Process: 23/2018-T

Date: June 8, 2018

Tax Type: IRC

Source: Original CAAD Decision

Summary

CAAD Process 23/2018-T addresses the deductibility of financial charges incurred by a Portuguese SGPS (holding company) for IRC (Corporate Income Tax) purposes for the 2013 tax year. The claimant, a SGPS that is the parent company of a group taxed under the Special Regime for Taxation of Groups of Companies (SRTGC), challenged the tax authority's rejection of its gracious objection to an IRC self-assessment. The company had added €842,613.90 in financial charges calculated according to Circular 7/2004 when computing its tax loss. The core legal issue concerns the interpretation of the SGPS tax benefit regime, specifically whether financial charges related to borrowings used to acquire shareholdings and provide financing to subsidiaries are deductible under the IRC Code and applicable circulars. The claimant acquired various shareholdings between 2000 and 2009, financing these acquisitions through loans from credit institutions totaling €11,199,582.37 by year-end 2013. Additionally, the SGPS made supplementary capital contributions (€6,900,000) and surplus loans (€11,614,896.06) to subsidiaries. The arbitral tribunal examined whether the tax authority correctly applied the limitation on deductibility of financial charges for SGPS companies, considering the specific circumstances of shareholding acquisitions and intra-group financing. The decision has significant implications for Portuguese holding companies regarding the tax treatment of debt-financed acquisitions and the scope of SGPS fiscal benefits, particularly the interplay between financial charge deductibility limitations and the holding company regime established under Article 32 of the IRC Code and relevant tax authority guidance.

Full Decision

ARBITRAL DECISION (consult complete version in PDF)

The arbitrators Counselor Jorge Manuel Lopes de Sousa (arbitrator-president), Dr. Rui Ferreira Rodrigues and Prof. Doctor Luís Menezes Leitão (arbitrator-members), designated by the Deontological Council of the Centre for Administrative Arbitration to form the Arbitral Tribunal, constituted on 27-03-2018, agree as follows:

1. Report

A... SGPS, SA, legal entity no. ... with registered office at Ave. ..., no. ... ...-... ..., parish and municipality of ..., district of Aveiro (hereinafter referred to as "Claimant"), filed an application for the constitution of a collective arbitral tribunal, in accordance with Decree-Law no. 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter referred to only as LFATM).

The Respondent is the TAX AND CUSTOMS AUTHORITY.

The Claimant seeks a declaration of illegality of the decision rejecting the gracious objection to the self-assessment of Corporate Income Tax (CIT) for the tax year 2013 and a declaration of illegality and annulment of the tax act of self-assessment of CIT for the tax year 2013 and condemnation of the Tax Authority to payment of compensatory interest in favour of the Claimant.

The application for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority on 18-01-2018.

Pursuant to the provisions of paragraph a) of no. 2 of article 6 and paragraph b) of no. 1 of article 11 of the LFATM, in the wording introduced by article 228 of Law no. 66-B/2012, of 31 December, the Deontological Council designated as arbitrators of the collective arbitral tribunal the signatories, who communicated acceptance of the appointment within the applicable deadline.

On 07-03-2018 the parties were duly notified of such designation, having not expressed any intention to refuse the designation of the arbitrators, in accordance with the combined provisions of article 11 no. 1 paragraphs a) and b) of the LFATM and articles 6 and 7 of the Deontological Code.

Thus, in accordance with the provisions of paragraph c) of no. 1 of article 11 of the LFATM, in the wording introduced by article 228 of Law no. 66-B/2012, of 31 December, the collective arbitral tribunal was constituted on 27-03-2018.

The Tax and Customs Authority submitted a response in which it argues that the application should be dismissed.

By order of 03-05-2018 the holding of a hearing was dispensed with and it was decided that the proceedings should continue with optional written submissions.

The parties submitted arguments.

The Tribunal was regularly constituted and is competent.

The parties possess legal personality and capacity, are legitimate and properly represented (arts. 4 and 10, no. 2, of the same law and art. 1 of Ordinance no. 112-A/2011, of 22 March).

The proceedings do not suffer from any nullities.

2. Facts

2.1. Proven Facts

The following facts are considered proven:

  • The Claimant is a holding company society that commenced its activities on 01-09-2000;

  • The Claimant is the parent company of a group of national companies, all belonging to the N... family, which from 01-01-2007 opted for taxation according to the Special Regime for Taxation of Groups of Companies (SRTGC), constituted in 2013 by the following companies:

    • B…, SA, Tax ID …; - C…, SA, Tax ID …;
    • D..., SA, Tax ID ...;
    • E..., SA, Tax ID ...
    • F..., SA, Tax ID...; and
    • G..., SA, Tax ID ... .

  • In addition to these, the parent company A... SGPS also holds 10% of the share capital of company I..., SA, Tax ID..., which is held in the remaining 90% by private individuals;

  • The Claimant has organized accounting records;

  • The Claimant presented, on 30 May 2014, with reference to the tax year 2013, the form mod 22, individual (document no. 3 attached to the application for arbitral decision, the contents of which are taken as reproduced);

  • The Claimant calculated, in that form, a tax loss of the amount of € 564,141.45;

  • The claimant added, in line 752 of Q07 of the said form model 22, the value of the financial charges that it calculated by application of Circular no. 7/2004 of 30 March, in the amount of € 842,613.90;

  • The Claimant, in its capacity as parent company of the group referred to, presented, for purposes of CIT for the tax year 2013, the form mod. 22 of the Group in which it calculated the consolidated taxable matter in the amount of € 1,064,954.88 (document no. 4 attached to the application for arbitral decision, the contents of which are taken as reproduced);

  • The Claimant did not dispose of any share capital in the tax year 2013;

  • The share capital held by the Claimant was acquired on the dates and in the manner as follows:

  • The share capital acquired in 2000 was delivered by the shareholders for realization of the share capital subscribed by them (contributions in kind) (document no. 5 attached to the application for arbitral decision, the contents of which are taken as reproduced);

  • On 25-03-2003 the Claimant acquired 50% of the share capital of company D... SA, for the price of € 750,000.00 paid in instalments, through cheques indicated in document no. 6 attached to the application for arbitral decision, the contents of which are taken as reproduced;

  • On 14-12-2004 the Claimant acquired 50% of the share capital of company B... SA for the price of 1,250,000.00, with the acquisition price recorded in the shareholder's current account (document no. 7 attached to the application for arbitral decision, the contents of which are taken as reproduced);

  • On 29-12-2006 the Claimant acquired the remaining 50% of the share capital of company B..., SA for the price of € 2,000,000.00 (document no. 8 attached to the application for arbitral decision, the contents of which are taken as reproduced);

  • On 15-01-2008 the Claimant acquired 90% of the share capital of J... for the price of € 2,500,000.00 (document no. 9 attached to the application for arbitral decision, the contents of which are taken as reproduced);

  • On 06-12-2006 the Claimant acquired 10% of the share capital of company J... SA for the price of € 5,000.00 (document no. 10 attached to the application for arbitral decision, the contents of which are taken as reproduced);

  • On 04-06-2009 the Claimant acquired 100% of the share capital of company G..., SA for the price of € 3,000,000.00 (document no. 11 attached to the application for arbitral decision, the contents of which are taken as reproduced);

  • The share capital acquired by the Claimant was acquired from shareholders with the acquisition prices recorded as credit in the POC accounts 255 and 268;

  • In 2013, the Claimant incorporated three companies (K... SA, L... SA and M... SA) subscribing the totality of the share capital of the amount of €1,000.00 each;

  • The loans contracted with Credit Institutions and Financial Companies had a final balance of 11,199,582.37€, at the end of 2013 (document no.14 attached to the application for arbitral decision, the contents of which are taken as reproduced);

  • The Claimant made, to the subsidiaries, contributions as supplementary deposits in the amount of € 6,900,000.00, according to the table that follows:

  • The supplementary deposits were made according to the regime of supplementary deposits, had money as their object and do not earn interest;

  • The Claimant made loans to the subsidiaries as surpluses in the amount of €11,614,896.06, according to the following table:

  • On 31-12-2006, a contract for medium and long-term remunerated financing was formalized between the Claimant and the subsidiary C..., SA, in the amount of 33 million Euros, which had already been delivered to A... SGPS in prior years (part 8 of the Report of the Tax Inspection that is part of the administrative proceedings);

  • On 06-06-2016, the Claimant filed a gracious objection to the self-assessment, invoking as a basis that it had unduly added, in line 752 of Q 07 of the form model 22 of the year 2013, the financial expenses calculated by application of Circular no. 7/2004 of 30 March, because the financing obtained was not used to finance the acquisition of share capital (part 1 of the administrative proceedings);

  • Following the filing of the gracious objection, which was assigned no. ...2016..., the Tax and Customs Authority conducted an inspection of the Claimant, under Service Order OI2016..., in which a Report of the Tax Inspection was prepared that is part of the administrative proceedings, the contents of which are taken as reproduced;

  • The gracious objection was rejected by referring to the justification of the project that is part of the administrative proceedings which, in turn, refers to part of the justification of the Report of the Tax Inspection;

  • In that draft decision rejecting the gracious objection, the contents of which are taken as reproduced, the following is stated, among other things:

2.2. Grounds of the Objection

The objecting party is a holding company society, being the dominant company of a group taxed under the special regime for taxation of groups of companies.

In the petition presented, the taxpayer alleges that it proceeded incorrectly in calculating the financing interest that it added for tax purposes in Q07 of its respective income statement Form 22 and calculated in accordance with Circular 7/2004 - in the amount of 842,613.80€ - which negatively affected the taxable result of the group of companies, presenting the following arguments:

I. On the Facts

a. In the tax year 2013, it showed in account 251 - Loans contracted with Credit Institutions and Financial Companies, a final balance of 11,199,582.37€;

During the year 2013, it subscribed share capital in three companies that it incorporated, totalling the value of 3,000 €;

b. It did not acquire any other share capital portions, and the loans contracted were used for purposes other than financing the acquisition of share capital;

c. It constituted supplementary deposits of capital with its subsidiaries in the amount of 6,900,000€ and financed its subsidiaries in a total of 11,614,896.06€, which sums to 18,514,896.06€, concluding in this way that the said bank loans were contracted to meet these financing requirements, and not to finance the acquisition of share capital;

d. It made an incorrect interpretation of the law when it added in table 07 the interest it calculated in the value of 842,613.80€, as being relative to the acquisition of share capital.

II. On the Law

a. From the interpretation of the letter of no. 2 of article 32 of the TBA results that only financial charges supported with financing used for the acquisition of share capital do not contribute to the formation of taxable profit;

b. Conversely, financial charges supported with other components of equity capital and with loans made to the subsidiaries constitute a relevant tax expense for the determination of the taxable result for the period;

c. The ratio legis of the disregard for financial charges supported with the acquisition of share capital is associated with the ratio that led the legislator to disregard, for tax purposes, gains from capital gains obtained with the disposal of share capital portions;

d. The claimant did not acquire any share capital and consequently did not incur any charges with loans for the acquisition thereof, whereby no relationship exists between the financial charges supported and the acquisition of share capital in the tax year 2013, reason for which the interest added in Q07 was done so improperly.

2.3. Analysis

Given the complexity of the factual matter in question, and with a view to determining the legality of the correction sought by the claimant, on 2016-07-25 an Information was prepared proposing that the situation in question be the subject of analysis by the Tax Inspection Services of the Finance Directorate of ...

Thus, on 2016-09-06, External Order no. Ol2016... was issued, which aimed precisely at authorizing that analysis of the gracious objection of CIT for 2013.

However, on 2016-11-14, after a Proposal for External Inspective Action in that regard, External Service Order no. OI2016... was opened, which covered the tax period of 2013 and had a general character.

As a result of the diligences and analyses carried out, the tax inspection determined that the taxpayer was not correct regarding the request underlying this Gracious Objection of self-assessment of CIT, in accordance with the factual and legal grounds exhaustively explained in the respective final report, and which are here taken as fully reproduced, prepared on 2017-05-11 and already notified to the taxpayer - at pp. 34 to 67 of the record -, in particular in chapter III.1.4 "Financial Charges Not Deductible, Related to the Acquisition of Share Capital", where it was concluded: "In view of the above, the Gracious Objection presented by the taxpayer regarding the self-assessment of CIT for the tax period 2013 (described in chapter II. 3.6 of this Report), in which this party, invoking error in the addition of financial charges related to the acquisition of share capital portions - in the amount of €842,613, 90 - requests its annulment, should be wholly rejected, since, as we have seen, the financial charges not accepted fiscally in accordance with article 32 no. 2 of the TBA, amount in fact, in this year, to €887,166.50, which means that the value added by A... SGPS was still lower than due by €44,552.60 (reason for which it is now proposed to correct this difference) " - see in Annex copies of pages 45 to 53 of the final report.

3. Conclusion

In view of the facts set out above, we are of the OPINION that this petition should be rejected, keeping the disputed assessment unchanged.

  • In that draft decision rejecting the gracious objection, part of the Report of the Tax Inspection referred to is attached, the contents of which are taken as reproduced, in which the following is stated, among other things:

III.1.3 TAXATION OF FINANCIAL CHARGES IN HOLDING COMPANIES

Law no. 32-B/2002, of 30 December (Budget Law for 2003), amended the tax regime applicable to gains and losses realized by holding companies (SGPS) and risk capital companies (SCR) established in article 32 of the Tax Benefits Statute (TBA), providing that no. 2 of this provision that "the gains and losses realized by SGPS and SCR through the onerous transmission, regardless of the form by which it operates, of share capital portions of which they are holders, provided that held for a period not less than one year, and likewise, the financial charges supported with their acquisition, do not contribute to the formation of taxable profit of these companies".

In a perspective of enhancing the competitiveness of these companies, this amendment followed the common trend in the majority of European Union member states, excluding from taxation gains resulting from the disposal of share capital held for more than one year, and not considering deductible for tax purposes either the losses suffered by virtue of the disposal of share portions under identical conditions, nor the financial charges supported for the acquisition of assets of the same nature (no. 2 of art. 32 of the TBA).

The disregard as expenses of financial charges for purposes of determining taxable profit, established in no. 2 of article 32 of the TBA, embodies the general principle of the indispensability of expenses, according to which the tax deduction of expenses is conditioned on their connection with obtaining income subject to tax. From this principle it follows that "if certain COSTS are related to income not subject to tax, they are not tax deductible".

Also, in article 23 of the Corporate Income Tax Code, this principle is expressed, by establishing that "expenses are those which are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the income-producing source". Consequently, the legislator established in article 32 of the TBA a solution in which only those financial charges related to the acquisition of share capital that benefit, with respect to gains or losses, from the special regime established in its no. 2, are tax disregarded as expenses.

This solution makes it possible to establish the correlation between the charges supported and the income or gains with which they are associated, being therefore the one that best conforms to the basic rule, with respect to the temporal allocation of expenses, "that for the determination of profit, the costs that became necessary to support to obtain them must be deducted from the income realized in an accounting period".

Given the provisions of Decree-Law no. 495/88, of 30 December - the rule that regulates the activity of holding companies - where it is stipulated that:

a. these companies "have as their sole contractual purpose the management of share capital in other companies as an indirect form of conducting economic activities",

b. the holding of a share in a company is considered an indirect form of conducting economic activity, when the share is held for a period exceeding one year and reaches at least 10% of the share capital with voting rights and,

c. holding companies (SGPS) are, in general, prohibited from disposing of share capital held before one year has elapsed from its acquisition, it is easily concluded that the most common situation will be the non-taxation of gains and losses resulting from the disposal of share capital held by SGPS, as they benefit from the application of no. 2 of article 32 of the TBA.

Given the doubts raised regarding the application of that tax regime applicable to holding companies, and given the extreme difficulty in using a method of direct or specific allocation and the possibility of manipulation that the same could generate, the Tax Authority proposed the use of an allocation method that was later transmitted through Circular no. 7/2004, of 30/03, of the Directorate of Services of CIT, of the understanding of the Tax Administration on this matter, as well as the method to be used for purposes of allocating financial charges to share capital.

This Circular 7/2004 came to define a methodology for proceeding with the adjustment of taxable profit, in the part relating to financial charges supported with the acquisition of share capital, that are capable of benefiting from the special regime established in no. 2 of article 32 of the TBA, advocating the use of a "formula that takes into account the following: the remunerated liabilities of SGPS and SCR should be allocated, first and foremost, to the remunerated loans granted by these to the subsidiaries and other investments generating interest, with the remainder being allocated to the remaining assets, namely share capital, in proportion to their respective acquisition cost".

As for the method of allocating financial charges associated with each of the share capital holdings, one could opt for a direct allocation of charges with debt inherent to the acquisition of share capital or the proportional allocation method stipulated in Circular 7 of 2004 of 30 March.

Now, if the choice of a method of direct or specific allocation appears, seemingly as the solution most consistent with the identification of financial charges effectively supported with the acquisition of share capital portions, its practical implementation is susceptible to presenting insurmountable difficulties.

For if direct allocation were to be accepted, the holding company would have to have the capacity to identify the funds it channeled for purposes of acquiring share capital in a given past accounting period, when, in that same period, simultaneously, it received dividends from its subsidiaries, received payments relating to services rendered to the same, paid its current charges, disposed of assets and received the corresponding realization value (to enumerate only some of the possible financial flows).

Whereby any allocation of the debt will be, thus, necessarily random.

In fact, one of the characteristics of currency is precisely its fungibility. Now, this characteristic makes it extremely difficult to implement any method of direct or specific allocation, to the extent that it could be very difficult to determine, for example, what the specific application of capital obtained through a particular loan is.

That Circular 7/2004 of the Directorate of Services of CIT thus comes to clarify the following:

  • The period in which the financial charges should be disregarded as expenses, for tax purposes, "should proceed, in the accounting period to which they relate, to the tax correction of those that were supported with the acquisition of share capital that are susceptible to coming to benefit from the special regime established in no. 2 of article 31 of the TBA, regardless of whether all the conditions are already met for the application of the special regime for taxation of gains (point 6).

  • As for the method to be used for purposes of allocating financial charges to share capital, point 7 provides that, "given the extreme difficulty in using a method of direct or specific allocation and the possibility of manipulation that the same would allow, that allocation should be made on the basis of a formula, that takes into account the following: the remunerated liabilities of SGPS and SCR should be allocated, first and foremost, to the remunerated loans granted by these to the subsidiaries and other investments generating interest, with the remainder being allocated to the remaining assets, namely share capital, in proportion to their respective acquisition cost".

The general principle of the indispensability of expenses, provided for in article 23 of the CIT Code, establishes that "Expenses are those which are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the income-producing source" and then, the financial charges that have been supported with the acquisition of share capital do not contribute to the formation of taxable profit, being a matter of the allocation of the charge to the tax regime applicable to the result of the operation for which it was undertaken (share capital held for a period not less than 1 year).

It is incumbent on the taxpayer, with reference to each tax period, to determine taxable profit, following for that purpose the methodology described by the tax legislator, aimed at the taxation of actual effective income, the taxpayer being required to make the addition, in order to disregard, as the law provides, the charges supported with the acquisition of share capital.

III.1.4 FINANCIAL CHARGES NOT DEDUCTIBLE, RELATED TO THE ACQUISITION OF SHARE CAPITAL

In the tax period of 2013, A... SGPS incurred financial charges, which were considered as a tax expense in its respective income statement. As explained in the previous chapter of this Report, the tax regime of SGPS in force in 2013 excludes from taxation the financial charges supported for the acquisition of share capital (no. 2 of art. 32 of the TBA).

It is incumbent on the taxpayer, with reference to each tax period, to determine taxable profit, following for that purpose the methodology described by the tax legislator, aimed at the taxation of actual effective income, the taxpayer being required to make the addition, in order to disregard, as the law provides, the charges supported with the acquisition of share capital. Thus, A... SGPS added, in field 752 (blank field) of table 07 of the income statement presented for the year 2013, the amount of €842,613.90 relating to financial expenses that it considered tax-not-accepted, in accordance with no. 2 of article 32 of the TBA, determined according to the Map of Calculation of Financial Charges Attributable to the Acquisition of Share Capital that it exhibited to us, and which is attached to this Report in Annex 15.

(...)

After analyzing the Map of Calculation of Financial Charges Attributable to Acquisition of Share Capital prepared by A... SGPS, the following discrepancies were found with respect to the values considered by the taxpayer:

  • the taxpayer considered as Remunerated Liabilities the credit balances of account 241 - State and Other Public Bodies - CIT, which is incorrect, since Remunerated Liabilities are only the bank financing recorded in account 25112 and the loans obtained from the subsidiaries, recorded in account 2541, as explained in chapter III.1.1.2 of this Report;

  • the taxpayer considered as Remunerated Assets the assets recorded in account 14212 – Other Financial Instruments - Bonds and Participation Titles; however, as was demonstrated in chapter III.1.1.1 of this Report, Remunerated Assets are only loans granted to subsidiaries recorded in accounts 4113 and 4142;

  • the taxpayer considered as Share Capital the acquisition value of the financial instruments shown in account 14, when, in reality, this item should include only the acquisition value of Share Capital recorded by the equity method (those assets are recorded at fair value) in account 41111, and also the investments in other companies recorded in account 4141;

  • it should be noted that, in calculating the acquisition value of Share Capital, we included the amount of supplementary deposits made with the subsidiaries E..., SA and F..., SA - totalling €2,500,000.00 - because it was determined that these assumed a nature of "quasi-capital", as described in chapter III.1.1.1 of this Report;

  • in turn, the amount of supplementary deposits considered in the item Other Assets was deducted from that value, with only those that constitute non-remunerated assets being considered in our calculation, amounting to €4,400,000.00.

With regard to the Financial Expenses considered for purposes of calculating financial charges related to share capital, in accordance with Circular 7/2004, it is important to note that only the Corrected Financial Expenses as per chapter III.1.2 of this Report were taken into account, that is, the Financial Expenses declared by A... SGPS less those that were determined should be disregarded for tax purposes as they are associated with loans granted to its subsidiaries without any remuneration, totalling €1,688,387.25 (see table presented on page 41 of this Report), and are distributed monthly as follows:

Attached to this Report in Annex 18 is the Map of Calculation of Financial Charges Not Accepted Fiscally in accordance with no. 2 of article 32 of the TBA, for the tax period of 2013, which amounted to €887,166.50, after recalculation of the values determined by the taxpayer, taking into account the discrepancies detected: erroneous consideration of the quantum of the items of Remunerated Liabilities, Remunerated Assets, and Other Assets.

It should be noted that the methodology used to calculate these charges followed that already used by the taxpayer, with only adjustments (already justified above) being made to some of the items considered by the taxpayer. Recall that, for the purposes of making a direct allocation of the financial charges supported to the acquisition of share capital, A... SGPS was notified (see Annex 7) to present the outgoing financial flows that supported the same, without having been able to justify them, thereby preventing the direct allocation of financial charges to the acquisition of share capital held by this SGPS, leaving only, in turn, the application of the methodology already used by the taxpayer.

We have, then, that of the €1,688,387.25 of Corrected Financial Expenses, €887,166.50 are not tax deductible by virtue of being considered related to share capital. Since A... SGPS had already added in table 07 of the Form 22 income statement for 2013 the amount of €842,613.90, this was deducted from our calculation, as demonstrated:

Thus, the amount of €44,552.60, relating to financial charges not tax deductible, should be added to the Taxable Result for the year 2013, in accordance with no. 2 of article 32 of the TBA.

It is concluded, therefore, that the total of Financial Expenses not deductible for tax purposes in the year 2013 shall be €1,108,275.45, by force of the provisions of no. 1 of article 23 of the CIT Code and no. 2 of article 32 of the TBA.

In summary, of the Financial Expenses declared by the taxpayer in the year 2013 - €1,909,496.20 - €801,220.75 are considered tax-accepted, as set out:

The disregard as costs of financial charges for purposes of determining taxable profit established in no. 2 of article 32 of the TBA embodies a corollary of the general principle of the indispensability of expenses according to which the tax deduction thereof is conditioned on their connection with obtaining income subject to tax and from which it follows that "if certain expenses are related to income not subject to tax, they are not tax deductible" - a principle that informs the provision in article 23 of the CIT Code.

As such, the legislator established in article 32 of the TBA a solution in terms of which only financial charges related to the acquisition of share capital portions that benefit, with respect to gains or losses, from the tax benefit provided for in no. 2 of art. 32 of the TBA, are tax disregarded as expenses.

On this rule, we cite Constitutional Court Judgment no. 42/2014, which considers that no discriminatory treatment of SGPS in comparison with other CIT taxpayers holding share capital can be found in the normative framework under analysis; it cannot be ignored that the latter are not in an equivalent starting position, to the extent that gains resulting from the realization of gains from the disposal of share capital are not susceptible to exemption from taxation (as occurs for SGPS).

Thus, SGPS (as stated in Arbitral Decision no. 21/2012, handed down by CAAD) are not in equal circumstances with other corporate entities, whereby one cannot expect those principles to be applied to them in the same way they are applied to other legal entities that do not enjoy the same exemption.

The use of the allocation method of Circular 7/2004 precisely aims, in accordance with the provisions of article 32 no. 2 of the TBA, to achieve taxation as close as possible to actual profit, of financial charges attributable to the share capital portions it holds.

The argument of uncertainty of the gain does not support the result that the taxpayer attributes to it in its Gracious Objection: this susceptibility, based on a perspective of implicit continuity of the SGPS's activity, persists in terms of neutralizing the financial charges it incurred, falling within the regular scope of its activity of managing share capital, the choice regarding the convenience and opportunity of disposing of the share capital portion and realizing gains. Among the various normative solutions to the problem of delay between financial charges and the realization of the gain, the Constitutional Court (in the cited Judgment) follows the position of Tiago Caiado Guerreiro, which considers more viable the adoption of the general rule regime and, at the moment of realization, if some of the situations provided for in article 32 of the TBA are verified, which imply the departure from the general rule regime, then make the appropriate corrections, allowing the financial charges supported to be considered tax deductible.

Recall that it is incumbent on the taxpayer, with reference to each tax period, to determine taxable profit, following for that purpose the methodology described by the tax legislator, aimed at the taxation of actual effective income, the taxpayer being required to make the addition, in order to disregard, as the law provides, the charges supported with the acquisition of share capital - now, A... SGPS disregarded, in the year 2013, financial charges supported with the acquisition of share capital in the amount of €842,613.90, in compliance with the provision of no. 2 of article 32 of the TBA.

The taxpayer presented to us the Map of Calculation of Financial Charges Attributable to the Acquisition of Share Capital prepared by itself (see Annex 15) which served as the basis for the calculation of that amount added in table 07 of its Model 22 income statement, as non-deductible financial charges in accordance with no. 2 of article 32 of the TBA.

A... SGPS now alleges in its Gracious Objection that that addition would have been improper, by virtue of the acquisition of share capital held in 2013 having been effected without recourse to any financing, arguing to have attached proof of the respective acquisition by exhibiting the articles of incorporation and reports of contributions in kind for the realization of capital (documents that are found in Annex 8).

Now, such argument cannot prevail, since, in addition to the share capital acquired in the year 2000 through contributions in kind (which are summarized in the table below):

A... SGPS subsequently acquired (until 2012), the share capital holdings that are listed below, regarding which it did not justify the sources of financing used:

As for the possibility of applying the direct method of allocating charges with debt inherent to the acquisition of share capital, it is found that its practical implementation presents insurmountable difficulties that A... SGPS itself recognizes it was unable to overcome/surpass: A... SGPS would have to have the capacity to identify the funds it channeled for acquisition of share capital in a given past accounting period, when, in that same period, simultaneously, it received dividends from its subsidiaries, received payments relating to services rendered to the same, paid its current charges, disposed of assets and received the corresponding realization value (to enumerate only some of the possible financial flows).

Which the taxpayer did not do, it being therefore not possible to resort to such method, nor likewise to the departure from the application of Circular 7/2004; it should be stated that there is no illegality in the application of article 32 no. 2 of the TBA in the formula contained in the Circular, given that any method is good, provided that the ratio legis of the rule is respected.

Otherwise, there would be a risk of accepting financial charges at the same time that gains resulting from the disposal of share capital were being exempted, which would violate the principle of tax neutrality and would lead, that too, to a solution against the law.

This would not be the case if, by hypothesis, the law established a solution providing that, if the taxpayer could not demonstrate direct allocation, then neither could it benefit from the exemption from taxation of gains obtained (which, as is known, does not exist).

Moreover, A... SGPS itself availed itself of Circular 7/2004 to determine the financial charges related to share capital held for more than one year, having for that purpose, in determining taxable profit, proceeded to add €842,613.90 in table O7, line 779, of the Model 22 income statement.

  • On 17-01-2018, the Claimant filed the application for arbitral decision that gave rise to the present proceedings.

2.2. Unproven Facts

It was not proved what form of financing was used for the acquisitions of share capital effected after those acquired in 2000, nor that the Claimant had incurred financial charges, in 2013, to acquire any of the share capital it held.

The Claimant alleges that the acquisitions of share capital that occurred between 2003 and 2009 were effected from shareholders, attaching copies of minutes and documents relating to entries in shareholder accounts and states that the acquisition prices were recorded as credit in POC accounts 255 and 268.

The Tax and Customs Authority does not dispute these statements.

Therefore, facts l) to r) are deemed proven.

2.3. Justification for the Determination of the Facts

The proven facts are based on the documents attached by the Claimant to the application for arbitral decision and on the administrative proceedings.

3. Legal Issue

Article 32, no. 2, of the Tax Benefits Statute (TBA), in the wording introduced by Law no. 64-B/2011, of 30 December (which corresponds to article 31, no. 2, in the wording prior to the republication made by Decree-Law no. 108/2008, of 26 June), establishes the following:

2 - The gains and losses realized by SGPS of share capital portions of which they are holders, provided that held for a period not less than one year, and likewise, the financial charges supported with their acquisition do not contribute to the formation of taxable profit of these companies.

The Directorate of Services of CIT issued, for purposes of interpretation and application of this rule, Circular no. 7/2004, of 30 March, providing in its nos. 6 and 7 the following:

Exercise in Which Tax Corrections of Financial Charges Should Be Made

  1. With regard to the exercise in which financial charges should be disregarded as costs, for tax purposes, the tax correction should be proceeded with, in the accounting period to which they relate, of those that were supported with the acquisition of share capital that are susceptible to coming to benefit from the special regime established in no. 2 of art. 31 of the TBA, regardless of whether all the conditions are already met for the application of the special regime for taxation of gains. If it is concluded, at the moment of disposal of the share capital, that all the requirements for application of that regime are not met, in that accounting period, the consideration as a tax cost of the financial charges that were not considered as costs in prior accounting periods shall be proceeded with.

Method to Be Used for Purposes of Allocating Financial Charges to Share Capital

  1. As for the method to be used for purposes of allocating the financial charges supported for the acquisition of share capital, given the extreme difficulty in using, in this matter, a method of direct or specific allocation and the possibility of manipulation that the same would allow, that allocation should be made on the basis of a formula that takes into account the following: the remunerated liabilities of SGPS and SCR should be allocated, first and foremost, to the remunerated loans granted by these to the subsidiaries and other investments generating interest, with the remainder being allocated to the remaining assets, namely share capital, in proportion to their respective acquisition cost.

The Claimant made application of this method when presenting the form 22 income statement for the tax year 2013, having indicated the amount of the financial charges that resulted from that application should be considered as supported with the acquisition of share capital.

Subsequently, the Claimant filed a gracious objection in which it argued that the indication it had made is not correct, because the loans contracted were used for purposes other than financing the acquisition of share capital. Specifically, the Claimant stated in the gracious objection that the loans contracted from Credit Institutions and Financial Companies had a final balance of 11,199,582.37€, in 2013 and that it established supplementary deposits of capital with its subsidiaries in the amount of 6,900,000€ and financed its subsidiaries in a total of 11,614,896.06€, which sums to 18,514,896.06€, concluding in this way that the said bank loans were contracted to meet these financing requirements, and not to finance the acquisition of share capital.

The Tax and Customs Authority rejected the gracious objection, understanding that the said method is applicable and its application should be corrected, for "the financial charges not accepted fiscally in accordance with article 32 no. 2 of the TBA, amount in fact, in this year, to €887,166.50, which means that the amount added by A... SGPS was still lower than due by €44,552.60".

The Tax and Customs Authority understood that, in addition to the share capital acquired in 2000, the Claimant did not prove the manner in which it financed the acquisition of share capital acquired between 2003 and 2009, noting, when considering the exercise of the right to be heard, that, on 31-12-2006, a contract for medium and long-term remunerated financing was formalized between the Claimant and the subsidiary C..., SA, in the amount of 33 million euros, which had already been delivered to A... SGPS in prior years.

In the present proceedings, the Claimant states, without opposition from the Tax and Customs Authority, that the acquisitions of share capital that occurred between 2003 and 2009 were effected from shareholders, attaching copies of minutes and documents relating to entries in shareholder accounts and states that the acquisition prices were recorded as credit in POC accounts 255 and 268.

In this context, it cannot be deemed proven that the said financing of 33 million euros was used to acquire share capital.

The general regime for the relevance of gains and losses and financial charges for the formation of taxable profit of entities subject to CIT, was reflected in the contribution of gains and financial charges in full [articles 20, no. 1, paragraph h), and 23, no. 1, paragraph a), of the CIT Code in the wording resulting from Decree-Law no. 159/2009, of 13 July), and in the contribution of losses at 50% [in accordance with articles 23, no. 1, in l) and 45, no. 3, of the same Code].

For SGPS, article 32, no. 2, of the TBA (in addition to other situations provided for in its no. 3), established a special regime, which did not necessarily result in benefit, which was reflected, in general, in the irrelevance for the formation of taxable profit of SGPS of gains and losses realized from share capital held for at least one year, accompanied by the non-contribution to the formation of taxable profit of financial charges supported with their acquisition.

In no. 2 of article 32 of the TBA it is established that the "financial charges supported with their acquisition" do not contribute to the formation of taxable profit, referring to share capital, whereby it must be concluded that its literal tenor indicates that only the financial charges that are connected with the acquisition of share capital are covered by the non-deductibility established therein.

In addition to being this the interpretation that results from the literal tenor, it is corroborated by the explanation for its introduction in the TBA that was given in the Report of the State Budget for 2003 (Law no. 32-B/2002, of 30 December).

In fact, as stated in Circular no. 7/2004, the regime of this rule was introduced in the TBA by Law no. 32-B/2002, of 30 December, which approved the State Budget for 2003, giving new wording to article 31, whose regime came to appear in article 32 after the renumbering made by Decree-Law no. 108/2008, of 26 June.

In Bill no. 28-IX, which came to give rise to the Budget Law for 2003, the text of that article 31, no. 2, appeared with wording identical to that in force in 2012 (in article 32, no. 2), the only difference being the addition of the reference to "ICR" (abbreviation for "risk capital investors"), which is irrelevant for the interpretation of the rule.

In the said Report of the State Budget for 2003 ( [1] ), after noting a shortfall in the execution of the 2002 budget regarding CIT ( [2] ) the introduction of several measures is announced aimed at the "broadening of the tax base and measures of moralization and neutrality", among which that of the non-deductibility of charges of a financial nature directly associated with the acquisition of share capital by SGPS, which is announced in the following terms:

"The disregard for deductibility, for purposes of determining taxable profit, of charges of a financial nature directly associated with the acquisition of share capital by SGPS, is established";

It is unequivocal, therefore, that it was intended that only financial charges directly associated with the acquisition of share capital should be covered by the non-deductibility.

By that express reference in the Report to the need for financial charges to be directly associated with the acquisition of share capital (which is also expressed in the text of the rule through the reference to "financial charges with their acquisition"), it is concluded that it is not sufficient, to determine the non-deductibility of financial charges, to establish that the SGPS holds share capital and incurred financial charges, it being necessary to demonstrate that there is a direct relationship between certain financial charges and the acquisition of certain share capital.

It is a corollary of this interpretation, imposed by the literal tenor of article 32, no. 2, that, if certain share capital portions were not acquired with liabilities generating financial charges (namely, those obtained by contributions in kind or with use of own capital), they are irrelevant for the purposes of the application of that rule, in the part that relates to the non-deductibility of financial charges.

It is also a corollary of this interpretation that, with respect to share capital acquired with financing generating charges, only the charges derived from the financing relating to their acquisition are non-deductible.

There is thus no legal support for departing from the rule of deductibility of financial charges, which is provided in paragraph c) of no. 1 of article 23 of the CIT Code, with respect to charges that are not directly associated with the acquisition of share capital.

Therefore, it is clear, in view of the wording of the final part of no. 1 of article 32 and the explanation given in the Report of the Budget for 2003, that the non-deductibility of charges applies only to those that are directly derived from financing used for the acquisition of share capital.

Being this the regime that is provided for in the law, it cannot be altered by regulatory means, for rules created by acts of a legislative nature cannot be, with external efficacy, interpreted, supplemented, modified, suspended or repealed by acts of another nature (article 112, no. 5, of the Constitution).

In the case at hand, it was not demonstrated that any of the share capital portions had been acquired with financing that would generate charges in 2013.

With regard to those acquired in 2013, the question of the applicability of the regime of article 32, no. 2, of the TBA does not arise, as they had not been acquired for more than one year.

With regard to all other acquisitions of share capital, the Claimant states in the present proceedings that they were acquired on credit from shareholders, with the credits entered in the accounts it identifies and these statements were not disputed by the Tax and Customs Authority.

In this context, the evidence produced points to the share capital not having been acquired with financing that would have generated charges in 2013.

At the very least, one is faced with a situation of founded doubt that, in accordance with article 100, no. 1, of the Code of Tax Procedure and Process, justifies the annulment of the tax act.

In any event, it is sufficient that the correction made was based on the method referred to in point 7. of Circular no. 7/2004, not provided for in the law, to have to conclude on the illegality of the correction made, in view of the most recent uniform case law of the Supreme Administrative Court, as can be seen from the following judgments:

– of 08-03-2017, handed down in case no. 0227/16: "point 7. of Circular no. 7/2004, of 30.03, of the Directorate of Services of CIT, establishes an indirect, presumptive method of allocation of financial charges in violation of articles 87 to 90 of the General Tax Law being, therefore, illegal";

– of 31-05-2017, handed down in case no. 01229/15: "point 7. of Circular no. 7/2004, of 30.03, of the Directorate of Services of CIT, establishes an indirect, presumptive method of allocation of financial charges in violation of articles 87 to 90 of the General Tax Law being, therefore, illegal";

– of 29-11-2017, handed down in case no. 01292/16: "by establishing an indirect and presumptive method, with regard to the allocation of financial charges, for purposes of calculating taxable profit, no. 7 of Circular no. 7/2004, of 30/03, of the Directorate of Services of CIT, violates the principle of tax legality";

– of 24-01-2018, handed down in case no. 0745/15, and of 31-01-2018, handed down in case no. 01157/17: "it is affected by a defect of violation of law the act of self-assessment of CIT made in compliance with the instructions contained in point 7. of Circular no. 7/2004, of 30.03, of the Directorate of Services of CIT, to the extent that it establishes an illegal method of allocation of financial charges supported with the acquisition of share capital".

Thus, in line with this case law, it should be concluded that the self-assessment made and the decision on the gracious objection suffer from a defect of violation of law, having been based on an incorrect interpretation of article 32, no. 2, of the TBA.

This defect justifies the annulment of the disputed assessment, in accordance with article 163, no. 1, of the Code of Administrative Procedure subsidiarily applicable in accordance with article 2, paragraph c), of the General Tax Law.

3.1. Matters of Prejudiced Knowledge

Given that it must be judged that the application for declaration of illegality of the self-assessment and of the rejection of the gracious objection is well-founded, due to error in interpretation of article 32, no. 2, of the TBA, these acts must be annulled, whereby the knowledge of the remaining issues of legality invoked becomes prejudiced, as being useless, as results from article 130 subsidiarily applicable by force of the provisions of article 29, no. 1, paragraph e), of the LFATM.

4. Compensatory Interest

The Claimant requests the payment of compensatory interest on the amount to be reimbursed.

In accordance with the provision of paragraph b) of article 24 of the LFATM, the arbitral decision on the merit of the claim for which no appeal or challenge may lie binds the Tax Administration from the end of the deadline provided for appeal or challenge, the latter being required to, in the exact terms of the substantiation of the arbitral decision in favor of the taxpayer and until the end of the deadline provided for the voluntary execution of decisions of the tax courts, "reestablish the situation that would exist if the tax act that is the subject of the arbitral decision had not been performed, adopting the acts and operations necessary for that purpose", which is in keeping with the provision of article 100 of the General Tax Law [applicable by force of the provision of paragraph a) of no. 1 of article 29 of the LFATM] which establishes that "the tax administration is obliged, in case of full or partial substantiation of objection, judicial challenge or appeal in favor of the taxpayer, to the immediate and full reconstitution of the legality of the act or situation that is the subject of the dispute, including the payment of compensatory interest, if applicable, from the end of the deadline of execution of the decision".

Although article 2, no. 1, paragraphs a) and b), of the LFATM uses the expression "declaration of illegality" to define the competence of the arbitral tribunals that function in the CAAD, not making reference to condemn decisions, it should be understood that their competencies include the powers which, in judicial challenge proceedings, are attributed to the tax courts, this being the interpretation that is in keeping with the meaning of the legislative authorization on which the Government based itself to approve the LFATM, in which it is proclaimed, as the first directive, that "the tax arbitration process should constitute an alternative procedural means to the judicial challenge proceedings and to the action for the recognition of a right or legitimate interest in tax matters".

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

Thus, no. 5 of article 24 of the LFATM, when stating that "payment of interest is due, regardless of its nature, in accordance with the terms provided for in the general tax law and in the Code of Tax Procedure and Process", should be understood as permitting the recognition of the right to compensatory interest in the arbitration process.

It is therefore necessary to assess the request for compensatory interest.

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

Article 43
Payment of Undue Tax Obligation

1 – Compensatory interest is owed when it is determined, in gracious objection or judicial challenge, that there was error attributable to the services from which results the payment of the tax debt in an amount higher than legally due.

2 – Error attributable to the services is also considered to exist in cases where, despite the assessment being made on the basis of the taxpayer's statement, this party followed, in completing it, the generic guidance of the tax administration, duly published.

The Claimant obtained a reimbursement as a consequence of the self-assessment of the group of which it is the parent company.

Following the substantiation of the application for arbitral decision, the Claimant is entitled to a reimbursement greater than that effected, which comes down to "undue payment" of the part not reimbursed, for purposes of the aforementioned no. 1 of article 43.

In accordance with no. 2 of this article 43, the error in the self-assessment is attributable to the Tax and Customs Authority, as the Claimant followed, in completing the form 22 income statement, the generic guidance of the tax administration, published in Circular no. 7/2004.

Compensatory interest is owed at the supplementary legal rate, on the amount of the reimbursement increase, in accordance with articles 43, nos. 1 and 2, and 35, no. 10 of the General Tax Law, article 24, no. 1, of the LFATM, article 61, nos. 3 and 4, of the Code of Tax Procedure and Process, article 559 of the Civil Code and Ordinance no. 291/2003, of 8 April (or such other ordinance or ordinances as may change the legal rate), from the date on which the reimbursement was effected until the payment of the amount to be reimbursed.

5. Decision

In these terms, this Arbitral Tribunal agrees to:

  • Judge the application for arbitral decision as well-founded and annul the self-assessment of CIT, relating to the tax year 2013, and the decision rejecting the gracious objection no. ...2016...;

  • Judge the application for compensatory interest as well-founded and condemn the Tax and Customs Authority to pay it to the Claimant, in the terms referred to in point 4 of this judgment.

6. Value of the Proceedings

In accordance with the provisions of article 306, no. 2, of the Code of Civil Procedure and article 97-A, no. 1, paragraph a), of the Code of Tax Procedure and Process and article 3, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of the proceedings is fixed at € 149,814.73.

7. Costs

In accordance with article 22, no. 4, of the LFATM, the amount of costs is fixed at € 3,060.00, in accordance with Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, to be paid by the Tax and Customs Authority.

Lisbon, 08-06-2018

The Arbitrators

(Jorge Lopes de Sousa)

(Rui Ferreira Rodrigues)

(Luís Menezes Leitão)

[1] Available at: http://www.dgo.pt/politicaorcamental/Paginas/OEpagina.aspx?Ano=2003&TipoOE=Or%u00e7amento+Estado+Aprovado&TipoDocumentos=Lei+%2F+Mapas+Lei+%2F+Relat%u00f3rio

[2] Stated in the Report of the State Budget for 2003, page 51:

"the budgetary execution of 2002 indicates a revenue shortfall resulting from the reduction in results presented by some of the largest companies in 2001, and it is foreseeable that this trend will worsen for 2002, which will determine a new shortfall in 2003 revenue. This trend will be aggravated by the impact of the reduction in the nominal CIT rate from 32% to 30% effective from 01/01/2002, which may be partially offset by the increase in the values of special payment on account".

Frequently Asked Questions

Automatically Created

Are financial charges incurred by SGPS companies deductible for IRC (Corporate Income Tax) purposes in Portugal?
Financial charges incurred by SGPS companies in Portugal are subject to specific limitations under the IRC Code. While SGPS companies benefit from a special tax regime under Article 32 of the IRC Code that exempts capital gains and dividends from qualifying shareholdings, financial charges related to borrowings are generally non-deductible when the borrowed funds are used to acquire shareholdings or provide financing to subsidiaries, as established in Circular 7/2004 from the Portuguese Tax Authority. The deductibility depends on demonstrating a direct connection between the debt and taxable income-generating activities, which is often challenging for holding companies whose primary activity is managing participations.
What is the legal framework governing the tax benefit for SGPS holding companies regarding financial charges deductibility?
Yes, Portuguese taxpayers can challenge an IRC self-assessment through a two-stage process. First, they must file a gracious complaint (reclamação graciosa) with the Tax Authority within a specified timeframe, typically 120 days from notification of the tax assessment or self-assessment. If the gracious complaint is rejected or not decided within the legal timeframe, the taxpayer may then initiate arbitration proceedings before CAAD (Centro de Arbitragem Administrativa) under the Legal Framework for Arbitration in Tax Matters (RJAT - Regime Jurídico da Arbitragem Tributária), established by Decree-Law 10/2011 of 20 January. This arbitration route provides an alternative to judicial courts for resolving tax disputes, offering a faster and specialized forum for tax litigation in Portugal.
Can a taxpayer challenge an IRC self-assessment through a gracious complaint (reclamação graciosa) and subsequent CAAD arbitration?
Yes, taxpayers are entitled to compensatory interest (juros indemnizatórios) when a tax self-assessment or tax authority decision is declared illegal by a CAAD arbitral tribunal or Portuguese courts. This right is established under Article 43 of the General Tax Law (Lei Geral Tributária) and serves to compensate taxpayers for the financial harm caused by unlawful tax collection or retention of overpaid amounts. Compensatory interest accrues from the date of payment of the undue tax until its refund, calculated at the legal interest rate applicable to tax matters. The tax authority is obligated to pay these interests automatically upon declaration of illegality, without requiring a separate claim from the taxpayer, as the interest compensates for the wrongful deprivation of funds resulting from the illegal tax assessment.