IRC Self-Assessment 2012: Fair Value of Financial Instruments and Fiscal Relevance of Losses | CAAD 231/2015-T

ARBITRAL DECISION

CAAD: Tax Arbitration

Case no. 231/2015-T

Subject: Corporate Income Tax (IRC), self-assessment for the 2012 tax period, tax relief of half of losses and negative equity variations, financial instruments, fair value measurement (articles 5 of Decree-Law 159/2009 and 18-9/a) and 45-3, of the IRC Code)

The arbitrators José Poças Falcão (arbitrator-president), Carla Castelo Trindade and António Martins (arbitrators-members), designated by the Ethical Council of the Administrative Arbitration Center (CAAD) to form the Arbitral Court, constituted on 18 June 2015, agree as follows:

I – REPORT

Parties to this dispute:

A… SGPS, SA, (hereinafter only "A…," or "Claimant"), Legal Entity no. …, with registered office at Avenue …, …, … Cascais, under the jurisdiction of the Cascais Tax Office -…, located at Street …, Tower … - …, … Lisbon and with Tax ID …

THE TAX AND CUSTOMS AUTHORITY, (hereinafter referred to as Respondent or TA).

Subject of the claim

The subject of the claim is the rejection of the Administrative Appeal (see Official Letter no. of 01.12.2014, a copy of which is attached as Doc. no. 1 and whose contents are deemed fully reproduced and administrative appeal whose first page is attached as Doc no. 2) and, indirectly, the (alleged) illegality of the self-assessment act relating to the Corporate Income Tax (IRC) for the tax period 2012 (see the IRC self-assessment calculation attached as Doc. no. 3 and whose contents are deemed fully reproduced).

Grounds presented by the Claimant

The Claimant alleged, in essence:

a) The Claimant is a holding company integrated into a Tax Group subject to the Special Tax Regime for Groups of Companies (RETGS) of which it is the dominant company.

b) In the tax period in question (2012), the Claimant proceeded, pursuant to article 122 of the IRC Code, to submit its individual income statement Form 22, on 30 July 2013, in which it determined a taxable profit of € 6,639,717.02 (attached as Doc. no. 4 and whose contents are deemed fully reproduced).

c) Having this influenced the overall result of the Group which was fixed at a taxable profit of € 11,330,140.41 and an amount of tax payable of € 739,473.99 (see Income Statement Form 22 of the Group attached as Doc. no. 5 and whose contents are deemed fully reproduced).

d) Now, the Claimant has held, since 2007, a financial interest of less than 5% (of 0.095%) in Bank …, S.A., with registered office at Square …, no. …, …, ..., and Unique Registration Number in the Commercial Registry Office of the ... and Legal Entity … (hereinafter, only "Bank…") – a fact which, moreover, is not disputed and expressly accepted by the TA in the decision rejecting the Administrative Appeal.

e) This interest was measured, in the tax period in question, in accordance with the applicable accounting and tax rules, at fair value through profit or loss.

f) However, under the Official Chart of Accounts (POC), i.e., until 31 December 2009, the interest was recorded, accounting-wise, in the Claimant's financial statements, at acquisition cost (€ 81,998,932), less impairments that reflected successive reductions in market value, which, under the tax rules in force at that time, had no tax relevance.

g) With the approval by Decree-Law no. 158/2009, of 13 June, of the System of Normalisation of Accounting (SNC), which succeeded the POC and entered into force on 1 January 2010, the Claimant proceeded to record the said interest, in accordance with Accounting and Financial Reporting Standard (NCRF) 27.

h) This NCRF defines, as a measurement criterion for financial instruments in the form of investments in equity instruments with publicly disclosed quotes, the fair value criterion with any fair value gains and losses recognised directly in the result for the period.

i) Thus, with the transition to the SNC, and in accordance with NCRF 3, the Claimant recognised in equity the effect arising from the recognition at fair value of the interest in Bank… on 31 December 2010, i.e., it recognised a loss in the amount of € 54,537,180.20.

j) For this reason, A…, once it had recorded a negative equity variation corresponding to the difference between the acquisition value of the interest and its official quote, relieved it in its equity.

k) This loss of fair value constituted a transition adjustment for the SNC, tax-relevant under the IRC Code, therefore the provisions of Article 5(1) of Decree-Law no. 159/2009, of 13 June, were applicable to it.

l) In accordance with which, the Claimant may deduct from taxable profit, in equal parts, over 5 years (i.e., from 2010 to 2014) in the proportion of 1/5 each year, that loss of fair value.

m) Therefore, the amount of € 5,453,718.02 recorded in its income statement, in field 705 — negative equity variations (transitional regime provided for in paragraphs 1, 5 and 6 of article 5 of Decree-Law no. 159/2009, of 13 July) - corresponds to 1/5 of 50% of the adjustment arising from the retrospective application of the fair value method in the total amount of € 54,537,180.20.

n) On the other hand, as there was during the 2012 fiscal year a negative variation in the quote of the interest in question, compared to its value as of 31 December 2011, the Claimant considered as tax-deductible only 50% of the respective loss recorded, which was € 2,069,654.48, i.e., it proceeded to increase taxable profit, in field 737 of Table 07 of the Income Statement Form 22 by the amount of € 1,034,827.24.

o) As can be seen from the foregoing, the Claimant chose, both as regards the transition adjustment and as regards the expense generated by the application of fair value relating to the aforementioned interest, to relief them, for tax purposes, in only half their value,

p) And it did so by applying the understanding of the TA explained above and set forth in the Interpretive Guidance issued in Case no. …/2011, with Order of 24.02.2011 of the Director-General of Taxes, according to which losses resulting from the application of fair value should only be considered at 50% for purposes of determining taxable profit.

q) And these were the facts that led to the determination of the tax result indicated above.

r) However, this action does not correspond to what the law imposes on the taxpayer.

s) And it was due to this understanding that the Claimant presented the corresponding Administrative Appeal against the self-assessment act for Corporate Income Tax (already attached as Doc. no. 2).

t) This appeal was expressly rejected by Official Letter of the Finance Directorate of Lisbon no. …, dated 6 January 2015 (already attached as Doc. no. 1).

u) The TA maintaining the understanding that the limitation provided for in Article 45(3) of the IRC Code applies to the deductibility of expenses arising from the application of fair value.

v) Indeed, as can easily be seen from the decision rejecting the administrative appeal, the TA understands that, in summary, the loss verified in the quotation of Bank… shares participates only at half for the determination of the taxable result, by application of article 45 of the IRC Code.

x) In that sense, the TA considers that the negative adjustments arising from the application of fair value are indeed losses that fit within the list provided for in Article 45(3) of the IRC Code.

aa) For this purpose, it invokes the Interpretive Guidance Case no. …/2011 with Order of 24/02/2014 of the Director General, which establishes the tax framework of the loss determined by a holding company as a result of the application of the fair value model.

bb) Highlighting the provision in point 5 thereof, which states that "as the reductions in fair value of these equity components are qualified as loss, they should be considered in accordance with the said article 45, no. 3, of the IRC Code, at 50% of its presents in this way a generic orientation that allows clarifying that article."

cc) Concluding from the foregoing that losses resulting from the fair value measurement of equity instruments provided for in Article 18(9/a) of the IRC Code participate in only 50% for determining taxable profit, by application of Article 45(3) of the IRC Code.

dd) This understanding, as far as the Claimant is concerned, is not correct for the reasons that it develops in its pleadings.

Constitution of the Arbitral Court

The petition for the constitution of the arbitral court was accepted by the President of CAAD and the Arbitral Court was duly constituted, on 18-6-2015, to consider and decide the subject matter of this case, and the Tax and Customs Authority was automatically notified in accordance with the provisions of article 18 of the RJAT (Legal Framework for Tax Arbitration approved by Law no. 10/2011, of 20 January with subsequent amendments).

The Claimant did not proceed to appoint an arbitrator, therefore, pursuant to the provisions of Article 6(1) and Article 11(1/b) of Decree-Law no. 10/2011, of 20 January, as amended by article 228 of Law no. 66-B/2012, of 31 December, the Ethical Council proceeded to designate the signatories as members of this Collective Arbitral Court.

The parties were subsequently and duly notified of this designation and did not manifest any intention to refuse it, in accordance with article 11(1), paragraphs a) and b), of the RJAT and articles 6 and 7 of the Ethical Code.

In compliance with the provision of Article 11(1/c) of Decree-Law no. 10/2011, of 20 January, as amended by article 228 of Law no. 66­B/2012, of 31 December, the collective arbitral court was duly constituted on 18-06-2015.

The TA's Response

The TA presented a response, maintaining, in essence, the position defended in the administrative phase of the case and raising, as a preliminary objection, the exception of material incompetence of the Arbitral Court, with the following grounds (in essence and in summary):

The exception of material incompetence of CAAD

a) Ultimately (see articles 100 and 101), the Claimant petitions that, by allegedly having been wrongly applied Article 45(3) of the IRC Code, "the self-assessment here in question should be altered accordingly, including in field 705 as a title of transition adjustments by retrospective application of fair value the amount of € 10,907,436.04 (instead of € 5,453,718.02) and eliminating the amount of € 1,034,654.48 increased in field 737, being, consequently, its individual taxable profit corrected to € 151,171.76 and the Group's taxable profit corrected to € 4,841,595.15".

b) Corrections that "should thus result in a reduction of the Corporate Income Tax payable from € 739,473.99 to € 179,748.40 within the scope of the RETGS, which means a reduction of € 559,725.59 (see RETGS calculation attached as doc. 6", for which it refers in the claim, ultimately.

c) Now, although such a claim could eventually derive from the execution of judgments that would be made in case the arbitral decision rendered were to be granted - which is conceded on a purely academic basis - such a claim exceeds the competence of this Court to the extent that it is not included in the matters indicated in Article 2(1) of the RJAT.

d) These establish: "1 - The competence of arbitral courts comprises the consideration of the following claims:

1st The declaration of illegality of tax assessment acts, self-assessment acts, withholding at source acts and payments on account;

2nd The declaration of illegality of acts fixing the taxable matter when it does not give rise to the assessment of any tax, acts determining the taxable matter and acts fixing equity values."

e) In summary, as the competence of arbitral courts derives from Article 2(1) of the RJAT and from Order no. 112-A/2011, of 22 March, by virtue of article 4 of the RJAT, we have that, as Jorge Lopes de Sousa correctly states, "the competence of Arbitral Courts comprises the consideration of claims relating to the declaration of illegality: (1) Of tax assessment acts administered by the Tax and Customs Authority (TA) [...]; (2) Of self-assessment acts, withholding at source and payments on account of taxes administered by the TA, provided they have been preceded by recourse to the prior administrative remedy provided for in articles 131 to 133 of the Code of Tax Procedure and Process (CPPT) [...]; (3) Of acts fixing the taxable matter without recourse to indirect methods, when it does not give rise to the assessment of any tax [...]; (4) Of acts determining the taxable matter without recourse to indirect methods [...]; (5) Of acts fixing equity values, for tax purposes, administered by the TA [...]; (6) Of acts assessing customs rights and charges of equivalent effect on the export of goods [...]; (7) Claims relating to export levies instituted under the Common Agricultural Policy (CAP) or under specific schemes applicable to certain goods resulting from the processing of agricultural products [...]; (8) Of acts assessing value added tax (VAT), special excise taxes (IEC's) and other indirect taxes on goods that are not subject to import rights [...]" - cf. JORGE LOPES DE SOUSA, Commentary on the Legal Framework for Tax Arbitration, Guide to Tax Arbitration, Almedina, 2013, pp. 105-108).

f) Beyond the competence for the direct consideration of the legality of claims of this type, arbitral courts operating at CAAD may consider acts of second or third degree that have as their object the consideration of the legality of acts of those types, namely acts that decide administrative appeals and hierarchical appeals, as results from the references in Article 10(1/a) of the RJAT to Article 102(2) of the Code of Tax Procedure and Process (CPPT), which refers to the judicial challenge of administrative appeals, and to the "decision of the hierarchical appeal".

g) As such, it is manifest that the consideration of the claim for recognition of the right formulated in articles 100 and 101 and reiterated in the request for arbitral ruling, ultimately, is not within these competencies, since there is no legal basis that allows for awards of a nature other than those arising from the powers fixed in the RJAT, even if they would constitute a consequence, at the level of execution, of the declaration of illegality of assessment acts.

h) As follows from the provision of article 24 of the RJAT, the definition of the acts in which the execution of arbitral awards must be concretized is, in the first place, the responsibility of the TA, with the possibility of recourse to the tax courts to require coercively the execution, within the scope of the judgment execution process, provided for in article 146 of the CPPT and articles 173 and following of the Code of Process in Administrative Courts. In this sense, this was already understood by the arbitral award of 2015-01-15, rendered in case no. 587/2014-T (see pages 3 to 6 thereof).

i) The material incompetence of the Court for the consideration of the claim identified above constitutes a dilatory exception that prevents the continuation of the case, leading to the dismissal of the instance as to the claim in question, in accordance with the provisions of articles 576, no. 2, 577, paragraph a) of the Code of Civil Procedure (CPC), applicable ex vi article 29, no. 1, paragraph e) of the RJAT.

The hearing of the Court with the parties provided for in article 18 of the RJAT was waived.

The claimant listed witnesses but the respective testimonies were subsequently dispensed with.

Both parties, notified to present their final submissions, on facts and law, in writing, proceeded to do so within the time granted.

Preliminary Ruling

The arbitral court is duly constituted.

The exception: material incompetence of the Arbitral Court

As an exception or preliminary issue, the TA raises the question of the (in)competence of the Arbitral Court alleging that the claim exceeds the competence of the Arbitral Courts constituted within the CAAD in light of the provision of article 2 of the RJAT.

The TA alleges substantially to support the exception that "(…) it is manifest that the consideration of the claim for recognition of the right formulated in articles 100 and 101 and reiterated in the request for arbitral ruling, ultimately, is not within these competencies, since there is no legal basis that allows for awards of a nature other than those arising from the powers fixed in the RJAT, even if they would constitute a consequence, at the level of execution, of the declaration of illegality of assessment acts.

h) As follows from the provision of article 24 of the RJAT, the definition of the acts in which the execution of arbitral awards must be concretized is, in the first place, the responsibility of the TA, with the possibility of recourse to the tax courts to require coercively the execution, within the scope of the judgment execution process, provided for in article 146 of the CPPT and articles 173 and following of the Code of Process in Administrative Courts. In this sense, this was already understood by the arbitral award of 2015-01-15, rendered in case no. 587/2014-T (see pages 3 to 6 thereof).

i) The material incompetence of the Court for the consideration of the claim identified above constitutes a dilatory exception that prevents the continuation of the case, leading to the dismissal of the instance as to the claim in question, in accordance with the provisions of articles 576, no. 2, 577, paragraph a) of the Code of Civil Procedure (CPC), applicable ex vi article 29, no. 1, paragraph e) of the RJAT (...)"

The Claimant presented a written response to the exception in execution of an order to that effect duly rendered by the Court, defending the unfoundedness of the exception on the grounds that, also in substance, the claim formulated is not what the TA claims, in so far as the claim is not what the TA alleges.

Let us see:

The TA states that the Claimant petitions (articles 100 and 101, of the initial pleading) that, "(…) by allegedly having been wrongly applied Article 45(3) of the IRC Code, «the self-assessment of Corporate Income Tax here in question should be altered accordingly, including in field 705 as a title of transition adjustment by retrospective application of fair value the amount of €10,907,436.04 (instead of €5,453,718.02) and eliminating the amount of € 1,034,654.48 increased in field 737, being, consequently, its individual taxable profit corrected to €151,171.76 and the Group's taxable profit corrected to €4,841,595.15".

The claim is defined, in procedural terms, as the plaintiff's claim, the right for which it requests or requires judicial protection and the manner in which it intends to obtain that protection (the judicial remedy requested, the legal effect sought (see, e.g., articles 186, 552-1/e) and 581-3. See also Manuel de Andrade, Elementary Notions of Civil Procedure, Coimbra Editora/1976, p. 111).

Now, in light of the foregoing and without need for other considerations, it will be easy to conclude that what the Claimant intends or petitions (legal effect) is clearly what appears, not only at the beginning or introduction of the initial pleading but, and especially, at the end of that pleading under the heading "of the claim" and containing clearly the aforesaid claim of the Claimant: the declaration of illegality of the rejection of the administrative appeal and the self-assessment act.

And since this is the scope or reach of the claim, naturally the material competence of the Arbitral Court is unquestionable in light of article 2 of the RJAT and Order no. 112-A/2011, of 22 March.

The exception of material incompetence raised by the TA is therefore unfounded.

This Court is thus materially competent, pursuant to Articles 2, no. 1, paragraph a), and 30, no. 1, of Decree-Law no. 10/2011, of 20 January.

The parties have judicial personality and capacity, are legitimate and are duly represented (articles 4 and 10, no. 2, of the same decree and article 1 of Order no. 112-A/2011, of 22 March).

The case is not vitiated by defects that would invalidate it.

It is necessary to consider the merits of the claim.

II STATEMENT OF REASONS

Facts Proven

In light of the various perspectives of consideration and decision of the subject matter of the claim, this Court considers the following essential facts proven:

a. The Claimant is a holding company (SGPS) that is integrated into a Tax Group subject to the Special Tax Regime for Groups of Companies (RETGS) of which it is the dominant company.

b. In the tax period in question in this case (2012), the Claimant proceeded to submit its individual income statement, in which it determined a taxable profit of € 6,639,717.02, an amount that influenced the overall result of the Group which was fixed at a taxable profit of € 11,330,140.41 and an amount of tax payable of € 739,473.99.

c. The Claimant has held, since 2007, a financial interest of less than 5% (of 0.095%) in Bank …, S.A.

d. This interest was measured, in the tax period of the 2012 fiscal year, at fair value through profit or loss.

e. Under the Official Chart of Accounts (POC), until 31 December 2009, the interest was recorded accounting-wise in the Claimant's financial statements at acquisition cost (€ 81,998,932), less impairments that reflected successive reductions in market value.

f. With the approval by Decree-Law no. 158/2009, of 13 June, of the System of Normalisation of Accounting (SNC), which succeeded the POC and entered into force on 1 January 2010, the Claimant proceeded to record the said interest in accordance with Accounting and Financial Reporting Standard (NCRF) 27.

g. This NCRF defines as a measurement criterion for financial instruments in the form of investments in equity instruments with publicly disclosed quotes the fair value criterion with any fair value gains and losses recognised directly in the result for the period.

h. With the transition to the SNC, and in accordance with NCRF 3, the Claimant recognised in equity the effect arising from the recognition at fair value of the interest in Bank… on 31 December 2010, i.e., it recognised a loss in the amount of € 54,537,180.20.

i. For this reason, and once it had recorded a negative equity variation corresponding to the difference between the acquisition value of the interest and its official quote, the claimant relieved it in its respective equity.

j. The amount of € 5,453,718.02 recorded in its income statement, in field 705 — negative equity variations (transitional regime provided for in paragraphs 1, 5 and 6 of article 5 of Decree-Law no. 159/2009, of 13 July) corresponds to 1/5 of 50% of the adjustment arising from the retrospective application of the fair value method in the total amount of € 54,537,180.20.

k. As there was, during the 2012 fiscal year, a new negative variation in the quote of the interest in question, compared to its value as of 31 December 2011, the Claimant considered as tax-deductible only 50% of the respective loss recorded, which was € 2,069,654.48, proceeding to increase taxable profit, in field 737 of Table 07 of the Income Statement by the amount of € 1,034,827.24.

l. The Claimant chose, both as regards the transition adjustment and as regards the expense generated by the application of fair value relating to the aforementioned interest, to relief them, for tax purposes, in only half their value, by applying the understanding of the TA set forth in the Interpretive Guidance issued in Case no. …/2011, with Order of the Director-General of Taxes, according to which losses resulting from the application of fair value should only be considered at 50% for purposes of determining taxable profit.

m. The claimant understands that this procedure does not correspond to what the law establishes and for this reason presented, in a timely manner, an Administrative Appeal against the self-assessment act for Corporate Income Tax.

n. Such appeal was rejected by Official Letter of the Finance Directorate of Lisbon no. …, dated 6 January 2015, based on the understanding that the limitation provided for in Article 45(3) of the IRC Code applies, in the case, to the deductibility of expenses arising from the application of fair value.

o. And the TA sustains this position in the Interpretive Guidance - Case no. …/2011, which establishes the tax framework of the loss determined by a holding company as a result of the application of the fair value model.

p. The TA emphasizes from that Interpretive Guidance the provision in point 5 thereof, which states that "as the reductions in fair value of these equity components are qualified as loss, they should be considered, in accordance with the said article 45, no. 3, of the IRC Code, at 50% of its presents in this way a generic orientation that allows clarifying that article."

q. Concluding therefore that losses resulting from the fair value measurement of equity instruments provided for in Article 18(9/a) of the IRC Code participate in only 50% for determining taxable profit, by application of Article 45(3) of the IRC Code.

Facts Not Proven

There are no other facts, of relevance to the decision, proven and/or not proven.

Reasoning

The Court bases its consideration and decision of the factual matter above on the critical analysis of all documentation incorporated in the file and in the instructing administrative process.

It should be noted that in terms of the strict factual framework there are no divergences in the positions of the parties.

The essence of the dispute is only and solely in the application and interpretation of Law and the Law.

II STATEMENT OF REASONS (cont.)

1. The Subject Matter of the Dispute and the Issues to be Decided

The legality of the Corporate Income Tax self-assessment act no. 2014 … relating to the Corporate Income Tax for 2012 is being discussed in this case.

Such self-assessment of Corporate Income Tax, according to the Claimant, "(…) directly and unequivocally violates mandatory legal provisions, both of a substantive and formal nature (…). In truth, as was demonstrated immediately in the initial pleading, the assessment is based on an erroneous interpretation of a legal provision that culminates in the application of a limitation to its deduction of expenses to which such limitation is not applicable.

It is, therefore, (…) a self-assessment affected by illegality which, as such, demands its annulment (…)"

2. Legal Framework

For the decision to be made, the following provisions of the IRC Code are relevant, hereinafter cited in the version in force at the time of the facts (2012):

Article 18, no. 9:

"Fair value adjustments do not contribute to the formation of taxable profit, being allocated as income or expenses in the tax period in which the elements or rights that gave rise to them are sold, exercised, terminated or settled, except when:

a) They relate to financial instruments recognised at fair value through profit or loss, provided that, where these are equity instruments, they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a shareholding in the capital equal to or greater than 5% of the respective share capital

…."

Article 23:

Expenses

"1 — Expenses are those that are proven to be indispensable for the realisation of income subject to tax or for the maintenance of the income-producing source, namely:

a) Those relating to the production or acquisition of any goods or services, such as materials used, labour, energy and other general production, maintenance and repair expenses;

b) Those relating to distribution and sale, including transport, advertising and merchandise placement;

c) Of a financial nature, such as interest on borrowed capital applied in business, discounts, premiums, transfers, exchange differences, credit operation expenses, debt collection and bond and other security issuance, redemption premiums and those resulting from the application of the effective interest method to financial instruments valued at amortised cost;

d) Of an administrative nature, such as remuneration, including that attributed as participation in profits, allowances, current consumables, transport and communications, rents, legal matters, insurance, including life insurance and operations in the "Life" branch, contributions to pension funds, contributions to pension funds and to any supplementary social security schemes, as well as expenses with employment termination benefits and other post-employment or long-term employee benefits;

e) Those relating to analyses, rationalisation, research and consultation;

f) Of a tax and paratax nature;

g) Depreciation and amortisation;

h) Adjustments in inventories, impairment losses and provisions;

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

j) Expenses resulting from the application of fair value to consumable biological assets that are not multi-year forestry operations;

l) Realised losses;

m) Indemnities resulting from events the risk of which is not insurable.

…"

Article 45, no. 3 of the IRC Code:

"The negative difference between realised gains and realised losses from the onerous transfer of shareholdings, including their redemption and amortisation with capital reduction, as well as other losses or negative equity variations relating to shareholdings or other equity components, namely supplementary contributions, contribute to the formation of taxable profit in only half their value."

Article 46 of the IRC Code

"1 - Realised gains or losses are considered to be the gains obtained or losses suffered from onerous transfer, whatever the title by which it operates, and also those arising from claims or those resulting from permanent assignment for purposes unrelated to the business activity conducted, relating to:

a) Tangible fixed assets, intangible assets, non-consumable biological assets and investment properties, even if any of these assets has been reclassified as a non-current asset held for sale;

b) Financial instruments, with the exception of those recognised at fair value in accordance with paragraphs a) and b) of no. 9 of article 18.

…"

3. Arbitral Decisions on the Subject Matter at Issue

The question of whether decreases in fair value of financial instruments that are recognised in results of the period should or should not suffer the limitation contained in article 45, no. 3, has already been the subject of arbitral decisions with different findings. The core of the arguments advanced in each of them is set forth below, extensively, given the relevance attributed to them for the theses in conflict.

Case 108/2013-T

In the Award rendered in case 108/2013-T (available at www.caad.org.pt), a decision favourable to the non-application of the limitation in article 45, no. 3, of the IRC Code is observed (i.e., admitting the deductibility at 100% of the fair value losses in question) based on the following arguments:

A) "Prior to the adoption of fair value, the equity variations relating to financial instruments were irrelevant from the point of view of the formation of taxable profit for each period, due to the effect of the provision of article 21(1/b) of the IRC Code. Only at the moment of realisation of the gain or loss did the equity variation verified acquire tax relevance. This tax framework had (as it has in the part in which it is maintained) three well-marked characteristics, namely:

• It was a single taxation, i.e., which occurred only once throughout the entire period of holding the financial instruments;

• It was dependent on a voluntary action of the taxpayer, in so far as the transaction of the instruments generating the equity variation, the condition of its tax relevance, would only occur if and when the taxpayer so wished;

• The measurement of the equity variation was fixed based on the specific transaction that triggered its tax relevance.

The combination of these three characteristics pointed out, provided fertile ground for accounting and tax manipulations, since the taxpayer could choose to trigger the tax relevance at the moment and terms in which such was most fiscally advantageous.

On the other hand, and given the relevance of the taxpayer's will in the mechanism of tax relevance of the equity variation, the system established was adequate to the adoption of mechanisms for conditioning such will, in order to conform it to economically more desirable behaviours, which, in the case, pass through the preference for realisation of gains, to the detriment of the realisation of losses.

It is in this context that the emergence of the provision of the former article 42(3) of the IRC Code, which precedes the current article 45(3) of the same, is explained.

Such provision, whether in its original wording, resulting from Law 32-B/2002, of 30 December, or in the wording given to it by Law 60-A/2005 of 30 December, is explained both objectively and subjectively (i.e., in light of the motivation expressed by the legislator) by needs linked to combating tax fraud and evasion and to expanding the tax base, aimed at the desired consolidation of public finances.

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

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

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

Accordingly, article 18(9) of the IRC Code applicable, provided that, as a rule, "Fair value adjustments do not contribute to the formation of taxable profit, being allocated as income or expenses in the tax period in which the elements or rights that gave rise to them are sold, exercised, terminated or settled.". This is a clear and deliberate emergence of the assumed realisation principle.

However, the same provision, in its paragraph a), establishes the exception to this regime, in the following terms: "(…) except when: a) They relate to financial instruments recognised at fair value through profit or loss, provided that, where these are equity instruments, they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a shareholding in the capital greater than 5% of the respective share capital;".

That is, and equally as assumed by the legislative entity, when the "income or expenses (…) relate to financial instruments recognised at fair value", "contribute to the formation of taxable profit" "provided that":

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

b. They are "equity instruments";

c. "they have a price formed in a regulated market"; and

d. "the taxpayer does not hold, directly or indirectly, a shareholding in the capital greater than 5% of the respective share capital.".

Meeting these conditions:

a. income resulting from the application of fair value to financial instruments is considered (article 20(1/f) of the IRC Code); and

b. expenses resulting from the application of fair value to financial instruments is considered (article 23(1/i) of the IRC Code).

In this way, where previously we had a single tax relevance (one-off), at the time of the transaction of such instruments, we now have a continuous tax relevance. That is, in light of the new provisions making up the tax relevance regime of accounting by fair value of financial instruments, income or expenses resulting from the application of fair value to these now become relevant directly to the formation of taxable profit (articles 20(1/f) and 23(1/i) of the IRC Code) of the very year in which they occur, provided that certain conditions are met (article 18(9) of the IRC Code), which include the formation of price in a regulated market, with equity variations being taxed not as gains or losses (article 46(1/b) of the IRC Code).

In this context, there clearly ceases to be any need relating to combating tax fraud and evasion, not only because the tax relevance of equity variations ceases to be conditioned by an act of will of the taxpayer, but also because the measurement is objectively fixed.

B) On the other hand, and for the same reasons, any measure for conditioning the will of the taxpayer, in the sense of favoring economically more "desirable" behaviours and, as such, in conformity with the interests of expanding the tax base and budget consolidation, equally lacks sense. The analysis of the normative text reveals with clarity that the legislator chose, to include therein, three types of situations that should be considered, based on the presumption of good legislative technique, as distinct, namely:

a. "The negative difference between realised gains and realised losses from the onerous transfer of shareholdings";

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

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

Let us see, then, whether the situation of the present case falls under any of the situations listed. The situation referred to in paragraph a) above will be manifestly inapplicable, not only because there was no realisation through onerous transfer, but also because article 46(1/b) excludes the situations described in article 18(9/a) from the concept of realised gains. In this way, any difficulty that exists in the case can only fall under one of the situations listed in paragraphs b) and c) above.

The apparent indiscriminate breadth of the provisions at issue, can, however, be reasonably mitigated if one notes that "losses" and "other negative equity variations" will be concepts, not redundant, but endowed with their own and distinct meaning. To understand this fact, it will be necessary to go back to articles 23 and 24 of the same Code, paying attention to the terminological evolution carried out by article 159/2009, of 13 December. In effect, before the entry into force of this latter decree, the articles referred to of the IRC Code referred, respectively, that:

• "Costs or losses are considered to be those that are proven to be indispensable for the realisation of income or gains subject to tax or for the maintenance of the income-producing source, namely the following: (...)";

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

It is verified, in this way, that when the current wording of article 45(3) of the IRC Code was enshrined, this Code expressly distinguished, for what is relevant here, three types of situations, namely:

a. Costs;

b. Losses;

c. Negative equity variations not reflected in the net result of the fiscal year.

The provision of article 42(3) (predecessor of the current 45(3)), should be considered, therefore, as reported to these concepts, defined in articles 23 and 24. In this way, and for obvious reasons, from the provision of that standard should be excluded the costs relating to "shareholdings or other equity components", including therein, only losses (as defined in article 23) and negative equity variations (as defined in article 24), relating to such holdings.

The normative alteration implemented by Decree-Law 159/2009, of 13 July, will not have altered anything of relevance on the matter at issue. In effect, notwithstanding the body of article 23 having come to refer only to expenses, the fact is that the IRC Code continues to use the expression "losses", including in article 23 itself (see no. 1, paragraph h)). This occurs consistently, moreover, with the SNC, which under point 2.1.3.e) of the annex to Decree-Law 158/2009 of 12 July, maintains the distinction between "expenses" and "losses".

In this way, it is concluded that article 45(3) of the IRC Code applicable, will be reported to:

a. negative differences between realised gains and realised losses from the onerous transfer of shareholdings;

b. other losses relating to shareholdings or other equity components; and

c. other negative equity variations relating to shareholdings or other equity components, being that by "losses" should be understood the facts qualifiable as such in light of the IRC Code, and by "negative equity variations" should be understood negative equity variations not reflected in the net result of the fiscal year, as defined in article 24.

"Expenses", as understood in light of the IRC Code, will not be included in the scope of the provision at issue, even if relating to shareholdings or other equity components.

C) On the other hand, and being at issue financial instruments of value not objectively quantifiable, the disregard of 50% of negative equity variations verified would also have a function to "compensate for" the natural tendency of economic operators to, at the fiscal level, inflate losses. However, those aspects will no longer be verified in the situations covered by article 18(9/a). Here, being faced with adjustments arising from the accounting of fair value, determined by objective criteria (with "a price formed in a regulated market"), there is no doubt or intervention of the taxpayer's will in the verification of the negative or positive equity adjustment. That is, these will occur or not, independent of the action and will of the taxpayer.

That is, recall, this situation of contingent (random, even) unjustified penalisation would only arise by virtue of the exception to the realisation principle regime of the situations covered by article 18(9/a) of the IRC Code applicable. That is, if with respect to those situations the general regime of the body of article 18(9) were applied, according to which the same would not contribute "to the formation of taxable profit, being allocated as income or expenses in the tax period in which the elements or rights that gave rise to them are sold, exercised, terminated or settled", the pointed inconsistency would not occur, since the fact that would trigger the contribution to the formation of taxable profit would only occur by will of the taxpayer, so it would be up to this to choose to realise the negative equity variation, with the consequent tax penalty, or defer this to a time when it was less voluminous or, even positive, diminishing or eliminating the penalty arising from the operation for itself and for the Government. It is the exception in paragraph a), by withdrawing the situations provided for therein from the scope of the realisation principle, that justifies the new regime of relevance for taxable profit, instituted.

Evidence of all that has been said is presented in the table prepared below, which demonstrates the unreasonableness of the application of article 45(3) to the situations covered by article 18(9/a):

The non-application of article 45(3) of the IRC Code to expenses, and specifically to "Expenses resulting from the application of fair value to financial instruments", with the full consideration of the equity effects verified, whether positive or negative, leads to consistency of taxation regardless of when the sale of the financial instrument takes place. That is, at whatever time is chosen to proceed with the sale of the financial instrument, the positive and negative equity changes offset each other, so that, ultimately, the taxpayer only has added to or reduced his taxable profit the difference between the acquisition value and the sale value.

Already if article 45(3) of the IRC Code were to be applied, as the TA claims, from the moment a negative equity change is verified, there will be a discrepancy between the tax relevance of negative and positive equity variations, without any justification, as has been said, since such variations occur in an objective manner and independent of the action or will of the taxpayer. Thus, if at the end of the second year in the example above the taxpayer proceeded with the realisation of the financial instrument at issue, despite having realised a gain of only 20 (which would be taxed as such under the realisation principle), would, in fact, have paid tax on 30 (40-10). Similarly, if this were done at the end of the third year, would have paid tax on 20, despite not having had any equity increase from the operation. And if it proceeded to the same realisation at the end of the sixth year, would have paid tax as if had had an equity increase of 30 (80-50), despite having had an actual equity variation of -20, which, under the realisation principle enshrined in the IRC Code, would be acceptable, even if in only 50% of its value (-10)!

It seems clear that such results, merely random and without any substantial justification that sustains them, could not have been intended by a reasonable legislator.

In these terms, considering that article 18(9/a) of the IRC Code applicable imposes the contribution "to the formation of taxable profit", without reserves or limitations, of "income or expenses" that "(…) relate to financial instruments recognised at fair value", "provided that" they are recognised "through profit or loss"; they are "equity instruments"; "have a price formed in a regulated market"; and "the taxpayer does not hold, directly or indirectly, a shareholding in the capital greater than 5% of the respective share capital", article 45(3) of the said Code not applying, in these cases, to the extent that they are not covered by the normative provision of the same, it is understood that the claim merits granting".

Case 25/2015-T

In the decision concerning case 25/2015-T (available at www.caad.org.pt), a decision favourable to the application of the limitation in article 45, no. 3 of the IRC Code is observed (i.e., admitting the deductibility of only 50% of the fair value losses) based on the following arguments:

A) "Given the characteristics of the relationship between accounting and tax matters and some criticisms or perplexities raised by paragraph a) itself of no. 9 of article 18 of the IRC Code, we do not consider evident either the Claimant's thesis, nor the learned considerations and conclusions of the decision of CAAD in case 108/2013-T. That is, we do not consider entirely demonstrated that, despite the legislator having provided, in paragraph a) of no. 9 of article 18 of the IRC Code, that there contribute "to the formation of taxable profit", without reserves or limitations, "income or expenses" that "(…) relate to financial instruments recognised at fair value", "provided that" they are recognised "through profit or loss"; they are "equity instruments"; "have a price formed in a regulated market"; and "the taxpayer does not hold, directly or indirectly, a shareholding in the capital greater than 5% of the respective share capital", has intended, in that case, to put an end to the unequal treatment of positive and negative variations, provided for in no. 3 of article 45 of the IRC Code.

For, regardless of a judgment of equity or rationality of tax policy on the maintenance of such a rule, justification can be found for the legislator to maintain such inequality of treatment.

From the outset, one cannot devalue the maintenance of the wording of the provision, without any reservation, when many other provisions underwent alterations, including the addition of paragraph b) of no. 1 of article 45 of the IRC Code".

B) "But let us examine other doubts that can explain the maintenance of such treatment, extended to the case of paragraph a) of no. 9, of article 18 of the IRC Code. One of the weighty arguments indicated in favour of the non-application of the provision in no. 3 of article 45 of the IRC Code, is that this provision was foreseen for situations in which gains were determined at the moment of realisation, and that moment was dependent on the voluntary action of the TP, whereas, after adaptation to the SNC, the expenses determined by application of no. 9 of article 18 of the IRC Code are not conditioned by the will of the taxpayer since the value of the financial instruments is objectively determined without the intervention of the latter in the formation of the price. The application of no. 3 of article 45 of the IRC Code would only make sense in cases in which the measurement of the equity variation is based on the realisation principle, in situations dependent on the voluntary action of the taxpayer, intended as a disincentive for taxpayers to make certain decisions, placing themselves in disadvantageous positions to benefit in terms of taxable profit formation, and in which the value of the financial instruments was not objectively determined.

But this assessment of the situation is unsuitable to be imposed unconditionally because, namely:

• The certainty and objectivity of the value found in the market, even if regulated, is not entirely immune to manipulations, as is proven by episodes that the international press has echoed;

• The 5% limit on the holding of interests provided for consideration of fair value, allows application of the provision to substantial investments, with unforeseeable consequences for tax revenues, namely in a period of financial and stock market crisis;

• Situations persist, even in the cases of application of values considered objectively determined in the market, in which the solution of unequal treatment of negative and positive results provided for in article 45, no. 3, is applied, such as the situations of sale in a regulated market, in which losses are reflected in taxable profit only at the moment of realisation, as in the cases of holding greater than 5% or of choice not to apply NCRF 27 (cf. note 9)."

C) "As for the argumentation based on the "expenses" and "losses" dichotomy, it seems to rest on an unjustified overvaluation of the distinction of these concepts. That is, in the process of adaptation to the new concepts of the SNC, it is possible to identify various terminological imprecisions. Ana Maria Rodrigues accounts for the attempts to overcome these imprecisions and hesitations as to the solutions for fear of increasing disruption in the legal order. As an example, she cites the headings of articles 20 and 23 of the IRC Code. As to the first, currently "income and gains", considers it should be only entitled "income", a concept that involves revenues and gains, and as to the second, "expenses and losses", observes that expenses is a concept that, in accounting, already includes losses.

It is also worth noting that, as to the measurement of the value of financial instruments, the legislator, in the Reform of the IRC in force as of Law no. 2/2014, replaced the concept "expenses", previously used in paragraph i) of no. 2 of article 23 with that of "losses" (cf. paragraph j) of no. 2 of article 23)"

D) "In a text written soon after the publication of Decrees-Laws nos. 158/2009 and 159/2009, both of 13 July, André Vasconcelos, identified questions raised by the application of rules aimed at the IRC for competition in determining the taxable profit of adjustments relating to financial instruments recognised at fair value through profit or loss, provided that these are equity instruments having a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a shareholding in the capital greater than 5% of the respective share capital. He considers that losses determined with fair value adjustments are not applicable to the concept of realised losses and that the main question arises in the framework of no. 3 of (then) article 42, concluding, despite admitting doubts about the legislator's intention, that «in reading that provision, and given the extensive breadth of the same, we are led to conclude that all losses referring to shareholdings, which include the financial assets now in analysis, will only be relevant for tax purposes in half their value».

The position of the Tax Administration came to be exposed in the Binding Information in case no. …/2011, rendered in a petition submitted by a company, and decided by Order of the Director-General of 24/2/2011, in the sense that: «As the reductions in fair value of these equity components are qualified as loss, they should be considered, in accordance with the said article 45, no. 3, of the IRC Code, at 50% of their value».

It should also be noted that, currently, there is no detectable existence at the time of appreciable controversy about the orientation recommended by the TA.

In the same sense as the interpretation disclosed, Luísa Anacoreta Correia, in an article written in the 2nd quarter of 2011, in the Journal of the Order of Official Auditors, states: «As mentioned above, the current IRC Code provides, in paragraph a) of no. 9 of article 18, the taxation regime by fair value variation, for quoted shares, when held in 5% or less and when accounted for at fair value through profit or loss. Based on this provision it could be concluded that, for those shares, both gains resulting from increases in fair value (whether in the year of sale or in earlier years) and losses resulting from decreases in fair value, would be considered fiscally. Nevertheless, no. 3 of article 45 provides that 50% of these losses in value will not be accepted fiscally».

And, further on: «It should be noted, in this context, that in cases where the entity holding the shares in question uses IAS 39 in its accounting treatment, either because it chose the IASB standard, or because it chose IAS 32, 39 and IFRS 7, alternatively to NCRF 27, the tax regime of fair value will be set aside in the vast majority of cases, it being sufficient that the shares are recognised at fair value through equity.

It should also be noted, as highly significant, the interpretation manifested in a publication, which embodies the collective participation of consultant E…, SA, subscribed by five partners, with comments and suggestions when preparing the recent Reform of IRC that led to the approval of Law no. 2/2014.

There, with the title, "Elimination of the restriction on the tax deductibility of losses and realised losses associated with shareholdings under certain conditions", the following is commented upon and suggested: «The imposition of this type of restrictions in the IRC results from a concern of the legislator with the performance of operations intended for tax evasion and which are based, in most cases, on a manipulation of the value at which shareholdings are traded. However, it is not understood that this rule be applied broadly and that the State taxes companies in a general way when they determine gains and does not allow them to relief in full, for tax purposes, the losses or losses they determine in the transfers of shareholdings. The principle of symmetry is thus violated. In cases in which shareholdings have a price formed in a regulated market and in which, consequently, there can be no doubts about the value established for the operations, an exception should be established to the rule of acceptance of only half the negative balance between realised gains and realised losses or other losses determined in each fiscal year, provided for in no. 3 of article 45 of the IRC Code. This change will also make it possible to prevent losses from fair value in shareholdings, recognised in results, which have a price formed in a regulated market and the taxpayer does not hold directly or indirectly, a shareholding in the capital greater than 5% of the respective share capital from being only accepted for tax purposes in 50%, despite representing potential losses. Already the gains from fair value determined in these financial instruments, including those relating to reversals of those losses, are currently taxed in full, which generates a double taxation that is urgent to correct».

And, it is further said, commenting on the preliminary draft of the proposal presented: «The discrimination suffered by losses from fair value in shareholdings, recognised in results, which have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a shareholding in the capital greater than 5% of the respective share capital will also be eliminated (the preliminary draft of the Reform proposes that this shareholding limit be reduced to 2%). With the changes foreseen, these losses come to be considered tax-deductible in full (currently they are only accepted for tax purposes in 50%».

Thus, within the framework of the measures proposed by E, the suggestion to "establish an exception to the deduction in only 50% of realised losses and losses of social parts when they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a shareholding in the capital greater than 5% of the respective share capital", has as comment "received in full", to the extent that, it is said, "the realised losses, except in case of liquidation, cease to be relevant, eliminating the provision in no. 3 of article 45 of the IRC Code."

That is, although proposing a legislative change, there is no appearance of any prior controversy about the legal refutation of the interpretation of the Binding Information disclosed by the TA and cited above.

Based on the above, it is concluded that:

• From a point of view of equity or adequacy of tax policy pursued, it may be questioned whether the legislator should not have done so already from the wording of the IRC Code in force from 2010 have revoked the limits on the deductibility of losses or negative equity variations associated with shareholdings, but, regardless of the answer to that question (which is not considered evident, even because account would have to be taken of the situation of financial crisis and restrictive budgetary measures already then existing), it is incumbent upon this court to judge according to the "constituted law" at the time of the situation being considered in this case;

• In light of the provisions of various provisions of the IRC Code in force in the fiscal years 2010 and 2011, the court does not consider convincing the arguments advanced for the non-application of no. 3 of article 45 of the same Code to cases of losses resulting from adjustments arising from fair value variations in shareholdings;

• Nor does it appear that, in the period in question, doubts have emerged in the doctrine about the continuation of application of the referred no. 3 of article 45 of the IRC Code to all cases of losses or negative equity variations, with opinions precisely in the sense of that interpretation, although expressing doubts and/or criticisms about the objectives of the policy pursued;

• Recognising, although the brilliance of the reasoning of the decision rendered in case 108/2013-T, within the scope of CAAD, some of its presuppositions raise serious doubts for us;

• This court does not consider confirmed the existence of a choice by the legislator in the sense of granting different treatment to cases of losses in equity instruments with value found in a regulated market, both because of the uncertainties that remain regarding how that value reflects economic reality, and because of uncertainty as to the impact of such a solution on tax revenues;

• The argumentation based on an overvaluation of the dichotomy of the terms "expenses" and "losses" also raises doubts, given the frequent terminological imprecision, of which is an example, precisely, the oscillation in the use of the referred concepts of losses and expenses;

• Taking into account that, by virtue of the combination of paragraph a) of no. 9 of article 18 with the provision in paragraph f) of no. 1 of article 20 and in paragraph i) of no. 1 of article 23 of the IRC Code, the gains and losses arising from the application of the fair value criterion through profit or loss contribute to the taxable profit of each fiscal year, the coexistence of these provisions with the wording of no. 3 of article 45, leads to the conclusion that, in introducing them into the IRC Code, if the legislator had intended to give different treatment to losses resulting from the application of fair value, would not have failed to alter the wording of the provision accordingly, making evident its intention, as he also did not do at the time of the creation of identical regimes for companies in the banking and insurance sectors;

• For the inadmissibility of no. 3 of article 45 of the IRC Code defended by the Claimant would result in a more unfavourable treatment granted to situations in which, in the valuation of social interests, the cost method were applied or, in case of choice for non-application of NCRF 27 (cf. note 9) gains or losses resulting from changes in fair value are recognised directly in equity, because losses verified in their sale would only be deducted at half, whereas losses recorded in social interests measured at fair value would, solely by virtue of their accounting recognition having been made in piecemeal fashion, based on variations verified each year in fair value, and not only in a single fiscal year, suffer no limitation, being fully deducted for purposes of determining taxable profit;

• It seems much more appropriate that the legislator has intended to maintain a uniform treatment of losses or negative equity variations associated with shareholdings, regardless of the level of shareholding that such holdings represent in the capital and the measurement criterion adopted, since, as mentioned, cases remained in which to the loss of value, despite being verified in equity instruments with price formed in a regulated market (such as situations in which the taxpayer holds more than 5% of the capital or in which holds less than 5% but chooses to account for the adjustments resulting from changes in fair value in equity accounts), the limitation of 50% deductibility of losses continued to apply.

• That is, it is understood that the legislator has given prevalence to the principle of neutrality in the tax treatment of losses or negative equity variations associated with shareholdings, regardless of the measurement method, while safeguarding, at the same time, the unpredictability of possible negative effects on tax revenues, arising from fluctuations in market quotations.

For these reasons, it is considered that the interpretation of the TA is not infirmed in the present case and that, before the alterations introduced in the IRC Code by Law no. 2/2014, of 16 January, no. 3 of article 45 was applicable to adjustments arising from the fair value measurement of financial instruments with the requirements defined in paragraph a) of no. 9 of article 18, and therefore the TA should have considered, in the fiscal years at issue in the present case, that the loss reflected in results in accounting could only be deducted for tax purposes in half its value.

4. The case under judgment

The court considers, at the outset, that the claimant is correct. For various reasons. On the one hand, and as to the literal element, the accounting and tax interpretation of the term "losses" leads to not accepting the limitation contained in article 45, no. 3, with respect to the specific situation described in the present case.

Furthermore, it is not considered decisive the sense of the interpretations invoked by the TA regarding this complex matter.

Regarding the teleological element, the legislator's intention when creating the provision is not considered applicable to the situation at issue, given the nature and substance of the phenomena at issue.

Finally, if the limitation in article 45, no. 3 were to be accepted, it would constitute an excess that is considered excessive of the principle that taxation should fundamentally be based on actual income, even when weighed in light of the Constitutional Court Award no. 85/2010, analysed below.

Let us see, therefore, each of these grounds.

4.1 Accounting and Tax Aspects to be Considered and Their Relevance to the Decision: On the Concept of "Loss" and its Application to the Concrete Case

4.1.1 The Imprecisions in the Adaptation of the IRC Code to the SNC

In light of the provision under discussion, it is a settled point for this court that the fair value losses at issue would not be classifiable in the part of article 45, no. 3, of the IRC Code in which it provides on:

"The negative difference between realised gains and realised losses from the onerous transfer of shareholdings, including their redemption and amortisation with capital reduction…,."

but only potentially concerning what relates to:

"other losses ….. relating to shareholdings or other equity components".

The dissection of the concept of "loss" (and also of "expense", as will be seen) is thus of clear centrality.

Now the adaptation of the IRC Code to the new accounting provisions arising with the SNC, carried out by Decree-Law no. 159/2009, of 13 July, gave rise to serious technical-interpretative difficulties, especially concerning the matter with which we are here dealing.

That this is so results evident from the fact that the parties in litigation extract from the same accounting and tax provisions conclusions that are diametrically opposed. In effect, in the initial pleading, the claimant sustains that, meeting the requirements provided for in no. 9 of article 18 of the IRC Code, the variations in the value of the financial instruments will be considered income (paragraph f) of no. 1 of article 20 of the IRC Code), or expenses (paragraph i) of no. 1 of article 23 of the IRC Code) of the tax period to which they relate. Thus, from the claimant's perspective, the qualification as expenses that article 23 contained for reductions in fair value in financial instruments would exclude from the scope of article 45, no. 3, the facts that are qualifiable as expenses by the IRC Code, for that article 45, no. 3, only referred to other losses. Now being expenses and losses different economic realities, the mere literal interpretation would remove, in the claimant's understanding, the TA's thesis.

To this view of the problem the TA counters that the income/gains and expenses/losses to which article 18, no. 9, paragraph a) referred would have to be confronted with the treatment given to them by the provisions of articles 20, 23 and 45 of the IRC Code. The respondent reputes the semantic question that emerges from the arbitral decision rendered in case no. 108/2013-T as irrelevant, built, in its perspective, around the dichotomy between the term "losses" used in article 45, no. 3, and the term "expenses" used in article 23 and in article 18, no. 9, paragraph a), of the IRC Code.

For the TA, the term expenses used both in the heading given to article 23, within the scope of the alterations introduced by Decree-Law no. 159/2009, of 13 July, as well as in the wording of paragraph i) of no. 1 of that provision (Expenses resulting from the application of fair value to financial instruments), must necessarily be understood in a broad sense, i.e. covering, in substance, expenses proper and losses.

The TA stresses that, although each of those terms has its own meaning, that dichotomy between "expenses" and "losses" can only be qualified as a terminological imprecision of the legislator without consequences at the level of the interpretation of those provisions. And, it adds, it could not be otherwise, taking into consideration article 17, no. 1 of the IRC Code, since, in the Chart of Accounts of the System of Normalisation of Accounting (SNC), account 661, where negative adjustments resulting from the use of fair value are recorded, has always been named "Losses from reductions in fair value in financial instruments".

Now, the decision based on the apprehension of the literality of the provisions is not, therefore, a simple task. Moreover, there is no conceptual definition in the IRC Code (but rather an enumeration) of expenses or of losses. That definition exists yes in the SNC, in particular in the Conceptual Framework. There it is stated that (bold ours):

69 — The elements of income and expenses are defined as follows:

….

(b) Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or the incurring of liabilities that result in decreases in equity, which are not those related to distributions to participants in equity.

76 — The definition of expenses includes losses as well as those expenses that result from the course of the ordinary (or regular) activities of the entity. Expenses that result from the course of the ordinary activities of the entity include, for example, cost of sales, salaries and depreciation. They usually take the form of an outflow or depletion of assets such as cash and cash equivalents, inventories and tangible fixed assets.

77 — Losses represent other items that meet the definition of expenses and may or may not arise in the course of ordinary activities of the entity. Losses represent decreases in economic benefits and as such are not in their nature different from other expenses. Hence they are not viewed as a separate element in this Conceptual Framework.

78 — Losses include, for example, those resulting from disasters such as fires and floods as well as those from the sale of non-current assets. The definition of expenses also includes unrealised losses such as, for example, those from the effects of an increase in the exchange rate of a foreign currency with respect to loans obtained from an entity in that currency. When losses are recognised in the statement of results, they are usually shown separately because knowledge of them is useful for purposes of making economic decisions. Losses are often reported net of related income.

This definition of expenses in the SNC, which, in the absence of a definition contained in the IRC Code and in light of the provision of article 17 of the IRC Code will be imported into the process of determining taxable profit, establishes that, in truth, the general concept of expense encompasses losses. But, when the legislator, in the already referred adaptation of the IRC Code to the SNC, in article 23, no. 1, paragraph h) refers to "Impairment losses", shows that imports to the IRC the concept of account "65 - Impairment losses" of the SNC, but that in paragraph i) and j) catalogs as "expenses resulting from fair value application" the amounts that in account 66 of the SNC are designated as losses from reductions in fair value. There are thus clear imprecisions observed.

Since reductions in fair value are designated, in the SNC, as losses, and the IRC Code, in article 23, never refers to losses from fair value but rather to expenses, there would thus, in a strictly literal plane, an evident conceptual disconnection. And it is largely from this disconnection that arise the disparate interpretations that the provision raises for the claimant and for the TA. And, also, the varying degrees of relative importance that the decisions made in cases 108/2013-T and 25/2015-T attribute to the literal element in the qualification of expenses or of losses, when the provision in article 23 of the IRC Code is calibrated with the limitation contained in article 45, no. 3, of the same code, as to the impact of reductions in fair value on financial instruments.

Systematising the matter, for now only in an accounting and tax plane, regarding the literal ambiguity of the provisions: can the claimant argue – and does – that, not providing article 23 of the IRC Code "losses from fair value" but rather "expenses", such legal qualification removes such reductions in value from article 45, no. 3, where it is required that such facts be qualified as losses.

The TA can counter - and does – that account 66 of the SNC qualifies as losses the reductions in fair value, and that would qualify them as phenomena to subsume in the provision of article 45, no. 3. And that the concept of expenses contained in article 23 encompasses losses.

Now, in face of such interpretative breadth, how to address the matter?

For this court, the interpretative key, in this accounting and tax plane, rests on the doctrinal distinction between expense and loss, and on its application to the concrete case of the present case.

Thus, from the excerpt above transcribed from the Conceptual Framework of the SNC (§§ 69-b and 76 to 78) it follows that the concept of loss translates (like that of expense) into a reduction of economic benefits. However, losses are distinguished, as a rule, by their non-regular, non-recurring nature. They are, therefore, the result of phenomena with a degree of occasional or non-repetitive nature well superior to "those expenses that result from the course of the ordinary (or regular) activities of the entity" (§76).

That this is so, is also observed in the extensive consideration that appears in the Statement of Financial Accounting Concepts no. 6, issued by the Financial Accounting Standards Board, where the concepts of expenses (expenses) and losses (losses) are developed. Indeed there are defined (§§ 81 and seq., bold and underlined ours):

-Expenses are outflows or other using up of assets or incurrences of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major or central operations.

• Losses are decreases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity except those that result from expenses or distributions to owners.

Gains and losses result from entities' peripheral or incidental transactions and from other events and circumstances stemming from the environment that may be largely beyond the control of individual entities and their managements. Thus, gains and losses are not all alike. There are several kinds, even in a single entity, and they may be described or classified in a variety of ways that are not necessarily mutually exclusive.

Gains and losses may also be described or classified as "operating" or "nonoperating," depending on their relation to an entity's major ongoing or central operations. For example, losses on writing down inventory from cost to market are usually considered to be operating losses, while major casualty losses are usually considered nonoperating losses.

Distinctions between revenues and gains and between expenses and losses in a particular entity depend to a significant extent on the nature of the entity, its operations, and its other activities. Items that are revenues for one kind of entity may be gains for another, and items that are expenses for one kind of entity may be losses for another. For example, investments in securities that may be sources of revenues and expenses for insurance or investment companies may be sources of gains and losses in manufacturing or merchandising companies. Technological changes may be sources of gains or losses for most kinds of enterprises but may be characteristic of the operations of high-technology or research-oriented enterprises."

As can be seen, this important North American doctrinal source sustains that losses have a peripheral or lateral nature to the regular activities of an entity. And, even, that the same phenomenon can be classified economically as an expense in some cases and loss in others, all depending on the economic and substantive framework of the economic facts in the presence in light of the business activities developed by business entities.

In national doctrine, J. Braz Machado[1] stresses that "Losses are extinct costs, that do not benefit the income-producing activities". The income, as defined by the Conceptual Framework of the SNC, is constituted by the income from regular activities of an entity.

In international literature, Libby et al[2], define losses (losses) as being "decreases in assets or increases in liabilities from peripheral transactions".

In fact, the distinction between costs and losses is ancient in the Portuguese accounting tradition, and was well marked in the POC. The SNC also distinguishes between expenses and losses. And, the IRC Code (in the version in force at the time of the facts) mentions, in various articles, the concept of losses.

And, for what matters here, article 45, no. 3, is clear. What is limited is the deductibility of "other losses" and not that of "other expenses" or of "other expenses and losses".

Accepting this distinction between expenses and losses, it will have consequences. And, for what is relevant here, the conclusion is as follows.

The claimant is a holding company (SGPS). Thus, its central or normal activity is the acquisition, holding and sale of social interests. The holding of securities (shares) of Bank…, quoted in a regulated market, in which changes in the market price are verified (translated accounting-wise by increases or reductions in fair value) does not constitute a peripheral, lateral or fortuitous phenomenon of its activity. The said alterations (whether more or less) in fair value in these equity instruments are regular or recurrent equity facts that emerge from its main activity.

They are, therefore, phenomena of modification of the value of the financial assets held within the scope of the

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