CAAD 208/2015-T: Fair Value Adjustments on Financial Instruments Under Article 45(3) CIRC – IRC Ruling

Case No. 208/2015-T

The arbitrators Dr. Jorge Manuel Lopes de Sousa (arbitrator-president), Dr. José Ramos Alexandre and Prof. Dr. Luísa Anacoreta, appointed by the Deontological Council of the Centre for Administrative Arbitration to form the Arbitral Tribunal, constituted on 01-06-2015, agree as follows:

1. Report

A... SGPS, S.A., Tax Number ..., with registered office at Rua ..., No. ..., ..., ...-..., ..., (hereinafter referred to as the "Claimant"), filed a request for the constitution of a collective arbitral tribunal, pursuant to the combined provisions of Articles 2 and 10, nos. 1 and 2, subparagraph a), of Decree-Law No. 10/2011, of 20 January (hereinafter "RJAT"), with a view to obtaining a declaration of partial illegality and annulment in this part of the self-assessment of Corporate Income Tax (IRC) and consequent municipal surcharge of the fiscal group AA... for the fiscal year 2011, with respect to the amount of € 242,123.28, as well as the reimbursement of this amount, with compensatory interest.

The request for constitution of the arbitral tribunal was accepted by the President of CAAD and notified to the TAX AUTHORITY AND CUSTOMS AUTHORITY on 23-03-2015.

Pursuant to subparagraph a) of Article 6, no. 2 and subparagraph b) of Article 11, no. 1 of the RJAT, the Deontological Council appointed as arbitrators the signatories, who communicated acceptance of the assignment within the applicable deadline.

On 15-05-2015, the Parties were notified of this appointment and did not manifest any intention to challenge the appointment of the arbitrators, in accordance with the combined provisions of Article 11, no. 1, subparagraphs a) and b) of the RJAT and Articles 6 and 7 of the Deontological Code.

Thus, in compliance with the provision of subparagraph c) of Article 11, no. 1 of the RJAT, the collective arbitral tribunal was constituted on 01-06-2015.

The Tax Authority and Customs Authority submitted a response, raising the exception of partial unarguability on the ground that the Claimant had not included in field 737 of individual Declaration Form 22 any indication of any depreciation relating to "losses related to equity interests or other equity components" occurring in 2011 and, therefore, this matter had not been subject to a gracious claim. Furthermore, the Tax Authority and Customs Authority argued for the dismissal of the request for arbitral pronouncement and, in any case, the non-existence of any right to compensatory interest.

By orders of 06-07-2015 and 08-07-2015, it was decided to dispense with the holding of the meeting provided for in Article 18 of the RJAT and that the case proceed with submissions.

The Parties submitted their arguments.

The arbitral tribunal was properly constituted and is competent.

The parties have legal personality and capacity, are legitimate (Articles 4 and 10, no. 2, of the same statute and Article 1 of Order No. 112-A/2011, of 22 March) and are properly represented.

The case does not suffer from any defects of form.

It is necessary to decide.

2. Exception of Partial Unarguability

Matter of Fact

2.1. Proven Facts

The following facts are considered proven:

A) The Claimant A... SGPS, S.A., is the holding company of a group of companies subject to the special tax regime for groups of companies ("RETGS"), whose corporate purpose is centred on the management of equity interests in other companies, as an indirect form of exercising economic activities.

B) In its capacity as holding company of the said group of companies, the Claimant proceeded to self-assess Corporate Income Tax and the consequent municipal surcharge for the fiscal year 2011 by submitting Declaration Form 22 for the Group on 22-05-2012 (document No. 1 attached to the request for arbitral pronouncement, the contents of which are hereby reproduced);

C) In fiscal year 2005, the Group AA... acquired 1,101,085 shares of C..., Ltd. (hereinafter, C...), formerly named D..., a company listed on the London Stock Exchange, with an acquisition cost of € 11,010,850.00, to which corresponded the acquisition by gift attribution of 1,376,356 preference shares (C... preference shares or C...) in 2010;

D) The acquisition of the said shares gave the Claimant a participation representing less than 5% of the capital of C...;

E) Until 31 December 2009, the equity interests in question were measured in the Claimant's financial statements at acquisition cost, in accordance with the accounting principles defined in the Official Chart of Accounts (POC);

F) Following the approval of the Accounting Standardisation System (SNC), which came into force on 1 January 2010, the Claimant began to measure, in its financial statements, the equity interests held in the capital of C... in accordance with Accounting Standard and Financial Reporting Standard 27 (NCRF 27), which provides that equity instruments, in particular equity interests traded on a regulated market and representing less than 20% of the capital of a given entity are measured at fair value through profit or loss;

G) By virtue of the adoption of the new accounting rules, the Claimant calculated a negative equity variation associated with the measurement of the interest held in C... in accordance with fair value, in the amount of € 7,982,866.25;

H) In the taxation period of 2011, depreciations occurred in the amounts of € 61,962.89 and € 16,477.73, with respect to the ... Ordinary and ... Preference shares, respectively, totalling € 78,440.62;

I) On 22 January 2011, the Claimant submitted a Binding Information Request with the aim of confirming the understanding of the Tax Authority regarding the tax treatment of that equity variation, in particular with respect to the limitation of the deduction to 50% as stated in Article 45, no. 3 of the CIRC;

J) In response to the Request, the IRC Directorate of Services informed that "In the event that a loss is calculated due to reduction of fair value, Article 45, no. 3 of the CIRC establishes that 'other losses relating to equity interests compete for the formation of taxable profit in only half their value'", concluding that "Since the reductions of fair value of these equity interests are qualified as losses, they should be considered, pursuant to the said Article 45, no. 3, of the CIRC, in 50% of their value";

K) The Claimant, following the understanding of the Tax Authority, considered, for tax purposes, in the self-assessment of Corporate Income Tax for 2011, in only 50%, the negative equity variation relating to the interest in C... resulting from the transition to the new accounting standard as regards fair value recognition (deferred over five taxation periods) and likewise, in 50% only, the depreciation occurring in the taxation period of 2011 itself with the said financial interest;

L) On 21-05-2012, the Claimant submitted its individual Declaration Form 22 for the taxation period of 2011 (document No. 7 attached to the request for arbitral pronouncement, the contents of which are hereby reproduced);

M) In field 705 of table 07 of its individual Declaration Form 22 for the year 2011, relating to "Negative equity variations (transitional regime provided for in Article 5, nos. 1, 5 and 6 of Decree-Law 159/2009, of 13/7)", it considered, as a negative equity variation resulting from the transition to the new accounting standard as regards fair value recognition, the amount of € 798,286.62, which corresponds to 50% of 1/5 of the total accumulated negative equity variation (7,982,866.25 €) (document No. 7 attached to the initial petition);

N) In the said individual Declaration Form 22 for the year 2011, the Claimant entered in field 737, relating to "50% of other losses relating to equity interests or other equity components (Article 45, no. 3, final part)" the value "0.00" (document No. 7 attached to the request for arbitral pronouncement);

O) In field 713 of the said individual Declaration Form 22, relating to "Non-deductible adjustments resulting from the application of fair value (Article 18, no. 9)" the Claimant entered the value of € 17,192,850.35 (document No. 7 attached to the request for arbitral pronouncement);

P) With respect to the appreciation occurring in 2012 with the financial interest in C..., this was considered by the Claimant at 100% in the self-assessment of that fiscal year, in accordance with the treatment confirmed by the Tax Authority in response to a new Binding Information Request, dated September 2013;

Q) On 21-05-2014, the Claimant filed a gracious claim against the self-assessment act of Corporate Income Tax for the taxation period of 2011 (document No. 2 attached to the request for arbitral pronouncement, the contents of which are hereby reproduced);

R) On 6 January 2015, it was notified, through Official Letter No. ... of 2 January 2015, of the decision dismissing the gracious claim, by order issued on 31 December 2014 by the Deputy Director of Finance of the Finance Directorate of Lisbon, which expresses agreement with an opinion and an information note in which is stated, among other things, the following: (document No. 3 attached to the request for arbitral pronouncement, the contents of which are hereby reproduced)

III - ARGUMENTS OF THE CLAIMANT

In its petition, the Claimant argues that:

• A... SGPS, S.A. is the holding company of a group of companies subject to the special tax regime for groups of companies ("RETGS"), provided for in Articles 69 et seq. of the Corporate Income Tax Code, and whose corporate purpose is centred on the management of equity interests in other companies, as an indirect form of exercising economic activities;

• Among the said financial interests, A... holds a participation of less than 5% of the capital of C..., Ltd. ("C...");

• The said participation results from an initial acquisition in fiscal year 2005 of 1,101,085 shares, with an acquisition cost of € 11,010,850.00 (C... Ordinary shares), the remaining shares (C... Preference shares), totalling 1,376,356 shares, being assigned to A... by gift, in fiscal year 2010;

• With respect to the form of accounting recognition, and until the end of fiscal year 2009, by virtue of the application of generally accepted accounting principles defined in the Official Chart of Accounts ("POC"), the said equity interest was measured in the Claimant's financial statements at acquisition cost;

• Following the approval of the Accounting Standardisation System ("SNC"), which repealed the previous POC and caused changes in the measurement and recognition of financial instruments, A... from 1 January 2010, began to measure the shares of C... at fair value through profit or loss, presenting at the date of transition a depreciation of € 7,982,866.25, subsequently undergoing changes in fair value;

• Given doubts as to the tax treatment to be given to that equity variation, in particular with respect to possible application of the limitation on deduction provided for in no. 3 of Article 45 of the Corporate Income Tax Code, it submitted on 22/01/2011 a binding information request with a view to clarifying the matter fully;

• The response given by the Tax Authority was as follows: "Given that the legislator has not excluded from the scope of no. 3 of Article 45 of the CIRC losses resulting from the measurement at fair value of equity instruments provided for in subparagraph a) of no. 9 of Article 18 of the CIRC, there is no doubt that they are only deductible in half their value" (pages 43 to 45);

• With respect to the effect in profit or loss of negative adjustments resulting from the application of the fair value criterion with respect to equity interests held in C..., in the total amount of € 78,440.62 (C... Ordinary shares - € 61,962.89 - and C... Preference shares - € 16,477.73), with reference to the taxation period of 2011, the amount of € 39,220.31 was considered in field 713 of table 07, corresponding to 50% of the said amount;

• In order to provide the previous understanding of the Tax Authority with some rationale and balance in the medium and long term, the claimant submitted a new binding information request (pages 52 to 61), with the aim of confirming the possibility of offsetting gains resulting from the application of fair value to equity instruments with a price formed in a regulated market, representing a participation of less than 5% in the respective capital also in half their value (and in the part in which it respected the reversal of losses accepted at 50%);

• In response to the said request (pages 62 to 65), the Tax Authority sanctioned that "when income is at issue associated with gains in value and whose variation in value should be recognised in profit or loss, as is the case here, those gains compete for the formation of taxable profit in their entirety";

• The claimant became aware of an arbitral decision, dated 25/11/2013, issued in the context of case No. 108/2013-T (pages 66 to 98), which addresses the tax treatment to be given to expenses resulting from the application of the fair value model in financial instruments whose offset is recognised through profit or loss;

• The said decision contradicts the understanding of the Tax Authority set forth in the response to the binding information request initially submitted by A... (in January 2011), "it is understood that Article 45, no. 3 of the CIRC should be interpreted to mean that its provision does not include expenses resulting from the application of fair value in financial instruments that are relevant for the formation of taxable profit in accordance with subparagraph a) of no. 9 of Article 18";

• Both gains and expenses associated with variations in fair value occurring during the period of holding of the equity interests should compete for the formation of taxable profit in 100% of their value, as the claimant has always contended;

• In view of the foregoing, the claimant cannot accept the understanding of the Tax Authority set forth in the binding information request submitted in 2011, according to which the deductibility of expenses resulting from the fair value model associated with equity instruments would be limited to 50% of their value, and therefore seeks to have recognised the possibility of deducting from taxable profit for fiscal year 2011 the portion relating to 50% of the fair value losses resulting from the interest held in C... that was not accepted for tax purposes, in the terms and on the grounds which are set out below;

• The wording of subparagraph a) of no. 9 of Article 18 of the CIRC makes it clear that income or expenses resulting from the application of the fair value model in the measurement of equity interests of equal to or less than [5%] in open companies that are traded on a regulated market should compete, in their entirety, for the formation of taxable profit;

• Accordingly, it remains only to assess whether expenses resulting from the variation in fair value of the equity instruments in question is applicable to the previous no. 3 of Article 45 of the CIRC, given that this legal provision was equally applicable to other losses relating to equity interests;

• If the legislator had intended to subsume the expenses resulting from the application of the fair value model to the provisions in the final part of no. 3 of Article 45 of the CIRC, it would have stated so expressly in the wording of that norm, and since it has not done so, the Tax Authority cannot attribute to the same norm a meaning that finds no correspondence in its letter;

• On the other hand, the fact that the literal element of no. 9 of Article 18 of the CIRC explicitly refers to "fair value adjustments" competing for the formation of taxable profit, without establishing any difference in the tax treatment given to income and expenses or any limitation on the deductibility of the latter, makes clear what the legislator's intention was regarding this matter;

• It is further added that no. 9 of Article 18 of the CIRC makes no reference to no. 3 of Article 45 of the CIRC, nor does that provision make any reference to negative fair value adjustments in equity instruments;

• In view of this framework, there are no grounds, in light of the literal element of no. 9 of Article 18 and no. 3 of Article 45, both of the CIRC, that can justify the limitation to 50% of the deductibility of the expense resulting from the application of the fair value method through profit or loss, sustained by the Tax Authority;

• Given the evolution of the fair value of the interests in C..., the gains now calculated are nothing more than reversals of the expenses calculated previously, and therefore, as a matter of coherence and fairness in taxation, expenses should be considered for tax purposes in the same measure as gains;

• Pursuant to no. 15 of Article 68 of the General Tax Law, binding information opinions expire in the event of subsequent alteration of the factual or legal presuppositions on which they are based, which the claimant understands to be the case here, and therefore, in order to restore tax justice, it is imperative that the understanding expressed by the Tax Authority in the binding information request submitted in the course of 2011 should not be applied;

And it requests:

• That fiscal expenses resulting from the application of fair value through profit or loss be recognised in their entirety;

• In this regard, it should be noted that, although the Tax Authority is bound by the understanding set forth in the response to the binding information request submitted on 22/01/2011, the claimant understands that, considering the arbitral decision which constitutes an alteration of law, which is hereby made known, the tax injustice advocated is revealed, in accordance with no. 5 of Article 78 of the General Tax Law, to be notorious, unequivocal and serious, in that it results in manifestly excessive and disproportionate taxation;

• The claimant considers it legitimate to deduct the present gracious claim against the tax act, requesting that fiscal expenses resulting from the application of fair value through profit or loss be recognised in their entirety;

• In this context, the claimant requests the reimbursement of tax paid in excess in fiscal year 2011, in the amount of € 209,376.75, plus the municipal surcharge, in the amount of € 12,562.61, and state surcharge, in the amount of € 20,937.68;

• Compensatory interest under Article 43 of the General Tax Law, calculated on the amount of tax unduly paid, in the value of € 242,877.03, and counted, until full reimbursement thereof, from the end of the date for official reimbursement of the tax.

IV - ANALYSIS OF THE REQUEST/OPINION

Having examined the petition of the Claimant as well as the documents filed in the case, the following considerations must be made:

1. On the matter addressed in the present case, the claimant requested on 22/01/2011 a binding information request, which gave rise to Binding Information Opinion No. ..., with order of 21/04/2011. In September 2013, the claimant made the same request on the same matter, and DSIRC based its understanding in an opinion with order in 2014. Thus, the last binding information opinion maintains all the understanding already set forth in Binding Information Opinion No. ..., as follows:

"17. Pursuant to subparagraph a) of no. 9 of Article 18 of the CIRC, adjustments resulting from the application of fair value compete for the formation of taxable profit when they concern equity instruments recognised at fair value through profit or loss, with a price formed in a regulated market and representing a direct or indirect participation of a percentage not exceeding 5% of the respective capital;

1. This being the current tax framework for changes in fair value occurring in this type of equity instrument, the adjustments that the claimant had to make at the date of transition to the SNC, as a result of the change in the accounting measurement policy (from the cost model to the fair value through profit or loss model) are considered relevant for tax purposes. They therefore fall within the transitional regime provided for in Article 5 of Decree-Law No. 159/2009, of 13 July, which amended, renumbered and republished the Corporate Income Tax Code.

2. However, we must not forget that no. 3 of Article 45 of the CIRC provides a restriction on the deductibility of losses relating to equity interests.

3. If the legislator had intended to exclude from the scope of this provision losses resulting from variations in fair value of equity instruments provided for in subparagraph a) of no. 9 of Article 18 of the CIRC, it would have stated so expressly. Not having done so, it is clear from the letter of the law that these losses are subject, like others, to the restriction provided therein.

4. Consequently, the negative transition adjustments resulting from the change in the measurement model necessarily have the same tax treatment as losses occurring already under the new Code.

5. Therefore, as regards the negative equity variation calculated at the date of transition and claimed by the claimant (4,952,247.00), it is necessary to separate positive adjustments (3,030,619.99) from negative adjustments (7,982,866.00), since the tax treatment of one and the other is not equal. Thus:

a) The (positive) effects on equity resulting from the change in measurement of the financial assets in question compete, in full, in equal parts, for the formation of the taxable profit of the taxation periods of 2010 and the four following taxation periods;

b) The (negative) effects on equity can only compete in 50% for the formation of taxable profit of the taxation periods of 2010 and the four following taxation periods. Financial charges incurred with the acquisition of equity interests.

1. As for the financial charges incurred with the acquisition of equity instruments which, at the date of transition, began to be measured (both accounting and tax) by the fair value through profit or loss model, it has already been sanctioned by a superior authority (Order of 2011-02-24, of the Director-General of Taxes, Case No. 39/2011) that they become deductible.

2. And because the change in the tax treatment of financial charges is inseparable from the effects on equity resulting from the adoption, for the first time, of the new accounting regulations, the deduction must be made, in equal parts, during the period in which these compete for the formation of taxable profit, that is, in the taxation period of 2010 and in the four following taxation periods.

Loss recognised in 2010 as a result of the application of the fair value model

1. As we referred to previously, given that the legislator has not excluded from the scope of no. 3 of Article 45 of the CIRC losses resulting from the measurement at fair value of equity instruments provided for in subparagraph a) of no. 9 of Article 18 of the CIRC, there is no doubt that these are only deductible in half their value.

2. And because the legislator used the expression "losses", and not "the negative difference between gains and losses", it follows that these must be treated separately from gains, such that:

a) Gains, falling within subparagraph f) of no. 1 of Article 20 of the CIRC, compete in full for the formation of taxable profit for the period in which they occur (2010);

b) As regards losses, although they are considered deductible pursuant to subparagraph i) of no. 1 of Article 23 of the CIRC, their deductibility is subject to the limitation imposed by the final part of no. 3 of Article 45, both of the CIRC.

1. Thus, the expenses resulting from the application of the fair value criterion in financial instruments that are relevant for the formation of taxable profit pursuant to subparagraph a) of no. 9 of Article 18 of the CIRC are encompassed by the limitation provided for in no. 3 of Article 45 (subsequently repealed by Law No. 2/2014, of 16 January) of the same statute, thus competing for the formation of taxable profit only in 50%, as provided for in the doctrinal note relating to the tax treatment of the loss calculated by SGPS as a result of the application of the fair value model (Case …/2011 - Order of 24/2/2011 of the Director-General).

2. The claimant also requests the payment of compensatory interest, invoking for this purpose Article 43 of the General Tax Law, without, however, specifying which of the various provisions of this article it considers applicable to the case (page 38).

3. Given that the situations provided for in no. 3 of Article 43 are clearly not at issue, nor are the requirements on which depends the right to compensatory interest under no. 1, in that it is not recognised in the present gracious claim that the taxpayer has paid tax "in an amount exceeding that legally due" due to "error attributable to the services".

4. Article 43 of the General Tax Law (LGT) defines the requirements for the right to compensatory interest in favour of the taxpayer, in particular in its no. 1 which provides: "Compensatory interest is due when it is determined, in a gracious claim or judicial challenge, that there was error attributable to the services resulting in payment of the tax debt in an amount exceeding that legally due."

5. That is, this provision establishes 4 requirements for this right to compensatory interest: The existence of an error in an act assessing a tax;

• That the error be attributable to the services;

• That the existence of such error is determined in a gracious claim or judicial challenge proceeding;

• That such error resulted in the payment of a tax debt in an amount exceeding that legally due.

1. This legal provision defines the requirements for the right to compensatory interest in favour of the taxpayer who has been subject to illegal taxation and, consequently, has made payment of tax exceeding that due.

2. For there to be entitlement to interest, it is essential that the verification of the requirements referred to above be carried out in a gracious claim or judicial challenge proceeding.

3. In view of the foregoing, we consider that the requirements established in the said Article 43 of the General Tax Law are not met to allow the recognition of the right to compensatory interest, and therefore, its request for compensatory interest does not succeed.

S) On 21-03-2015, the Claimant submitted the request for arbitral pronouncement that gave rise to the present case.

2.2. Unproven Facts and Grounds for the Determination of Fact

The facts were established as proven on the basis of documents attached to the initial petition and forming part of the administrative file.

As regards whether or not the amount of € 39,220.31 was included in field 713 of the individual declaration forming part of document No. 7 attached to the request for arbitral pronouncement, what is proven is the objective content of what appears in the declaration.

3. Issue of Partial Unarguability

The Tax Authority and Customs Authority argues that the self-assessment is not challengeable as to the depreciation of 78,440.62 (total amount) of shares in C... occurring in 2011 on the ground that, in summary, no amount was included in field 737 of Declaration Form 22 (individual) which the Claimant submitted, forming part of document No. 7 attached to the request for arbitral pronouncement.

Consequently, the Tax Authority and Customs Authority considers that there was no self-assessment as to that depreciation, namely as to the value of 50% of that depreciation, the legality of which the Claimant challenges, and therefore that self-assessment was not subject to a gracious claim, which leads to the conclusion that the requirement demanded by subparagraph a) of Article 2 of Order No. 112-A/2011, of 22 March is not met.

The Claimant argues, in its submissions, that the amount of € 39,220.31 (corresponding to 50% of the depreciation of the shares referred to in 2011) is included in field 713 of Declaration Form 22, making up part of the amount of € 17,192,850.35 indicated there.

The fact that no amount was not included in field 737 of the individual Declaration Form 22 with reference to 50% of the said depreciation of those shares in 2011 cannot lead to the conclusion that it was not included in the declaration, in particular in field 713, where "Non-deductible adjustments resulting from the application of fair value (Article 18, no. 9)" should be indicated, as the Claimant argues. In fact, in light of the understanding of the Tax Authority and Customs Authority, adopted by the Claimant in preparing the individual Declaration Form 22, adjustments derived from the application of fair value will be partially deductible and partially non-deductible, as they are subject to the regime of Article 45, no. 3, of the CIRC of deduction at 50%.

On the other hand, if one understands, as will be stated below, that it is appropriate to make a distinction between "expenses" and "losses" and that negative equity variations of financial instruments resulting from the application of the fair value rule should be qualified as "expense" and not as "loss", one must conclude that the entry of such adjustments in field 737 of that Declaration would be incorrect, as it refers to "50% of other losses relating to equity interests or other equity components (Article 45, no. 3, final part)" and no. 1 of Article 23 of the CIRC, although it continues to make reference to equity variations which it qualifies as losses [in particular in subparagraph h)], expressly qualifies as "expenses", in its subparagraph i), negative equity variations "resulting from the application of fair value in financial instruments".

That is, in light of the terminology used by the CIRC, if negative equity variations "resulting from the application of fair value in financial instruments" are considered "expenses", the reference to "losses" made in field 737 will refer to other negative equity variations that are qualified as "losses" and not as "expenses". ( [1] )

On the other hand, it is indisputable that the Claimant submitted to the consideration of the Tax Authority and Customs Authority in the gracious claim this question of the illegality of the self-assessment due to the inclusion of the amount of € 39,220.31 in field 713, as it was expressly referred to in Article 15 of the claim.

Thus, having the question been submitted to the consideration of the Tax Authority and Customs Authority in the gracious claim, there is no unarguability based on the requirement made in subparagraph a) of no. 1 of Article 2 of Order No. 211-A/2011, of 22 March.

On the other hand, in situations of self-assessment followed by a gracious claim in which an express decision is issued, what subsists in the legal order is the position of the Tax Authority and Customs Authority before the taxpayer as defined by the decision on the gracious claim, in the part in which the legality of the self-assessment was submitted to the consideration of the Tax Authority and Customs Authority.

Consequently, the question that arises for the Tribunal is whether the illegality of the self-assessment should be declared or whether it should be maintained in the legal order on the grounds invoked in the gracious claim and only those grounds, as, according to settled case law, reasoning given after the fact is irrelevant.

In fact, in a dispute concerning mere legality, the legality of the challenged act must be assessed as it occurred, with the reasoning that was used in it, with no relevance given to other possible reasoning that could support other acts of total or partially coinciding decisional content with the act performed.

Thus, the Tribunal cannot, when confronted with the invocation of an illegal ground as support for the decision to dismiss the claim, assess whether the gracious claim should have been dismissed for other reasons. ( [2] )

For this reason, it is in light of the grounds for the decision on the gracious claim that the question of the legality or illegality of the self-assessment must be assessed.

In the case in question, as regards the reasons for the dismissal of the Claimant's claim, the dismissal decision invokes only, in summary, that "the expenses resulting from the application of the fair value criterion in financial instruments that are relevant for the formation of taxable profit under subparagraph a) of no. 9 of Article 18 of the CIRC are encompassed by the limitation provided for in no. 3 of Article 45 (subsequently repealed by Law No. 2/2014, of 16 January) of the same statute, thus competing for the formation of taxable profit only in 50%, as provided for in the doctrinal note relating to the tax treatment of loss calculated by SGPS as a result of the application of the fair value model (Case 39/2011 - Order of 24/2/2011 of the Director-General)".

In the context of the gracious claim, in which the illegality of the assessment was expressly invoked regarding the inclusion of 50% of the depreciation and it was intended that the entire depreciation be considered as an expense, the decision of the Tax Authority and Customs Authority must be interpreted as dismissing also this request on the ground stated and only on that ground and not on other hypothetical grounds such as that the amount of € 39,220.31 was not included in the declaration or that the gracious claim lacked an object in that respect.

Therefore, nothing prevents the assessment of the legality of the self-assessment as it subsisted in the legal order following the decision on the gracious claim, with the grounds invoked therein.

4. Matter of Law

The corrections made by the Tax Authority and Customs Authority were based on the interpretation it made of the regime of Article 45, no. 3 of the CIRC, in the wording in force in 2010-2011, which it understood to be applicable to adjustments resulting from the application of the fair value model in financial instruments, whose offset is recognised through profit or loss.

It is accepted by the Parties that the financial interests in question should be accounted for in accordance with the fair value criterion and that the adjustments were recognised through profit or loss.

The question to be resolved in the case is thus properly delimited, which is then to determine whether the accounting loss resulting from the retrospective application of the fair value method and the accounting losses verified in fiscal years 2010 and 2011, resulting from the depreciation of the share price, properly accounted for in accordance with the applicable fair value criterion, and recognised in profit or loss, should be taken into account in full, or only in 50%.

4.1. Regulatory Framework

Article 45, no. 3 of the CIRC, in the wording given by Decree-Law 159/2009, of 13 July, establishes the following:

"3 - The negative difference between realised gains and losses from the paid transfer of equity interests, including their redemption and amortization with reduction of capital, as well as other losses or negative equity variations relating to equity interests or other equity components, in particular supplementary contributions, compete for the formation of taxable profit in only half their value."

The general norm on the determination of taxable profit under the Corporate Income Tax Code is Article 17 of the CIRC which establishes that:

"1 - The taxable profit of corporations and other entities referred to in subparagraph a) of no. 1 of Article 3 is constituted by the algebraic sum of the net profit for the period and the positive and negative equity variations verified in the same period and not reflected in such profit, determined on the basis of accounting and eventually corrected under the terms of this Code."

With respect to adjustments resulting from the application of fair value, no. 9 of Article 18 of the same Code provides that:

"9 - Adjustments resulting from the application of fair value do not compete for the formation of taxable profit, being imputed as income or expenses in the taxation period in which the elements or rights that gave rise to them are sold, exercised, extinguished or liquidated, except when:

a) They concern financial instruments recognised at fair value through profit or loss, provided that, if they are equity instruments, they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a participation in capital exceeding 5% of the respective capital; or

b) This is expressly provided for in this Code."

Article 20, no. 1 of the CIRC specifies the concept of income, establishing, as far as is relevant here, the following:

"Income is considered to be that resulting from operations of any kind, as a result of either normal or occasional action, either basic or merely accessory, including in particular:

(...)

f) Income resulting from the application of fair value in financial instruments;

(...)

h) Realised gains;"

Article 23, no. 1 of the CIRC defines the concept of "expenses", establishing as follows:

"1 - Expenses are considered to be those that are demonstrably necessary for the realisation of income subject to tax or for the maintenance of the producing source, in particular:

(...)

i) Expenses resulting from the application of fair value in financial instruments;

(...)

l) Realised losses;"

With respect to positive equity variations, Article 21, no. 1 of the CIRC provides that:

"Positive equity variations not reflected in the net profit for the taxation period also compete for the formation of taxable profit, except:

(...)

b) Potential or latent gains, even if expressed in accounting, including revaluation reserves under fiscal legislation;"

As regards negative equity variations, Article 24, no. 1 of the CIRC refers to:

"Under the same conditions referred to for expenses, negative equity variations not reflected in the net profit for the taxation period also compete for the formation of taxable profit, except:

(...)

b) Potential or latent losses, even if expressed in accounting;"

As regards gains and losses, Article 46, no. 1 of the same Code provides that:

"1 - Realised gains or losses are considered to be income obtained or losses suffered through paid transfer, whatever the title by which it operates and likewise those resulting from disasters or those resulting from the permanent assignment to purposes other than the activity exercised, with respect to:

(...)

b) Financial instruments, with the exception of those recognised at fair value under subparagraphs a) and b) of no. 9 of Article 18;"

Article 5 of Decree-Law No. 159/2009, of 13 July, establishes the following:

Article 5

Transitional Regime

"1 - The effects on equity resulting from the adoption, for the first time, of international accounting standards adopted pursuant to Article 3 of Regulation No. 1606/2002 of the European Parliament and Council, of 19 July, which are considered fiscally relevant under the terms of the Corporate Income Tax Code and the respective implementing legislation, resulting from the recognition or non-recognition of assets or liabilities, or from changes in their respective measurement, compete, in equal parts, for the formation of taxable profit of the first taxation period to which such standards apply and of the four following taxation periods.

(...)"

4.2. Analysis of the Issue

In analysing this issue, the reasoning of the arbitral award of 25-11-2013, issued in case No. 108/2013-T, will be closely followed, which merits the agreement of the signatories.

The aforementioned Article 45, no. 3 of the CIRC stems from the renumbering of the former Article 42, no. 3, carried out by Decree-Law 159/2009.

This no. 3 of Article 42 in question, in turn, was introduced by Law 32-B/2002, of 30 December, with the following wording:

"The negative difference between realised gains and losses from the paid transfer of equity interests, including their redemption and amortization with reduction of capital, competes for the formation of taxable profit in only half their value."

In accordance with the Report of the Ministry of Finance for the State Budget of 2003 (p. 33), the legislative intervention in the area in question (Corporate Income Tax) was guided by "two priorities, namely the fight against tax fraud and evasion and the broadening of the tax base", with the alteration that is here of interest falling within the scope of "Broadening of the tax base and moralization and neutrality measures" (p. 51).

The current wording of the norm under analysis resulted already from the alteration implemented by Law 60-A/2005 of 30 December, and pursuant to the corresponding Report of the Ministry of Finance (p. 31), the measure in question fell within the scope of "FIGHT AGAINST EVASION AND TAX FRAUD AND OTHER MEASURES DIRECTED TOWARDS BUDGETARY CONSOLIDATION".

Now, no. 9 of Article 18 of the applicable CIRC obtains its justification directly in the preamble of Decree-Law 159/2009, of 13 July, which introduced it in the said Code, where one can read:

"Still in the field of bringing accounting and taxation closer together, the application of the fair value model to financial instruments, whose offset is recognised through profit or loss, is accepted, but only in cases where the reliability of the determination of fair value is principally assured. Thus, equity instruments which do not have a price formed in a regulated market are excluded. Furthermore, the application of the realisation principle was maintained with respect to financial instruments measured at fair value whose offset is recognised in equity, as well as equity interests corresponding to more than 5% of the capital, even if recognised at fair value through profit or loss. (...)

In the same sense, assets covered by the regime of realised gains and losses are identified as tangible fixed assets, intangible assets, investment properties, financial instruments, with the exception of those in which adjustments resulting from the application of fair value compete for the formation of taxable profit in the taxation period."

These expressly stated intentions have correspondence in that provision of no. 9 of Article 18, as well as in the introduction, by the same legal instrument, of subparagraphs f) and i) of number 1 of Articles 20 and 24 of the CIRC, as well as of subparagraph b) of no. 1 of Article 46.

Within the set of amendments introduced by the said Decree-Law 159/2009, of 13 July, it should also be noted that where previously one spoke of revenue and gains (Article 20), one now speaks of income, and where previously one spoke of costs or losses (Article 23), one now speaks of expenses.

Prior to the adoption of fair value, equity variations relating to financial instruments were irrelevant from the point of view of the formation of taxable profit for each period, due to the effect of the provision of Article 21, no. 1, subparagraph b) of the CIRC, which established that "potential or latent gains, even if expressed in accounting, including revaluation reserves legally authorised" did not compete for the formation of taxable profit. Only at the time of realisation of the gain or loss did the equity variation verified assume fiscal relevance.

This tax framework, which amounted to single taxation (which occurred only once over the entire period of holding of the financial instruments), dependent on a voluntary action of the taxpayer (in that the transaction of the instruments generating the equity variation, a condition of the tax relevance thereof, would only take place if and when the taxpayer so wished) and in which the valuation of the equity variation was fixed as a function of the concrete transaction that triggered its tax relevance, provided fertile ground for accounting and tax manipulations, since the taxpayer could choose to trigger the tax relevance at the moment and in the terms in which this would be fiscally most profitable for it.

On the other hand, and given the relevance of the will of the taxpayer in the mechanism of tax relevance of the equity variation, the system established was suitable for the adoption of mechanisms for conditioning that will, in order to conform it to economically more desirable behaviour, which, in this case, passed through the preference for the realisation of gains, at the expense of the realisation of losses.

It is in this context that the emergence of the provision of the former Article 42, no. 3 of the CIRC is explained, which precedes the current Article 45, no. 3 thereof.

That provision, both in its original wording, resulting from Law 32-B/2002, of 30 December, and in that given to it by Law 60-A/2005 of 30 December, is explained, both objectively and subjectively (that is, in light of the motivation expressed by the legislator), by needs linked to the fight against tax fraud and evasion and to the broadening of the tax base, directed at the sought budgetary consolidation of the public accounts.

The acceptance of the application of the fair value model to financial instruments, operated by Decree-Law 159/2009, of 13 July, introduced, in the part covered, a radically different model, both in terms of valuation and in terms of tax relevance of the equity variations relating to the holding of those instruments.

In fact, the legislator's intention when adopting the fair value model, properly evidenced, was, assumed and expressly, to maintain "the application of the realisation principle with respect to financial instruments measured at fair value whose offset is recognised in equity, as well as equity interests corresponding to more than 5% of the capital, even if recognised at fair value through profit or loss".

As for "financial instruments" corresponding to less than "5% of capital", "whose offset is recognised through profit or loss, (...) in cases where the reliability of the determination of fair value is principally assured", the legislative intention was to accept "the application of the fair value model", excluding the realisation principle.

In line with this legislative intention, Article 18, no. 9 of the CIRC came to provide that, as a rule, "Adjustments resulting from the application of fair value do not compete for the formation of taxable profit, being imputed as income or expenses in the taxation period in which the elements or rights that gave rise to them are sold, exercised, extinguished or liquidated", which embodies an evident and deliberate aflorement of the assumed realisation principle.

However, the same provision, in its subparagraph a), establishes the exception to this regime, "when: a) They concern financial instruments recognised at fair value through profit or loss, provided that, if they are equity instruments, they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a participation in capital exceeding 5% of the respective capital".

That is, when the "income or expenses (...) concern financial instruments recognised at fair value", "compete for the formation of taxable profit" "provided that":

a) They are recognised "through profit or loss";

b) They are "equity instruments";

c) "They have a price formed in a regulated market"; and

d) "the taxpayer does not hold, directly or indirectly, a participation in capital exceeding 5% of the respective capital".

Having met these conditions:

a) income resulting from the application of fair value in financial instruments are considered [Article 20, no. 1, subparagraph f) of the CIRC]; and

b) expenses resulting from the application of fair value in financial instruments are considered [Article 23, no. 1, subparagraph i) of the CIRC].

In this way, where previously we had a single tax relevance, at the time of transaction of those instruments, we now have continuous tax relevance. That is, given the new provisions forming part of the regime of tax relevance of the accounting recognition at fair value of financial instruments, income or expenses resulting from the application of fair value to these now become directly relevant for the formation of taxable profit [Articles Article 20, no. 1, subparagraph f), and Article 23, no. 1, subparagraph i) of the CIRC] in the year in which they occur, provided that certain conditions are met (Article 18, no. 9 of the CIRC), which include the formation of price in a regulated market, with the equity variations verified not being taxed as gains or losses [Article 46, no. 1, subparagraph b) of the CIRC].

In this framework, there no longer exist any needs relating to the fight against tax fraud and evasion, both because the tax relevance of the equity variations ceases to be conditioned by an act of will of the taxpayer and also because the valuation is objectively fixed.

On the other hand, and for the same reasons, any measure of conditioning the will of the taxpayer likewise lacks sense, in the sense of favouring economically more "desirable" behaviour and, as such, in conformity with the interests of broadening the tax base and budgetary consolidation.

Notwithstanding these amendments introduced by Decree-Law 159/2009, of 13 July, the former Article 42, no. 3 of the CIRC, renumbered as Article 45, no. 3, retained its validity, with its wording unchanged.

Hence the question arises, as occurs in the case, whether or not such provision will apply to depreciations relating to financial instruments that compete for the formation of taxable profit, under Article 18, no. 9, subparagraph a) of the CIRC.

On a first analysis, based exclusively on the literal wording of no. 3 of Article 45, an affirmative answer is suggested to this question, in light of the broad scope of the provision of this norm.

However, a careful and coordinated interpretation of the applicable regulatory provisions for the analysis of the question, which have been indicated, leads to a different conclusion.

In fact, Article 45, no. 3 of the CIRC refers to:

"The negative difference between realised gains and losses from the paid transfer of equity interests, including their redemption and amortization with reduction of capital, as well as other losses or negative equity variations relating to equity interests or other equity components, in particular supplementary contributions, compete for the formation of taxable profit in only half their value."

Analysis of the regulatory text reveals with clarity that the legislator chose, to include therein, three types of situations which, based on the presumption of good legislative technique, should be regarded as distinct, namely:

a) "The negative difference between realised gains and losses from the paid transfer of equity interests";

b) "other losses (...) relating to equity interests or other equity components";

c) "other (...) negative equity variations relating to equity interests or other equity components".

Let us then see whether the situation in the case can be reduced to any of the enumerated situations.

The situation referred to under subparagraph a) above will be manifestly inapplicable, not only because no realisation was effected through paid transfer, but also because Article 46, no. 1, subparagraph b) of the CIRC excludes the situations described in Article 18, no. 9, subparagraph a) from the concept of realised gains.

Thus, the possibilities remain for the situation in the case to fall under some of the situations listed in subparagraphs b) and c) above.

The apparent indiscriminate breadth of the provisions in question could, however, be reasonably mitigated if one notes that "losses" and "other negative equity variations" are concepts which, though not redundant, have their own distinct meaning.

To understand this, it will be necessary to go back to Articles 23 and 24 of the same Code, noting the terminological evolution operated by Article 159/2009 of 13 December.

In fact, before the entry into force of the latter statute, the articles referred to of the CIRC referred, respectively, to:

• "Costs or losses are considered to be those demonstrably necessary for the realisation of revenue or income subject to tax or for the maintenance of the producing source, in particular the following: (...)";

• "Under the same conditions referred to for costs or losses, negative equity variations not reflected in the net profit for the fiscal year also compete for the formation of taxable profit, except: (...)".

It is verified, in this way, that when the current wording of Article 45, no. 3 of the CIRC was established, that Code expressly distinguished, for what is relevant here, three types of situations, namely:

a) Costs;

b) Losses;

c) Negative equity variations not reflected in the net profit for the fiscal year.

The provision of Article 42, no. 3 (predecessor of the current 45, no. 3) should be considered, thus, as reported to these concepts, defined in Articles 23 and 24, in the versions prior to Decree-Law No. 159/2009.

In this way, and for obvious reasons, from the provision of that norm should be excluded costs relating to "equity interests or other equity components", including therein only losses (as defined in Article 23) and negative equity variations (as defined in Article 24), relating to those interests.

And that this is so, that is, that the expression "other losses or negative equity variations" used in the current Article 45, no. 3 of the CIRC does not have an indiscriminately broad sense, but rather a precise sense, defined in Articles 23 and 24, is borne out from the outset by the fact that the legislator employed the same distinction.

Furthermore, the inclusion in the scope of the provision in question not only of losses (as defined in Article 23) and negative equity variations (as defined in Article 24), but also of costs (as defined in Article 23 in the version prior to Decree-Law No. 159/2009) would lead to, for example, the acquisition cost of equity interests competing only in half its value for the determination of taxable profit, which would obviously be inconceivable in a minimally reasonable legislator and, consequently, is an interpretation to be rejected, by virtue of the rule of Article 9, no. 3 of the Civil Code, which requires that it be presumed that the legislator adopted the most sound solutions.

The regulatory alteration implemented by Decree-Law 159/2009, of 13 July, will not have altered anything of relevance in the matter in question. In fact, notwithstanding the body of Article 23 having begun to refer only to expenses, the fact is that the CIRC continues to use the expression "losses", including in the very Article 23 (see no. 1, subparagraph h)). This occurs in keeping, moreover, with the SNC, which pursuant to point 2.1.3.e) of the annex to Decree-Law 158/2009 of 12 July, maintains the distinction between "expenses" and "losses".

In this way, it is concluded that Article 45, no. 3 of the CIRC will refer to:

a) negative differences between realised gains and losses from the paid transfer of equity interests;

b) other losses relating to equity interests or other equity components; and

c) other negative equity variations relating to equity interests or other equity components.

It being the case that by "losses" should be understood facts qualifiable as such in light of the CIRC, and by "negative equity variations" should be understood negative equity variations not reflected in the net profit for the fiscal year, as defined in Article 24.

Not included in the scope of the provision in question will thus be facts qualifiable as "expenses", in light of the CIRC, even if relating to equity interests or other equity components.

The Tax Authority itself seems to recognise this, since in the "Instructions for Completing Table 07, Form 22" ( [3] ), regarding field 737, it refers that "In this field are entered, in 50%, amounts relating to other losses (which are not losses on realisation, as these follow the 'mechanism' of gains and losses on realisation) relating to equity interests or other equity components. For example, amounts are entered in this field 737 corresponding to 50% of losses due to reductions in fair value, when these fall within the scope of Article 23, no. 1, subparagraph i), by virtue of the provision of Article 18, no. 9, subparagraph a)".

It happens that Article 23, no. 1, subparagraph i) of the CIRC does not refer to the amounts in question as "losses", but as "expenses", and therefore their entry in the field in question would be incorrect.

Moreover, if there were any doubt, if the legislator, when Decree-Law 159/2009 of 13 December came into force, intended to encompass the situations listed in Article 18, no. 9, subparagraph a) of the CIRC within the scope of Article 45, no. 3 of the same statute, it would have:

• included "Expenses resulting from the application of fair value in financial instruments", not in Article 23, but in Article 24 of the CIRC ( [4] ); or

• referred to such situations as "losses resulting from the application of fair value in financial instruments" and not as "expenses".

In the framework that has just been set out, it should therefore be considered that Decree-Law 159/2009, of 13 July, introduced, with respect to the part covered by the acceptance of the application of the fair value model to financial instruments, a special regime of relevance for the calculation of taxable profit, justified both by its own objectivity and by the confessed intention of bringing accounting closer to taxation.

This circumstance is, given the current wording of the CIRC, not susceptible to generating any type of doubt, as is evidenced, in particular, by the wording of Articles 20, no. 1, subparagraphs f) and h), 23, no. 1, subparagraphs i) and l), and, in particular, 46, no. 1, subparagraph b), in light of which the legislator's intention to remove adjustments resulting from the application of the fair value criterion in financial instruments, as recognised by the CIRC, from the regime of gains and losses is evidenced in a clear manner.

Now, the regime resulting from the combination of Articles 45, no. 3 and 46 of the CIRC only makes sense from the perspective of the relevance of the equity variations in question under the prism of the said realisation principle.

For in that, given the principle, the assessment of the equity variation as a function of a transaction, there will always be a voluntary factor in relation thereto.

That is, in the regime for which the provision of Article 45, no. 3 was thought and instituted, the realisation of losses, and other situations listed, was dependent on a voluntary action corresponding to their realisation. Now, in this framework, it will be understandable that the legislator institutes mechanisms for disincentivising an action susceptible to being regarded as undesirable, in the case the realisation of losses or other negative equity variations. In providing that such situations will only have relevance in 50% of the accounted amount, the tax legislator is, objectively, conditioning the actions encompassed by the legal provision, imposing a negative incentive thereto.

On the other hand, and given that the financial instruments in question are of non-objectively quantifiable value, the disregard of 50% of the negative equity variations verified would also have a function of "compensating for" the natural tendency of economic operators to, at the tax level, inflate losses.

However, those aspects will not be present already in situations encompassed by Article 18, no. 9, subparagraph a). Here, being faced with adjustments resulting from the accounting recognition of fair value, determined by objective criteria (with "a price formed in a regulated market"), there is no doubt or intervention of the will of the taxpayer in the occurrence of the negative or positive equity adjustment. That is, these will occur or not, independently of the action and will of the taxpayer.

Now, penalising, in these cases, the taxpayer with a disregard of 50% of the expense incurred would be entirely unjustified, both from an economic and from a legal point of view.

For it should be recalled that this situation of contingent (indeed, random) unjustified penalisation would only come about due to the exception of the situations encompassed by Article 18, no. 9, subparagraph a) of the CIRC from the regime of the realisation principle. That is, if, as regards those situations, the general regime of the body of Article 18, no. 9 were applied, according to which the same would not compete "for the formation of taxable profit, being imputed as income or expenses in the taxation period in which the elements or rights that gave rise to them are sold, exercised, extinguished or liquidated", the pointed inconsistency would not exist, since the fact that would trigger the competition for the formation of taxable profit would only occur by will of the subject of the obligation, whereby it would be for the latter to choose whether to realise the negative equity variation, with the consequent tax penalisation, or to defer it to a moment in which it would be less voluminous or even positive, diminishing or eliminating the penalisation resulting from the operation for itself and for the Treasury. It is the exception of subparagraph a), in withdrawing the situations provided therein from the scope of the realisation principle, that justifies the new regime of relevance for taxable profit, which has been instituted.

Evidence of all that has just been stated is presented in the table drawn up below, which demonstrates the unreasonableness of the application of the provision of Article 45, no. 3 to the situations encompassed by Article 18, no. 9, subparagraph a):

The non-application of the provision of Article 45, no. 3 of the CIRC to expenses, and concretely to "Expenses resulting from the application of fair value in financial instruments", with the full consideration of the equity repercussions verified, whether positive or negative, leads to coherence in taxation whatever the time at which the sale of the financial instrument occurs. That is, whenever it is chosen to proceed with the sale of the financial instrument, the positive and negative equity changes compensate for one another, so that, ultimately, the taxpayer only has added to or subtracted from its taxable profit the difference between the acquisition value and the sale value.

If, however, the provision of Article 45, no. 3 of the CIRC were applied, as the Tax Authority and Customs Authority intends, from the moment in which a negative equity change occurs, there will be a discrepancy between the tax relevance of negative and positive equity variations, without any justification, as has been stated, since such variations occur in an objective manner and independently of the action or will of the taxpayer. Thus, if by the end of the second year in the above example the taxpayer proceeded with the realisation of the financial instrument in question, notwithstanding having realised a gain of only 20 (which would be taxed as such under the realisation principle), would ultimately have paid tax on 30 (40-10). Similarly, if it proceeded with that realisation by the end of the third year, it would have paid tax on 20, notwithstanding not having had any equity increase with the operation. And if it proceeded with the same realisation by the end of the sixth year, it would have paid tax as if it had had an equity increase of 30 (80-50), notwithstanding having had an actual equity variation of -20, which, under the realisation principle enshrined in the CIRC, would be relevant, albeit in only 50% of its value (-10)!

It seems clear that such results, merely random and without any substantive justification to sustain them, could not have been intended by a reasonable legislator, who, by the imperative of Article 104, no. 2 of the Constitution of the Portuguese Republic, must base the taxation of companies fundamentally on their real income.

It is true that the alternative solution, which excludes the application of Article 45, no. 3, leads to the situation that, if ultimately a loss is verified, this ends up having been considered at 100%, and not 50%, as would occur under the realisation principle. This would be the case if, in the above table example, the realisation occurred in years 4 or 6. However, this positive discrimination (or rather, non-negative discrimination) by the choice of the fair value criterion could be justified, from the outset, insofar as in the regime of Article 18, no. 9, subparagraph a), there is no longer any sense to any disincentive to the realisation of losses, since these will have tax relevance independently of their actual realisation. One should also not fail to note that, on one hand, accounting recognition at fair value is considered more in conformity with the bringing together of accounting and taxation, a purpose confessedly pursued by the legislator of Decree-Law No. 159/2009, of 13 July, and, on the other, the circumstance that we are dealing with objectively evaluated realities, without significant scope for tax-convenient manipulations.

That is, as had been advanced already, the reasons for the fight against tax fraud and evasion, nor the reasons for budgetary consolidation, which demonstrably stood at the genesis of the provision of Article 45, no. 3 of the CIRC, are present.

Thus, it must be concluded that situations must be removed from the field of application of this Article 45, no. 3 in which its raison d'être does not apply, in harmony with the old maxim "cessante ratione legis cessat eius dispositio (where the raison d'être of the law ends, its scope ends)". ( [5] ). "The teleological method has increasingly moved into the foreground compared to literal interpretation. According to the long-known principle: cessante ratione legis, cessat lex ipsa, the end and raison d'être should matter more than the literal sense. The ratio should prevail, not only within the limits of a literal tenor often equivocal, but also breaking the bonds of that literal tenor or restricting a legal formula with scope too broad". ( [6] )

Thus, in summary, in obedience to the hermeneutic requirements of Article 9 of the Civil Code, according to which "Interpretation shall not be confined to the letter of the law, but shall reconstruct from the texts the legislative thought, having particularly in account the unity of the legal system, the circumstances in which the law was drawn up and the specific conditions of the time in which it is applied" (no. 1), and "In determining the sense and scope of the law, the interpreter shall presume that the legislator adopted the most sound solutions and was able to express its thought in adequate terms." (no. 3), it is understood that Article 45, no. 3 of the CIRC should be interpreted to mean that its provision does not include expenses resulting from the application of fair value in financial instruments, which are relevant for the formation of taxable profit under subparagraph a) of no. 9 of Article 18.

In these terms, considering that Article 18, no. 9, subparagraph a) of the applicable CIRC requires the competition "for the formation of taxable profit", without reservations or limitations, of "income or expenses" which "(...) concern financial instruments recognised at fair value", "provided that" they are recognised "through profit or loss"; they are "equity instruments"; "they have a price formed in a regulated market"; and "the taxpayer does not hold, directly or indirectly, a participation in capital exceeding 5% of the respective capital", not applying, in these cases, Article 45, no. 3 of the said Code, in that they are not encompassed by the normative provision of the same, it is understood that the request merits allowance.

Consequently, the self-assessment is illegal as to the deduction in only 50% of the adjustments resulting from the application of fair value, whether those subject to the transitional regime provided for in Article 5, no. 1 of Decree-Law No. 159/2009, or those occurring in the year 2011.

For the foregoing, the self-assessment and the decision on the gracious claim that maintained it suffer from a defect of violation of law, due to incorrect interpretation of Article 45, no. 3 of the CIRC, and therefore a declaration of illegality is warranted.

5. Compensatory Interest

The Claimant requests that the Tax Authority and Customs Authority be condemned to pay it compensatory interest.

4.1. Admissibility of the Recognition of Right and Condemnation to Pay Compensatory Interest in Arbitral Proceedings

In accordance with the provision of subparagraph b) of Article 24 of the RJAT, the arbitral decision on the merits of the claim which is not susceptible of appeal or challenge binds the tax administration from the end of the deadline provided for appeal or challenge, and this must, in the exact terms of the allowance of the arbitral decision in favour of the taxpayer and until the end of the deadline provided for the voluntary execution of judgments of judicial tax tribunals, "restore the situation that would exist if the tax act that is the subject of the arbitral decision had not been practised, adopting the necessary acts and operations for that purpose", which is in keeping with the provision in Article 100 of the General Tax Law [applicable by virtue of the provision in subparagraph a) of no. 1 of Article 29 of the RJAT] which establishes that "the tax administration is obliged, in case of total or partial allowance of a claim, judicial challenge or appeal in favour of the taxpayer, to the immediate and full restoration of the legality of the act or situation that is the subject of the dispute, including the payment of compensatory interest, if applicable, from the end of the deadline for execution of the decision".

Although Article 2, no. 1, subparagraphs a) and b) of the RJAT uses the expression "declaration of illegality" to define the competence of the arbitral tribunals functioning in CAAD, making no reference to condemnatory decisions, it should be understood that the powers that are attributed to judicial tribunals in judicial challenge proceedings are comprised in their competences, and this is the interpretation that is in keeping with the sense of the legislative authorisation on which the Government based itself for approving the RJAT, in which it proclaims, as the first guideline, that "the tax arbitral process must constitute an alternative procedural means to judicial challenge proceedings and to an action for the recognition of a right or legitimate interest in tax matters".

The judicial challenge proceeding, although it is essentially a procedure for the annulment of tax acts, admits the condemnation of the Tax Administration in the payment of compensatory interest, as is inferred from Article 43, no. 1 of the General Tax Law, in which it is established that "compensatory interest is due when it is determined, in a gracious claim or judicial challenge, that there was error attributable to the services resulting in payment of the tax debt in an amount exceeding that legally due" and from Article 61, no. 4 of the Code of Tax Procedure and Process (in the wording given by Law No. 55-A/2010, of 31 December, to which no. 2 corresponds in the original wording), which provides that "if the decision recognising the right to compensatory interest is a judicial decision, the deadline for payment is counted from the beginning of the deadline for its voluntary execution".

Thus, no. 5 of Article 24 of the RJAT, in stating that "payment of interest is due, regardless of its nature, under the terms provided for in the general tax law and the Code of Tax Procedure and Process", should be understood as permitting the recognition of the right to compensatory interest in the arbitral proceeding.

4.2. Reimbursement of the Amount Paid in Excess and Right to Compensatory Interest in Cases of Self-Assessment

In cases of unduly paid tax, the taxpayer has the right to be reimbursed, as follows from the provisions of Articles 100 of the General Tax Law and 24, no. 1, subparagraph b) of the RJAT.

The substantive regime of the right to compensatory interest is regulated in Article 43 of the General Tax Law, which establishes the following:

Article 43

Unduly Paid Tax Contribution

"1 - Compensatory interest is due when it is determined, in a gracious claim or judicial challenge, that there was error attributable to the services resulting in payment of the tax debt in an amount exceeding that legally due.

2 - It is also considered that there is error attributable to the services in cases in which, notwithstanding the assessment being carried out on the basis of the taxpayer's declaration, the latter has followed, in its completion, the general guidance of the tax administration, duly published.

3 - Compensatory interest is also due in the following circumstances:

a) When the legal deadline for the official reimbursement of taxes is not met;

b) In the event of annulment of the tax act by initiative of the tax administration, from the 30th day after the decision, without the credit note having been processed;

c) When the revision of the tax act by initiative of the taxpayer is made more than one year after the latter's request, unless the delay is not attributable to the tax administration.

4 - The rate of compensatory interest is equal to the rate of compensatory interest.

5 - In the period between the date of the end of the deadline for voluntary execution of a judicial decision that has become final and the date of issue of the credit note, with respect to the tax that should have been reimbursed by a judicial decision that has become final, interest on arrears are due at a rate equivalent to twice the rate of arrears interest defined in the general tax law for debts to the State and other public entities."

In the case in hand, there is payment of unduly paid tax as to the parts of the self-assessment in which the request for arbitral pronouncement succeeds.

Of the various situations in which compensatory interest is due as indicated in Article 43 of the General Tax Law, such interest will be due if it is understood that error attributable to the services occurred.

In the case in question, the taxes unduly paid were self-assessed, and therefore the Tax Authority and Customs Authority had no involvement in the practice of the act on which the payment was based, it being the Claimant itself to which the practice of the same is attributable.

Therefore, as to the act of self-assessment, error attributable to the services did not occur, and there is therefore no entitlement to compensatory interest derived from its practice.

However, the same does not apply to the decision on the gracious claim, as the Claimant's claim should have been allowed as to the illegality of the self-assessment, and the non-allowance of the claims is attributable to the Tax Authority and Customs Authority.

This case of the Tax Authority and Customs Authority maintaining a situation of illegality, when it should restore it, should be framed, by mere declarative interpretation, within no. 1 of Article 43 of the General Tax Law, as it is a situation in which there is an adequate causal nexus between an error attributable to the services and the maintenance of an unduly paid amount, and the omission to restore legality when the action that would restore it should be taken should be equated with the action. ( [7] )

In the case in hand, the gracious claim was submitted on 21-05-2014, and therefore the deadline for decision ended on 21-09-2014 (Article 57, no. 1 of the General Tax Law).

For what has been stated, it should be understood that, from the moment in which the deadline for decision on the gracious claim is completed, compensatory interest begins to run.

Compensatory interest will be calculated at the legal rate and paid in the terms of Articles 43, nos. 1, and 35, no. 10 of the General Tax Law, of Article 24, no. 1 of the RJAT, of Article 61, nos. 3 and 4 of the Code of Tax Procedure and Process, of Article 559 of the Civil Code and Order No. 291/2003, of 8 April (or other orders that may change the legal rate).

5. Decision

In accordance with the foregoing, the arbitrators agree in this Arbitral Tribunal to:

a) Hold the request for arbitral pronouncement to be allowable as to the claim for declaration of illegality of the order dismissing the gracious claim issued on 31 December 2014 by the Deputy Director of Finance of the Finance Directorate of Lisbon as to the partial illegality of the self-assessment of Corporate Income Tax (and consequent municipal surcharge) of fiscal group AA... for fiscal year 2011, with respect to the amount of € 242,123.28;

b) Annul the said order dismissing;

c) Annul the self-assessment, in the part relating to adjustments resulting from the application of fair value, with respect to the amount of € 242,123.28 of Corporate Income Tax and consequent municipal surcharge;

d) Condemn the Tax Authority and Customs Authority to pay to the Claimant the sum of € 242,123.28, plus compensatory interest, counted from 22-09-2014, at the legal subsidiary rate, until full reimbursement of the amount referred to.

6. Value of the Case

In accordance with the provision in Article 306, no. 2 of the Code of Civil Procedure and 97-A, no. 1, subparagraph a) of the Code of Tax Procedure and Process and 3, no. 2 of the Regulations on Costs in Tax Arbitration Proceedings, the case is assigned a value of € 242,123.28.

7. Costs

Pursuant to Article 22, no. 4 of the RJAT, the amount of costs is fixed at € 4,284.00, in accordance with Table I annexed to the Regulations on Costs in Tax Arbitration Proceedings, to be borne by the Tax Authority and Customs Authority.

Lisbon, 25 September 2015

The Arbitrators

(Jorge Manuel Lopes de Sousa)

(José Ramos Alexandre)

(Luísa Anacoreta)