participations at the historical tax value of old ones—in this case, the Authority demonstrated the capital increase used appraised value (€1,339,895) instead of nominal value (€3,750), and the taxpayer's participation increased from €1,000 to €1,340,895; and (2) the operation lacked valid economic reasons beyond tax deferral. The Authority argued the taxpayer provided no concrete evidence of business motivations, leaving tax advantage as the only verified reason. Notably, while the Authority bears the burden for anti-abuse allegations, taxpayers must affirmatively prove entitlement to the neutrality regime's requirements.
How does CAAD arbitration work for challenging IRS tax assessments related to share exchanges in Portugal?
CAAD (Centro de Arbitragem Administrativa) arbitration for challenging IRS assessments related to share exchanges operates under the RJAT (Legal Framework for Tax Arbitration, Decree-Law 10/2011). Taxpayers file a request for arbitral award seeking annulment of tax assessments and related decisions. The process involves: (1) automatic notification to the Tax Authority upon acceptance; (2) appointment of a three-arbitrator collective tribunal by CAAD's Deontological Council; (3) submission of written pleadings (request and reply); (4) parties may present final arguments; and (5) the tribunal issues a binding arbitral award. In Process 205/2017-T, the taxpayer challenged the partial rejection of an administrative complaint against IRS assessment 2016... (€192,943.48) for 2015, related to a denied tax neutrality claim on a share exchange operation.
What are the legal consequences when a share exchange is found to lack valid economic reasons under Portuguese tax law?
When a share exchange is found to lack valid economic reasons under Portuguese tax law, the tax neutrality regime is denied, and several legal consequences follow: (1) immediate taxation of capital gains realized on the exchange at the time of the transaction rather than deferral; (2) assessment of IRS on the difference between the fair market value received and the historical cost basis of the exchanged participation; (3) application of compensatory interest on unpaid taxes from the original due date; and (4) potential subsequent assessments if additional tax deficiencies are identified. In this case, the taxpayer faced IRS assessment 2016..., compensatory interest assessment 2016..., and subsequent assessment 2017..., totaling €192,943.48. The denial effectively treats the exchange as a taxable realization event, eliminating the deferral benefit intended for legitimate business restructurings.