IRC Capital Increase via Reserves - CAAD Case 237/2016-T Analysis

Process: 237/2016-T

Date: December 13, 2023

Tax Type: IRC

Summary

CAAD Case 237/2016-T addresses the IRC tax treatment of capital increases through incorporation of free reserves and procedural defects in tax inspections. The taxpayer, A... SGPS S.A., challenged an IRC assessment of €188,910.76 for 2011, arguing three main grounds: (1) the inspection was improperly classified as internal when it should have been external, requiring prior notification under Article 49 RCPIT; (2) the assessment lacked adequate factual and legal substantiation mandated by Article 268(3) of the Portuguese Constitution and Article 153(1) CPA; and (3) the Tax Authority erroneously treated the subscription of shares in a capital increase through incorporation of free reserves as a taxable dividend distribution. The claimant argued that capital increases via incorporation of reserves constitute a distinct corporate operation from dividend distribution, involving no asset outflow to shareholders and no income recognition under accounting standards. The company contended that absent a specific corrective provision in the IRC Code, the Tax Authority cannot disregard the accounting treatment. This decision was issued following annulment of the original 2017 arbitral decision by the Central Administrative Court South (TCAS) in June 2023. The case highlights critical issues regarding the classification of tax inspections, constitutional requirements for tax assessment substantiation, and the proper fiscal characterization of corporate restructuring operations involving reserve capitalization under Portuguese tax law.

Full Decision

TAX ARBITRATION JURISPRUDENCE

Case No. 237/2016-T

Decision Date: 2023-12-13
IRC

Claim Value: € 188,910.76

Subject Matter: Corporate Income Tax (IRC) - Lack of substantiation - Qualification of inspection activity - Increase in capital through incorporation of free reserves - Distribution of dividends * Annulment of previous arbitral decision by TCAS – New decision – Reform of arbitral decision (attached to decision).
*Replaces the arbitral decision of 14 March 2017.

ARBITRAL DECISION

The Arbitrators José Poças Falcão (President), Francisco Nicolau Domingos and Maria Isabel Guerreiro (co-arbitrators), appointed by the Deontological Council of the Administrative Arbitration Centre (CAAD) to form this Collective Arbitral Tribunal, in compliance with the decision of the Central Administrative Court South – abbreviated "TCAS" – rendered on 23-6-2023 in case no. 51/17.6BCLSB, which decided to annul the arbitral decision previously rendered, hereby agree as follows:

I. REPORT

A... SGPS, S.A, taxpayer no. ..., with registered office at Rua ..., no...., ...-..., Lisbon, hereinafter referred to as the Claimant, submitted on 21/04/2016 a request for arbitral pronouncement, in which it requests that the Corporate Income Tax (IRC) assessment act no. 2015..., executed by the Honorable Director-General of the Tax Authority (AT), with reference to the year 2011, in the amount of € 188,910.76 be declared illegal and annulled with the necessary legal consequences, specifically the reimbursement of the tax paid unduly by the Claimant, plus the corresponding indemnity interest at the legal rate.

The President of the Deontological Council of CAAD appointed on 14/06/2016 as arbitrator-president Mr. Judge José Poças Falcão and as co-arbitrators Prof. Francisco Nicolau Domingos and Dr. Maria Isabel Guerreiro, who declared accepting the assignment, pursuant to the terms legally provided.

On 01/07/2016 the arbitral tribunal was constituted.

In compliance with the provisions of art. 17, nos. 1 and 2, of Decree-Law no. 10/2011, of 20 January (RJAT), the Respondent was notified on 06/07/2016 to, if it so wished, submit a response and request the production of additional evidence.

On 26/09/2016 the Respondent submitted its response, in which it argues that the request for declaration of illegality of the assessment in question should be judged not well-founded and that there was no error attributable to the services, a condition necessary for the payment of indemnity interest.

The tribunal on 23/12/2016 dispensed with the meeting referred to in art. 18 of RJAT, granted a time period for the parties to submit final written arguments, extended the time period to render the decision and fixed the deadline for its rendering.

The parties submitted final written arguments reiterating the arguments already invoked in the other pleadings.

The tribunal on 27/02/2017 again extended by 2 months the time period to render the arbitral decision.

POSITIONS OF THE PARTIES

The Claimant begins by previously noting that the inspection procedure sustaining the IRC assessment act no. 2015..., although it was qualified as internal by the Tax and Customs Authority (AT), the truth is that it was based on elements gathered by it from the Claimant and which thus were not in its possession, a circumstance that justifies, in its view, the classification of such procedure as external. And, if it is so, it will be illegal, insofar as the prior notification referred to in art. 49 of the Supplementary Regime of Tax Inspection Procedure (RCPIT), art. 59, no. 3, al. l) and art. 69, no. 2, both of the General Tax Law (LGT), was omitted. Therefore, it observes that if it did not receive such notification with the description of all the rights, duties and guarantees of the taxpayer, the consequent IRC assessment must be declared illegal, given the vice generating annullability.

Secondly, it adds that the inspection procedure and the consequent IRC assessment are not substantiated in fact and in law, as expressly and concretely required by art. 268, no. 3 of the Constitution of the Portuguese Republic (CRP) and art. 153, no. 1 of the Administrative Procedure Code (CPA), therefore, its lack necessarily determines the illegality of the assessment act executed and consequent annulment.

Thirdly, it alleges that it is entirely without merit to make a correction to the taxable profit of the Claimant arising from the circumstance that the subscription of shares of Bank B..., within the scope of a capital increase through incorporation of reserves, constitutes a dividend from a corporate, accounting and fiscal perspective.

Thus, the Claimant argues, based on art. 21, no. 1, al. a) of the Commercial Companies Code (CSC), that all partners have the right to share in profits, profits of the year being distributable and also free reserves, that is, constituted on the basis of profits carried forward from previous years. As well as, the delivery of resources to partners or shareholders does not have to be made in cash, and can be made in kind.

On the other hand, it also refers that the capital increase through incorporation of reserves is, first and foremost, a subspecies of capital increase that operates in exchange for the incorporation of available reserves – art. 91, no. 1 of CSC. Thus, in the capital increase through incorporation of reserves there is no delivery of assets by the partners to the company – as occurs in the case of a capital increase through new contributions – or by the company to the partners, particularly because it is possible that there is not even the issuance of new shares.

It also concludes in this scope that the distribution of dividends and the capital increase through incorporation of reserves constitute two autonomous operations, whose effects do not overlap and, as such, cannot be treated as one and the same thing for accounting and fiscal purposes.

On the accounting plane, it observes that the capital increase through incorporation of reserves cannot be considered a dividend, not only because it does not embody the distribution of a profit or outflow of funds, but also because it lacks the characteristics of probability in occurrence and certainty in quantification, typical of a dividend.

Thus, at the moment when new shares are attributed as a result of the increase in the nominal value of capital through incorporation of reserves, because there is no increment in the value of the corresponding participation, there is no place for the recording of any income. It argues that this is the case even if, simultaneously and even due to the influence of the capital increase, increases in the market value of the social participations are recorded.

However, in such case only if such participations are recognized at fair value in exchange for results, and at the moment fair value tests were conducted, will income be determined. However, if such recognition is made in exchange for reserves, which is what occurs in the case sub judice, then such gain or latent income is only accounted for when it is realized, through the onerous transfer of the social participations.

From the perspective of fiscal law, it argues that a corrective nature of the accounting result is adopted, based on such result, subsequently providing various alterations or corrections, in order to adapt it to its function, that is, to serve as the base of incidence of the tax.

Therefore, if the AT intends to disregard or correct the accounting result of the Claimant for fiscal purposes, it would always have to resort to a "corrective" rule provided for in the IRC Code, which, in its view, did not occur, because the accounting result reflects the operations that occurred during the year.

To support the above-mentioned conclusion it refers that: i) art. 20, no. 1, al. c) of the IRC Code does not establish, regarding the concept of dividends, any rule of a "corrective" nature, limiting itself to considering them in the list of examples of taxable income for informational purposes; ii) fiscal law does not set forth any concept of dividend, therefore, the AT must accept the definition that results from the applicable accounting rules and from the provisions of Corporate Law – art. 11, no. 2 of LGT and iii) moreover – art. 46, no. 1, al. b) of the IRC Code - incorporates a sufficiently complete concept of capital gain to encompass the results actually determined by the Claimant.

Thus it argues that, if it acquired for valuable consideration 11,920,000 shares of Bank B... for the value € 112,597,738, in February 2011, on the occasion of a capital increase through incorporation of reserves, it subscribed for another 183,438 shares, in the period of February and March of the same year, transferred onerous all such shares, for the value of € 99,297,428.60, resulting in a capital loss of € 13,300,309.40, we are faced with a "loss" suffered through "onerous transfer of a financial instrument (which, because it was not recognized at fair value in exchange for results, is not covered by the exception provided in the final part of art. 46, no. 1, al. b) of the IRC Code)". This loss is given by the difference between the amount of the sum of the values of realization of the transfers of € 99,297,428.60 and the acquisition value of € 112,597,738.00 – art. 46, no. 1, al. b) and no. 2 of the IRC Code.

Moreover, the conclusion is in no way altered by the fact that we are faced with shares subscribed in a capital increase through incorporation of reserves. The only specialty that results from this is that they were subscribed without the performance of any consideration.

If the capital increase through incorporation of reserves and by distribution of dividends lead to two distinct taxable facts – dividends and capital gains – and, in the proceedings, the relevant factuality is subsumed under the latter, the AT cannot proceed with their unification, under penalty of violation of art. 8 of LGT.

It also refers that the concepts of dividend and capital gain/loss are today fully autonomous, because, as the legislator refined the concept of capital gain, it abandoned the autonomous taxation of capital increases through incorporation of reserves - whose taxation has not been maintained in the Code of Income Tax on Individuals (CIRS), nor in the IRC Code.

It results from the provisions of art. 20, no. 1, al. h) of the IRC Code that only "realized capital gains" are considered taxable income. Strictly speaking, capital gain, unlike dividend, up to the sale, constitutes a mere expectation or latent gain, without any legal protection and which only in exceptional cases has accounting relevance.

In summary, the legislator was concerned with effecting taxation only at the moment it is realized, excluding the taxation of any latent gain, because contingent – art. 20, no. 1, al. h) of the IRC Code and provided for the exclusion of fair value adjustments or as a relevant circumstance for source withholding, even in the case of dividends, the moment of their being placed at disposal. Thus, a capital increase through incorporation of reserves does not constitute any distribution of dividends, but the realization of a capital gain or loss, at the moment when the shares subscribed in the capital increase operation are transferred onerous, whereby, a different interpretation would violate the principle of legality – art. 3, no. 1, al. a) and 2, art. 17, no. 1, art. 20, no. 1, al. c) and h) and art. 46, all of the IRC Code.

It concludes, requesting the reimbursement of the amount of tax unduly paid, plus indemnity interest.

Response of the AT (Tax and Customs Authority)

The Respondent, in its response, defends itself by invoking:

The non-existence of external inspection.

It argues that it proceeded with the correct qualification of the inspection activity, complying with the provisions of art. 13 of RCPIT, which provides for the possibility of inspection procedures being of two types (internal and external) and that, in the concrete case, it is indisputable that we are faced with an inspection activity of an internal nature, since the inspection acts were carried out exclusively in the services of the AT. It further adds that nothing prevents requesting clarifications from the taxpayer when the inspection is carried out entirely in the services of the AT.

It concludes, in this scope, noting that, even if the inspection is qualified as external, the lack of prior notification described in art. 49 of RCPIT will never generate the annullability of the decision of the procedure, but constitutes an irregularity, without invalidating effects, if the interested party was given knowledge of the procedure and its object in time to participate in it and if it was given the possibility of exercising its right of hearing during the inspection procedure.

(ii) The receipt of dividends in kind.

Within the scope of its defense it argues that the receipt by the Claimant of 183,384 new shares as a result of a capital increase of Bank B... within the scope of the "Shareholder remuneration program" called "C..." should be treated as the receipt of dividends in kind, especially because another form of interpretation would transform the actual nature of the gain.

In support of its position it argues that Bank B..., alongside the traditional instrument of remuneration of shareholders, through the distribution of dividends in cash, adopted for the dividends of October/November 2010 and January/February 2011, the so-called "alternative option". This consisted in the issuance of subscription rights attributed to all shareholders - one per share – and in the offer of options to shareholders regarding the destination of the subscription rights, more specifically: a) receipt in cash through the sale of the subscription rights to the issuing entity, receiving as consideration the value corresponding to the previously fixed price; b) their transaction on stock exchanges during a short period of time and c) their conversion into shares issued within the scope of a capital increase through incorporation of reserves/undistributed profits.

Therefore, having the Claimant opted to convert the subscription rights into new shares which it accounted for, at the date of receipt as dividends, valuing the 183,384 shares at € 1,676,863.30 (quotation of € 9.14) it should not have executed the reversal of the entry on 31/12/2011, because such accounting movement did not suffer from any error, since the operations in question could not be reduced to a simple capital increase through incorporation of reserves. In sum, the option of the Claimant to receive the 183,384 shares, rather than receive its share of dividends in cash, does not disqualify the operation as remuneration as dividends, because the new shares received in exchange for the dividends to which it was entitled had the effect of an increase in equity, because not only the number of shares held increased, but also the percentage held in the capital of the issuing entity was reinforced.

It concludes affirming that if the tax act in question is not illegal, there is no error attributable to the services and, thus, the requirements for the recognition of the right to indemnity interest are not fulfilled.

Thus, these are the issues that the tribunal must address:

Whether the inspection procedure/assessment act suffers from the vice of lack of substantiation due to absolute absence of any factual and legal elements;

Whether the inspection procedure/assessment act suffers from the vice of omission of essential formality – prior notification described in art. 49 of RCPIT;

Whether, in accordance with what was decided in the aforementioned Decision of TCAS of 23-6-2023, rendered in Case no. 51/17.6BCLSB, the assessment act is affected by unconstitutionality arising from the interpretation, by the AT, of article 20-1/c) of the 2011 IRC Code

Whether indemnity interest is due.

CASE MANAGEMENT

The proceedings do not suffer from nullities, the arbitral tribunal is regularly constituted and is materially competent to know and decide the claim, consequently verifying the conditions for the final decision to be rendered.

FACTUAL MATTER

PROVEN FACTS

The Claimant is a holding company (SGPS).

On 31/12/2010 it held 11,920,000 shares of Bank B..., S.A. (B...) representing 0.14% of capital which it acquired in 2004, for the value of € 112,597,738.00.

The shares of B... have a price formed in a regulated market - stock quotation

The shares of B... held by the Claimant were acquired for the global value of € 112,597,738.00 (€ 9.45 per share) and were recognized in its assets on 31/12/2010.

Such shares were recognized in its assets on 31/12/2010 with a fair value of € 94,501,760.00, in exchange for a negative value in reserves of € 18,095,978.00.

In June 2010 B... resolved a capital increase through incorporation of free reserves in light of the "Consolidated Text of the Law on Joint Stock Companies" of Spain.

The resolution has in particular the following tenor: i) "It is resolved to increase capital by the amount resulting from the multiplication (a) of the nominal value of half (0.5) euro per share of Bank B..., S.A (...) by (b) the number determinable of new shares of Bank B... that results from the formula indicated in point 2 below (the new shares)"; ii) "The increase will be made by means of the issuance and placing into circulation of the new shares, which will be ordinary shares, with a nominal value of half (0.5) euro, of the same class and series as those currently in circulation" and iii) "...the capital increase will be entirely made by incorporation of the free reserve, called voluntary reserves, resulting from undistributed results".

The capital increase was made through incorporation of free reserves.

In the content of the operation disclosed to shareholders and to the market it was stated that it was decided to "...increase the capital of Bank B... by incorporation of voluntary reserves from undistributed results by an amount determinable in accordance with the terms provided in the said resolution".

The capital increase was resolved within the scope of the shareholder remuneration program called – "C...".

Each shareholder, within the scope of such capital increase, received one free subscription right per share held.

Such subscription rights were available for trading on the Stock Exchanges in Spain and on Euronext between 17/01/2011 and 26/01/2011.

After the expiration of such period there was an automatic conversion of the subscription rights into shares issued in exchange for an incorporation of the free reserves of B....

The shareholders of B... had at their disposal three alternatives: i) sell the subscription rights to Bank B..., which would acquire them at a previously agreed price; ii) sell such rights in the market, during the trading period and iii) maintain the rights and receive shares of Bank B..., attributed according to the number of subscription rights they held at that moment.

Within the scope of the operation described in 4.1.6. and 4.1.7. B... registered a capital increase in the amount of € 55,576,453 in exchange for the incorporation of reserves of the same value and issued 111,152,906 shares, each with a nominal value of € 0.5, subscribed by shareholders who opted for this alternative.

The Claimant opted to receive shares of B..., having been attributed, in February 2011, 183,384 new shares which at the time had a price formed in a regulated market of € 9.14 each, which makes a total market value of € 1,676,863.30.

The Claimant made the accounting entry no. B3-2000002, in the amount of € 1,676,863.30, by debit of account 41411.1 – B... ... and credit in account 79 – Dividends.

As a result of the capital increase through incorporation of reserves, the Claimant came to hold a total of 12,103,384 shares (11,920,000 purchased and 183,384 attributed).

The Claimant on 08/02/2011 transferred in stock exchange 183,384 of such shares, for the price of € 1,648,788.60, with accounting losses of € 82,639.03 being determined.

On 31/03/2011 the Claimant transferred ownership of the remaining shares it still held (11,920,000) to the capital of company D..., SARL, for the market value of such shares of € 8.19 each, which corresponds to a total realization value of € 97,648,640.00.

In the 2011 fiscal year the Claimant determined a negative fiscal result of € 470,083.10.

On 05/02/2015 Service Order no. 2015... was issued, initiating an inspection procedure of the Claimant which had as its object the IRC of the 2011 fiscal year and which the AT qualified as internal.

On 24/06/2015 the AT sent to the Claimant a "request for fiscally relevant elements" in which it requested: "1. Regarding all Capital Gains realized in the fiscal year as a result of the transfer of capital shares or any financial investments, present for each one and where applicable: 1.1. Identification of the transferred asset; 1.2. Indication of the date, value and form of transfer; 1.3. Identification of the counterparty in the transfer operation; 1.4. Declaration on the existence or not of special relations, as defined in no. 4 of art. 63 of the IRC Code, with the counterparty identified in the previous subpoint and, if applicable, indication of the nature of the relation; 1.5 Indication of the date, value and form of acquisition of the transferred asset; 1.6 Identification of the counterparty in the acquisition; 1.7 Declaration on the existence or not of special relations, as defined in no. 4 of art. 63 of the IRC Code, with the counterparty identified in the previous subpoint and, if applicable, indication of the nature of the relation; 1.8 Send copy of the capital gains and losses map; 1.9 Send copy of the statement of account 79.21 – B... and copy of the supporting documents for the accounting entries made; 1.10. Send copy of the statement of account 68.62 – Transfers, and copy of the supporting documents for the accounting entries (...) 3. Regarding the C... capital share, inform the form and how it was transferred and the calculations made in the determination of the result determined. Also inform whether the shares held were quoted on the stock exchange, regulated market, and what procedure was adopted and tax treatment given to the transition adjustment, provided for in art. 5 of Decree-Law no. 159/2009, of 13 July".

The Claimant responded to such request by letter dated 02/07/2015.

The AT on 10/07/2015 sent a new e-mail to the Claimant with the following tenor: "...2. In the month of February, through accounting entry no. B3-2000005, the amount € 1,676,863.30 was recorded as a credit in account 786232 – B..., as dividends. In the month of December, through accounting entry no. 12000052, account 786232 – B..., the amount of € 1,676,863.30 was moved as a debit, by credit to account 6862 – Transfers. This entry appears to be incorrect. The value received as dividends should have concurred positively for the determination of taxable income for 2011 fiscal year, which, both by the accounting entry and by verification of the values in table 07 of the income statement mod. 22 did not occur. In reality, such accounting entry, caused a decrease in the amount determined in account 6862 – Transfers, that is the final value would be € 14,977,172.69, and not what was determined € 13,300,309.39. The following table exemplifies the effect caused by the incorrect accounting of the regularization entry made in December 2011:

As declared / Proposed
1 Dividends – / 0.00 / 1,676,863.30
2 Transfer – account 6862 / 13,300,309.39 / 14,977,172.69
3 = (1-2) Net result / -13,300,309.39 / -13,300,309.39
4 Addition table 07 of mod. 22 / 13,300,309.39 / 14,977,172.69
5 = (3+4) Taxable profit / 0.0 / 1,676,863.30

Information is appreciated regarding the matter described".

The Claimant responded to the request by e-mail dated 17/07/2015.

The AT on 20/08/2015 sent a new e-mail to the Claimant in which it informed that it intended to make the following corrections to the taxable profit of 2011: "...- From dividends, € 1,676,863.30; - From losses related to capital shares, € 20,011.96...".

The Claimant on 03/09/2015 responded by e-mail to the communication described in the previous number.

On 15/10/2015 the Claimant was notified of the draft administrative decision in which a correction to the taxable profit for the 2011 fiscal year in the amount of € 1,676,863.30 was proposed, since the value of the shares subscribed, upon the capital increase through incorporation of reserves of Bank B... constituted a dividend.

In the content of the inspection report is contained the following substantiation: "...A... was a shareholder of Bank B..., had the right to receive dividends distributed, which it received in new shares. In fact, to account for the new shares, taking into account the way in which it acquired the right to them, in its assets it necessarily had to have considered as consideration the corresponding income. It could not have made the regularization entry made at year end, through which it allocated the value of the income from dividends, to the amount determined and respecting losses from shares it already held in the previous year" and "...the taxpayer had the right to dividends which it received through new shares of B..., with the fair value guaranteed by B..., which appreciated the participation in B..., there was therefore a capital increment. And thus, the increment should have been recognized and acknowledged as income from the fiscal year, as dividends which it actually received in kind, through new shares".

Consequently, on 25/11/2015 the Director-General of the AT proceeded with the assessment no. 2015..., in the amount of € 188,910.76.

The Claimant made on 19/01/2016 the payment of the amount determined in the assessment no. 2015....

The Claimant submitted the request for constitution of the arbitral tribunal that led to the present proceedings on 21/04/2016.

4.2. FACTS THAT ARE NOT CONSIDERED PROVEN

There are no facts with relevance to the decision that have not been given as proven.

4.3. SUBSTANTIATION OF THE FACTUAL MATTER CONSIDERED PROVEN

The factual matter given as proven has its source in the documents used for each of the alleged facts and whose authenticity was not called into question.

ON THE LAW

5.1. Lack of Substantiation

The Claimant alleges that the assessment is not substantiated, because, in its view, it is not possible to understand the reasons for the decision, particularly because it contains no factual and legal motivation.

Jurisprudence on the substantiation of the assessment act holds that: "The act will be sufficiently substantiated when the addressee, placed in the position of a normal recipient – the bonus pater familiae referred to in art. 487, no. 2 of the Civil Code – can come to know the factual and legal reasons that are at its genesis, in order to allow the addressee to choose, in an informed manner, between the acceptance of the act or the activation of the legal means of challenge, and so that, in the latter circumstance, the tribunal can also exercise the effective control of the legality of the act, assessing its legal correctness in light of its contextual substantiation"[1]. Or, said in another way, the substantiation must incorporate elements of fact and law that allow the addressee of the act to understand the decision-making process of the AT.

In the case sub judice, it is possible to discern in the inspection report, in section III, facts and legal rules that frame the corrections to taxable profit. For which reason, the tribunal considers that the act is sufficiently substantiated, since it contains the minimum references to the factual and legal matter used by the AT for its execution. Particularly because, the lack of substantiation imputed to it did not constitute any obstacle for the Claimant to defend its illegality and consequent annulment in a pleading in which it imputes to the assessment a list of vices. In sum, the act does not suffer from the vice of lack of substantiation that the Claimant attributes to it.

5.2. Inspection Procedure

The Claimant argues, on this point, that the acts executed denote the existence of a procedure distinct from the internal one and, as such, the omission of the prior notification provided for in art. 49, nos. 1 and 2 of RCPIT must lead to the annulment of the assessment executed.

Therefore, first, it is necessary to determine in the case sub judice the true nature of the procedure used by the AT.

To accomplish such task we must mobilize the pertinent legal framework.

Thus, art. 13 of RCPIT provides that: "Regarding the place of execution, the procedure can be classified as:

Internal, when the inspection acts are executed exclusively in the services of the tax administration through formal and consistency analysis of documents;

External, when the inspection acts are executed, totally or partially, in the facilities or dependencies of taxpayers or other tax-bound parties, of third parties with whom they maintain economic relations or in any other location to which the administration has access".

In another way, art. 49 of RCPIT provides that: "1 – The external inspection procedure must be notified to the taxpayer or tax-bound party with a minimum advance notice of five days regarding its commencement.

The notification provided for in the previous number is effected by a notice letter drawn up according to the model approved by the director-general of Taxes, containing the following elements:

a) Identification of the taxpayer or tax-bound party subject to inspection;

b) Scope and extent of the inspection to be carried out.

The notice letter will contain an annex containing the rights, duties and guarantees of taxpayers and other tax-bound parties in the inspection procedure".

Before anything, one could question: is the qualification regarding the nature of the procedure executed by the AT binding for the tribunal?

Jurisprudence answers such question as follows: it is not. Or, said in another way, when it is verified that the content of the acts concretely executed is contrary to the qualification attributed, the tribunal is not prevented from altering it. Thus, even though a procedure is classified by the AT as internal, should it come to pass that the acts executed exceed mere formal correction analysis of documents and their compatibility with the filed statements - it is imperative to conclude that one is faced with a procedure of an external nature.

In this scope, the inspection procedure, regarding the place of execution, can be qualified as internal or external. The former, when acts of an inspection nature are executed solely and exclusively in the services of the AT, through formal and consistency analysis of documents. Already in the latter, we are faced with a true "investigatory activity"[3] through which it is sought to assess the accuracy of the values declared in light of the rules of substantive Tax Law or if there is an omission in the declaration of such values.

In the concrete case, analyzing the corrections executed it is verified that the procedure was not aimed only at the gathering of information, on the contrary, it can be affirmed that it went beyond this, insofar as the access to the information provided by the Claimant grounded the corrections executed to taxable profit and led to the assessment in question. That is, we are faced with an inspection that is materially external.

Thus, if it is so, what is the legal effect arising from the lack of prior notification referred to in art. 49 of RCPIT?

On this point the most recent jurisprudence holds that: "I - Although the inspection procedure was erroneously qualified as internal, when it should have been as external, such error is irrelevant to the decision to be rendered if it cannot be concluded that any essential formality imposed by this latter form of inspection was neglected. II - The lack of the prior notification provided for in art. 49 of RCPIT does not generate the annullability of the decision of the procedure, such formality being degraded to a mere irregularity, without invalidating effects, if the interested party was given knowledge of the procedure and its object in time to participate in it and if it was given the legal possibility of exercising its right of hearing during the inspection procedure"[4].

In this line also the doctrine concludes that: "The lack of notification of the beginning of the procedure should, however, only generate invalidity if it is demonstrated that the interested party was not aware of the procedure and its respective object, and that by force of such lack of awareness the party cannot participate in it in a timely manner (our emphasis). Thus, if the inspected taxpayer was notified of the service order/dispatch marking the beginning of the procedure, if it was notified of the draft conclusions of the inspection report, the eventual lack of notification of the notice letter is degraded to a mere irregularity, without invalidating effects"[5].

Reverting such interpretation to the concrete case it is imperative to conclude that the lack of prior notification provided for in art. 49 of RCPIT does not generate the annullability of the decision of the inspection procedure/assessment, because the Claimant was given knowledge of the procedure and object, having participated in it on 02/07/2015, 17/07/2015 and 03/09/2015, as well as within the scope of the exercise of its right of hearing. Now, if it is so, the lack of notification of the notice letter is generative of a mere irregularity and, as such, the IRC assessment that is the object of these proceedings cannot be annulled.

5.3. Concurrence of the Value of Transfer of Shares Following Capital Increase Through Incorporation of Free Reserves for the Determination of Taxable Profit

The problem that arises in this scope consists of determining whether the amount of € 1,676,863.30 concerning the price of the shares delivered by Bank B... España to its shareholder A... SGPS, SA., following a capital increase through incorporation of free reserves carried out in 2011, should concur for the determination of taxable profit for such year or whether a loss recognized in accounting should be acknowledged as the Claimant argues.

The starting point for responding to the question obliges the description of the corporate concept of reserves and its modality of free reserves. On this matter, doctrine holds regarding the first concept that: "Reserves are amounts (in principle, generated by the company itself) that partners cannot - by legal or contractual imposition – or do not want to distribute"[6]. Being certain that in the delimitation of the modality of free reserves it refers that: "These are the reserves that partners can, each year, decide to constitute through the non-distribution of the corresponding profits. (...) Partners, just as they can freely constitute such reserves, can, in the same way, freely give them whatever destination they wish"[7].

Now, one such destination consists in the capital increase through incorporation of free reserves.

Therefore jurisprudence holds that: "... it was proven that the reserves that served to make capital increases resulted from the accumulation of dividends/profits or other amounts to be divided among partners who, instead of being divided, were converted into capital increases. That is, the company's profits (and dividends), rather than being distributed to partners were converted into capital increase". Or, said in another way, from a corporate perspective, profits (dividends) can be converted into capital increases.

Art. 20, no. 1, al. c) of the IRC Code (in the wording in force at the time) provided that: "Are considered income those resulting from operations of any nature, as a consequence of normal or occasional action, basic or merely accessory, in particular: (...) c) Of a financial nature, such as interest, dividends, discounts, premiums, transfers, exchange differences, bond issue premiums and those resulting from the application of the effective interest method to financial instruments valued at amortized cost; (...)".

Doctrine argues that: "The notion of income-increment, which underlies the quantification of taxable profit, leads to the legal establishment of a broad concept of revenues or gains, capable of encompassing any positive patrimonial variations of the company's net equity..."[8]. Thus, revenues or gains can result, not only from the normal functioning of the company's activity, but also from an occasional or merely accessory action, as is the case with "dividends". That is, within the concept of revenues or gains in IRC all those not excepted by law are included.

In the concrete case, with the attribution of shares to the Claimant and subsequent sale there was a capital increment in its legal sphere and thus the income of € 1,676,863.30 should concur for the determination of taxable profit.

In that line, in the OECD Model Tax Convention on Income and Property[9] it is referred that: "Are considered dividends not only distributions of profits defined annually by the general assembly of shareholders, but also other benefits, in cash or its equivalent, such as free shares (underlined), bonuses, liquidation profits and hidden distributions of profits".

The Questions of (Un)constitutionality

The Claimant invokes, although lightly and without adequate and consistent substantiation or argumentation, the non-observance by the AT, in the tax act sub juditio, of the constitutional principles of tax capacity and taxation by actual income, provided for in article 103-1, of CRP and, ultimately, the principle of equality.

Thus, it is in light of these principles that it considers unconstitutional the understanding that supports the tax act in the sense that there was a capital increment in the subscription of shares through incorporation of reserves because, in its view, the appropriate fiscal treatment of the eventual income obtained would be through the taxation of capital gains if and when the onerous transfer of the shares occurred, insofar as taxation was due, under the legal terms, being this the "(...) only orientation that guarantees compliance with the constitutional principles of tax capacity and taxation by actual income, provided for in article 103-1, of CRP and, ultimately, the principle of equality provided for in article 13, of CRP (...)".

Let us see:

The principle of tax capacity expresses and implements the principle of fiscal or tax equality in its aspect of "uniformity" – the duty of all to pay taxes according to the same criterion – tax capacity filling the unitary criterion of taxation.

This criterion consists in that the incidence and distribution of taxes – of "fiscal taxes" more precisely – should be made according to economic capacity or "capacity to spend" (in the classical Portuguese formulation, of Teixeira Ribeiro, "Justice in Taxation" in "Bulletin of Economic Sciences", vol. XXX, Coimbra 1987, no. 6, an author who also refers to it as "capacity to pay" – ability to pay – or economic capacity – wirtschaftliche Leistungsfähigkeit) of each one and not according to what each one eventually receives in goods or services (benefit criterion).

The current Constitution of the Republic does not expressly establish this principle with its long tradition in Portuguese constitutional law - the Constitutional Charter of 1826 expresses it in the formula of taxation "according to the possessions" of citizens and, in the 1933 Constitution, article 28 establishes it in the obligation imposed on all citizens to contribute to public charges "according to their possessions").

Notwithstanding the silence of the Constitution, it is the generalized understanding of doctrine that "tax capacity" continues to be a basic criterion of our "Fiscal Constitution" and that it can (or should) be reached from the structuring principles of the fiscal system formulated in articles 103 and 104 of CRP (see Casalta Nabais "The Fundamental Duty to Pay Taxes", pp. 445 et seq., where, however, it is argued that, although the principle does not require – to have constitutional support – a specific and direct precept, it is not entirely useless or indifferent its express establishment).

There are authors, however, who contest the practical legal operability of the principle of tax capacity, due, in particular, to its marked and indisputable indeterminability, not being there anything other than a "master key formula" unsuitable for a legal-constitutional test of taxes, either because it would only "establish that 'one should pay what one can pay' without defining the 'capacity to pay'", or because it "would provide no concrete criterion for the fair distribution of tax burdens to all taxpayers", or also because it "would say very little about the rates to consider correct for taxes or their exact progression, if this, to some extent, can result from such a principle" (see Casalta Nabais op. cit. pp. 459 and 461).

Differently, other authors, as is the case of Casalta Nabais himself, recognize still "important benefits" to the principle, which "distances the fiscal legislator from arbitrariness, obliging the legislator, in the selection and articulation of taxable facts, to adhere to revelations of tax capacity, that is, to erect as object or taxable matter of each tax a certain presupposition that is manifestation of such capacity and is present in the various legal cases of the respective tax" and has "special density regarding the tax(es) on income" requiring "a concept of income broader than income-product" and implying "both the principle of net income (...) and the principle of available income (...)" ("Tax Law", pp. 157/168).

In any event, it must be recognized that it is not easy to derive very clear and certain legal consequences from the principle of tax capacity, translated into a judgment of constitutional inadmissibility of a certain or certain solutions adopted by the fiscal legislator.

Certain methods of taxation, by their very structure, can, after all, end up leading to the imposition of situations or realities in which the tax capacity is entirely lacking, or (and with greater probability) in which the measure of the tax required does not have effective correspondence with such capacity, going beyond (and, perhaps, considerably beyond) it; this is what Casalta Nabais ("The Fundamental Duty...", pp. 497/498 and 501/502) considers, when he refers to "traditional solutions of tax law" with support in "fiscal interest", in particular "presumptions", considering this legislative technique "driven by legitimate concerns for simplification of practicability of tax laws", but which "must be compatible with the principle of tax capacity, which passes, both through the illegitimacy of absolute presumptions, insofar as they prevent the proof of the non-existence of the tax capacity aimed at in the respective law, and through the suitability of relative presumptions to translate the corresponding economic presupposition of the tax" and, further on, alluding to "normal income", when he argues that it "can only be contested in cases where taxation leads to situations of intolerable inequity".

But, if we adhere to what such author writes in the cited work [...], one cannot but conclude that the solution in question is compatible with the principle of tax capacity. That is, to admit that in the case at hand one is faced with a "presumption", it admits proof to the contrary and, to consider that it is a taxation by "normal income", one cannot say that it necessarily leads to "situations of intolerable inequity".

It is not unaware that, in a later writing, the same author came to argue the constitutional non-conformity of the rule inherent in section c) of article 87 of LGT ("The constitutional framework of business taxation", in The 25 years of the Constitution of the Portuguese Republic of 1976, ed. AAFDL, 2001).

The principle of tax capacity (taxable capacity, also frequently designated by capacity to pay – ability to pay – or economic capacity – wirtschaftliche Leistungsfähigkeit) as "a basic criterion of our 'fiscal Constitution'" – implementing the duty of all to pay taxes according to the same criterion, - tax capacity is the unitary criterion of taxation.

Moreover, it is clear that the "principle of tax capacity" must be made compatible with other principles with constitutional dignity, such as the principle of the Social State, the freedom of conformation of the legislator, and certain requirements of practicability and cognoscibility of the taxable fact, also indispensable for the fulfillment of the purposes of the fiscal system.

The Constitutional Court has also recognized that "the principle of taxation of actual income expresses a broader constitutional requirement that extends to all taxation of income", and not only to the taxation of corporate income, for which it is expressly enshrined in article 104, no. 2, of the Constitution ("Taxation of companies is fundamentally based on their actual income). This being certain, however, that such can assume diverse intensity of meanings depending on the plane of taxation in which one is (of companies or individuals).

Regarding the principle of equality, with express establishment in article 13, of CRP, it translates an essential directive directed to the legislator: treat equally what is essentially equal and unequally what is essentially unequal, without such meaning the elimination of the freedom of conformation of the legislator in the determination of the elements of comparison that it considers decisive to operate the differentiation.

It is important to emphasize, in the context of the application of the Law by the administrative authorities and Courts, the need to ascertain whether the respective acts establish prohibitions differentiated by Law or by the Constitution, that is, whether the equality of treatment or self-binding of the administration was called into question.

In this very summary framework of the principles and constitutional norms one does not foresee in what way or with what grounds can the Claimant bring to the discussion the violation or non-observance of the aforesaid constitutional principles and rules in the interpretation by the AT of the provision of article 20-1/c) of the 2011 IRC Code and determined the concept of dividend, interpretation which, as was seen above, this Arbitral Tribunal endorsed (see above, 5.3).

Consequently and in conclusion: the request for arbitral pronouncement cannot succeed.

DECISION

In accordance with the foregoing, this Arbitral Tribunal agrees to judge the arbitral claim totally not well-founded, the additional IRC assessment no. 2015... remaining in the legal order, with all legal consequences.

VALUE OF THE PROCEEDINGS

In accordance with the provisions of articles 306, no. 2, of the Code of Civil Procedure and 97-A, no. 1, section a), of the Code of Tax Procedure and 3, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings (RCPAT) the value of the proceedings is set at € 188,910.76.

COSTS

Pursuant to art. 22, no. 4, of RJAT, the amount of costs is set at € 3,672.00, pursuant to Table I attached to RCPAT, at the charge of the Claimant.

Lisbon, 13-12-2023

The Collective Arbitral Tribunal,

José Poças Falcão
(Arbitrator President)

Francisco Nicolau Domingos
(Co-Arbitrator)

Maria Isabel Guerreiro
(Co-Arbitrator)

With dissenting opinion which follows.

DISSENTING OPINION

In this arbitral action it is in question to determine whether the amount of €1,676,863.30, corresponding to the price in the regulated market, of the 183,384 shares delivered by Bank B... España to its shareholder A... SGPS, SA (the Claimant), following the capital increase of the Bank through incorporation of reserves, carried out in 2011, should be considered income arising from dividends (in kind) and concur for the determination of taxable profit for this fiscal year, as the Tax Authority understands, or if, from an accounting perspective, the realization of a loss recognized in accounting should be acknowledged, due to the transfer of the said shares, in the same 2011 fiscal year, as well as the shares that gave rise to them, for the global value of €13,300,309.40, taking into account the actual acquisition and realization values, of all the shares held, that is, the shares originally acquired (11,920,000 shares) for the value of 112,597,738€ and the shares attributed (183,384 shares), gratuitously, following the capital increase of the Bank through incorporation of reserves, taking into account the realization value of all the shares for the total value of € 99,297,428.60, as the Claimant understands.

Let us see.

At the close of the 2011 fiscal year, the accounting entries made by the Claimant, related to the transfer of the shares of Bank B..., correctly reflected the recognition of an accounting loss, in the total amount of €13,300,309.40, since the relevant operation carried out in the fiscal year with the said shares susceptible of recognition in results was its transfer.

Now, as there was no distribution of dividends by Bank B... while the Claimant held the shares, in the 2011 fiscal year, there was no place for the recognition of any income arising from dividends in this fiscal year, either from an accounting perspective or from a fiscal perspective.

In fact, the Accounting Standard and Financial Reporting 20 – Income, (this Accounting Standard, of the Accounting Normalization System, approved by Decree-Law no. 158/2009, of 13 July, must be applied in the accounting of income arising from transactions and events, including among which, the use by others of assets of the entity that produce dividends), establishes in its paragraph 5, that income in the form of dividends results from distributions of profits to holders of investments in equity in proportion to their holdings of equity and, in paragraph 30, that income arising from shares, dividends should only be recognized or accounted for when the shareholder's right to receive payment is established.

From a fiscal perspective, article 20 - Income and gains, of the IRC Code, not establishing a definition for income in the form of dividends and also not containing a specific rule for its recognition, the definition contained in art. 5 of the Code should be considered, in addition to the rules contained in the said Accounting Standard.

For which reason the Claimant corrected the entry initially made in account 786232- Dividends, in the amount of €1,676,863.30, which corresponded to the price in the regulated market of the said shares, annulling it by transfer of the respective amount to account 6862-Transfers, in which the loss recognized in accounting realized with the transfer of all shares, in the global value of €13,300,309.40, was determined.

That is: the amount initially accounted for in account 786232- Dividends, of €1,676,863.30 corresponded only to the measurement, at fair value, of the 183,384 shares, for the value of the respective quotation in the regulated market and not an amount received, or placed at its disposal, as a distribution of profits. We are not faced with a reality that can be subsumed under the accounting and fiscal concept of dividend, or profit, according to art. 5 of the Code, applicable by force of art. 3, no. 1, section b) of the IRC Code.

Concluding, I thus consider that we are not faced with the receipt of dividends but with a reality distinct from the perspective of commercial and fiscal legislation, to wit: the use of subscription rights to increase the number of shares of Bank B... following the capital increase resolved and executed by such banking entity, having the Claimant, in consequence, received, in February 2011, gratuitously (without any consideration and as a result of such capital increase through incorporation of reserves), 183,384 shares.

Therefore I consider that the Claimant is right when it concludes that no income claimed by the AT arising from dividends paid or distributed in the 2011 fiscal year occurred.

(Maria Isabel Guerreiro)

CAAD: Tax Arbitration
Case No.: 237/2016-T
Subject Matter: IRC - Lack of substantiation; Qualification of inspection activity; Capital increase through incorporation of free reserves; Distribution of dividends.

*Replaced by the arbitral decision of 13 December 2023.

ARBITRAL DECISION

The arbitrators Mr. Judge José Poças Falcão (arbitrator-president), Prof. Francisco Nicolau Domingos and Dr. Maria Isabel Guerreiro (co-arbitrators) appointed by the Deontological Council of the Administrative Arbitration Centre (CAAD) to form the Arbitral Tribunal, constituted on 01/07/2016, agree as follows:

REPORT

A… SGPS, S.A, taxpayer no.…, with registered office at Rua …, no.…, …, …-…, Lisbon, hereinafter referred to as the Claimant, submitted on 21/04/2016 a request for arbitral pronouncement, in which it requests that the Corporate Income Tax (IRC) assessment act no. 2015…, executed by the Honorable Director-General of the Tax Authority (AT), with reference to the year 2011, in the amount of € 188,910.76 be declared illegal and annulled with the necessary legal consequences, specifically the reimbursement of the tax paid unduly by the Claimant, plus the corresponding indemnity interest at the legal rate.

On 01/07/2016 the arbitral tribunal was constituted.

The parties submitted final written arguments reiterating the arguments already invoked in the other pleadings.

The tribunal on 27/02/2017 again extended by 2 months the time period to render the arbitral decision.

POSITIONS OF THE PARTIES

The Claimant begins by previously noting that the inspection procedure sustaining the IRC assessment act no. 2015…, although it was qualified as internal by the Tax and Customs Authority (AT), the truth is that it was based on elements gathered by it from the Claimant and which thus were not in its possession, a circumstance that justifies, in its view, the classification of such procedure as external. And, if it is so, it will be illegal, insofar as the prior notification referred to in art. 49 of the Supplementary Regime of Tax Inspection Procedure (RCPIT), art. 59, no. 3, al. l) and art. 69, no. 2, both of the General Tax Law (LGT), was omitted. Therefore, it observes that if it did not receive such notification with the description of all the rights, duties and guarantees of the taxpayer, the consequent IRC assessment must be declared illegal, given the vice generating annullability.

Thirdly, it alleges that it is entirely without merit to make a correction to the taxable profit of the Claimant arising from the circumstance that the subscription of shares of Bank B…, within the scope of a capital increase through incorporation of reserves, constitutes a dividend from a corporate, accounting and fiscal perspective.

Thus it argues that, if it acquired for valuable consideration 11,920,000 shares of Bank B… for the value € 112,597,738, in February 2011, on the occasion of a capital increase through incorporation of reserves, it subscribed for another 183,438 shares, in the period of February and March of the same year, transferred onerous all such shares, for the value of € 99,297,428.60, resulting in a capital loss of € 13,300,309.40, we are faced with a "loss" suffered through "onerous transfer of a financial instrument (which, because it was not recognized at fair value in exchange for results, is not covered by the exception provided in the final part of art. 46, no. 1, al. b) of the IRC Code)". This loss is given by the difference between the amount of the sum of the values of realization of the transfers of € 99,297,428.60 and the acquisition value of € 112,597,738.00 – art. 46, no. 1, al. b) and no. 2 of the IRC Code.

Moreover, it concludes, arguing that the legislator had, not only the concern of autonomizing the concept of capital gain/loss, but was also clear as to the moment of taxation of capital gain, that of its realization. It results from the provisions of art. 20, no. 1, al. h) of the IRC Code that only "realized capital gains" are considered taxable income. Strictly speaking, capital gain, unlike dividend, up to the sale, constitutes a mere expectation or latent gain, without any legal protection and which only in exceptional cases has accounting relevance.

It concludes, requesting the reimbursement of the amount of tax unduly paid, plus indemnity interest.

The Respondent, in its response, defends itself by invoking:

The non-existence of external inspection.

With effect, it argues that it proceeded with the correct qualification of the inspection activity, complying with the provisions of art. 13 of RCPIT, which provides for the possibility of inspection procedures being of two types (internal and external) and that, in the concrete case, it is indisputable that we are faced with an inspection activity of an internal nature, since the inspection acts were carried out exclusively in the services of the AT. It further adds that nothing prevents requesting clarifications from the taxpayer when the inspection is carried out entirely in the services of the AT.

The receipt of dividends in kind.

Within the scope of its defense it argues that the receipt by the Claimant of 183,384 new shares as a result of a capital increase of Bank B… within the scope of the "Shareholder remuneration plan" called "… " should be treated as the receipt of dividends in kind, especially because another form of interpretation would transform the actual nature of the gain.

In support of its position it argues that Bank B…, alongside the traditional instrument of remuneration of shareholders, through the distribution of dividends in cash, adopted for the dividends of October/November 2010 and January/February 2011, the so-called "alternative option". This consisted in the issuance of subscription rights attributed to all shareholders - one per share – and in the offer of options to shareholders regarding the destination of the subscription rights, more specifically: a) receipt in cash through the sale of the subscription rights to the issuing entity, receiving as consideration the value corresponding to the previously fixed price; b) their transaction on stock exchanges during a short period of time and c) their conversion into shares issued within the scope of a capital increase through incorporation of reserves/undistributed profits.

Thus, these are the issues that the tribunal must address:

Whether the inspection procedure/assessment act suffers from the vice of lack of substantiation due to absolute absence of any factual and legal elements;

Whether the inspection procedure/assessment act suffers from the vice of omission of essential formality – prior notification described in art. 49 of RCPIT;

Whether indemnity interest is due.

CASE MANAGEMENT

FACTUAL MATTER

4.1. PROVEN FACTS

4.1.1. The Claimant is a holding company (SGPS).

4.1.2. On 31/12/2010 it held 11,920,000 shares of Bank B..., S.A. (B...) representing 0.14% of capital which it acquired in 2004, for the value of € 112,597,738.00.

4.1.3. The shares of B... have a price formed in a regulated market - stock quotation.

4.1.4. The shares of B... held by the Claimant were acquired for the global value of € 112,597,738.00 (€ 9.45 per share) and were recognized in its assets on 31/12/2010.

4.1.5. Such shares were recognized in its assets on 31/12/2010 with a fair value of € 94,501,760.00, in exchange for a negative value in reserves of € 18,095,978.00.

4.1.6. In June 2010 B... resolved a capital increase through incorporation of free reserves in light of the "Consolidated Text of the Law on Joint Stock Companies" of Spain.

4.1.7. The resolution has in particular the following tenor: i) "It is resolved to increase capital by the amount resulting from the multiplication (a) of the nominal value of half (0.5) euro per share of Bank B..., S.A (...) by (b) the number determinable of new shares of Bank B... that results from the formula indicated in point 2 below (the new shares)"; ii) "The increase will be made by means of the issuance and placing into circulation of the new shares, which will be ordinary shares, with a nominal value of half (0.5) euro, of the same class and series as those currently in circulation" and iii) "...the capital increase will be entirely made by incorporation of the free reserve, called voluntary reserves, resulting from undistributed results".

4.1.8. The capital increase was made through incorporation of free reserves.

4.1.9. In the content of the operation disclosed to shareholders and to the market it was stated that it was decided to "...increase the capital of Bank B… by incorporation of voluntary reserves from undistributed results by an amount determinable in accordance with the terms provided in the said resolution".

4.1.10. The capital increase was resolved within the scope of the shareholder remuneration program called – "… ".

4.1.11. Each shareholder, within the scope of such capital increase, received one free subscription right per share held.

4.1.12. Such subscription rights were available for trading on the Stock Exchanges in Spain and on Euronext between 17/01/2011 and 26/01/2011.

4.1.13. After the expiration of such period there was an automatic conversion of the subscription rights into shares issued in exchange for an incorporation of the free reserves of B….

4.1.14. The shareholders of B... had at their disposal three alternatives: i) sell the subscription rights to Bank B..., which would acquire them at a previously agreed price; ii) sell such rights in the market, during the trading period and iii) maintain the rights and receive shares of Bank B..., attributed according to the number of subscription rights they held at that moment.

4.1.15. Within the scope of the operation described in 4.1.6. and 4.1.7. B... registered a capital increase in the amount of € 55,576,453 in exchange for the incorporation of reserves of the same value and issued 111,152,906 shares, each with a nominal value of € 0.5, subscribed by shareholders who opted for this alternative.

4.1.16. The Claimant opted to receive shares of B..., having been attributed, in February 2011, 183,384 new shares which at the time had a price formed in a regulated market of € 9.14 each, which makes a total market value of € 1,676,863.30.

4.1.17. The Claimant made the accounting entry no.…, in the amount of € 1,676,863.30, by debit of account 41411.1 – C… in account 79 – Dividends.

4.1.18. As a result of the capital increase through incorporation of reserves, the Claimant came to hold a total of 12,103,384 shares (11,920,000 purchased and 183,384 attributed).

4.1.19. The Claimant on 08/02/2011 transferred in stock exchange 183,384 of such shares, for the price of € 1,648,788.60, with accounting losses of € 82,639.03 being determined.

4.1.20. On 31/03/2011 the Claimant transferred ownership of the remaining shares it still held (11,920,000) to the capital of company D…, for the market value of such shares of € 8.19 each, which corresponds to a total realization value of € 97,648,640.00.

4.1.21. In the 2011 fiscal year the Claimant determined a negative fiscal result of € 470,083.10.

4.1.22. On 05/02/2015 Service Order no. 2015… was issued, initiating an inspection procedure of the Claimant which had as its object the IRC of the 2011 fiscal year and which the AT qualified as internal.

4.1.23. On 24/06/2015 the AT sent to the Claimant a "request for fiscally relevant elements" in which it requested: "1. Regarding all Capital Gains realized in the fiscal year as a result of the transfer of capital shares or any financial investments, present for each one and where applicable: 1.1. Identification of the transferred asset; 1.2. Indication of the date, value and form of transfer; 1.3. Identification of the counterparty in the transfer operation; 1.4. Declaration on the existence or not of special relations, as defined in no. 4 of art. 63 of the IRC Code, with the counterparty identified in the previous subpoint and, if applicable, indication of the nature of the relation; 1.5 Indication of the date, value and form of acquisition of the transferred asset; 1.6 Identification of the counterparty in the acquisition; 1.7 Declaration on the existence or not of special relations, as defined in no. 4 of art. 63 of the IRC Code, with the counterparty identified in the previous subpoint and, if applicable, indication of the nature of the relation; 1.8 Send copy of the capital gains and losses map; 1.9 Send copy of the statement of account 79.21 – B… and copy of the supporting documents for the accounting entries made; 1.10. Send copy of the statement of account 68.62 – Transfers, and copy of the supporting documents for the accounting entries (...) 3. Regarding the C... capital share, inform the form and how it was transferred and the calculations made in the determination of the result determined. Also inform whether the shares held were quoted on the stock exchange, regulated market, and what procedure was adopted and tax treatment given to the transition adjustment, provided for in art. 5 of Decree-Law no. 159/2009, of 13 July".

4.1.24. The Claimant responded to such request by letter dated 02/07/2015.

4.1.25. The AT on 10/07/2015 sent a new e-mail to the Claimant with the following tenor: "...2. In the month of February, through accounting entry no.…, the amount € 1,676,863.30 was recorded as a credit in account…–B…, as dividends. In the month of December, through accounting entry no.…, account…–B…, the amount of € 1,676,863.30 was moved as a debit, by credit to account 6862 – Transfers. This entry appears to be incorrect. The value received as dividends should have concurred positively for the determination of taxable income for 2011 fiscal year, which, both by the accounting entry and by verification of the values in table 07 of the income statement mod. 22 did not occur. In reality, such accounting entry, caused a decrease in the amount determined in account 6862 – Transfers, that is the final value would be € 14,977,172.69, and not what was determined € 13,300,309.39. The following table exemplifies the effect caused by the incorrect accounting of the regularization entry made in December 2011:

Information is appreciated regarding the matter described".

4.1.26. The Claimant responded to the request by e-mail dated 17/07/2015.

4.1.27. The AT on 20/08/2015 sent a new e-mail to the Claimant in which it informed that it intended to make the following corrections to the taxable profit of 2011: "...- From dividends, € 1,676,863.30; - From losses related to capital shares, € 20,011.96...".

4.1.28. The Claimant on 03/09/2015 responded by e-mail to the communication described in the previous number.

4.1.29. On 15/10/2015 the Claimant was notified of the draft administrative decision in which a correction to the taxable profit for the 2011 fiscal year in the amount of € 1,676,863.30 was proposed, since the value of the shares subscribed, upon the capital increase through incorporation of reserves of Bank B... constituted a dividend.

4.1.30. In the content of the inspection report is contained the following substantiation: "...A... was a shareholder of Bank B..., had the right to receive dividends distributed, which it received in new shares. In fact, to account for the new shares, taking into account the way in which it acquired the right to them, in its assets it necessarily had to have considered as consideration the corresponding income. It could not have made the regularization entry made at year end, through which it allocated the value of the income from dividends, to the amount determined and respecting losses from shares it already held in the previous year" and "...the taxpayer had the right to dividends which it received through new shares of B..., with the fair value guaranteed by B..., which appreciated the participation in B..., there was therefore a capital increment. And thus, the increment should have been recognized and acknowledged as income from the fiscal year, as dividends which it actually received in kind, through new shares".

4.1.31. Consequently, on 25/11/2015 the Director-General of the AT proceeded with the assessment no. 2015..., in the amount of € 188,910.76.

4.1.32. The Claimant made on 19/01/2016 the payment of the amount determined in the assessment no. 2015....

4.1.33. The Claimant submitted the request for constitution of the arbitral tribunal that led to the present proceedings on 21/04/2016.

4.2. FACTS THAT ARE NOT CONSIDERED PROVEN

There are no facts with relevance to the decision that have not been given as proven.

4.3. SUBSTANTIATION OF THE FACTUAL MATTER CONSIDERED PROVEN

The factual matter given as proven has its source in the documents used for each of the alleged facts and whose authenticity was not called into question.

ON THE LAW

5.1. Lack of Substantiation

Jurisprudence on the substantiation of the assessment act holds that: "The act will be sufficiently substantiated when the addressee, placed in the position of a normal recipient – the bonus pater familiae referred to in art. 487, no. 2 of the Civil Code – can come to know the factual and legal reasons that are at its genesis, in order to allow the addressee to choose, in an informed manner, between the acceptance of the act or the activation of the legal means of challenge, and so that, in the latter circumstance, the tribunal can also exercise the effective control of the legality of the act, assessing its legal correctness in light of its contextual substantiation". Or, said in another way, the substantiation must incorporate elements of fact and law that allow the addressee of the act to understand the decision-making process of the AT.

5.2. Inspection Procedure

Therefore, first, it is necessary to determine in the case sub judice the true nature of the procedure used by the AT.

To accomplish such task we must mobilize the pertinent legal framework.

Thus, art. 13 of RCPIT provides that: "Regarding the place of execution, the procedure can be classified as:

Internal, when the inspection acts are executed exclusively in the services of the tax administration through formal and consistency analysis of documents;

The notification provided for in the previous number is effected by a notice letter drawn up according to the model approved by the director-general of Taxes, containing the following elements:

a) Identification of the taxpayer or tax-bound party subject to inspection;

b) Scope and extent of the inspection to be carried out.

The notice letter will contain an annex containing the rights, duties and guarantees of taxpayers and other tax-bound parties in the inspection procedure".

Before anything, one could question: is the qualification regarding the nature of the procedure executed by the AT binding for the tribunal?

In this scope, the inspection procedure, regarding the place of execution, can be qualified as internal or external. The former, when acts of an inspection nature are executed solely and exclusively in the services of the AT, through formal and consistency analysis of documents. Already in the latter, we are faced with a true "investigatory activity" through which it is sought to assess the accuracy of the values declared in light of the rules of substantive Tax Law or if there is an omission in the declaration of such values.

Thus, if it is so, what is the legal effect arising from the lack of prior notification referred to in art. 49 of RCPIT?

5.3. Concurrence of the Value of Transfer of Shares Following Capital Increase Through Incorporation of Free Reserves for the Determination of Taxable Profit

The starting point for responding to the question obliges the description of the corporate concept of reserves and its modality of free reserves. On this matter, doctrine holds regarding the first concept that: "Reserves are amounts (in principle, generated by the company itself) that partners cannot - by legal or contractual imposition – or do not want to distribute". Being certain that in the delimitation of the modality of free reserves it refers that: "These are the reserves that partners can, each year, decide to constitute through the non-distribution of the corresponding profits. (...) Partners, just as they can freely constitute such reserves, can, in the same way, freely give them whatever destination they wish".

Now, one such destination consists in the capital increase through incorporation of free reserves.

Doctrine argues that: "The notion of income-increment, which underlies the quantification of taxable profit, leads to the legal establishment of a broad concept of revenues or gains, capable of encompassing any positive patrimonial variations of the company's net equity...". Thus, revenues or gains can result, not only from the normal functioning of the company's activity, but also from an occasional or merely accessory action, as is the case with "dividends". That is, within the concept of revenues or gains in IRC all those not excepted by law are included.

In that line, in the OECD Model Tax Convention on Income and Property it is referred that: "Are considered dividends not only distributions of profits defined annually by the general assembly of shareholders, but also other benefits, in cash or its equivalent, such as free shares (underlined), bonuses, liquidation profits and hidden distributions of profits".

DECISION

VALUE OF THE PROCEEDINGS

COSTS

Pursuant to art. 22, no. 4, of RJAT, the amount of costs is set at € 3,672.00, pursuant to Table I attached to RCPAT, at the charge of the Claimant.

Lisbon, 13-12-2023

The Collective Arbitral Tribunal,

José Poças Falcão
(Arbitrator President)

Francisco Nicolau Domingos
(Co-Arbitrator)

Maria Isabel Guerreiro
(Co-Arbitrator)

With dissenting opinion which follows.

DISSENTING OPINION

Let us see.

Therefore I consider that the Claimant is right when it concludes that no income claimed by the AT arising from dividends paid or distributed in the 2011 fiscal year occurred.

(Maria Isabel Guerreiro)

Frequently Asked Questions

Automatically Created

What is the IRC tax treatment of capital increases through incorporation of free reserves in Portugal?

Under Portuguese IRC law, capital increases through incorporation of free reserves generally do not constitute taxable dividend distributions. This corporate operation involves converting existing reserves into share capital without asset outflows to shareholders or new contributions. Article 91(1) of the Commercial Companies Code permits such increases through available reserves. The key distinction is that no economic benefit is transferred to shareholders at the moment of capitalization - there is no increment in the participation's value, merely a reclassification within equity. Tax recognition typically occurs only upon subsequent disposal of shares. However, the Tax Authority may challenge this treatment if it views the operation as substantively equivalent to a dividend distribution, requiring specific corrective provisions in the IRC Code to adjust the accounting result.

When can a Portuguese tax arbitral decision be annulled and reformed by the TCAS?

Portuguese tax arbitral decisions can be annulled by the Central Administrative Court South (TCAS) or Central Administrative Court North when legal errors are identified through judicial review. When the TCAS annuls an arbitral decision, it remands the case to the original arbitral tribunal to issue a new decision correcting the identified defects. In Case 237/2016-T, the TCAS annulled the original March 2017 arbitral decision on June 23, 2023, requiring the same arbitral tribunal (composed of José Poças Falcão, Francisco Nicolau Domingos, and Maria Isabel Guerreiro) to issue a reformed decision. This judicial oversight ensures arbitral decisions comply with applicable legal standards and constitutional requirements, while maintaining the specialized nature of tax arbitration within Portugal's administrative justice system.

What constitutes a lack of adequate reasoning (falta de fundamentação) in Portuguese tax assessments?

Under Portuguese law, adequate reasoning (fundamentação) in tax assessments is a constitutional requirement under Article 268(3) of the Constitution and Article 153(1) of the Administrative Procedure Code. Tax assessments must contain sufficient factual and legal substantiation explaining: (1) the factual basis for the tax adjustment, including specific circumstances and evidence; (2) the legal provisions supporting the assessment; and (3) how the law applies to the established facts. The lack of fundamentação (falta de fundamentação) constitutes a vice generating annulability of the administrative act. In IRC assessments, this means the Tax Authority must clearly articulate which income items are being adjusted, the evidentiary basis for corrections, and the specific IRC Code provisions justifying the tax treatment. Mere conclusory statements or generic legal citations are insufficient to satisfy this constitutional guarantee of taxpayer rights.

How does the classification of a tax inspection action affect the validity of an IRC tax assessment?

The classification of tax inspection actions as internal or external significantly affects procedural validity and taxpayer rights. Internal inspections are based on documents already in the Tax Authority's possession, while external inspections involve gathering information directly from taxpayers. External inspections require prior notification to taxpayers under Article 49 RCPIT, Article 59(3)(l), and Article 69(2) of the General Tax Law (LGT), informing them of their rights, duties, and guarantees. If an inspection is improperly classified as internal when it actually involved requesting documents from the taxpayer (thus being external in nature), the failure to provide prior notification constitutes a procedural defect generating annulability. In Case 237/2016-T, the taxpayer argued that since the Tax Authority requested information not already in its possession, the inspection should have been classified as external, making the subsequent IRC assessment illegal for lack of proper notification.

Can a taxpayer claim reimbursement and indemnity interest after an unlawful IRC tax assessment is annulled?

Yes, taxpayers can claim reimbursement and indemnity interest following annulment of unlawful IRC assessments, provided certain conditions are met. Upon annulment, the taxpayer is entitled to reimbursement of taxes paid unduly. Indemnity interest is additionally payable under Article 43 of the General Tax Law when there has been an error attributable to the tax services, compensating taxpayers for the time value of money improperly retained by the State. In Case 237/2016-T, the claimant sought not only annulment of the €188,910.76 IRC assessment but also reimbursement plus corresponding indemnity interest at the legal rate. The Tax Authority contested the indemnity interest claim, arguing there was no error attributable to the services. The burden is on the taxpayer to demonstrate that the error in assessment was attributable to the Tax Authority's actions or omissions, not merely that the assessment was subsequently found to be unlawful.

IRC Tax Case 237/2016-T: Capital Increase by Reserve Incorporation and Dividend Distribution – Arbitral Decision Reform

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IRC Tax Case 237/2016-T: Capital Increase by Reserve Incorporation and Dividend Distribution – Arbitral Decision Reform

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