IRC Cost Deductibility: CAAD Arbitration on Additional Tax Assessment (Case 221/2013-T)

Case No. 221/2013-T

The arbitrators Dr. Jorge Manuel Lopes de Sousa (arbitrator-president), Dr. Paulo Lourenço and Prof. Doctor Jorge Júlio Landeiro de Vaz, appointed by the Deontological Council of the Administrative Arbitration Centre to form the Arbitral Tribunal, constituted on 14-11-2013, agree as follows:

1. Report

A… – HOLDING, SOCIEDADE GESTORA DE PARTICIPAÇÕES SOCIAIS, S.A. NIPC, filed a request for constitution of the collective arbitral tribunal, pursuant to the combined provisions of articles 2nd and 10th of Decree-Law No. 10/2011, of 20 January (Legal Regime of Arbitration in Tax Matters, hereinafter referred to only as RJAT), in which the TAX AUTHORITY AND CUSTOMS AUTHORITY is the Respondent, with a view to the declaration of illegality of the additional corporate income tax assessment No. 2010 …, in the amount of € 170,470.28, relating to the year 2008, and of the assessment of compensatory interest No. 2010 …, in the amount of € 6,090.22 (total amount of € 176,560.50).

The request for constitution of the arbitral tribunal was accepted by the President of the CAAD and automatically notified to the Tax Authority and Customs Authority on 17-09-2013.

Pursuant to the provisions of paragraph a) of No. 2 of article 6th and of paragraph b) of No. 1 of article 11th of the RJAT, in the wording introduced by article 228th of Law No. 66-B/2012, of 31 December, the Deontological Council appointed as arbitrators of the collective arbitral tribunal Counsellor Jorge Lopes de Sousa, Dr. Paulo Lourenço and Prof. Doctor Jorge Júlio Landeiro de Vaz, who communicated acceptance of the assignment within the applicable period.

On 30-10-2013 the parties were duly notified of that appointment, and did not manifest a will to refuse the appointment of the arbitrators, pursuant to the combined provisions of article 11th, No. 1, paragraphs a) and b) of the RJAT and of articles 6th and 7th of the Deontological Code.

Thus, in accordance with the provisions of paragraph c) of No. 1 of article 11th of the RJAT, in the wording introduced by article 228th of Law No. 66-B/2012, of 31 December, the collective arbitral tribunal was constituted on 14-11-2013.

The Tax Authority and Customs Authority filed a response.

By ruling of 3-2-2014, the meeting provided for in article 18th, No. 1, of the RJAT was dispensed with and the notification of the Parties for optional simultaneous written submissions was ordered, within a period of 10 days.

The Parties filed submissions.

The arbitral tribunal was duly constituted and is competent.

The parties possess legal personality and capacity and are legitimate (arts. 4th and 10th, No. 2, of the same statute and art. 1st of Ordinance No. 112-A/2011, of 22 March).

The proceedings do not suffer from any nullities and no exceptions have been raised or any obstacle to the consideration of the merits of the case is apparent.

1. Matters of Fact

2.1. Facts deemed proven

a) The Claimant acquired, in October 2007, 6,613,300 shares of the Bank (hereinafter, "B");

b) With that acquisition the Claimant bore a cost of € 18,604,449.59, increased by expenses in the amount of € 18,603.21;

c) The Claimant classified that cost in accounting in the sub-account 4113 — Financial Investments \ Equity Shares \ Other Companies;

d) In April 2008, the "B" proceeded with an increase in share capital, through the issuance of 1,083,270.433 new shares, at a nominal unit value of € 1.00 (one euro), plus an issue premium of € 0.20 (twenty cents);

e) Given the number of "B" shares that the Claimant held on that date, it was granted the right to subscribe for 1,983,754 new shares, at the unit subscription price of € 1.20 (one euro and twenty cents);

f) The Claimant only subscribed for part of those shares (numbering 183,968), at the unit price of € 1.20, having disposed of the subscription rights for the remaining shares it could subscribe for;

g) On 14 and 15 April 2008, the Claimant disposed of the subscription rights relating to 1,799,786 shares of "B", at the unit sale price of € 0.833432419, having collected the total amount of € 1,500,000.00 (one million five hundred thousand euros), that is, the Claimant disposed of the subscription rights that provided it with 6,000,000 of the shares it owned, at the unit price of € 0.25;

h) Intending the Claimant to reflect such operation and its consequences in its accounting, it experienced some doubts, which it would clarify through consultations with Mr. Dr. C… and the then president of the Accounting Normalization Commission, Mr. Dr. D…;

i) In accordance with the opinions obtained, the Claimant separated out the cost of acquisition of the subscription rights (as a component of the comprehensive cost of acquisition of the shares from which those rights derive), having determined a capital loss in accounting, corresponding to the difference between that cost and the realization value of those rights;

j) Taking into account that, during 10, 11 and 14 to 18 April 2008, both subscription rights and "B" shares without those rights were traded on the stock exchange, the Claimant determined the average quotations of both securities — € 0.2154 and € 1.9172, respectively — and from this concluded that the average value of the subscription rights corresponded to approximately 10.10035% of the average value of the shares (with rights), in accordance with the table that follows:

k) Subsequently, the Claimant applied that percentage to the historical cost of acquisition of the "B" shares that it held (€ 2.813187 per share, as referred to in a note on page 20 of the inspection report), thus determining the cost attributed to the subscription rights it had;

l) Comparing that cost with the realization value of the rights, the Claimant thus determined a capital loss of € 204,600.00, and proceeded to record it in accounting in Account 6941 — Extraordinary Costs and Losses / Losses on Fixed Assets / Disposal of Financial Investments;

n) The Tax Inspection Services of the Finance Directorate of … conducted an inspection of the Claimant, ordered by Service Order OI…;

o) In the report of that inspection, which is part of the administrative file together with the response, the contents of which are given as reproduced, the Tax Authority and Customs Authority disagreed with the classification and accounting treatment given by the Claimant to the proceeds of the disposal of the subscription rights, having considered that it should be classified, in its entirety, as income, with the acquisition cost of the shares remaining unchanged, and further stating the following:

"Regarding the disposal operation, "A…" characterized that amount collected as if it were a realization value, having, in the desire to find a corresponding negative component, proceeded to reduce, by € 1,704,600.00 the acquisition cost of the equity stake held before the capital increase.

That characterization allowed the determination of a capital loss of € 204,600.00, subject to recording in accounting, in general ledger account 69 – Extraordinary Costs and Losses, sub-account 6941 – Losses on Fixed Assets \ Disposal of financial investments.

Consequently, the net result, shown for the financial year 2008, is influenced, negatively, by the amount of that reduction made to assets, that is, by € 1,704,600.00.

In the quantification of taxable profit, for that financial year, "A…" did not make any correction to that classification, having the loss, thus considered, fully contributed to its formation.

According to Article 17, number 1, of the Corporate Income Tax Code, "The taxable profit of corporate entities and other entities mentioned in paragraph a) of No. 1 of article 3.° is constituted by the algebraic sum of the net result of the financial year and the positive and negative changes in equity verified in the same period and not reflected in that result, determined on the basis of accounting and possibly corrected according to this Code.

In other words, the fiscal result variable depends, in the first place, on the net result of the financial year, determined on the basis of accounting.

However, and in accordance with number 3, of the same legal provision, "In order to allow the determination referred to in No. 1, accounting must:

a) Be organized in accordance with accounting normalization and other legal provisions in force for the respective activity sector, without prejudice to compliance with the provisions set out in this Code; (...)"

This means that, on the date of the facts, the accounting of "A…" must comply with the accounting regulations enshrined in the Official Chart of Accounts (POC), so it is important to verify whether the characterization adopted, for the operation in question, deserves recognition in that regulation.

In this assessment, Chapter 5.4.3 of the POC is of particular interest, which establishes the measurement criteria acceptable in the valuation of financial investments. Thus, the equity stake in "B", not representing a financial investment in a subsidiary and associated company, is subject to the category of other financial investments, whose valuation criterion is that of acquisition cost [point 5.4.3.4; POC], subject to adjustment only in the following two circumstances and in the manner determined there:

"When, with respect to other financial investments, any of them has, at the balance sheet date, a market value or recovery value less than that recorded in accounting, this should be subject to the corresponding reduction, through the appropriate item of account 49 "Adjustments of financial investments", which in these cases will be offset by the appropriate item of account 684 "Financial costs and losses – Adjustments of financial applications [point 5.4.3.6; POC].

"The adjustments to assets referred to in Nos. 5.4.3.5 and 5.4.3.6 shall be reduced or eliminated when the reasons that gave rise to them no longer exist [point 5.4.3.7; POC].

Now, it is concluded that there is a complete absence of correspondence between the circumstances, provided for in accounting normalization and in the accounting treatment attributed to the disposal in question. In other words, that regulation does not embrace the accounting record made, concluding that it violates the regulation.

Equally in opposition to the applicable accounting normalization, although here with its express denunciation, for users of financial information, are found the situations described in note 1 of the Annex to the Balance Sheet and Statement of Results (ABDR), according to which:

"For the reasons set out in the Report of the Board of Directors, no adjustments were made for the difference between the acquisition cost and the quotation on 31 December 2008, with respect to the shares quoted on the stock exchange that form part of the Company's Assets" [Note 1 - Deviations from POC; ABDR].

And, in note 3, of that financial statement, we can identify the assets subject to those deviations:

"... As stated in note 1, with respect to shares held in Bank E…, S.A and Bank "B"…, S.A it was decided not to make adjustments for the differences between their respective acquisition costs and stock exchange quotations on 31 December 2008" [Note 3 - Valuation Criteria; ABDR].

These mean that, in the valuation of equity stakes that are not in subsidiary and associated companies, such as examples are "Bank E…, SA" and "Bank "B", SA", "A…", did not proceed as provided for in point 5.4.3.6 of the POC, reproduced above.

In summary, as far as the equity stake in "Bank "B", SA" is concerned, "A…" made an adjustment to its acquisition value, whose motivations and circumstances are not envisaged by the accounting regulation, constituting a deviation from point 5.4.3.4 of the POC. Conversely, it refrained from making an adjustment, whose nature, distinct from the former, is expressly provided for in that regulation, constituting a deviation from point 5.4.3.6 of the POC. The non-compliance with the applicable accounting regulation is evident in both actions.

As regards the tax implications of these actions, we conclude that the first is not neutral and the second is neutral, since, contrary to the first, in this second, tax and accounting laws provide for different rules [1].

By the above, we conclude that "A…", by violating the applicable accounting regulation, reported a net result for the financial year 2008, undervalued by € 1,704,600.00, having that effect, improperly contributed to the formation of the respective tax result.

Without prejudice to the penalty to be applied, provided for the disagreement of accounting with the accounting normalization in force, the increase of that amount to the net result of the financial year 2008 shall be made, in the determination of the tax result of the same, thus neutralizing that effect. The taxable profit of "A…", for the financial year 2008, will amount to € 1,581,514.20.

(...)

VII. INFRACTIONS VERIFIED

The irregularity described in Chapter III. constitutes an infraction of Article 17, numbers 1 and 3, of the Corporate Income Tax Code and constitutes a tax misdemeanor, for failure to organize accounting in harmony with the rules of accounting normalization and consequent inaccuracies made in accounting books and record-keeping, punishable by Articles 121 and 119, of the General Regime of Tax Infractions.

The failure to update the elements contained in the registration statement, due to the changes that occurred, described in Chapter 11.3., constitutes an infraction of Articles 109, No. 1, paragraph a) and 110, No. 5, both of the Corporate Income Tax Code, constituting failure to file statements, punishable by Article 117 of the General Regime of Tax Infractions;

p) On 28-4-2010, on the first page of the Inspection Report, a ruling was issued by the Chief of the Tax Inspection Services Division in the following terms:

"With this report, the inspection procedure is concluded, in accordance with art. 62° of the RCPIT. The SP exercised the right to a hearing, provided for in art. 60° of the RCPIT and in art. 60° of the LGT, the arguments presented were considered, as stated in section IX of this report. From this analysis, it is concluded that the SP should not be given reason, since contrary to the accounting treatment given by the SP to the disposal of subscription right, with the consequent tax repercussions, it is demonstrated that, in accordance with accounting and tax legislation, such operation should be classified as income and never as a capital loss. The Correction Document and the notice should proceed."

q) In accordance with this understanding, the Tax Administration proceeded to correct the net result of the financial year 2008, fixing the taxable profit of the Claimant at € 1,581,514.20;

r) Following that correction, the Tax Authority and Customs Authority, on 1-6-2010, issued the corporate income tax assessment No. 2010 …, in the amount of € 170,470.28, relating to the year 2008, and the assessment of compensatory interest No. 2010 …, in the amount of € 6,090.22, and on 9-6-2010 made the offset, which resulted in an amount payable of € 176,560.50;

s) On 15-11-2010, the Claimant filed an administrative complaint, which was subsequently dismissed by ruling of 20-10-2011, issued by the Finance Director of …, by delegation, which was based on information that states, among other things, the following:

"The issue subject of this petition concerns the accounting and tax problem of treating the disposal of subscription rights for new shares resulting from the capital increase, motivated by the absence of a perfectly defined accounting and tax criterion for this type of operations.

By the complainant, and following the opinion of Dr. C… with the agreement of the President of the CNC as well as in the methods adopted by other countries given the scarcity of national literature on the subject, the following procedure was adopted:

In accounting terms from the perspective of the transferor, according to the position assumed by the present complainant, it was that corresponding to the sale to a reduction of the rights that were granted by the ownership of the shares there will be a reduction in the acquisition value of those shares. Such reduction should correspond to the "theoretical" cost of acquisition of the rights contained in the subscription of new shares because there is a reduction on the part of the transferor of its participation in the capital of "B".

For this purpose, an acquisition cost for the subscription rights was considered taking into account the weight that these represent in the total value of the shares and the quotation of those same shares on the stock exchange in the days preceding the capital increase operation.

In tax terms, and following the accounting solution adopted, it was considered that, being rights inherent to equity shares included in financial investments, the same shall be classified under art. 44° of the CIRC and as such the corresponding capital gains or losses should be calculated and not consider the entire proceeds of the sale as a financial return.

Existing some doubts as to the tax treatment to be given to the disposal of subscription rights for new shares resulting from the capital increase, it was by the IRC Services Directorate advocated the following understanding that we now transcribe:

"Indeed, the disposal of subscription rights implies, for its transferor, a diminution of its participation in the capital of the company but, as a general rule, the absolute value of the same is maintained, and the value received by the disposal of said rights, beyond a compensation for the loss of the diminution of its participation, is a gain that has its source in that participation.

Now, if it assumes the nature of a gain, whether it be financial or extraordinary, then, according to the rules of taxability that govern the taxation of corporate entities, this must be taxed.

Within the POC until 31/12/2009, in which the present operation falls, "(...) the subscription right is considered as a security, assuming, per se, an autonomous character before the asset from which it originated.

Indeed, in opposition to the understanding that defends the disposal of subscription rights as the existence of an innocuous reduction of rights in tax terms, it is confirmed the notion that it is a gain subject to taxation, incapable of diminishing the acquisition value of the instrument from which it originated.

In truth, it can even be admitted that the acquisition value of the shares was diminished by the value of the consideration, if the right in question, the right of preference in the subscription of new shares, ceased with its disposal, which is not true. The truth is that the right remains well present, whenever the management body deliberates a capital increase with cash contributions, the right of preference is not limited, and to its holder is always granted the possibility of exercising that same right, not exercising it or disposing of it.

If then what results from the disposal of the right of preference is a gain and not a reduction of the acquisition value, so that its classification can be made in accordance with the classification of the financial instrument in question, before article 43° (current article 46°) of the Corporate Income Tax Code – Concept of Capital Gains and Losses, in the wording on the date of the facts, it only contained transactions that were materialized in disposals of elements of fixed assets.

Now, as can be verified, with the disposal of subscription rights, there was no alteration of the value of the fixed assets of the transferor. Especially because it is a short-term asset which, by nature, does not exceed one month and is traded separately from the asset from which it originated. Therefore, the value of the consideration is not capable of being constituted in a capital gain or loss in tax terms, which means that, that value assumes the nature of a gain of a financial nature classifiable in No. 1 of article 20° of the Corporate Income Tax Code".

In view of the understanding set out above, the sale of subscription rights should be considered as a financial/extraordinary income classifiable in No. 1 of art° 20° of the CIRC, at the date of the occurrence of the facts, and not as a capital loss under art. 43° of the same statute.

Contrary to what is alleged by the complainant, this type of income should be qualified as financial/extraordinary and not subsumed as capital income, does not become subject to withholding at source in accordance with art° 88° of the CIRC.

t) On 2-12-2011, the Claimant filed a hierarchical appeal of the decision dismissing the administrative complaint, which was subsequently dismissed by ruling of 30-5-2013, which referred to information in which it states, among other things, the following:

1. It is important to note that, in accordance with article 2° of Decree-Law No. 410/89, of 21 November, the present appellant, in the financial year 2006, was obligated to apply to its accounting records the rules contained in the Official Chart of Accounts (POC).

2. As stated in the administrative complaint proceeding, the understanding of the Tax Administration (TA) regarding the tax classification relating to the disposal operation of subscription rights, is in a direction different from that advocated by the present appellant.

3. It is in fact the understanding of the TA that the disposal of subscription rights implies, for its transferor, a diminution of its participation in the capital of the company after the corresponding capital increase, but, as a general rule, the absolute value of the same is maintained, and the value received by the disposal of said rights, beyond a compensation for the loss of the diminution of its participation, is a gain that has its source in that participation.

4. If it assumes the nature of a gain, whether it be financial or extraordinary, then according to the rules of taxability that govern the taxation of corporate entities, this must be taxed.

5. The subscription right results from the existence of a type of security, which is the share, but which only arises when the respective deliberation of a capital increase takes place, in accordance with article 458.° of the Commercial Societies Code. And from this it can be said that the subscription right is distinguished from the other right, which is the right granted by the possession of a given share, from which to its holders is granted, namely, the right to receive dividends originating from the company's profits, the right of preference in the subscription of shares in a capital increase or the right to receive shares at no cost, when capital increases occur through incorporation of reserves.

6. In summary, the subscription right is a right distinguished from a security. It has an autonomous character before the asset from which it originated.

7. It cannot be admitted that there is a reduction in the acquisition value of the corresponding shares, because the said subscription right has been disposed of. Indeed, for the same shares that right will always continue to exist for future capital increases, in proportion to the then participation in the company.

8. Indeed, what results from the disposal of the subscription right is a gain and not a reduction in the acquisition value, so that its classification can be made in accordance with the classification of the financial instrument in question, before article 43° of the CIRC (in the wording on the date of the facts, current article 46°) – since in it only transactions that were materialized in disposals of elements of fixed assets had a place.

9. With the disposal of subscription preference rights, there was no alteration in the value of the fixed assets of the transferor. The subscription preference right, by its nature, is born and dies in each capital increase operation, whose duration is, as a rule, of very short duration (until the subscription of new shares or transfer of that right). It is traded separately from the asset from which it originated. Therefore, the value that is attributed is not capable of originating a capital gain or loss in tax terms, which means that that value assumes a gain of a financial nature classifiable in No. 1 of article 20° of the CIRC.

10. In the absence of withholding at source in case of an eventual requirement of withholding at source, in accordance with article 88° of the CIRC, it is not relevant for the present correction, since if there is an obligation of withholding at source, such withholding assumes the nature of tax on account, and the obligation to proceed with its withholding would fall to the income payor. It would not fall, in the inspection procedure under review, any obligation to correct the withholding at source, which should eventually be made, in accordance with No. 6 of that article.

11. As regards the understanding advocated by the present appellant, as a result of the opinion of the Mr. University Prof. Dr. C… – corroborated by the University Prof. Dr. D…, and with due respect, notwithstanding the functions they held or hold at the CNC, it is nevertheless a personal opinion, not binding the understanding of that Commission.

12. Also on such understanding, notwithstanding what has been stated previously to the contrary, it is important to demonstrate that the solution advocated by the author, if accepted, becomes inexecutable when extrapolated to other companies whose capital participation is represented by quotas (also provided for in article 266.° of the CSC) or by shares not quoted on the stock exchange.

13. To summarize, if such accounting procedures were applied, they would be exceptional for companies with stock exchange listing of their participations, which is against the principle of accounting normalization, and without overlooking the characteristics of financial information required and referred to in §3.2.3. of the POC, such as comparability, when it states: (...) On the other hand, companies must adopt normalization, in order to achieve comparability between them.".

14. Still another pertinent question that arises is that the right to subscribe is granted to persons (for being holders of participation) who, on the date of the deliberation of a capital increase are shareholders (in this sense, article 458.° of the CSC), from which it is deduced that the holder of shares, regardless of enjoying its right of preference in the subscription of new shares, can possibly, and if it wishes, even before the acquisition of new shares, divest itself of the shares that it previously had in portfolio, that is, divesting itself of its participation in the company, resulting, in accounting terms, an elimination of its financial investment.

15. For merely academic purposes, if resulting in the elimination of the financial investment, the solution presented by the present appellant – of going to deduct from the acquisition cost of the shares the "theoretical cost" of the subscription right is impracticable, since there is no value on the balance sheet representative of the said participation (which in the meantime was also disposed of), not being possible to deduct the said "theoretical cost".

16. It is the case to use the words of the author of the article brought to the proceedings, when commenting on other alternative solutions to the accounting procedure to be adopted: "now, in theoretical terms, it could even happen that the sale price of the rights was greater than the acquisition value of the shares [which in the previous example, the acquisition value would be zero after the disposal of the participation, which would even make accounting registration impossible; (...)

Of the other doctrines in force in other Member States of the European Union

1. It follows from the previous reasoning that it cannot be concluded that there is a void in the accounting rules to be observed in the transfer of subscription preference right, since these are deduced from the valuation criteria contained in the POC, relating to financial investments. For which reason it does not require a request for clarification from the CNC.

2. As regards the examples presented regarding accounting treatment in other countries, it is noted that on 18 September 1999, Decree-Law No. 367/99 was published (which defines the tasks of the Accounting Normalization Commission (CNC), which in its preamble states: "(...) that on the technical level it establishes, as in other countries, the existence of three levels of normalization: Official Chart of Accounts (POC), the accounting directives, which will have binding effect, and technical interpretations" (...).

3. And it follows from §13° of Chapter IV - Generally accepted accounting principles in the national accounting regulation of accounting Directive No. 18/05: "Thus, the CNC, in privileging a conceptual perspective of economic substance for financial reporting, considers that the adoption of generally accepted accounting principles in the national accounting regulation should be subordinated, first, to the POC and to accounting directives and their respective technical interpretations, supplementarily, in the order indicated, to:

1 International Accounting Standards, adopted under Regulation No. 1602/2002, of the European Parliament and of the Council, of 19 July;

2 International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS), issued by the IASB, and their respective SIC-IFRIC interpretations"(...)

1. Now, from this it does not follow that the fact that other Member States have adopted accounting rules different from those that were adopted for the national territory (by imposition of the rules contained in the POC and accounting directives), that the same should be taken into account, solely by virtue of that Member State belonging to the European Union.

2. Although the present appellant comes to report the accounting treatment of the disposal of subscription rights for shares, contained in the Plan General de Contabilidad (Spain) and other doctrinal sources from Switzerland and Belgium, it does not seem appropriate to apply criteria for the accounting of financial investments adopted by those countries, since the POC, in 2008, had its own criteria.

3. In the eventual absence of express reference, either in the POC or in Accounting Directives, regarding the accounting treatment to be applied to the transfer of subscription preference right, it also does not seem appropriate to resort by analogy to the legislation of other countries since the Accounting Directive No. 18/05, expressly states that, supplementarily, it accepts only recourse to International Accounting Standards.

4. Indeed, accounting harmonization at the European level is not done directly between Member States, but rather between the community guidelines and the respective Member States.

III CONCLUSION

1. It is important to conclude that the IT acted correctly, when it considered the gain resulting from the disposal of subscription rights for shares of "B", as income, in accordance with No. 1 of article 20° CIRC, contrary to the present appellant, when it understood to be faced with a value that would translate the realization value for the determination of a capital gain or loss in tax terms, in accordance with article 43° of the CIRC.

2. In these terms, it is proposed that the present hierarchical appeal should not be upheld.

u) On 16-9-2013, the Claimant filed the request for constitution of the arbitral tribunal which gave rise to the present proceedings.

2.2. Reasoning for the decision on matters of fact

The facts were deemed proven based on the administrative file and on the assertions of the Claimant which are not questioned by the Tax Authority and Customs Authority, there being no controversy over the factuality relevant to the decision.

1. Matters of Law

3.1. Subject matter of the dispute

The Claimant disposed of subscription rights for shares of "B" and, following consultations with accounting specialists, proceeded as follows:

– understood that the acquisition cost of the subscription rights is a component of the acquisition cost of the shares from which those rights derive;

– understood that the disposal of subscription rights for shares implies a reduction in the value of the shares that give rise to those rights, which should be reflected as a capital loss in the accounting of the transferor of the rights;

– noting that during 10, 11, 14 and 18 April 2008 both subscription rights and shares of "B" without those rights were traded on the stock exchange, the Claimant determined the average quotations of both securities and from this concluded that subscription rights corresponded to approximately 10.10035% of the average value of shares with rights;

– subsequently, the Claimant applied that percentage to the historical acquisition cost of the shares of Bank "B" of which it was the holder, determining the cost of the subscription rights that it disposed of;

– comparing that cost with the realization value of the rights, the Claimant determined the capital loss it determined in the sale, which it recorded in accounting.

The Tax Authority and Customs Authority understood that the proceeds of the disposal of subscription rights should be classified, in its entirety, as income, with the acquisition cost of the shares remaining unchanged, so it proceeded to correct the Claimant's tax base.

In defining the subject matter of the dispute it must be taken into account that the tax arbitration process, as an alternative means to the judicial challenge process (No. 2 of article 124.° of Law No. 3-B/2010, of 28 April), is, like this, a procedural means of mere legality, in which the aim is the elimination of the effects produced by illegal acts, annulling them or declaring their nullity or non-existence [articles 2.° of the RJAT and 99.° and 124.° of the CPPT, applicable by force of the provision in article 29.°, No. 1, paragraph a), of that statute] ([2]), so that the acts must be assessed as they were performed, the court not being able, in the face of the finding of the invocation of an illegal ground as support for the administrative decision, to assess whether its action could have been based on other grounds, even if invoked subsequently by the Tax Authority and Customs Authority in administrative or judicial challenge. ([3])

On the other hand, Tax Contentious Courts have only the function of settling disputes arising from the practice of the act whose legality is contested, considering the issues raised by the parties whose knowledge is necessary to assess that legality, to the strict extent of that necessity, as follows from the principle of limitation of acts, currently generically stated in article 130.° of the Code of Civil Procedure.

From this perspective, it is important only to assess whether the correction made by the Tax Authority and Customs Authority to the Claimant's tax base has legal support, for purely tax purposes, and not to determine which is the most appropriate way to account for the disposal of subscription rights.

Thus, the question which is the subject matter of the present arbitration process is whether the proceeds of the disposal of subscription rights for shares should be considered entirely as income for corporate income tax purposes, since this was the grounds for the correction made.

3.2. The terms of the dispute

With regard to the determination of the tax base for corporate income tax, article 17.° of the CIRC (wording in force in 2008) establishes the following:

Article 17.°

Determination of Taxable Profit

1. The taxable profit of corporate entities and other entities mentioned in paragraph a) of No. 1 of article 3.° is constituted by the algebraic sum of the net result of the financial year and the positive and negative variations of equity verified in the same period and not reflected in that result, determined on the basis of accounting and possibly corrected according to this Code.

2. For the purposes of the previous number, the net surpluses of cooperatives are considered as the net result of the financial year.

3. In order to allow the determination referred to in No. 1, accounting must:

a) Be organized in accordance with accounting normalization and other legal provisions in force for the respective activity sector, without prejudice to compliance with the provisions set out in this Code;

b) Reflect all operations carried out by the taxpayer and be organized so that the results of operations and variations of equity subject to the general regime of corporate income tax can be clearly distinguished from those of the remainder.

As can be seen from No. 1 of this article 17.°, not all the rules necessary for the determination of the tax base of entities subject to corporate income tax are set out in the tax law, with a generic reference being made to accounting norms, but with primacy of the rules of this Code ("...corrected according to this Code").

The justification for these relationships between taxation and accounting is given in point 10 of the Preamble to the CIRC, in these terms:

"Given that taxation falls upon the economic reality constituted by profit, it is natural that accounting, as an instrument of measurement and information of that reality, plays an essential role as the basis for the determination of taxable profit.

The relationships between accounting and taxation are, however, an area that has been marked by a certain controversy and where, therefore, different ways of conceiving these relationships are possible. Setting aside an absolute separation or total identification, a solution marked by realism continues to be privileged and which, in essence, consists of basing, at the source, taxable profit on the accounting result to which, extra-accounting, corrections are introduced – positive or negative – set out in law to take into account the objectives and constraints peculiar to taxation."

In this line, it can be said that "accounting provides a conceptual basis for the operational definition of taxable profit, but, given the objectives and principles that frame taxation, there cannot be an identification between this and the accounting result since accounting also has objectives and principles that are its own and that must be safeguarded. In some countries, an opt is even made for a complete separation between these two quantities, but the tradition in which we are inserted is that of partial dependence of taxable profit in relation to the accounting result" ([4])

In the case in question, the position of the Tax Authority and Customs Authority underlying the contested assessment is based exclusively on accounting considerations, with Nos. 1 and 3 of article 17.° of the CIRC being the only rules that are referred to in the inspection report and in the ruling that was issued on it.

However, although the inspection report does not refer to article 20.° of the CIRC, in the ruling that considered the proposal formulated therein, which is, after all, the act that determined the correction of the Claimant's tax base underlying the contested assessment, it is stated that "it is concluded that the SP should not be given reason, since contrary to the accounting treatment given by the SP to the disposal of subscription right, with the consequent tax repercussions, it is demonstrated that, in accordance with accounting and tax legislation, such operation should be classified as income and never as a capital loss" [paragraph p) of the matters of fact established].

After the assessment act, namely in the opinion on which the dismissal of the administrative complaint was based and in point 33 of the opinion on which the hierarchical appeal decision was based, reference is made to article 20.°, No. 1, of the CIRC, indicating that it is faced with "gain of a financial nature".

But, as has been said about the irrelevance of subsequent reasoning, only the reasoning underlying the assessment act and not its successive must be considered, and so what is in question is only whether there is a "gain", as this results from the application of accounting norms, namely point 5.4.3.4. of the POC, applicable through article 17.°, Nos. 1 and 3, of the CIRC.

3.3. Assessment of the question

The accounting norm that the Tax Authority and Customs Authority invokes is point 5.4.3.4. of the POC in which it is stated that "other financial investments are recorded at acquisition cost", referring to financial investments that are not represented by equity shares in subsidiary and associated companies, referred to in point 5.4.3.3..

However, that point 5.4.3.4., regardless of whether it can reveal, as the Tax Authority and Customs Authority argues, incorrectness of the accounting procedure used by the Claimant regarding the treatment given to the recording of the value of shares held, does not solve the problem of the accounting treatment of the proceeds from the disposal of participatory rights, nor does it allow any conclusion regarding its tax relevance, which, for what has been said, need not coincide with accounting relevance, even when the latter is explicit.

In fact, the referred accounting norm is directly aimed at financial investments whose value does not undergo reduction, because, when any of those financial investments "has, at the balance sheet date, a market value or recovery value less than that recorded in accounting, this should be subject to the corresponding reduction", without prejudice to the adjustment being subsequently reduced or eliminated, when the reasons that gave rise to it no longer exist (points 5.4.3.6. and 5.4.3.7. of the POC).

In the case of disposal of subscription rights, what is in question is precisely a situation in which there may be a reduction in the value of the equity share resulting from the disposal, so that the referred rule in point 5.4.3.4. cannot be considered an obstacle to a reduction in the value of the equity share.

In any case, none of these norms establishes the specific regime for the accounting treatment of a financial investment (acquisition of shares) that grants its holder a set of rights, after one of those rights is separated and disposed of, which becomes a new autonomous security, being even susceptible to being traded on the stock exchange with complete autonomy in relation to the equity share whose possession generates this autonomous security.

Thus, it must be concluded that there is no specific regulation in the legislation in force in 2008 for the accounting treatment of the disposal of subscription rights.

On the other hand, as is evident from the article "Disposal of Subscription Rights", published in the Magazine of the Chamber of Official Accounting Technicians, No. 112, whose copy was attached to the file, the question of the determination of the appropriate accounting treatment is controversial, with various solutions being raised. ([5])

Furthermore, it is also found that, contrary to what happens in Portugal, in other countries there is specific tax regulation for the disposal of subscription rights, as is the case of Spain, where it was already provided for in the Plan General De Contabilidad of 1990 (approved by Royal Decree No. 1643/1990, of 20 December), in valuation rule 8.ª, regarding "Securities", that "In the case of sale of preferential subscription rights or segregation of the same for their exercise, the amount of the cost will reduce the acquisition price of the respective securities. Said cost shall be determined by applying some general acceptance valuation formula and in harmony with the principle of prudence: at the same time, the amount of the valuation corrections recorded in accounting shall be reduced proportionally". This regime was maintained in Point 2.5.2. of the new Plan General Contabilidad of 2007 (Approved by Royal Decree No. 1514/2007, of 16 November) in which it is stated: "In the case of sale of preferential subscription rights and similar or segregation of the same for their exercise, the amount of the cost of the rights will reduce the book value of the respective assets. Said cost shall be determined by applying some general acceptance valuation formula".

This fact that the accounting solution advocated by the Claimant has long been legislatively adopted in Spain leaves no room for doubt that it is, at least, a reasonable solution, in accounting terms.

On the other hand, the thesis defended by the Tax Authority and Customs Authority has as a corollary that the proceeds of the disposal of subscription rights always constitute taxable income for corporate income tax purposes, even when the investment in shares that generates such rights causes overall loss (as occurs in the case in question), which is incompatible with the principles of taxation of companies falling fundamentally on their real income (article 104.°, No. 3, of the Constitution of the Portuguese Republic) and based essentially on taxable capacity (article 4.°, No. 1, of the LGT).

Furthermore, the understanding that the proceeds from the disposal of subscription rights should be considered income in full has no logical coherence, because the fact that those rights are autonomous securities that are distinguished from another security will normally have as its effect a devaluation of the latter: having subscription rights an autonomous value, shares that allow their exercise will not normally have the same value as shares that do not allow them, because those rights have been disposed of. Moreover, the Tax Authority and Customs Authority itself, in the decision on the administrative complaint, acknowledged that "the disposal of subscription rights implies, for its transferor, a diminution of its participation in the capital of the company" and, although, in its perspective, "as a general rule, the absolute value of the same is maintained, and the value received by the disposal of said rights, beyond a compensation for the loss of the diminution of its participation, is a gain that has its source in that participation", the fact is that, on one hand, that alleged "rule", whose correspondence to reality the Tax Authority and Customs Authority does not demonstrate, cannot be considered more than a guess, and, on the other hand, its application could only be justified in relation to situations where the assumption on which it is based was verified, of being fully recovered the acquisition cost of the shares that generate the subscription rights, which would impose that the application of that hypothetical rule be set aside when exceptions were proven, as occurs in the case before us. ([6])

In this context, it must be concluded that it is, at the minimum, doubtful that the appropriate accounting solution is that advocated by the Tax Authority and Customs Authority, which is not explicitly provided for in the POC, finds no support in doctrine or case law and leads to a result irreconcilable with the basic principles that govern the taxation of company income.

In any case, in matters of tax incidence, there are increased requirements of legal certainty, which underlie the principle of typicality of taxes ("null taxation without law"), embodied in article 104.°, No. 2, of the Constitution of the Portuguese Republic, which imposes a degree of requirement for determinability and precision of law "that guarantees to the recipients of the regulation a precise, exact and timely knowledge of the legal criteria that the Administration is to use, thus reducing the excessive risks that, for those recipients, would result from an indeterminate regulation regarding the very assumptions of the Administration's action". ([7])

In the case in question, it is manifest that from the mere generic reference made to accounting norms in article 17.°, Nos. 1 and 3, of the CIRC, without explicit support in the text of any accounting norm, there does not result with the minimum of clarity required in tax incidence norms that corporate income tax falls on the proceeds of the disposal of subscription rights for shares, so that, moreover, there is an insuperable constitutional obstacle to the adoption of the thesis defended by the Tax Authority and Customs Authority.

It should also be said that the CIRC indirectly confirms that the disposal of subscription rights does not fall within the scope of corporate income tax, by making no reference to it in its article 20.°, in particular in paragraph c) of No. 1 in which "financial income" is generically indicated, giving as examples "interest, dividends, discounts, premiums, transfers, exchange differences and premiums on bond issues". In truth, although the enumeration made there has an exemplary nature, the fact that, as regards income related to shares, only dividends are indicated and not also subscription rights, points to the fact that the tax legislator did not intend to consider as income the proceeds from their disposal, since these are typical rights and frequently exercised associated with the ownership of shares, provided for and regulated in articles 458.° to 460.° of the Commercial Societies Code, and, therefore, if it were understood that such proceeds should be considered as income, it would be normal for an express reference to be made, which would be justified notably by the fact that this is a solution which, for what has been said, does not result from accounting norms.

For that matter, the non-incidence of corporate income tax on the proceeds of the disposal of subscription rights can be explained, on one hand, by the existence of other means for taxation of the real income of companies associated with the ownership of shares and, on the other hand, by the difficulty of quantification of the gains ([8]), because the separation and disposal of the subscription right implies at least a temporary reduction in the value of the share and the subsequent recovery of the former value, which the Tax Authority and Customs Authority raises in the decision on the hierarchical appeal, is uncertain, hypothetical and eventual.

It is a situation which, from what can be seen, would be appropriate to regulate, as has long been done in Spain, but, in the absence of regulation, the principle of legality opposes the proceeds of the disposal of subscription rights being considered income for purposes of corporate income tax incidence.

By the above, it is to be concluded that the correction made by the Tax Authority and Customs Authority is affected by a defect of violation of law, namely violation of article 17.°, Nos. 1 and 3, of the CIRC and point 5.4.3.4. of the POC, which justifies its annulment [articles 99.° paragraph a) of the CPPT and 135.° of the Code of Administrative Procedure, applicable by force of the provisions in articles 29.°, No. 1, paragraph a), of the RJAT and 2.°, paragraph c), of the LGT].

1. Decision

In accordance with the above, the parties to this Arbitral Tribunal agree to:

a) Uphold the application for arbitral ruling, in its entirety;

b) Annul the additional corporate income tax assessment No. 2010 …, in the amount of € 170,470.28, relating to the year 2008, and the assessment of compensatory interest No. 2010 …, in the amount of € 6,090.22.

1. Value of the proceedings

In accordance with the provisions of art. 315.°, No. 2, of the CPC and 97.°-A, No. 1, paragraph a), of the CPPT and 3.°, No. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of the proceedings is fixed at € 176,560.50.

1. Costs

Pursuant to art. 22.°, No. 4, of the RJAT, the amount of costs is fixed at € 3,672.00, in accordance with Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, to be borne by the Tax Authority and Customs Authority.

Lisbon, 24 February 2014

The Arbitrators

(Jorge Manuel Lopes de Sousa)

(Paulo Lourenço)

(Jorge Júlio Landeiro de Vaz)