Process: 233/2017-T

Date: October 24, 2017

Tax Type: IRC

Source: Original CAAD Decision

Summary

CAAD Process 233/2017-T addresses a fundamental conflict between the principle of specialization of fiscal years and tax justice in Portuguese corporate income tax (IRC). The case involved A..., S.A., a shipbuilding company that recognized a naval vessel design asset worth €15 million in 2006-2007, generating taxable profits. When the contract with the Portuguese State was not extended in 2011, the company de-recognized the asset in its 2011 accounts through shareholders' equity. However, when the State ultimately purchased the design for €25.5 million in December 2012, the company attempted to deduct the €15 million de-recognition expense in its 2012 IRC return. The Tax Authority issued an additional IRC assessment, challenging this deduction. The core legal issue centers on whether the expense should be allocated to 2011 (when accounting de-recognition occurred) or 2012 (when the final transaction materialized and revenue was recognized). The arbitral tribunal must balance the accrual principle requiring expenses to be allocated to their proper fiscal year against considerations of tax justice, particularly given the company's earlier taxation on the asset recognition. This case exemplifies the complexity of applying periodization rules when commercial transactions span multiple fiscal years and involve contract extensions, highlighting tensions between strict compliance with fiscal year allocation principles and achieving equitable tax outcomes under IRC legislation.

Full Decision

ARBITRAL DECISION

The arbitrators Cons. Jorge Lopes de Sousa (arbitrator-president), Prof.ª Doctor Leonor Fernandes Ferreira and Prof.ª Doctor Glória Teixeira (arbitrator-members), appointed by the Deontological Council of the Administrative Arbitration Centre to form the Arbitral Tribunal, constituted on 21-06-2017, agree as follows:

1. Report

A…, S.A. (hereinafter "A…" or "Claimant"), legal entity no. …, with registered office at …, …-… …, hereby, pursuant to section a) of no. 1 of article 2.º and articles 10.º et seq. of Decree-Law no. 10/2011, of 20 January (Legal Regime for Arbitration in Tax Matters or "RJAT"), submits a request for arbitral determination seeking a declaration of illegality of the additional corporate income tax (IRC) assessment no. 2016…, relating to the tax year 2012.

The PORTUGUESE TAX AND CUSTOMS AUTHORITY is the Respondent.

The request for constitution of the arbitral tribunal was accepted by the President of the CAAD and automatically notified to the Portuguese Tax and Customs Authority on 04-04-2017.

Pursuant to section a) of no. 2 of article 6.º and section b) of no. 1 of article 11.º of the RJAT, in the wording introduced by article 228.º of Law no. 66-B/2012, of 31 December, the Deontological Council appointed as arbitrators of the collective arbitral tribunal the signatories hereto, who communicated acceptance of their appointment within the applicable time period.

On 05-06-2017 the parties were duly notified of this appointment, having manifested no intention to refuse the appointment of the arbitrators, pursuant to the combined provisions of article 11.º no. 1 sections a) and b) of the RJAT and articles 6.º and 7.º of the Deontological Code.

Accordingly, in compliance with the provisions of section c) of no. 1 of article 11.º of the RJAT, in the wording introduced by article 228.º of Law no. 66-B/2012, of 31 December, the collective arbitral tribunal was constituted on 21-06-2017.

On 08-09-2017, the Portuguese Tax and Customs Authority submitted a reply in which it argued that the request should be dismissed as unsubstantiated.

By order of 09-09-2017 a hearing was dispensed with and it was decided that the proceedings would continue with written submissions.

The parties submitted written submissions, the Claimant on 22-09-2017 and the Respondent on 02-10-2017.

The arbitral tribunal was duly constituted, in accordance with the provisions of articles 2.º, no. 1, section a), and 10.º, no. 1, of Decree-Law no. 10/2011, of 20 January, and is competent.

The parties are duly represented, possess legal personality and capacity and have standing (articles 4.º and 10.º, no. 2, of the same decree-law and article 1.º of Ordinance no. 112-A/2011, of 22 March).

The proceedings are not vitiated by any nullities.

2. Facts

2.1. Established Facts

Based on the elements contained in the file and in the administrative proceedings appended to the record, the following facts are considered established:

- The Claimant is a limited company, with share capital of € 29,875,000.00, held 100% by "B…, SGPS, S.A." (hereinafter, simply "B…"), since 2005;

- B…, in turn, is a SGPS (public capital holding company), supervised by the Ministries of Finance and Public Administration and National Defence;

- The Claimant's principal activity is the construction and repair of naval vessels;

- In December 2013, through Council of Ministers Resolution no. …/2013, the Claimant's difficult economic situation was declared;

- On 16 February 2005, A… and the Portuguese State entered into a base contract for the acquisition by the latter of a Multi-Purpose Logistics Ship (NPL), intended for the Portuguese Navy (document no. 5 attached with the request for arbitral determination, the contents of which are reproduced herein);

- At the genesis of this contract was the transfer by "C…" (C…) of the basic design of the NPL, to which A… acceded pursuant to the offset agreement concluded within the scope of the "Programme Relating to the Acquisition of Submarines";

- In the following years 2006 and 2007, A… recognized in accounting terms the asset associated with this basic design of the NPL, such recognition amounting to € 15,000,000.00, being € 3,750,000.00 in 2006 and € 11,250,000.00 in 2007, and generated positive patrimonial variations that contributed to the formation of the taxable profit of those same tax years (facts accepted by the Portuguese Tax and Customs Authority in article 6.º of its submissions);

- Pursuant to no. 1 of clause 45.º of the aforementioned base contract concluded between A… and the Portuguese State in 2005, the latter would expire on 30 April 2007, if the acquisition contract were not concluded, unless the parties agreed to its extension;

- The contract concluded with the Portuguese State was successively extended, for a period of one year in each extension, in order to prevent its expiration, through amendments to its clause 45.º (document no. 6, attached with the request for arbitral determination, the contents of which are reproduced herein);

- The last contractual extension indicated 31 December 2011 as the new deadline (5th agreed date);

- These extensions occurred either on the eve of the date of contractual expiration, or even on the day itself (the 2nd and 3rd extensions were agreed on the last day);

- In 2011, until 31 December, no contractual extension was effected;

- The administration of the Claimant, at the end of March 2012, elected to de-recognize the basic design of the ship in question, then valued at € 15,000,000.00, "as well as to effect the accounting movements related to the values recorded in products and work in progress" (Board of Directors Decision "De-recognition C-242 Multi-Purpose Logistics Ship" of 26 March 2012, attached to the request for arbitral determination as document no. 7, the contents of which are reproduced herein);

- The de-recognition of this asset was recorded, with reference to 2011, in an account of shareholders' equity: 575 Reserves – Donations;

- This expense was not recognized for tax purposes by reference to that year of 2011;

- By Council of Ministers Resolution no. …/2012, published in the Diário da República on 20-09-2012, the Portuguese State decided to acquire the NPL design from the Claimant;

- On 27-12-2012, the Portuguese State acquired the NPL design from the Claimant for the amount of € 25,500,000.00, invoice no. … being issued, dated 27.12.2012, in the amount of € 25,500,000.00, plus VAT, with the description "Additional work developed by A…, S.A., within the scope of the basic design project of the Multi-Purpose Logistics Ship (NPL), including the corresponding contractual technical specification, in accordance with Council of Ministers Resolution no. …/2012, published in Diário da República on 20 September 2012" (document no. 8, attached with the request for arbitral determination, the contents of which are reproduced herein);

- This invoice was recognized in the accounts as revenue, in account 72 - Service Provision;

- With reference to the year 2012, A… recognized revenue of € 25,500,000.00 arising from this "additional work", and also recognized the reduction in shareholders' equity associated with the de-recognition of the asset that was associated therewith of € 15,000,000.00, the accounting entry supporting which had been recognized in the prior year of 2011, without having then affected the retained earnings;

- A… deducted, in a blank line of the income tax return model 22 relating to the tax year 2012, the aforementioned amount of € 15,000,000.00, in box 07 relating to the determination of taxable profit (line 775);

- The accounting recognition of the element of the asset associated with the basic design of the NPL generated positive patrimonial variations, in the amount of € 3,750,000.00 (2006) and € 11,250,000.00 (2007), which contributed to the formation of the taxable profit of those same tax years;

- A tax inspection was carried out on the Claimant, relating to the tax year 2012, following Internal Service Order filed under no. OI2016…, of 08-02-2016;

- In the tax documentation process, submitted by the Claimant to the Portuguese Tax and Customs Authority on 17-03-2016, is contained the image of the accounting entry no. …, of 31-12-2011, in the amount of € 15,000,000.00 (Annex 1 of the Tax Inspection Report);

- In the "Legal Certification of Accounts" issued for the year 2012 there is a qualification regarding the same matter, in the following terms:

"In the accounting disclosure of the contract relating to the acquisition of additional work developed by A…, S.A. within the scope of the basic design project of the multi-purpose logistics ship, including the corresponding technical specification, in the total amount of 25,500 thousand euros, the Company recognized this transaction entirely as revenue of the period. In our opinion, having regard to the initial accounting treatment of this project, we believe that a component should now have been recorded in shareholders' equity, for which reason the result for the period is overstated by 15,000 thousand euros";

- In the "Report and Accounts for 2012", there is no reference to the amount of € 15,000,000.00, with several allusions regarding the Multi-Purpose Logistics Ship, namely: i. To the financial proceeds resulting from the acquisition by the General Directorate of Armament and Defence Infrastructure of the additional work developed within the scope of the basic design of that ship, including the corresponding technical specification. ii. To the contribution of the profit resulting from the provision of services associated with the additional work developed within the scope of the Multi-Purpose Logistics Ship project to the positive evolution of operating results. iii. To the growth of the asset driven by the variation in the customers account, arising from the provision of services associated with the additional work within the scope of the Multi-Purpose Logistics Ship;

- Through letter no. … of 11-07-2016, the Claimant was requested to provide the accounting movement, for the year 2012, referring to the amount deducted in box 07, line 775, and to indicate the legal basis for making the aforesaid deduction, attaching supporting documentation;

- The Claimant did not submit a replacement Tax Return Model 22 for the tax year 2011, reflecting the deliberate de-recognition in 2012;

- In the Tax Inspection Report prepared in the aforementioned inspection action, a copy of which is contained in document no. 4 attached with the request for arbitral determination, the contents of which are reproduced herein, the following is stated, among other things:

15) In summary, we have the following facts:

15.1) In 2011, faced with the expiration of the base contract for the acquisition of the Multi-Purpose Logistics Ship (NPL), A… de-recognized the asset corresponding to the basic design provided by "C…".

15.2) This de-recognition effected in accounts of assets and shareholders' equity that resulted in a negative patrimonial variation in 2011.

15.3) In 2012, there was invoiced (invoice no. …, dated 27.12.2012, in the amount of € 25,500,000.00, plus VAT) the "Additional work developed by A…, S.A., within the scope of the basic design project of the Multi-Purpose Logistics Ship (NPL), including the corresponding contractual technical specification, in accordance with Council of Ministers Resolution no. …/2012, published in Diário da República on 20 September 2012".

15.4) This invoice was recognized in the accounts as revenue, in account 72 - Service Provision, as shown in the image of the accounting entry extracted from the SAF-T(PT) file of the accounts.

16) In light of the Accounting Standardization System (SNC) and in accordance with Accounting and Financial Reporting Standard 20 (NCRF 20), paragraphs 20 to 28, when the outcome of a transaction cannot be reliably estimated and it is not probable that the costs incurred will be recovered, the revenue is not recognized and the costs incurred are recognized as an expense; however, when the uncertainties that prevented the outcome of the transaction from being reliably estimated cease to exist, the revenue is recognized in accordance with reference to the stage of completion and not in accordance with the criterion of recovery of costs incurred.

17) The accounting treatment of the facts set out in point 15, by A…, is in accordance with SNC, given that in the absence, in 2011, of extension of the base contract for the acquisition of the Multi-Purpose Logistics Ship, they effected the de-recognition using shareholders' equity accounts, reducing the company's assets, not through expenses with direct influence on the net result of the period, but directly in a component of shareholders' equity, in line with the qualification in the "Legal Certification of Accounts" issued for the year 2012, referred to in point 11.

18) In 2012, with the decision taken in the Council of Ministers (Council of Ministers Resolution no. …/2012), there was invoiced the Additional work developed by A…, S.A., within the scope of the basic design project of the Multi-Purpose Logistics Ship (NPL), including the corresponding contractual technical specification, with A… correctly recognizing the corresponding revenue.

19) Taxable profit, according to article 17.º of the Corporate Income Tax Code, consists of the algebraic sum of the net result of the period with the positive and negative patrimonial variations occurring in the same period and not reflected in that result, determined on the basis of the accounts, and possibly corrected (tax corrections) in accordance with the Corporate Income Tax Code.

20) With the accounting entries in accordance with SNC and these being the basis for determining taxable profit, it remains to verify whether corrections are made in accordance with the Corporate Income Tax Code, that is, to verify whether there are revenues and expenses reflected in the net result of the period, as well as positive and negative patrimonial variations occurring in the same period and not reflected in that result, which should be added to or deducted in the determination of taxable profit by virtue of the Corporate Income Tax Code.

21) In the case at hand we have revenue of € 25,000,000.00, obtained and recognized in the accounts in the year 2012, and a negative patrimonial variation of € 15,000,000.00, incurred and recognized in the accounts in the year 2011. Now, pursuant to no. 1 of article 18.º of the Corporate Income Tax Code, revenues and expenses, as well as the other positive or negative components of taxable profit, are attributable to the tax period in which they are obtained or incurred. On the other hand, when the positive or negative components relate to prior periods, they are only attributable to the tax period when on the date of closing of the accounts of that to which they should be attributed they were unforeseeable or manifestly unknown (no. 2 of article 18.º of the Corporate Income Tax Code).

22) We thus have, the deduction in the determination of the taxable profit of 2012, of a negative patrimonial variation of € 15,000,000.00, relating to 2011, contrary to the provisions of articles 17.º and 18.º of the Corporate Income Tax Code, which means that that amount cannot be deducted from the net result of the period of 2012 to determine taxable profit.

23) Thus, the amount deducted in box 07, line 775 of the income tax return (model 22 of the IRC) must be eliminated, resulting in a correction in the amount of € 15,000,000.00 to the declared tax losses, as per the following schedule:

24) As a result of the correction made in the determination of taxable profit, we ascertained:

24.1) The taxable base, to which the IRC rate (25%) set out in article 87.º of the Corporate Income Tax Code is applied.

24.2) Autonomous taxation, given that upon ascertaining taxable profit, the provision of no. 14 of article 88.º of the Corporate Income Tax Code is no longer applied, that is, the rates are not increased by 10 percentage points, decreasing from € 31,559.58 to € 18,252.79, as demonstrated below:

- Following the inspection action, the Portuguese Tax and Customs Authority issued additional corporate income tax assessment no. 2016…, dated 02-11-2016, in the amount of € 190,149.45 (document no. 1 attached with the request for arbitral determination, the contents of which are reproduced herein);

- The project referred to was dependent on political decisions, and the Claimant did not have, at the end of 2011, certainty whether a new extension of the expiration date of the contract would not be decided;

- On 03-04-2017, the Claimant submitted the request for arbitral determination that gave rise to the present proceedings.

2.2. Unestablished Facts

It was not established that the Portuguese Tax and Customs Authority, following the correction made unfavourable to the Claimant that it made regarding the tax year 2012, on the basis of the principle of specialization of tax years, made a corresponding favourable correction regarding the tax year 2011.

2.3. Reasoning for the Determination of the Facts

The established facts are based on the documents attached by the Claimant with the request for arbitral determination and on the administrative proceedings.

There is no disagreement between the parties regarding the factual matters relevant to the resolution of the case, which is documented.

As for the political dimension of the project, it is a notorious fact, inherent to a contract between A… and the State.

With respect to the absence of certainty, at the end of 2011, that the contract would not continue, the statements of the Claimant appear credible, not least given that several prior extensions had occurred.

3. Law

3.1. Positions of the Parties

In 2005, A… and the Portuguese State concluded a base contract for the acquisition by the latter of a Multi-Purpose Logistics Ship (NPL), intended for the Portuguese Navy.

In the following years 2006 and 2007, A… recognized in accounting terms the asset associated with the basic design of the NPL, in the amount of € 15,000,000.00, being € 3,750,000.00 in 2006 and € 11,250,000.00 in 2007, facts which generated positive patrimonial variations that contributed to the formation of the taxable profit of those same tax years (fact accepted by the Portuguese Tax and Customs Authority in article 6.º of its submissions).

The contract had an expiration date at the end of April 2007, but had annual extensions until 31-12-2011.

At the end of March 2012, the administration of the Claimant decided to de-recognize the basic design of the ship in question, then valued at € 15,000,000.00, with accounting movements being made relating to the values recorded.

The de-recognition of this asset was recorded in an account of shareholders' equity – 575 - Reserves (donations) in 2011 and the expense was not recognized for tax purposes by reference to that year of 2011.

There was no further extension of the contract after 31-12-2011 and, at the end of 2012, the Portuguese State itself acquired the design from the Claimant, for the amount of € 25,500,000.00.

With reference to the year 2012, A… recognized revenue of € 25,500,000.00 arising from this service provision and also recognized the tax expense associated with the de-recognition of the asset that was associated therewith of € 15,000,000.00, notwithstanding the fact that the accounting entry supporting it had been recognized in the prior year of 2011, without having then affected the retained earnings, and deducted, in a blank line of the income tax return model 22 relating to the tax year 2012, the aforementioned amount of € 15,000,000.00.

The Portuguese Tax and Customs Authority understood that the accounting entries are in accordance with SNC and, with these being the basis for determining taxable profit when the Corporate Income Tax Code does not contradict this, understood that the aforementioned deduction in the determination of the taxable profit of 2012, of a negative patrimonial variation of € 15,000,000.00, relating to 2011, contradicts the provisions of articles 17.º and 18.º of the Corporate Income Tax Code, whereby that amount cannot be deducted from the net result of the period of 2012 to determine taxable profit.

The Claimant argues that the accounting procedure it adopted may not have been correct in light of Accounting and Financial Reporting Standard 20 (NCRF 20), paragraphs 20 to 28, since, at the end of 2011, it found itself in a situation of uncertainty as to the continuation of the project, and one could only speak of certainty after the occurrence of the expiration period that ended on 31-12-2011, and that NCRF 24 resorts, to illustrate by way of example a situation in which an event should give rise to a disclosure rather than an adjustment, to the circumstance that after the balance sheet date a plan is announced for the discontinuation of an operating activity.

The Claimant notes that the decision as to the non-continuity of the project (which, given its materiality in the economic and financial context of the Claimant, could easily be equated with the decision to discontinue an operating activity) was only taken on 26 March 2012, and therefore, after the balance sheet date. Indeed, the Claimant notes that the "formation" of that "certainty" was emerging throughout 2012, apparently culminating in the decision of the Board of Directors to "de-recognize" the asset underlying the basic design of the NPL (the reasoning for which would later be shown to be, in no way, certain, being in fact reversed when, at the end of that same year, the Portuguese State decided to acquire the said project!).

Furthermore, the Claimant argues, invoking the jurisprudence of the Supreme Administrative Court, that there is a violation of the principle of fairness.

The Portuguese Tax and Customs Authority, in its submissions, states that the "loss" of equity caused by the removal of that element of the asset from the company's sphere, as a result of the expiration of the contract concluded in 2005 between A… and the State and the concomitant assumption of the abandonment of the NPL construction project, should have been attributed to the tax period in which the economic effect manifested itself, and that faced with the uncertainty as to the fate of the basic design of the NPL and, likewise, the unpredictability as to the design of the solution that the government would adopt, it would be necessary to conclude that the "loss" of equity became effective in the tax year 2011.

The Portuguese Tax and Customs Authority adds that this conclusion would not prejudice the accounting and tax recognition of any future financial compensation to be provided by the State, as indeed occurred with Council of Ministers Resolution of September 2012, since, notwithstanding its connection to an operation recognized for tax purposes in a prior tax year, no. 2 of article 18.º of the Corporate Income Tax Code permits the corresponding revenue (amount invoiced) to be attributed to the tax period in question (in this case, 2012), by reason of, on the date of closing of the 2011 accounts, the said operation being unforeseeable or manifestly unknown.

The Portuguese Tax and Customs Authority states that "the right to the deduction of the negative patrimonial variation is not in issue, which results from the provision of article 24.º of the Corporate Income Tax Code, combined with article 18.º no. 1, however, the deduction should be made to the fiscal result of 2011, which implies that it be purged from the fiscal result of 2012" and "states that the correction made by the TA does not affront the principle of fairness, to the extent that weight is given to the effect of the deduction of the negative patrimonial variation to the taxable profit of 2011, since, unlike what is alleged, the TA did not apply the norm relating to the specialization of tax years mechanically" and that "the correction made is intended precisely to ensure strict compliance with the principle of specialization, by considering that the negative patrimonial variation should be attributed to the tax year – 2011 - in which the accounting element of the asset associated with the basic design of the NPL was removed from the Claimant's patrimonial sphere".

The Portuguese Tax and Customs Authority states that "the tax non-consideration of the negative patrimonial variation in the calculation of the taxable profit of 2012 does not determine any duplication of tax, provided that weight is given to the effect of its deduction to the taxable profit of 2011".

3.2. Consideration of the Issue

3.2.1. Issue of the Tax Year to Which the Negative Patrimonial Variation Resulting from the Expiration of the Contract Should Be Attributed

Article 17.º, no. 1, of the Corporate Income Tax Code establishes the rule that

1 – The taxable profit of legal entities and other entities mentioned in section a) of no. 1 of article 3.º is constituted by the algebraic sum of the net result of the period and the positive and negative patrimonial variations occurring in the same period and not reflected in that result, determined on the basis of the accounts and possibly corrected in accordance with this Code.

In the case at hand, the Portuguese Tax and Customs Authority agreed with the accounting treatment given by the Claimant to the de-recognition of the asset resulting from the expiration of the contract, but the Claimant now, in the present proceedings, ventures to suggest that the treatment it itself gave may not have been correct.

The Claimant's considerations appear to be worth considering, but, in the absence of accounting standards from which it follows with certainty that a different accounting treatment should have been given than what was given, it is the accounting that was carried out that should serve as the basis for the determination of taxable profit, with the corrections that the Corporate Income Tax Code requires.

In any event, the question of accounting treatment loses relevance in the case at hand, since no. 2 of article 18.º of the Corporate Income Tax Code expressly establishes a specific regime for the attribution of positive or negative patrimonial variations to the tax periods which, in the event it does not coincide with what follows from the accounting rules, prevails over them, for tax purposes, in consonance with the final part of no. 1 of article 17.º.

That is, if the application of accounting rules leads to a result different from that resulting from no. 2 of article 18.º of the Corporate Income Tax Code at the level of attribution of positive or negative patrimonial variations to tax periods, then the application of the regime of article 18.º, no. 2, will be one of the corrections to be made to which the final part of no. 1 of article 17.º alludes.

As follows from the evidence produced, the de-recognition of the asset that embodied the contract in question was carried out accounting-wise with reference to the tax year 2011, but the Claimant only gave it tax significance in the tax year 2012.

Article 18.º of the Corporate Income Tax Code establishes the principle of specialization of tax years, pursuant to which,

1 - Revenues and expenses, as well as the other positive or negative components of taxable profit, are attributable to the tax period in which they are obtained or incurred, irrespective of their receipt or payment, in accordance with the accrual basis of accounting.

2 – The positive or negative components considered as relating to prior periods are only attributable to the tax period when on the date of closing of the accounts of that to which they should be attributed they were unforeseeable or manifestly unknown.

In light of these rules, notably no. 2, the understanding of the Portuguese Tax and Customs Authority appears to be correct that, for tax purposes, the negative patrimonial variation that embodies the de-recognition of the asset in question should be attributed to the tax year 2011.

In fact, Clause 45.º of the Base Contract Relating to the Acquisition of a Multi-Purpose Logistics Ship (NPL) Intended for the Portuguese Navy, in the wording given to it by Contractual Amendment no. 5, has the following wording:

45.º

(Expiration)

This Base Contract expires if the Acquisition Contract is not concluded by the longest period provided for in Clause 5.º, or by 31 December 2011, whichever period expires first, without prejudice to the term of validity being able to be extended by agreement of the Parties to that effect.

In light of this contractual clause, it is manifest that, as the Acquisition Contract was not concluded by 31-12-2011, nor was there agreement between the parties by that date for its extension, the contract expired immediately.

Therefore, on the date of closing of the accounts relating to the tax year 2011, the contract was no longer in force, whereby the negative patrimonial variation had already occurred and that occurrence was necessarily within the knowledge of the Claimant.

The expiration of the contract is not, therefore, a "post-balance sheet event" for the purposes of NCRF 24, since, in the definition provided by the latter, "these are those events, favourable and unfavourable, which occur between the balance sheet date and the date on which the financial statements are authorized for issue, by the management body".

Consequently, it is neither reasonable to consider, the unforeseability of the negative patrimonial variation or its lack of knowledge, in order to render possible its attribution to the tax year 2011 by application of no. 2 of article 18.º of the Corporate Income Tax Code, which has as its field of application cases in which negative patrimonial variations result from external situations which the taxpayer cannot control or know about. ( [1] )

Therefore, the negative patrimonial variation had to be attributed to the tax year 2011, by force of no. 2 of article 18.º of the Corporate Income Tax Code.

3.2.2. Issue of the Prevalence of the Principle of Fairness Over the Principle of Specialization of Tax Years

The principle of fairness, invoked by the Claimant, is imposed on the totality of the activity of the Portuguese Tax and Customs Authority by articles 266.º, no. 2, of the CRP (Portuguese Constitution) and 55.º of the LGT (General Tax Law).

From the concurrent observance of the principles of legality and fairness it follows that the duty of the Portuguese Tax and Customs Authority to apply the principle of legality does not translate into a mere formal subordination to the rules that specifically regulate certain situations, encompassing also the duty of the Portuguese Tax and Customs Authority to take into account the consequences of its activity and to refrain from the strict application of rules when from them there arises a manifestly unfair result.

The application of the principle of fairness would be to prevail over the principle of specialization of tax years in cases in which non-compliance has not resulted in prejudice to the public interest and it has not been concretized intentionally with the objective of obtaining tax advantages.

The Supreme Administrative Court has adopted this understanding, having decided, regarding the principle of specialization of tax years, that "this principle should tend to conform itself and be interpreted in accordance with the principle of fairness, with constitutional and legal conformation (articles 266.º, no. 2 of the CRP and 55.º of the LGT), in order to permit the attribution to a tax year of costs relating to prior tax years, provided that it does not result from voluntary and intentional omissions, with a view to effectuating the transfer of results between tax years". ( [2] )

The Portuguese Tax and Customs Authority itself has long recognized the need for flexibility in the application of the principle of specialization of tax years, in Circular Letter no. C-1/84, of 8-6-84, published, with the respective opinion, in Science and Tax Technique, nos. 307-309, pages 781-791, in which the following understanding was adopted, regarding the parallel question that arose in the field of Industrial Tax:

Whenever in a given tax year there are costs and revenues of prior tax years, the corresponding tax treatment should follow the following rules:

a) Non-acceptance of costs and revenues resulting from voluntary or intentional omissions in the tax year in which they are accounted for, considering, in principle, as such those which were practiced with tax intentions, namely, when:

- a period of exemption is about to expire or about to commence;

- the taxpayer has an interest in reducing losses in a given tax year to derive greater benefit from the carry-forward of losses provided for in article 43.º of the Code;

- the taxpayer intends to reduce the amount of taxable profits to relieve its tax burden.

b) In the remaining cases, costs and revenues of prior tax years should not be corrected.

In situations in which the attribution of expenses or negative patrimonial variations to a tax year different from that to which they should be attributed in light of the principle of specialization of tax years results in tax advantages for the taxpayers, it should be presumed, based on the rules of life and common experience, that the alteration of the correct attribution was effected intentionally, as it is normal for taxpayers to seek to reduce their tax burden. On the contrary, when from the alteration of the correct attribution of expenses there arise no advantages, it should be presumed that the incorrect attribution to the tax years is not intentional.

In cases in which the Supreme Administrative Court has admitted that the principle of fairness should prevail over strict legality relating to the principle of specialization of tax years, these are situations in which from non-compliance with this principle there arises no prejudice to the public interest, namely situations in which the taxpayer obtained no advantages or was even prejudiced by the error it made in the application of the principle of specialization of tax years. In situations of this type, it cannot be justified that the taxpayer be inflicted with greater tax burden, in the name of a fetishistic and uncritical respect for compliance with legality and apart from any perspective of pursuing the public interest, which is the primary duty to be observed by the Public Administration, as follows from no. 1 of article 266.º of the CRP.

However, in the case at hand, the attribution of the negative patrimonial variation in question to the tax year 2012, instead of being attributed to the tax year 2011, has as its corollary advantages for the Claimant, which justify presuming that the inadequate attribution was intentional and imply that the principle of specialization of tax years cannot be set aside on the basis of purported considerations of fairness.

In truth, with the transfer of the negative patrimonial variation in question from the tax year 2011 to the tax year 2012, the Claimant was able to give full tax significance in the tax year 2012 to the said negative patrimonial variation: with its consideration, there is verified in the tax year 2012 a tax loss of € 12,899,187.62; without considering it, there is instead a taxable profit of € 2,100,812.38, as is evident from the correction schedule contained in point 23) of the Tax Inspection Report.

Moreover, the attribution of the said negative patrimonial variation in the tax year 2011 would not have assured tax effect to the Claimant, since it only increases the accumulated tax losses in the years 2007 to 2011 from € 61,184,889.14 to € 76,184,889.14, of which only € 1,575,609.29 were deducted in 2012, and it is neither certain nor foreseeable whether this increase in losses will be fiscally utilized by the Claimant in the future.

Thus, the certainty of the immediate tax significance of the said negative patrimonial variation in 2012, with elimination of taxation in this tax year, constitutes an evident advantage for the taxpayer, which arises from the transfer of the negative patrimonial variation from the tax year 2011, to which it should be attributed, to that of 2012, which leads to the presumption that the transfer to the tax year 2012 of the tax significance of the negative patrimonial variation recognized accounting-wise in the tax year 2011 was intentional, which constitutes an obstacle to the application of the principle of fairness, in light of the said jurisprudence of the Supreme Administrative Court.

The advantage that arises for the Claimant from the transfer of the tax significance of the negative patrimonial variation from 2011 to 2012, which confers immediate tax significance to it, is further potentially heightened by the amendment introduced by Law no. 64-B/2011, of 30 December, in no. 2 of article 52.º of the Corporate Income Tax Code ( [3] ), which introduced a maximum limit to the deduction of tax losses corresponding to 75% of the respective taxable profit of each tax year, which made it more difficult and less probable to obtain complete tax significance of tax losses of the tax year 2011 in future tax years.

On the other hand, from the attribution of the negative patrimonial variation of the tax year 2012 there results prejudice to the public interest, since there is no longer any taxable base of the IRC in this tax year, whereas with the attribution of that negative patrimonial variation to the tax year 2011 there is, in the tax year 2012, a taxable base of € 525,203.09, with the consequent IRC assessment which is being challenged in the present proceedings.

In this context, it cannot be considered demonstrated that there is before us a non-intentional transfer of the tax significance of the said negative patrimonial variation from the tax year 2011 to 2012, nor that from it there results prejudice to the public interest, whereby there is not verified a situation in which, in light of the jurisprudence cited, the principle of fairness should prevail over the principle of specialization of tax years.

The Claimant, however, places the question of the weighing of the principle of fairness from another perspective, combined with the principle of proportionality, corroborated by the principle of taxation fundamentally on the basis of the real income of companies, enunciated in article 104.º, no. 3, of the CRP, which is that the said negative patrimonial variation is connected with the obtaining of the revenue of € 25,500,000.00, saying, in summary: "if it is true that the disposal of the NPL design corresponds to the revenue of € 25,500,000.00, it is no less true that the cost of acquisition of the asset that underlay it amounted to € 15,000,000.00, whereby the real income — profit — generated with this transaction cannot be but € 10,500,000.00".

This thesis, however, does not correspond to the reality that follows from the facts determined, since the Claimant did not expend the sum of € 15,000,000.00 to acquire the NPL design, accounted for in the account "576 – Reserves – Donations" (which, in accordance with the explanatory note of the POC (Chart of Accounts) in force until the end of 2009, serves as the counterparty to donations of which the company is the beneficiary). Moreover, the asset derived from this design was eliminated with the expiration of the contract, as the Claimant itself recognized accounting-wise, with reference to the tax year 2011.

In this context, the revenue of € 25,500,000.00 constitutes a patrimonial increase of this amount obtained in the tax year 2012, which contributes to the formation of the respective taxable profit, pursuant to articles 18.º, nos. 1 and 2, 20.º and 21.º of the Corporate Income Tax Code, independently of whether it should be considered entirely a result of the period (as was considered by the Claimant) or should be partially considered a component of shareholders' equity (as is ventured in the qualification contained in the "Legal Certification of Accounts" issued for the year 2012, appended to the Tax Inspection Report).

On the other hand, in a State governed by the rule of law, based on popular sovereignty and the primacy of law (articles 2.º and 3.º of the CRP), the applier of the law cannot supersede its personal criteria on the adequate definition of the public interest to those formulated legislatively by the competent constitutional bodies, whereby it cannot set aside the application of tax law on the basis of considerations of fairness when from that setting aside there arises, notably, prejudice to the public interest in the collection of taxes in the manner legally provided.

In the case at hand, as has been stated, there is not verified a situation in which from non-compliance with the principle of specialization of tax years there does not arise prejudice to the public interest in the collection of taxes, since the transfer of the said negative patrimonial variation from the tax year 2011 to that of 2012 implies an evident diminution of tax revenue in this tax year.

On the other hand, the application of the principle of specialization of tax years, which is in harmony with national and international accounting standards, does not contend with the principle that "the taxation of companies is fundamentally based on their real income", enunciated in article 104.º, no. 2, of the CRP, since the separation of the taxation of the income of companies into tax years of annual duration is necessary to implement this taxation in consonance with the rule of annuality of budget law, provided for in no. 1 of article 106.º of the CRP, from which stems the necessity of annual authorization for the collection of taxes on income.

Furthermore, it is not demonstrated that "the non-acceptance of the deduction made in 2012 and, at the same time, its non-recognition for tax purposes in 2011, determines a duplication of tax and, in the limit, unjust enrichment of the State's coffers at the expense of the Claimant, which appears inconceivable, without more, in a State governed by the rule of law".

In truth, the said negative patrimonial variation does not cease to have the significance attributed to it in the tax year 2011 to which it relates, as is expressly recognized by the Portuguese Tax and Customs Authority in article 12.º of its submissions: "the right to the deduction of the negative patrimonial variation is not in issue, which results from the provision of article 24.º of the Corporate Income Tax Code, combined with article 18.º no. 1, however, the deduction should be made to the fiscal result of 2011, which implies that it be purged from the fiscal result of 2012". For this reason, that significance can be obtained by the Claimant by submitting a replacement Tax Return Model 22 for the tax year 2011, reflecting the deliberate de-recognition in 2012, which it did not do.

Thus, the invoked violation of the principles of fairness and the taxation of companies fundamentally on the basis of their real income is not demonstrated.

4. Decision

For these reasons, this Arbitral Tribunal agrees to:

- Dismiss the request for arbitral determination;

- Absolve the Portuguese Tax and Customs Authority of the claim.

5. Value of the Proceedings

In accordance with the provisions of article 305.º, no. 2, of the Code of Civil Procedure and article 97.º-A, no. 1, section a), of the Code of Tax Procedure and article 3.º, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of the proceedings is fixed at € 190,149.45.

6. Costs

Pursuant to article 22.º, no. 4, of the RJAT, the amount of the costs is fixed at € 3,672.00, pursuant to Table I appended to the Regulation of Costs in Tax Arbitration Proceedings, to be borne by the Claimant.

Lisbon, 24-10-2017

The Arbitrators

(Jorge Lopes de Sousa)

(Leonor Fernandes Ferreira)

(Glória Teixeira)

[1] Essentially in this sense, reference may be made to the decision of the Supreme Administrative Court of 25-6-2008, case no. 0291/08.

[2] Decision of the Supreme Administrative Court of 2-4-2008, case no. 0807/07.

In the same line, reference may be made to the following decisions of the Supreme Administrative Court: of 13-11-1996, case no. 020404; of 29-02-2000, case no. 024039, published in the Bulletin of the Ministry of Justice no. 494, page 182; of 05-02-2003, case no. 01648/02; of 25-06-2008, case no. 0291/08.

[3] Applicable to the deduction from the taxable profits of the tax periods that commence on or after 1 January 2012 of the tax losses ascertained in tax periods prior to 1 January 2012, or in progress on that date, by virtue of the provision of article 116.º, no. 2, of the aforementioned law no. 64-B/2011, of 30 December.

Frequently Asked Questions

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What is the principle of specialization of fiscal years (princípio da especialização dos exercícios) in Portuguese IRC?
The principle of specialization of fiscal years (princípio da especialização dos exercícios) in Portuguese IRC requires that revenues and expenses be attributed to the fiscal year to which they economically relate, regardless of when cash flows occur. Under Article 18 of the IRC Code, taxable income must be determined according to accrual accounting principles, ensuring each fiscal year reflects its proper economic substance. This principle prevents taxpayers from arbitrarily shifting income or expenses between years for tax optimization purposes.
How does the principle of tax justice apply to IRC additional assessments in Portugal?
The principle of tax justice in IRC additional assessments requires that taxation be fair and proportionate, respecting taxpayers' economic capacity and avoiding double taxation or unjust enrichment by the State. In Portuguese tax law, this constitutional principle (Article 103 of the Portuguese Constitution) mandates that tax assessments consider the overall tax situation of the taxpayer. When applying correction assessments, the Tax Authority must balance strict legal compliance with equitable outcomes, particularly where taxpayers have already been taxed on related transactions in prior years.
Can a taxpayer challenge an additional IRC tax assessment through CAAD arbitration?
Yes, taxpayers can challenge additional IRC assessments through CAAD (Centro de Arbitragem Administrativa) arbitration under the Legal Regime for Arbitration in Tax Matters (RJAT - Decree-Law 10/2011). Article 2(1)(a) of RJAT grants jurisdiction to arbitral tribunals to review the legality of tax assessments, including IRC liquidations. Arbitration provides an alternative to judicial courts, offering faster resolution with specialized arbitrators. Taxpayers must submit a request for arbitral determination within the legal deadline, and the CAAD automatically notifies the Tax Authority to present its defense.
What are the legal grounds for contesting IRC liquidation related to fiscal year allocation of expenses?
Legal grounds for contesting IRC liquidation related to fiscal year allocation include: (1) violation of the principle of specialization of fiscal years under Article 18 of the IRC Code; (2) incorrect application of accrual accounting principles; (3) breach of tax justice principles requiring fair attribution of income and expenses; (4) misapplication of the matching principle when expenses relate to revenues recognized in the same fiscal year; and (5) errors in applying periodization criteria for complex multi-year transactions. Taxpayers must demonstrate that the Tax Authority incorrectly allocated revenues or expenses to the wrong fiscal year.
How does CAAD Process 233/2017-T address the conflict between periodization rules and tax justice in corporate taxation?
CAAD Process 233/2017-T addresses the conflict by examining whether strict application of fiscal year allocation rules (requiring the €15 million expense to be recognized in 2011 when de-recognized) conflicts with tax justice principles given that: (1) the taxpayer was taxed on the asset recognition in 2006-2007; (2) the final transaction generating €25.5 million revenue occurred in 2012; and (3) disallowing the 2012 deduction could result in disproportionate taxation. The tribunal must balance the technical requirement that expenses belong to the year of their economic occurrence against fairness considerations, particularly the matching principle suggesting expenses should offset related revenues in the same fiscal period.