IRC Tax Deductibility of Interest Charges Under Article 23 CIRC – CAAD Arbitration 209/2016-T

ARBITRAL DECISION

Claimant: A…, SA

Respondent: Tax and Customs Authority

I – REPORT

A) The Parties and Constitution of the Arbitral Tribunal

1. A…, SA, collective entity no. …, with registered office at Rua …, no. …/... …-… …, hereinafter referred to as "Claimant", filed a request for the constitution of an Arbitral Tribunal, pursuant to the provisions of paragraph a) of no. 1 of article 2, no. 1, paragraph a), article 3, no. 1, article 6, no. 1 and article 10, no. 1, paragraph a), of Decree-Law no. 10/2011, of 20 January, hereinafter referred to as "RJAT", to challenge the additional Corporate Income Tax (IRC) assessment no. 2015…, relating to the fiscal year 2011, with the Tax and Customs Authority hereinafter referred to as "AT" as the Respondent. The Claimant seeks the declaration of illegality of the additional IRC assessment and the corresponding interest accrual, relating to the year 2011, with the consequent annulment.

2. The request for constitution of the arbitral tribunal was accepted by the President of CAAD on 05-04-2016 and subsequently notified to the Tax and Customs Authority. In accordance with the provisions of paragraph a) of no. 2 of article 6 and paragraph b) of no. 1 of article 11 of the RJAT, as amended by article 228 of Law no. 66-B/2012, of 31 December, the Deontological Council appointed the undersigned on 02-06-2016 as arbitrator to serve on the sole arbitral tribunal. The parties were immediately notified of this appointment and expressed no wish to refuse the appointment of the designated arbitrators, in accordance with the combined provisions of article 11, no. 1, paragraphs a) and b) of the RJAT and articles 6 and 7 of the Deontological Code.

Thus, in compliance with the provision of paragraph c) of no. 1 of article 11 of the RJAT, as amended by article 228 of Law no. 66-B/2012, of 31 December, the sole arbitral tribunal was constituted on 20-06-2016. On 25-06-2016 an arbitral order was issued and the AT was notified to present its response within the legal deadline.

1. The Tax and Customs Authority responded on 14-09-2016, contested the arbitral request, arguing that it should be judged unfounded, in the terms and with the grounds set forth in the Response, attached to the case file, and which is hereby fully reproduced.

No exceptions were raised nor was witness testimony requested, and the questions to be decided by the tribunal are exclusively matters of law. On 26-10-2016, an arbitral order was issued dispensing with the meeting provided for in article 18 of the RJAT and a deadline was set for the parties to present, if they wished, written submissions. A deadline was also set for issuing the decision by 15 December 2016, subsequently extended to 19 December.

The parties did not submit written submissions.

The Claimant paid the subsequent arbitration fee.

B) PROCEDURAL REQUIREMENTS:

1. The arbitral tribunal was regularly constituted. The parties have legal personality and capacity, are legitimate and are represented (articles 4 and 10, no. 2, of the same statute and article 1 of Ordinance no. 112-A/2011, of 22 March). The proceedings do not suffer from any nullities that prevent examination of the merits of the case.

It is appropriate to examine and decide on the merits of the request.

II. Factual Matters

A) Proven Facts

1. Based on the elements contained in the case file, the following relevant facts are considered proven for the examination of the merits of the case:

a) The Claimant A…, SA is a joint-stock company. With registered office at Rua …, …/…, in …, and is registered in the Commercial Registry of …;

b) Its business activity is dedicated to the design, production and distribution of all types of hydraulic and industrial hoses, connections, transmission belts and other hydraulic and industrial components and is classified, for VAT purposes, under the normal scheme with monthly periodicity, registered with CAE …;

c) The Claimant began its operations on 17/05/1977 and carries out its business in various countries around the world, as a result of its internationalization, integrating group B…, together with companies C…, D…, E…, F…, G…, H…, I…, J…, K…; L…, M… and N…, local companies, totally autonomous, created in each of these countries in accordance with their respective legal systems;

d) In the Claimant's accounting, in the fiscal year 2011, there were customer current account balances, resulting from sales effected, with different payment terms and different actual average collection times;

e) Among its customers with the largest volume of business, several companies of group B…, headquartered in foreign territories, stand out, such as C…, among others;

f) By Service Order no. O12014…, an inspection action was ordered in the name of the Claimant, for the period of 2011, on the grounds of monitoring the declarative obligations of taxpayers who made cross-border transfers to destinations with privileged tax regimes;

g) In the period in question (2011), the Claimant made several transfers of amounts exceeding 12,500.00 to Hong Kong, which the Claimant confirmed and justified before the Tax Inspection, which concluded that these were exclusively payments for the supply of goods to the company, and detected no discrepancies, as shown in the Inspection Report attached to the case file, which is hereby reproduced;

h) The inspection action began on 2015-06-30, with partial scope, in the area of IRC, which became general by letter of 2015/…/…, in accordance with the provisions of paragraph a) of article 15 of the RCPITA;

i) On 2015/10/16 the inspection proceedings were concluded;

j) By Letter no. …/…, of 26-10-2015, the Claimant was notified of the draft Tax Inspection Report (RIT), and of the deadline to exercise the right to a hearing, in accordance with the provisions of article 60 of the RCPIT;

k) The Claimant exercised its right to a hearing, as appears in a document attached to the present arbitral request, which is hereby reproduced;

l) The final RIT maintained all the conclusions contained in the draft Report;

m) The inspection proceedings resulted in the following corrections unfavorable to the Claimant:

i) Correction in the amount of €31,371.94, relating to an oversight in duplicate accounting of an invoice, in the amount of €7,000.00, and the remainder relating to gifts to customers, not properly documented and/or considered in duplicate;

ii) Correction in the amount of €63,808.61, resulting from the fiscal disallowance of this expense, which the AT considered to be financing borne by the Claimant.

n) The RIT proposed the following purely arithmetic corrections shown in the table and in the Note on Determination of Taxable Matter for IRC purposes for 2011, transcribed below:

"CONCLUSIONS OF THE INSPECTION ACTION

III.1 Technical Corrections — Taxable Matter for IRC — Duplicate Invoice - €7,000.00

III.1 Technical Corrections — Taxable Matter for IRC — Gifts to customers - €24,371.94

III.2 Technical Corrections — Taxable Matter for IRC – Interest - €63,808.81

TOTAL - €95,180.55

Note on Determination of IRC:

"2 - Determination of Taxable Matter:"

Taxable Profit Declared in the Fiscal Year ……………………………… € 838,610.81

Purely Arithmetic Corrections ……………………………………………… € 95,180.55

Corrected Taxable Profit …………………………………………………….. € 933,791.36

Taxable Matter ……………………………………………………………………… € 933,791.36

o) The subject matter of the present arbitral proceedings relates only to the correction mentioned in k), (ii), in the amount of €63,808.61 (point III.2 Summary table of inspection action conclusions above);

p) The value of this correction corresponds to costs incurred with interest on loans contracted with various banking entities, to meet the Claimant's treasury needs, which the Inspection disallowed for purposes of determining the taxable matter for IRC purposes - 2011;

q) Following the corrections identified, a Statement of Account Reconciliation and the corresponding IRC and interest assessment were issued, both challenged herein.

B) Unproven Facts

1. There are no facts relevant to the examination of the merits of the case that are considered unproven.

C) Justification for the Determination of Factual Matters

1. The proven facts are based on documents attached to the case file by the Claimant and attached to the case file, accepted by the Respondent, so there remain no disputed facts. There is no divergence between the parties regarding the facts mentioned in the case file, but exclusively regarding the legal issue underlying the disputed assessment. It should be noted that the factual matter on which the Tribunal has the duty to pronounce is not all that was alleged and proven, but only that considered relevant or with interest or relevance to the decision (See articles 591, 592, 596 and 607 of the CPC and 123-2 of the CPPT, applicable by virtue of article 29 of the RJAT).

III - Legal Matters

1. It is evident from the case file, as can be seen from the summary of the factual matters stated and from the Report, that the Claimant and the Respondent diverge only on the question of whether the Claimant should be admitted to the right to deduct the costs incurred with interest on bank loans, to meet treasury needs, recorded in the accounts. These costs were disallowed by the AT, for IRC purposes, with the arguments contained in the RIT found attached to the case file as document no. 5 attached to the PA and which is hereby reproduced. In summary, the inspection concluded that the aforementioned financial costs arising from loans contracted by the Claimant were intended to finance the companies of the group, headquartered in foreign territories. The respondent (AT) ratified the decision proposed by the inspection and, accordingly, made the corresponding correction and issued the disputed IRC assessment in the case file.

2. From the AT's perspective, the Claimant has no right to deduct the amounts incurred with interest on bank loans contracted, given that it believes that these costs only occurred because the Claimant granted very extended payment terms to the group companies headquartered abroad. Although, as emerges from the analysis of the Report and the Response that the AT attached to this case file, the companies in question are local companies, with their own legal personality, autonomous and subject to the rules in force in their respective countries and not all presented current account balances in the fiscal year in question.

Thus, the legal issue under examination is whether the AT's position is correct when in the Report that justified the additional IRC assessment challenged here, it concluded that:

"(…) the taxpayer financed free of charge the companies C…, D…, F… and N…, and it is true that the taxpayer needed to meet its treasury needs."

In the AT's view, the financial charges incurred with the loans contracted by the Claimant in the period in question (2011) are related to obtaining credit for the purpose of financing the group companies, so that, despite the management authority attributed to the companies, the taxpayer may assume the commitments based on the group, such situation must be recorded in accounting, but disallowed for purposes of determining taxable profit.

Let us, therefore, examine whether the interpretation that the AT made is or is not in accordance with the applicable legal provisions contained in the IRC Code, in particular those resulting from article 23 of the IRC Code.

1. In the present case, the issue to be decided centers on whether the additional IRC assessment, resulting from the corrections to taxable profit made, as a consequence of the disallowance as a tax deduction of the financial costs with loans, in the amount of €63,808.61. Thus, the issue to be decided is whether, in light of the provisions of article 23 of the IRC Code, the costs incurred with loans contracted by the company in a given fiscal year, to meet treasury needs, are or are not deductible for purposes of determining taxable profit for IRC purposes.

Having delimited the issue to be decided, it is important to note that the Tribunal is not obliged to analyze all the legal arguments raised by the parties in their pleadings and/or submissions, but only must analyze and decide the issues raised in the cause of action and in the requests. Therefore, the essential issue that must be examined is whether the indebtedness contracted by the Claimant to meet its treasury needs was or was not exclusively determined by the need to finance the group companies, or whether its necessity was determined indistinctly by the need to finance its commercial activity, due to the payment terms granted to its suppliers in general, among which are the group companies headquartered abroad, with which the Claimant maintains regular commercial relations.

Arising from the essential issue under examination is the question of whether what is truly at issue is the financing of the group companies or the financing of the economic activity of the Respondent, due to the commercial credits it holds over suppliers to whom it grants various and relatively deferred payment terms.

1. Putting the issue in these terms, let us examine whether the Respondent's thesis, which led it to disallow these costs, is properly substantiated. It is important to note that it is incumbent on the AT to demonstrate that the loans contracted were intended exclusively and specifically for the financing of the group companies headquartered abroad. This conclusion contained in the Tax Inspection Report (RIT), which is at the origin of the disputed assessment, must be properly substantiated, in fact and in law, in order to guarantee the legality of the act performed and challenged here.

According to the applicable legal rules on the burden of proof, it is incumbent on the AT to demonstrate the factual basis on which it supports its final conclusion and the consequent fiscal correction and additional tax assessment. This principle is established in the LGT, in articles 74 and 75, which refer, respectively, to the burden of proof and the presumption of truthfulness of the taxpayer's declaration and other elements.

It remains, therefore, to decide whether the challenged act complies or does not comply with the law, in particular the regime of deductibility of tax costs contained in article 23 of the IRC Code.

1. In the present case, the substance or reality evidenced by the analysis described in the RIT, constructed from the inspection of the Respondent's accounting, points to the financing obtained by A… SA from various credit institutions, which the IT describes and analyzes in detail. It should be noted that no irregularities or inaccuracies were detected by the inspection. The oversights or corrections determined in point III.1 of the report were recognized and accepted by the Claimant.

As for the financing of the company, there is no doubt that it had the purpose of meeting treasury needs, as results from the RIT itself. What the Respondent questions is its necessity and justification, by considering that the Claimant only needed such financing because it grants very extended payment terms to its customers, exceeding what it considers normal and what appears in the invoices. Now, by following this reasoning, the AT is "judging" the Claimant's management criteria, namely, as regards its policy of payment terms granted to customers, all of them including group companies, which it is legally not empowered to do.

It should be noted that it results from the proven factual matters that the Claimant has various commercial credits over suppliers (external to the group and five group companies) to which it grants deferred payment terms, in many cases exceeding 90 days. And, regardless of the term appearing in the invoice, it also happens, as is normal in any economic activity, that the actual collection period exceeds the term fixed in the invoice. In fact, not all customers comply with the payment terms set out in the invoices, which is a notorious fact in economic life.

Furthermore, the fiscal year 2011 corresponded to one of the worst economic years ever, in Portugal and in the world, so it is not surprising that companies had to tolerate longer collection periods in order to sell their products. To all this, the RIT was totally oblivious, limiting itself to concluding that the loans contracted were intended for the free financing of five group companies, although without demonstrating a direct and evident causal link between the amounts of loans contracted and the amounts of commercial credits of the said group companies.

1. The factuality contained in the RIT that serves as the basis for the disputed assessment, namely in tables 10 and 11, demonstrates precisely the opposite, as the current account balances of the five group companies, accumulated over the period, are totally different from the amounts of loans contracted, and it is not even possible to establish any causal link between one thing and the other, which would support the Report's conclusion. The volume of financing obtained from the banking entities mentioned in the RIT shows that the funds thus obtained were intended to finance the company's economic activity, either to finance treasury, allowing sufficient liquidity to provide attractive payment conditions for its customers, or for other purposes or charges of the company, from personnel charges, taxes, investment, and others, everything can be financed with the company's funds obtained from the Banks. It is not possible to establish a direct relationship between the financing obtained and the current account balances of the group companies, nor did the AT make any effort to demonstrate this, limiting itself to drawing a conclusion.

Therefore, it is necessary to conclude that we are dealing with financing of the company's economic activity.

1. Nevertheless, it is true that among the total commercial credits of the Claimant, resulting from sales made, there are some over five companies of group B…, located in foreign territories, with which A… has regular commercial relations. We are, as the AT acknowledges, dealing with commercial credits resulting from the economic activity developed by the Claimant, possibly subject to a longer average collection time than that granted to other customers, but identical to that granted to some customers, which do not belong to the group, but are of great importance to the company.

Thus, the conclusion contained in the RIT on the issue of financing the group companies is not accompanied by full and unequivocal demonstration that this financing was something foreign to the company's economic activity. On the other hand, the balance of the current account with customers of group B…, throughout the fiscal year, according to the values contained in the RIT (table 10), was always much higher than the amounts of loans outstanding. By way of example only, in December 2011, the total balance of credits over customers of group B… was €3,918,250.20, the assets totaled more than €9,000,000.00 (nine million euros) and the total balance of loans contracted was €1,700,000.00. It is not clear, therefore, how the conclusion contained in the report can be sustained, which led to the disallowance of the tax costs resulting from the payment of interest on loans.

In the RIT it is possible to discern the current account balances between A… and some of the companies of the Group located in Brazil, Peru, Chile, Middle East and Colombia, resulting from the different commercial credits arising from transactions between these group companies (see Table 10 - page 15 of the RIT – monthly balances of current accounts).

In Table 11, appearing on page 16 of the RIT, the amounts of bank indebtedness of A… are described, discriminating the amounts by months and banking institutions. And, immediately, without further consideration, the inspection concludes that: "it was then determined that the taxpayer financed free of charge the companies C…, D…, E…, F… and N…, and it is certain that the taxpayer needed to resort to bank indebtedness to meet its inherent treasury needs."

In fact, from the information contained in the RIT and, in particular, the total values summarized in the two Tables mentioned above, we can conclude that the total current account balances with the five group companies in question are variable monthly, ranging from 1,888,065.01 in April 2011 to 3,918,250.20 in December, with considerable fluctuations from company to company and from month to month. This evidences a typical current account balance associated with commercial transactions between the companies mentioned. From Table 11, relating to the loans contracted by A…, we conclude that its total value (with all credit institutions) ranges between €972,543.74 corresponding to the month of April, €1,998,107.02 in November and €1,700,000.00 in December 2011. Now, although the amount owed by companies B… in December 2011 was quite high (higher than what occurred in previous months), the value of loans from the Bank even decreased compared to the previous months, which indicates the opposite of what was concluded by the AT.

The truth is that the RIT contains no other information about these numbers, which makes it impossible to establish any causal nexus between the financing obtained and the current account balances of customers. It is known that the financing needs of companies are diverse and the loans contracted by companies can be intended for various purposes, including the payment of any company liabilities, including the payment of social charges, taxes and others. The connection established by the Respondent between the financing obtained and the current account balances with the group companies is not understood. As the Claimant rightly states, "if at the end of the 2011 balance sheet the assets totaled more than 9 million euros, how can it be claimed that the bank indebtedness was exclusively determined by the need to finance the debts of B… customers, when these credits, in December 2011, did not reach 4 million euros?" (see art. 55 of the arbitral request).

One final note, to emphasize that the numbers presented in table 10 and those contained in table 11 do not allow the Tribunal to establish an evident or probable causal relationship between the current account balances with the group companies and the resort to bank loans, given the disparity of values, which means that they may have various possible justifications and different from the one intended by the Inspection. Nothing is said about the origin, its connection with the reality underlying the company's activity, what specific commercial transactions were entered into between the applicant and the group companies with current account balances (note that this situation relates only to some group companies), at what prices and on what payment terms they concretely occurred, case by case, in order to be able to draw some substantiated and valid conclusion from the numbers it presents in the respective Tables. It does not appear from the RIT that any analysis was conducted of the concrete conditions under which such transactions may have occurred, despite the provisions of article 63 of the IRC Code on transfer pricing. No other connection is evidenced that would allow the conclusion that the indebtedness of company A… originated exclusively from the fact that there were those current account balances with the group companies.

1. The Respondent, faced with the Claimant's arguments in the exercise of the right to a hearing, attempted to demonstrate that there is a favoring of the group companies in terms of the term granted for payment of the invoices. But the analysis focuses essentially on the term appearing in the description of the invoices of the customers in question and not properly on the analysis of the actual collection period. The calculation technique used to determine the average collection period is confusing and does not properly consider the relevant periods for each customer under analysis, which depend, naturally, on their size, relative importance to the requesting company, the volume of business conducted, given that all these constraints interfere with the concrete negotiating conditions of each contract and the payment period granted to each customer.

From the analysis resulting from the final part of the RIT, regarding other customers with current account balances (a matter that was only analyzed because the Claimant raised it in the exercise of the right to a hearing), it is possible to conclude that:

• many other customers not belonging to the group benefited from deferred payment terms for the invoices;

• the terms are differentiated from customer to customer depending on the volume of sales invoiced;

• among the five group companies, we find differentiated payment terms, with the most generous applied to C…, which is one of the largest customers in absolute terms of the company.

Once again, it is not clear how this factuality can lead the AT to the decision contained in the RIT, which led it to the disputed assessment. To which is added that the law does not confer on the AT the power to interfere in the management of the company's business, as results from the final conclusion of the RIT:

"Nevertheless, while we are dealing with intra-group commercial credits, it is a matter of the free financing by the taxpayer of the companies that are part of Group B…, due to the fact that there is a group relationship and total control by A…, embodied in operations with companies with which it is in a situation of special relationships and with respect to which it has a more favorable collection policy than that practiced with the remaining customers.

Thus, it results from the factuality given as proven that the taxpayer recorded, in the period of 2011, as a tax expense, the financial charges with interest and stamp duty, derived from the obtaining of bank financing, whose necessity arises from the fact of not receiving within the stipulated terms, the credits it has over the group companies, with the taxpayer bearing entirely the said charges, since it did not debit them to the beneficiary companies.

The taxpayer's treasury management was thus prejudiced by the expansion of the collection terms of the invoices issued to the Group B… companies in contrast with the payment terms and advances practiced with respect to the 2 main suppliers.

Now, this deficient treasury management of the taxpayer, resulted, as was reported above, in the need to resort to bank indebtedness, incurring financial charges, whose indispensability and connection with the activity of the taxpayer is not sufficiently demonstrated in light of the provisions of article 23° of the IRC Code.

In view of the foregoing, the total expenses identified in table 8, totaling €63,808.61, should not contribute to the determination of taxable profit for IRC purposes."

1. On the plane of strict legality to which the AT's actions are bound, the question of assessing the admissibility or not of deductible costs from taxable profit relates to the question of the indispensability of costs for purposes of the provisions of article 23 of the IRC Code, assessed by the connection with the normal activity of the tax subject. We are within the scope of the application of the rules for determining the taxable matter, strictly bound by law, despite the resort to the indeterminate concept of "indispensability".

Now, article 23, no. 1, of the IRC Code provides, (as worded in 2011), in the part that is relevant for deciding the issue:

Article 23

"1 - Costs or losses are considered as those that are demonstrably indispensable for the realization of profits or gains subject to tax or for the maintenance of the productive source, in particular the following:

a) Charges relating to the production or acquisition of any goods or services, such as materials used, labor, energy and other general manufacturing, preservation and repair expenses;

b) Distribution and sales charges, covering transport, advertising and placement of goods;

c) Charges of a financial nature, such as interest on third-party capital applied in the operation, discounts, premiums, transfers, exchange differences, expenses with credit operations, debt collection and issuance of shares, bonds and other securities and redemption premiums;

d) Charges of an administrative nature, such as remuneration, allowances, pensions or retirement supplements, current consumption material, transport and communications, rents, litigation, insurance, including life insurance and operations in the "Life" branch, contributions to retirement savings funds, contributions to pension funds and to any complementary social security schemes;

(…)"

From this it follows that, in order for a given expense of a collective entity to be deductible for IRC purposes, two legal requirements must be met, namely: the verification of that expense and its indispensability for the exercise of the collective entity's activity.

The disallowance of expenses incurred with the activity and recorded in the accounts imposes on the AT the burden of proving the factual and legal requirements that, in light of the law in force, allow such disallowance.

As António Moura Portugal rightly states on this point: "the deductibility or acceptance of costs contained in the balance sheet ceased to be a matter of fact and becomes a matter of law, with repercussions at the level of the burden of proof, which ceases to be the responsibility of the taxpayer. (…) The legal solution of acceptance of the tax subject's accounting provides the taxpayer's records with a presumption of truthfulness, in the sense that it is accepted that this information reflects a faithful and true picture of the company's financial situation, transferring the burden of proof of the inconsistency or falsity of this information as a faithful representation to the Tax Authority.[1]

According to the jurisprudence of the higher courts, as well as arbitral jurisprudence, the requirement of indispensability of expenses for the realization of income subject to tax or for the maintenance of the productive source, established by article 23 of the Corporate Income Tax Code, must be assessed based on its contribution to obtaining profits, that is, to the realization of the collective entity's corporate purpose.

Thus, the Supreme Administrative Court has been declaring, as regards the meaning and functioning of the requirement of indispensability of costs for tax purposes, that the requirement of indispensability of a cost must be interpreted as an indeterminate concept, requiring case-by-case application, as a result of an analysis from a business economic perspective, in the perception of an economic causal relationship between the assumption of a cost and its realization in the interest of the company, in view of the corporate purpose of the collective entity in question.[2]

Also in accordance with STA jurisprudence, expressed in numerous Judgments, indispensable costs are, therefore, equivalent to costs incurred in the interest of the company, or in other words, all those that present a causal relationship with the obtaining of the company's profits. The "indispensable" cost is equivalent to every cost incurred for the obtaining of profits. As a rule, therefore, tax deductibility depends only on a causal and justified relationship with the company's productive activity.

In other words, only costs that have no causal and justified relationship with the company's productive activity will not be indispensable. In the present case, as we have already seen, the costs in question present a causal and justified relationship with the company's activity, since they are intended to finance its activity and the AT did not demonstrate that the destination or purpose of those funds was otherwise. A causal nexus was not even demonstrated between the resort to loans and the amounts of sales made to the group companies, due to the fact that they benefited from deferred payment terms, similar to what occurs with other customers of the company.

1. This is the understanding that has been followed by the Tax Dispute Section of the Supreme Administrative Court[3], which has admitted that "the indispensability between costs and profits must be assessed on the basis of a positive judgment of subsumption in corporate activity: indispensable costs are equivalent to expenses incurred in the interest of the company". It is not a matter of "judging" the good or bad management developed in the company, but of objectively determining whether the costs incurred were or were not incurred in the interest of the company and its business.

As is also stated in STA Judgment no. 164/12, of 4-9-2013, "we can today consider accepted by doctrine and jurisprudence a concept of indispensability that, moving definitively away from the idea of causality between expenses and income, places the emphasis on the relationship of expenses with the activity pursued by the tax subject, that is, considering that the said concept of indispensability is verified whenever expenses are incurred in the interest of the company, in the pursuit of its respective activities".

Also on this matter, the Northern Court of Appeals, by Judgment of 14/3/2013, considers that the solution adopted among us points to the fact that "this requirement of indispensability of costs for the realization of profits or maintenance of the productive source was «initially associated with a condition of "reasonableness" (article 26° of the former CCI)» and that if it is true that «"reasonableness" is present in some provisions of the IRC Code, expressly (23°), … it became intolerable to use it as a basis for quantitatively limiting the charges incurred by tax subjects. (…) Indispensability must thus be assessed on the basis of a positive judgment of subsumption in corporate activity, which, by nature, should not be scrutinized by Tax Law, which should not interfere, much less evaluate the taxpayer's business decisions. Only this conception is in accordance with the principles of freedom of business management and, at the same time, respects the specific interests of tax law (which are at the basis of the express limitation that is made to the deductibility of certain charges)." (emphasis ours)

This indispensability for the obtaining of profit or maintenance of the productive source can be direct or indirect (mediate).

As António Moura Portugal rightly points out, "the tax deductibility of the cost should depend only on a justified relationship with the company's productive activity", and this indispensability is verified "whenever - by operation of the theory of specialization of collective entities - corporate operations are subsumed into its capacity, by subsumption to its corporate purpose and, in particular, as long as they are connected with the obtaining of profit even if indirectly or mediately".[4]

Also Rui Duarte Morais argues that the requirement of "indispensability", as a condition of acceptance of the tax cost, cannot be referred to the nature of the charge, but rather to the circumstances in which it occurred. Thus, "if the assumption of the charge that originates the cost was presided over by a genuine business motivation - the understanding of the partners and/or managers of the company, the only ones who have the right to decide on the social interest - the cost is indispensable. When it should be concluded that the charge was determined by other motivations (personal interest of the partners, administrators, creditors, other companies in the same group, business partners, etc.), then such cost should not be considered indispensable"[5].

1. In the case at hand, we are dealing with customer credits resulting from invoiced sales that generated profits for the company. The AT has no power to interfere in the definition of payment terms granted to customers and the necessary wait for payment, which so often occurs far beyond the term appearing in the invoice, and which is a risk inherent to the activity of any company. On the other hand, in the pursuit of increasing its sales, the company cannot fail to provide its customers with conditions that allow the realization of sales, at the risk of endangering its survival and failing to secure a relevant position in the market, especially in a period of global economic crisis, with particular and dramatic impact in Portugal.

Even the granting of more generous terms to certain customers appears normal in any activity, especially depending on their size and relative importance to the company. In the case of group B… companies, this condition is understandable in light of the size of the volume of business between the companies considered and in the perspective of internationalization of the group, which justifies the resort to financing to maintain the level of sales, conquer international markets and carry out exports of high value to the company and to the national economy. On the other hand, if the AT wanted to investigate other constraints of the business established between the Claimant and the group companies, it should have resorted to the application of the regime provided for in article 63 of the IRC Code, in order to assess whether the transactions carried out complied or did not comply with the rules imposed by the transfer pricing regime. If it did not do so, certainly because it understood that it had no basis for doing so, it cannot use the avenue of article 23 of the IRC Code to disallow the costs with the financing of the company's activity, unless it proved that the motivation for the resort to these loans was otherwise, in particular the favoring of shareholders, third parties or any other purpose foreign to the company's activity.

Clearly this does not occur in the present case, even if it is admitted that the financing had, among other purposes, to supply treasury difficulties arising from the extended terms that the company grants to its customers in general and to group companies B…. Precisely because, if it chose not to provide these terms and not to sell, this would result in a loss for the company and for the State as a tax creditor. To which is added that non-receipt within the terms appearing in the invoice is not a fact attributable to the creditor, as is generally known.

What matters is that the company's interest is well evidenced in the factuality described, with no basis whatsoever to consider that motivations foreign to the interest of its company activity determined the resort to loans to meet treasury needs.

1. Given this, the AT should only disallow as tax costs those that clearly do not have the potential to generate profits or are not justified at all as maintenance of the productive source.

As is rightly stated in the arbitral judgment given in process no. 314/2015 T, of 26-04-2016: "(…) the control to be exercised by the AT on the verification of this requirement of indispensability must be by the negative, that is, the AT should only disallow as tax costs those that clearly do not have the potential to generate an increase in gains, the competent administrative agent responsible for determining the taxable matter cannot arrogate to itself the role of manager and qualify indispensability at the level of good and bad management, according to its feeling or personal sense; it is sufficient that it is an operation carried out as an act of management, without entering into the assessment of its effects, positive or negative, of the expense or charge assumed for the results of the realization of profits or for the maintenance of the productive source. (…)

That is: the rule being freedom of economic initiative and taxation of companies should fundamentally focus on their actual income (see article 104, no. 2, of the CRP), the provision of no. 1 of article 23 of the IRC Code, by limiting the relevance of costs to those "demonstrably indispensable for the realization of profits or gains subject to tax or for the maintenance of the productive source" must be understood as allowing the tax relevance of all expenses actually incurred that are potentially suitable to provide profits or gains, regardless of the result (success or failure) that they concretely provided."

The very letter of the law (no. 1 of article 23 of the IRC Code) points in that direction, as it chose the future verbal tense "will be" instead of "were". That is, the legislator expresses a perspective of future possibility of obtaining profits, well knowing that economic activity contains within itself a natural risk, particularly as regards receipts and the term in which these may occur.

Thus, this tribunal, in harmony with already consistent arbitral jurisprudence, which it adheres to, understands that "expenses that, at the time they are incurred, appear as potentially generating profits are to be considered indispensable for the realization of profits, which has as a corollary that the tax relevance of a cost can only be eliminated when it is to be concluded, in light of the rules of common experience, that it had no potential to generate profits, that is, when it is demonstrated that the act that generates the costs cannot be considered as an act of management, because it cannot be expected, with acceptable probability, that from the expense incurred a profit may result". - See Arbitral Judgment of 15 June 2012, of CAAD, given in process no. 29/2012-T.

1. Returning to the present case, it is important to emphasize that, for the judgment of indispensability of the costs of financing the Claimant's treasury, it suffices that there exist an economic causal relationship between the assumption of the cost (financial charges derived from loans) and the realization in the interest of the Claimant company (providing more sales, facilitating longer payment terms). The business interest that is assessed is that of the company itself that deducts the cost for tax purposes, the same being to say that the costs provided for in article 23 of the IRC Code must respect the company itself.

Now, in the case at hand, the aforementioned current account balances originate in transactions (sales and supplies) that occurred with the Claimant's customers, among which are several companies of group B… located outside Portugal, which are part of the same group, but all are constituted with complete autonomy and are independent collective entities, constituted in accordance with the rules of the respective countries where they were founded. What unites them is the fact that they belong to the same industry, the same economic group and certainly share commercial interests in the production and commercialization of their products, which justifies and legitimizes the commercial transactions between them that occurred. As for the fact that these are commercial credits, there is no doubt whatsoever, as it is the Respondent itself that admits it, when it describes the balances of the current accounts and when, further on, it refers to the average collection time of the respective invoices, after being called upon to make the rebuttal with the Claimant's arguments in the exercise of the prior hearing.

1. In disallowing the costs with the financing contracted with various banking entities by A… Portugal, with the argument (fragile and inconsistent) that these treasury financing needs were determined by the fact of granting an extended time for payment of the respective invoices to the group companies, the AT decided with manifest error as to the factual and legal requirements underlying. The conclusion that the loans contracted were intended to finance the group companies is not demonstrated and is totally foreign to the very factuality resulting from the RIT.

Now, this tribunal cannot discern the basis on which such a connection could be established. Neither in fact nor in law do we find justification or basis for such an original interpretation of the numbers that the Inspection itself analyzes, because if these financing operations were determined exclusively by the need to grant more extended terms to the group companies for payment of the respective invoices, then the values contained in Tables 10 and 11 contained in the RIT would be approximate, consistent with the credits of the group companies, so as to reveal this relationship. Now, this is clearly not evidenced.

The law is clear and leads to a conclusion very different from that sustained by the Respondent. Regardless of the current account balances with the group companies (some of them), of the average collection term of the amounts invoiced to customers (whether of the group or not), the AT did not demonstrate that the financing obtained by the Claimant from banking entities was intended for any purpose other than that connected with the activity developed by the Claimant. This is because, as the AT itself acknowledges, the current account balances with customers result from commercial credits (sales) of goods produced by the Claimant company. Therefore, the connection with the activity and the indispensability of the costs are demonstrated.

1. As already explained above, expenses that, at the time they are incurred, appear as potentially generating profits are to be considered indispensable. Now, certainly, it is not because a commercial transaction is carried out between two companies of the same group that this transaction becomes, without more, bereft of the possibility of generating profits. This would lead, in the extreme, to the defense of the non-existence of any legitimate economic interest in the constitution of economic groups. Moreover, these transactions are not even at issue, but rather an alleged indebtedness to finance the group companies, which is not proven.

It is certain that, at no time is it alleged that the commercial transactions in question, between the group B… companies, did not generate profits for company A…. Now, the treasury needs supplied by the resort to loans provided, among other things, the possibility of offering good payment conditions to the largest customers, in order to allow the realization of these and many other sales, as well as will have provided the financing of many other company needs. Therefore, they were intended for the financing of its activity.

In fact, when we reflect on the financing of the company now Claimant, its volume of invoicing, the profits generated, the taxes paid and the current account balances evidenced in the RIT, we cannot establish a causal nexus between the loans to meet treasury needs and the intention of indirect financing of the five group companies mentioned there. It was incumbent on the AT to demonstrate this causal nexus, which did not occur.

It is not apparent that any direct or indirect financing of the group companies has occurred, as alleged by the AT.

1. In conclusion, not having been demonstrated that the Claimant's resort to financing had any purpose other than to meet treasury needs arising from the Claimant's normal activity, it is concluded that these are normal operations related to the economic activity of the Claimant.

Thus, both because the disallowance of the costs with financing of the Claimant's treasury is not properly substantiated, nor demonstrated the condition invoked regarding the alleged financing of the group companies, the purely arithmetic corrections made and which generated the correction to the 2011 IRC assessment appear to be illegal for violation of the factual and legal requirements that, in accordance with the provisions of article 23 of the IRC Code, permit the deduction of costs indispensable for the realization of the Claimant's economic activity.

Being so, it is necessary to conclude that the disputed assessment is illegal, for violation of law, and consequent error in the qualification and quantification of the taxable matter for IRC purposes, so that its annulment is necessary with all legal consequences.

V - Decision

Accordingly, this arbitral tribunal decides as follows:

a) To judge the arbitral request submitted by the Claimant as well-founded and to declare the illegality of the disputed assessment act and the corresponding statement of interest accrual;

b) In accordance with this decision, the disputed assessment should be annulled, with the legal consequences, in particular, the correct values should be determined, for IRC purposes for the year 2011, after consideration of the value of the arithmetic correction improperly processed, with the corresponding account reconciliation and the determined value returned to the Claimant.

c) To order the Respondent to pay the costs of the proceedings.

VALUE OF THE PROCEEDINGS

The value of the proceedings is fixed at €19,312.28 in accordance with article 97-A, no. 1, a), of the CPPT, applicable by virtue of paragraphs a) and b) of no. 1 of article 29 of the RJAT and no. 2 of article 3 of the Regulation of Costs in Tax Arbitration Proceedings.

COSTS

The arbitration fee is fixed at €1,224.00, in accordance with Table I of the Regulation of Costs in Tax Arbitration Proceedings, to be paid by the unsuccessful party, in accordance with articles 12, no. 2, and 22, no. 4, both of the RJAT, and article 4, no. 4, of the cited Regulation.

Lisbon, 16 December 2016

Let it be notified.

The sole arbitral tribunal,

(Maria do Rosário Anjos)

[1] Moura Portugal, A. (2004) "The Deductibility of Costs in Portuguese Tax Jurisprudence", Coimbra Editor, pgs. 171 et seq.

[2] On this matter, see STA Judgments of 15 June 2011 and 29 March 2006. In the same sense, see Judgment of the Northern Court of Appeals of 16 October 2014. All available at www.dgsi.pt.

[3] On this matter, see among others, Judgment of STA of 30 November 2011, at www.dgsi.pt.

[4] See Moura Portugal, A., above cited work, 113 et seq.

[5] See Duarte Morais, R. (2007) Notes on IRC, Almedina, Coimbra, pág. 87 et seq.