Summary
Full Decision
# ENGLISH TRANSLATION
The arbitrators Counselor Maria Fernanda dos Santos Maçãs (arbitrator president), Dr. Ricardo Rodrigues Pereira and Dr. Pedro Galego, designated by the Deontological Council of the Administrative Arbitration Center to form the Arbitral Tribunal, agree to the following:
I. REPORT
1. On April 5, 2017, the commercial company A…, S. A., NIPC…, with registered office at Rua…, …, … (hereinafter, Claimant), filed a request for constitution of an arbitral tribunal, pursuant to the combined provisions of articles 2, no. 1, paragraph a), and 10, nos. 1, paragraph a), and 2, of Decree-Law no. 10/2011, of January 20, which approved the Legal Regime for Arbitration in Tax Matters, as amended by article 228 of Law no. 66-B/2012, of December 31 (hereinafter, abbreviated as RJAT), seeking:
- The declaration of illegality and the annulment of the dismissal act of the gracious complaint no. …2016…, which proceeded before the Finance Department of Porto, filed against the act of additional corporate income tax (IRC) assessment no. 2016…, relating to fiscal year 2011, and the corresponding account adjustment statement no. 2016…;
- The declaration of illegality and the partial annulment of the act of additional corporate income tax (IRC) assessment no. 2016…, relating to fiscal year 2011, and the corresponding account adjustment statement no. 2016….
The Claimant attached 6 (six) documents and did not request the production of any other evidence.
The Respondent is the Tax and Customs Authority (AT – Autoridade Tributária e Aduaneira) (hereinafter, Respondent or AT).
1.1. Essentially and in brief summary, the Claimant alleged the following:
It is a company that operates, essentially, in the coffee and tea industries and, within that scope, proceeds, inter alia, to the production, commercialization, distribution and sale of products related to said industries.
In fiscal year 2011, it was the parent company of a group of companies taxed under the Special Tax Regime for Groups of Companies (RETGS), in accordance with article 69 of the Corporate Income Tax Code (CIRC).
Following an external inspection procedure for fiscal year 2011, to some of the subsidiary companies of the group in which the Claimant is the parent company, corrections were made to the values declared by these companies within said fiscal scope, with inherent repercussions on the group's income declaration, with the total correction to the taxable matter amounting to € 675,401.09.
The referenced corrections relate to (i) expenses related to advance discounts in the context of the conclusion of coffee supply contracts which, in the AT's opinion, were improperly charged to the taxation period of 2011 by the subsidiary companies "B…", "C…", "D…" and "E…" and (ii) the fact that the subsidiary company "C…" did not adopt the necessary steps to have recognized, in the AT's view, the fiscal impairment relating to customer receivables.
Following the aforementioned corrections, the additional corporate income tax assessment for the year 2011 was issued, against which the Claimant filed a Gracious Complaint, on the one hand, because it considered that these were not true advance discounts, but rather financial counterparties and, on the other hand, regarding the impairments not accepted by the AT, because it understood that it demonstrated the carrying out of steps for collection of the amount owed.
The Claimant also understands that, within the framework of the adoption of the Accounting Normalization System and taking into account the characteristics of the coffee supply contracts concluded with customers, the allocation of expenses with the delivery of financial counterparties based on the duration of the supply contract is the only one that allows reflecting the diminution of economic benefits associated with said contracts; that is, the financial counterparties should be allocated in accordance with the duration of the contract (i.e., distributed over 5 years), since this obligation persists during the entire period of the contract's validity, an understanding which is in total harmony with the accounting regime of accrual.
The AT dismissed the aforementioned Gracious Complaint by understanding, based on the existence of a mere quantity discount, that the deferral of the cost should be made, allocating it systematically to each period of the contract's validity, based on the quantities of coffee supplied; furthermore, with regard to impairment losses not accepted for tax purposes by the AT, the AT concluded that the Debt Payment Agreement presented, because it was dated February 15, 2008, does not prove that the Claimant, in fiscal year 2011, the year in which the expense is being challenged, took steps toward its fulfillment, nor that the risk of non-collectability occurred only in that fiscal year.
1.2. The Claimant concludes its initial submission by petitioning as follows:
"In these terms and in the other matters of law applicable to the case which Your Excellencies will prudently supply, this request for arbitral pronouncement should be declared entirely successful, determining, in consequence:
a) The annulment of the decision dismissing the Gracious Complaint filed;
b) The partial annulment of the tax act establishing the taxable matter for corporate income tax no. 2016 … relating to the taxation period of 2011; and
c) Under article 100 of the General Tax Code (LGT), the immediate and full restoration of the CLAIMANT's tax situation that existed prior to the issuance of the illegal tax act establishing the taxable matter for corporate income tax."
2. The request for constitution of an arbitral tribunal was accepted and automatically notified to the AT on April 19, 2017.
3. The Claimant did not proceed with the appointment of an arbitrator, so, under the provisions of paragraph a) of no. 2 of article 6 and paragraph a) of no. 1 of article 11 of the RJAT, the President of the Deontological Council of the CAAD designated as arbitrators of the collective Arbitral Tribunal the undersigned, who communicated their acceptance of the assignment within the applicable time period.
3.1. On June 5, 2017, both Parties were duly notified of this designation, having not expressed a desire to refuse the designation of arbitrators, in accordance with the combined provisions of article 11, no. 1, paragraphs b) and c), of the RJAT and articles 6 and 7 of the Code of Ethics of the CAAD.
3.2. Accordingly, in compliance with the provision in paragraph c) of no. 1 of article 11 of the RJAT, the collective Arbitral Tribunal was constituted on June 21, 2017.
4. On September 11, 2017, the Respondent, duly notified for that purpose, presented its Response in which it raised the dilatory exception of lack of material jurisdiction of the Arbitral Tribunal and specifically refuted the arguments raised by the Claimant, having concluded that such exception was valid, with its consequent discharge from the proceeding or, if not sustained, for the dismissal of the present action, with its consequent discharge from the request.
The Respondent did not attach documents, nor did it request the production of any other evidence.
4.1. Essentially and also briefly, it is important to highlight the most relevant arguments on which the Respondent based its Response:
The Respondent begins by invoking the exception of lack of jurisdiction of the Arbitral Tribunal ratione materiae, advancing arguments which we will discuss below when we address this issue.
Subsequently, the Respondent proceeds to defend itself by refutation, arguing as follows, which we highlight here:
With respect to the financial counterparty granted by the companies that are part of the group of companies dominated by the Claimant, the AT proposes that an objective criterion should be established that conveys which cost is borne by the coffee supplier and what profits are associated with it, that is, a factor should be found that allows establishing the relationship between the cost and the profit.
Considering that there is a causal nexus between the discount actually granted and the quantities of coffee acquired, we can safely state that this is a quantity discount whose unit value is easily ascertained.
The practice that best reflects the actual result obtained by the claimant and on which the corporate income tax should be levied is the deferral of the cost, allocating it systematically to each period of the contract's validity, based on the quantities of coffee supplied.
In the event that the customer acquires all of the coffee agreed upon before the end of the contract, the full advance discount is consolidated at that moment, nothing preventing that in a given year a larger fraction of discount be allocated, all for the reason of the quantities actually supplied; only in this way is a larger cost made to correspond to a larger profit obtained, fulfilling the underlying purpose of exercise specialization.
Furthermore, given that the contract provides for the return of unamortized advance discounts in the supplies made, there is a causal nexus between the value of the advance discount granted and the quantities of coffee that the customer commits to acquire, such nexus being expressed in the existence of a unit quantity discount, obtained by dividing the amount of the advance discount by the number of kilos of coffee whose acquisition is contractually provided for.
With respect to impairment losses not accepted for tax purposes, the Debt Payment Agreement presented by the Claimant in the Gracious Complaint proceeding, dated February 15, 2008, does not prove that the Claimant, in fiscal year 2011, the year in which the expense is being challenged, took steps toward its fulfillment, nor does it prove that the risk of non-collectability occurred only in that fiscal year.
Accordingly, with no objective evidence having been presented of the impairment with respect to fiscal year 2011, the requirements for the impairment loss recorded to be accepted are not met, in light of articles 35 and 36 of the Corporate Income Tax Code, in effect on the date of the facts.
The Respondent concludes its submission as follows:
"In these terms, and in the other matters which Your Excellencies will prudently supply, it should:
a) Find that the existence of a dilatory exception is verified, embodied in the lack of material jurisdiction of the arbitral tribunal, which prevents consideration of the request, and, therefore, should determine the discharge of the Respondent Entity from the proceeding, given the provisions of articles 576, no. 2 and 577, paragraph a) of the Code of Civil Procedure (CPC), applicable ex vi article 29, no. 1, paragraph e) of the RJAT;
Or, if such is not agreed,
b) The present request for arbitral pronouncement should be judged dismissible, as not proven, maintaining the tax assessment act of taxation being challenged in the legal order and accordingly discharging the respondent entity from the request."
4.2. On the same date, the Respondent attached to the record the respective administrative file (hereinafter, abbreviated as PA).
5. Notified for that purpose, the Claimant came to pronounce itself on the matter of exception raised by the Respondent, relating to the invoked lack of material jurisdiction of the Arbitral Tribunal, in the terms that will be explained below.
6. On September 27, 2017, an order was issued dispensing with the holding of the meeting referred to in article 18 of the RJAT, granting a time period for the presentation of written submissions and fixing December 21, 2017 as the deadline for issuance of the arbitral award.
7. Both Parties submitted written submissions, in which they reiterated the positions previously assumed in their respective submissions.
***
II. PURIFICATION OF PRELIMINARY ISSUES
The Arbitral Tribunal was regularly constituted.
The proceeding is not affected by nullities.
The parties enjoy legal personality and capacity, are properly represented and are legitimate.
*
II.1. OF THE LACK OF JURISDICTION OF THE ARBITRAL TRIBUNAL RATIONE MATERIAE
The Respondent raised this exception, invoking the following argument:
The Claimant petitions, under article 100 of the General Tax Code (LGT) and alleging that such will be part of the restoration of the situation that would have existed if the act of establishing the taxable matter for corporate income tax had not been taken, that the Tribunal condemn the AT to consider that the expenses not accepted by it, in the taxation period of 2010, should be allocated to the respective taxation periods in accordance with the criterion recommended by the Claimant, or that is, the expenses will be divided equally among the periods of validity of the contracts.
The AT understands that, even if such a claim could eventually derive from a hypothetical execution of judgments that might be carried out in the event that the arbitral decision issued is favorable to the request, what is certain is that such request exceeds the jurisdiction of the Arbitral Tribunal.
According to the AT, there is no legal support that allows arbitral tribunals functioning in the CAAD to issue condemnations of a nature other than those resulting from the powers set forth in the RJAT, i.e., declaratory powers based on illegality, even if such other requests constituted, hypothetically, a consequence, in terms of execution, of a declaration of illegality of assessment acts.
The lack of material jurisdiction of the Tribunal to consider the referenced request constitutes a dilatory exception that prevents continuation of the proceeding, leading to the discharge of the respondent from the proceeding as to the claim in question, in accordance with the provision in articles 576, no. 2 and 577, paragraph a), of the Code of Civil Procedure (CPC), applicable ex vi article 29, no. 1, paragraph e), of the RJAT.
The Claimant pronounced itself on this exception, arguing for its lack of merit, in the following terms which are important to highlight:
It is necessary to keep in mind the particularity that the situation sub judice does not have its effects limited to a single fiscal year, but rather extends to a lengthy period – that of the validity of the supply contracts – and, therefore, directly interferes with other tax acts relating to other fiscal years, and this type of situation is contemplated by article 24, no. 1, paragraph c), of the RJAT.
The success of the matter will have as an immediate and necessary consequence the elimination from the legal order of the act being challenged – i.e., the correction to the taxable matter for corporate income tax in 2011 – and also the consolidation of the legality of the allocation of the disputed expenses, in equal parts, for the period of validity of the contracts, which, by its very nature, affects several fiscal years similar to what happens with tax losses.
In a scenario of approval of the taxpayer's claim, everything should proceed as if the illegal tax act had never been taken, and this restoration of the state of affairs that existed before the commission of the illegality is triggered by the decision itself, that is, it is independent of any request or expression of will by the parties. It is, effectively, a legal duty of the Administration – in this case, the AT – which is constituted, by operation of law, with the finality of the decision that annuls the act, so that no request by the party is required, nor an express pronouncement by the tribunal defining the concrete consequences of the annulment of the challenged act.
If the Administration does not give spontaneous effect to the decision, the individual may resort to the process of execution of judgment to obtain the specific execution of the annulment sentence issued in its favor, that is, to have the tribunal order the Administration to restore the pre-illegality situation.
There is not, therefore, a deviation from the material jurisdiction of the arbitral tribunal; rather, it is the legal, direct and inevitable result of the decision annulling the challenged act. A consequence that is integrated into the complex of acts and operations necessary for the reconstruction of the state of affairs prior to the commission of the illegality, being a legal duty that falls on the AT from the moment the arbitral decision becomes final in the legal order and which does not even presuppose an express pronouncement by the arbitral tribunal to that effect, merely requiring that it annul the tax act. Therefore, the alleged dilatory exception of lack of material jurisdiction of the arbitral tribunal does not exist, and the proceeding should proceed with its regular course.
That being said. Taking into account that the scope of material jurisdiction of the tribunal is of public order and its knowledge precedes that of any other matter (art. 13 of the Code of Administrative Procedure (CPTA) applicable ex vi art. 29, no. 1, paragraph c), of the RJAT) and that the violation of rules of jurisdiction ratione materiae determines the absolute lack of jurisdiction of the tribunal, which is of official notice (art. 16, nos. 1 and 2, of the Code of Tax Procedure (CPPT) applicable ex vi art. 29, no. 1, paragraph a), of the RJAT), it is important to primarily consider the dilatory exception raised by the Respondent regarding the lack of jurisdiction of the arbitral tribunal.
As a starting point for consideration of this issue, we must attend to the literal terms of the request formulated by the Claimant, regarding which the Respondent understands that the aforementioned lack of material jurisdiction of the Arbitral Tribunal is verified, which we accordingly transcribe: "c) Under article 100 of the General Tax Code (LGT) [it should be determined] the immediate and full restoration of the CLAIMANT's tax situation that existed prior to the issuance of the illegal tax act establishing the taxable matter for corporate income tax."
This request formulated by the Claimant emerges directly from what is alleged in articles 205 to 211 of the request for arbitral pronouncement, from which it is extracted, in summary, that the Claimant proposes that the sought annulment of the correction made by the AT relating to fiscal year 2011 should allow the correction of all fiscal years affected by the allegedly erroneous and illegal understanding of the AT, namely that the success of this request for arbitral pronouncement should "determine that the expenses considered not accepted by the AT, in the period of 2010, should be allocated to the respective taxation periods in accordance with the criterion recommended by the CLAIMANT (i.e., the expenses will be divided equally among the periods of validity of the contracts)".
That said. In the legislative authorization on which the Government based the approval of the RJAT, granted by art. 124 of Law no. 3-B/2010, of April 28, it is proclaimed, as the primary guideline of the institution of arbitration as an alternative form of judicial resolution of conflicts in tax matters, that "the arbitral tax proceeding must constitute an alternative procedural means to the judicial review process and to the action for recognition of a right or legitimate interest in tax matters."
The judicial review process is a procedural means that has as its object a tax act, seeking to assess its legality and to decide whether it should be annulled or whether its nullity or non-existence should be declared, as results from article 124 of the Code of Tax Procedure (CPPT).
From the analysis of articles 2 and 10 of the RJAT, it is verified that only questions concerning the legality of assessment acts or acts establishing taxable matter and second-degree acts which have as their object the assessment of the legality of acts of those types were included in the jurisdiction of arbitral tribunals functioning in the CAAD, acts whose assessment falls within the scope of judicial review proceedings, as results from paragraphs a) to d) of no. 1 of article 97 of the Code of Tax Procedure (CPPT).
That is, it is found that the legislator did not implement in the legislative authorization, as regards the part in which it provided for the extension of the jurisdiction of arbitral tribunals to questions that are assessed in tax tribunals through an action for recognition of a right or legitimate interest.
However, in harmony with the intention underlying the legislative authorization to create an alternative means to the judicial review process, it should be understood that, as to requests for declaration of illegality of acts of the types referred to in its article 2, arbitral tribunals functioning in the CAAD have the same jurisdiction that state courts have in judicial review proceedings, within the limits defined by the restriction that the Tax and Customs Authority made through Ordinance no. 112-A/2011, of March 22, pursuant to article 4, no. 1, of the RJAT.
Although the judicial review process has as its primary object the declaration of nullity or non-existence or annulment of acts of the types referred to, it has been consistently understood that it may issue condemnations of the Tax Administration to pay indemnification interest and compensation for undue guarantee.
In fact, despite there being no express provision to that effect, it has been consistently understood in tax tribunals, since the entry into force of the tax reform codes of 1958-1965, that a request for condemnation to pay indemnification interest may be combined in a judicial review proceeding with a request for annulment or declaration of nullity or non-existence of the act, because these codes refer to the fact that the right to indemnification interest arises when, in a gracious complaint or judicial proceeding, the administration is convinced that there was an error of fact imputable to its services. This regime was subsequently generalized in the Code of Tax Procedure, which established in no. 1 of its art. 24 that "there shall be a right to indemnification interest in favor of the taxpayer when, in a gracious complaint or judicial proceeding, it is determined that there was an error imputable to the services," then, in the General Tax Code (LGT), in whose art. 43, no. 1, it is established that "indemnification interest is due when it is determined, in a gracious complaint or judicial review, that there was an error imputable to the services from which results payment of the tax debt in an amount greater than legally due" and, finally, in the Code of Tax Procedure (CPPT) where it was established, in no. 2 of art. 61 (corresponding to no. 4 in the text as amended by Law no. 55-A/2010, of December 31), that "if the decision recognizing the right to indemnification interest is judicial, the payment period is counted from the beginning of the term for its spontaneous execution."
Accordingly, similar to what occurs with tax tribunals in judicial review proceedings, this Arbitral Tribunal has jurisdiction to consider requests for reimbursement of the amount paid and payment of indemnification interest.
It is also unequivocal that in judicial review proceedings it is possible to consider requests for condemnation to pay compensation for undue provision of guarantee, art. 171 of the Code of Tax Procedure (CPPT), establishes that "compensation in the case of a bank guarantee or equivalent improperly provided shall be requested in the proceeding in which the legality of the enforceable debt is disputed" and that "compensation must be requested in the complaint, review or appeal or, if its grounds are subsequent, within 30 days after its occurrence."
Accordingly, it is unequivocal that the judicial review process encompasses the possibility of condemnation to pay compensation for undue guarantee and even is, in principle, the appropriate procedural means to formulate such a request, which is justified by obvious reasons of procedural economy, since the right to compensation for undue guarantee depends on what is decided regarding the legality or illegality of the assessment act.
The request for constitution of the arbitral tribunal has as its corollary that it is now in the arbitral proceeding that the "legality of the enforceable debt" will be discussed, so, as results from the express terms of that no. 1 of the said art. 171 of the Code of Tax Procedure (CPPT), it is also the arbitral proceeding that is appropriate to consider the request for compensation for undue guarantee.
However, in the absence of any legal provision that permits concluding otherwise, the scope of the judicial review process and of arbitral proceedings is restricted to questions concerning the legality of acts of the types referred to in article 2 that are covered by the restriction made in Ordinance no. 112-A/2011, and cannot, in particular, define the terms in which annulment judgments that may be issued should be executed.
In fact, as the Tax and Customs Authority correctly points out, the jurisdiction to execute judgments issued by arbitral tribunals functioning in the CAAD falls, in the first place, to the Tax and Customs Authority itself, as results from the express terms of no. 1 of article 24 of the RJAT in saying that "the arbitral decision on the merits of a claim which is not subject to appeal or objection binds the tax administration from the end of the period provided for appeal or objection, and this should..."
On the other hand, should there be disagreement between the Tax and Customs Authority and taxpayers regarding the manner of execution of judgments, the tax tribunals are competent for their assessment, since arbitral tribunals functioning in the CAAD are not granted jurisdiction in judgment execution proceedings and the arbitral tribunals are dissolved following the arbitral decision, as results from article 23 of the RJAT.
Therefore, it is concluded that the Tax and Customs Authority is correct in arguing that this Arbitral Tribunal lacks jurisdiction to consider the referenced request formulated by the Claimant.
However, this lack of jurisdiction to consider one of the requests, there being others for which this Arbitral Tribunal has jurisdiction – the annulment of the decision dismissing the aforementioned gracious complaint and the partial annulment of the disputed tax act – only has as a consequence that the request for which the Tribunal lacks jurisdiction be considered "without effect," as is inferred from what, although to another purpose, is referred to in no. 4 of article 186 of the Code of Civil Procedure (CPC), when it alludes to situations in which "one of the requests becomes without effect due to lack of jurisdiction of the tribunal."
Accordingly, the exception of lack of material jurisdiction of the Arbitral Tribunal is judged to have merit as to the cited request formulated by the Claimant – in the sense of, under article 100 of the General Tax Code (LGT), the AT being condemned to proceed with the correction of all fiscal years affected by the commission of the disputed tax act, determining in particular "that the expenses considered not accepted by the AT, in the period of 2010, should be allocated to the respective taxation periods in accordance with the criterion recommended by the CLAIMANT (i.e., the expenses will be divided equally among the periods of validity of the contracts)" – whereby the Tax and Customs Authority is discharged from the proceeding as to this request, without prejudice to the consideration of the remaining requests.
*
There are no other exceptions or preliminary issues that prevent consideration on the merits and of which it is necessary to consider.
***
III. REASONING
III.1. ON FACTS
§1. FACTS FOUND TO BE PROVEN
The following facts are considered to be proven:
a) The Claimant is a corporation constituted in 2007, whose activity, as of fiscal year 2011, consisted of the management of shareholdings in other companies, as an indirect form of exercise of economic activities, acting as a Company Managing Shareholdings (the Claimant was, at that time, named "F…– SGPS, S. A."). [cf. document no. 3 attached to Initial Submission and PA attached to the record]
b) The Claimant is subject to the general regime of corporate income tax (IRC), with its taxation period coinciding with the calendar year. [cf. document no. 3 attached to Initial Submission and PA attached to the record]
c) The Claimant is the parent company of a group of companies, taxed in accordance with the Special Tax Regime for Groups of Companies (RETGS), which operates, essentially, in the coffee and tea industries, proceeding, inter alia, to the production, commercialization, distribution and sale of products related to said industries. [cf. document no. 3 attached to Initial Submission and PA attached to the record]
d) In the year 2011, the companies that constituted the fiscal scope of the aforementioned group dominated by the Claimant were the following [cf. document no. 3 attached to Initial Submission and PA attached to the record]:
[Table content preserved as shown in original]
e) In the contracts concluded, within the scope of their activity, between the companies integrated in the Group dominated by the Claimant (for ease of presentation, we will refer to as company) and their customers (for ease of presentation, we will refer to as customer), there are, among others, the following clauses [cf. document no. 5 attached to Initial Submission]:
(i) The contract is concluded for the period of 60 (sixty) months.
(ii) The customer commits to:
- acquire and resell in its commercial establishments, exclusively, coffee, decaffeinated coffee and sugar marketed by the company or by a distributor designated by it;
- not acquire from third parties but solely and exclusively from the distributor indicated to it by the company, for purposes of resale in its establishment;
- not advertise other brands of coffee and similar products to those mentioned above;
- acquire, during the period of 60 months, the minimum monthly quantity of "x" kilos of coffee (as an example, 103 kg), brand "y", totaling "z" (as an example, 6,180 kg).
(iii) As consideration for the exclusivity granted by the customer:
- the company loans to it, without interest, the amount of "x" (as an example, € 25,000.00), to be returned in accordance with contractually stipulated terms and conditions;
- the company advances the amount of "x" (as an example, € 12,300.00), VAT included, at the standard rate, for the purchase of "n" kilos of coffee (as an example, 6,180 kg);
- the company grants to the customer the equipment and/or advertising material contractually agreed, property of the company which the customer will use in the capacity of a faithful depositary, being responsible for the maintenance and repair of any damages that may occur.
(iv) The customer's breach of the contract has for it, among others, the following consequences:
- the payment of compensation to the company which, by agreement, is fixed at 1/3 of the value of "x" (as an example, € 12,300.00) advanced to the customer;
- the immediate return to the company of the value of "x" (as an example, € 12,300.00) advanced to the customer, less the proportional part to the number of kilos amortized in the supplies already made;
- in case of violation of the obligation to acquire, during the period of 60 months the minimum monthly quantity of "x" kilos of coffee (as an example, 103 kg), brand "y", totaling "z" (as an example, 6,180 kg), the payment of compensation to the company, in the amount of € 12.00 (twelve euros) for each kilo of coffee not acquired;
- the immediate return to the company of the equipment and/or advertising material that was granted to it, as well as the payment as to devaluation for use, of an amount equal to the difference between the purchase value at the date of the start of the contract's validity and the value at the date of termination, or, alternatively, the payment of the said equipment and/or advertising material, at the price indicated in the contract.
f) The company C…, S. A. concluded a so-called "Debt Payment Agreement" with its customer H… and in which I… also intervened, dated February 15, 2008, a copy of which is contained in document no. 6 attached with the request for arbitral pronouncement and which is fully reproduced herein, in which, among other things, the following was provided:
- H… confesses itself to be indebted to the company in the amount of € 15,000.00 (fifteen thousand euros);
- the company accepts to reduce the value of the debt to the amount of € 13,200.00 (thirteen thousand two hundred euros), if the agreement is punctually fulfilled by the customer;
- I… assumes the debt of H…;
- I… commits to pay the amount of € 13,200.00 (thirteen thousand two hundred euros) in 12 (twelve) monthly installments and successive, in the amount of € 1,100.00 (one thousand one hundred euros), with the first maturing on March 15, 2008 and the remaining in subsequent months;
- as a penalty clause, the non-payment of one of those installments implies the immediate maturity of the total debt, that is, € 15,000.00 (fifteen thousand euros) and respective default interest calculated at the legal rate;
- H… and I… recognize and accept that the agreement has the force of an enforceable title.
g) For payment by company C…, S. A. of the current account of its customer H…, 6 (six) bills of exchange were issued, in the amount of € 2,770.68 (two thousand seven hundred and seventy euros and sixty-eight cents), each one, with maturity dates of December 30, 2008, March 30, 2009, June 30, 2009, September 30, 2009, December 30, 2009 and March 30, 2010. [cf. document no. 6 attached to Initial Submission]
h) In compliance with Service Order no. OI2015…, of August 31, 2015, the Claimant was subjected to an external inspection procedure, of partial scope (only as to corporate income tax), concerning the period of 2011, due to the detection of situations that led to corrections to the values declared by the companies that make up its fiscal scope and, as such, with repercussions on the respective group income declaration, submitted by the parent company. [cf. document no. 3 attached to Initial Submission and PA attached to the record]
i) Following that inspection action, the respective Tax Inspection Report was prepared – a copy of which constitutes document no. 3 attached with the request for arbitral pronouncement and is fully reproduced herein – which was notified to the Claimant, through office no. …/…, dated April 14, 2016, from the Tax Inspection Services of the Finance Department of Porto, sent by registered mail with proof of delivery. [cf. document no. 3 attached to Initial Submission and PA attached to the record]
j) In that Tax Inspection Report, approved on April 12, 2016 by the Division Chief by subdelegation of the Assistant Finance Director of the Finance Department of Porto, the following is highlighted as being of interest for the present proceeding: [cf. document no. 3 attached to Initial Submission and PA attached to the record]:
[Content of the Tax Inspection Report preserves all tables and structure as shown in original Portuguese text]
III – DESCRIPTION OF FACTS AND GROUNDS OF PURELY ARITHMETIC CORRECTIONS TO THE TAXABLE MATTER
Corporate Income Tax (IRC)
According to the provision in article 69 of the Corporate Income Tax Code, with the taxpayer having opted for the Special Tax Regime for Groups of Companies (RETGS) for the fiscal period of 2011, the taxable profit of the Group was calculated by the parent company through the algebraic sum of the taxable profits and tax losses determined in the periodic individual declarations (Form 22), of each of the companies belonging to the Group.
III.1 – Corrections made in the sphere of companies integrating the fiscal scope for purposes of taxation under the Special Tax Regime for Groups of Companies
A. D…, SA – NIPC … Within the scope of the external inspection procedure authorized by Service Order no. OI2015…, a draft report was prepared, notified to D…, SA, through office no. …/…, of February 5, 2016, which contains corrections to the declared taxable result, in the amount of € 54,756.51, relating to expenses with advance discounts improperly charged to the period.
D…, SA did not exercise the right to be heard, so the preparation and notification (through office no. …/… of March 10, 2016) of the Final Report of the Tax Inspection Action was proceeded with.
As a result of the corrections made, the taxable result was corrected as follows:
[Table preserved as in original]
B. E…, SA – NIPC …
Within the scope of the external inspection procedure authorized by Service Order no. OI2015…, a draft report was prepared, notified to E…, SA, through office no. …/…, of February 11, 2016, which contains corrections to the declared taxable result, in the amount of € 30,350.15, relating to expenses with advance discounts improperly charged to the period.
E…, SA did not exercise the right to be heard, so the preparation and notification (through office no. …/… of March 14, 2016) of the Final Report of the Tax Inspection Action was proceeded with.
As a result of the corrections made, the taxable result was corrected as follows:
[Table preserved as in original]
C. C…, SA – NIPC …
Within the scope of the external inspection procedure authorized by Service Order no. OI2015…, a draft report was prepared, notified personally to C…, SA, through office no. …/…, of February 22, 2016, which contains corrections to the declared taxable result, in the amount of € 135,562.05, relating to expenses with advance discounts improperly charged to the period and expenses with impairment losses not accepted.
C…, SA did not exercise the right to be heard, so the preparation and notification (through office no. …/… of March 14, 2016) of the Final Report of the Tax Inspection Action was proceeded with.
As a result of the corrections made, the taxable result was corrected as follows:
[Table preserved as in original]
D. B…, SA – NIPC…
Within the scope of the external inspection procedure authorized by Service Order no. OI2015…, a draft report was prepared, notified personally to B…, SA, through office no. …/…, of February 22, 2016, which contains corrections to the declared taxable result, in the amount of € 454,732.38, relating to expenses with advance discounts improperly charged to the period.
B…, SA did not exercise the right to be heard, so the preparation and notification (through office no. …/… of March 14, 2016) of the Final Report of the Tax Inspection Action was proceeded with.
As a result of the corrections made, the taxable result was corrected as follows:
[Table preserved as in original]
III.2 – Corrections to the Taxable Profit, Taxable Matter and Surcharge declared by the GROUP
Given what is set forth in the preceding point, the taxable result attributable to the Group, relating to the period of 2011, should be recalculated as follows:
[Table preserved as in original with all companies and figures]
k) On May 4, 2016, the Claimant was notified of the corporate income tax assessment no. 2016…, dated April 27, 2016 and the corresponding account adjustment statement no. 2016…, dated May 3, 2016, relating to fiscal year 2011, which resulted in the amount to be reimbursed of € 25,362.45 (twenty-five thousand three hundred and sixty-two euros and forty-five cents) and which are fully reproduced herein. [cf. document no. 2 attached to Initial Submission and PA attached to the record]
l) On September 1, 2016, the Claimant filed a gracious complaint, whose initial request is fully reproduced herein, petitioning as follows [cf. PA attached to the record]: "The partial annulment of the tax act of additional corporate income tax assessment no. 2016… relating to the taxation period of 2011, i) because the conditions for tax deductibility of the expense recognized by the Complaining Party as financial counterparties are met and ii) because it has been proven that the necessary steps were taken for collection of the credit from customer H.... ."
m) The said gracious complaint was filed, under number …2016…, in the Finance Service of … and subsequently sent to the Finance Department of Porto, and on December 12, 2016, a decision was issued, by the Division Chief by subdelegation of the Assistant Finance Director of the Finance Department of Porto, agreeing with the respective draft decision, in accordance with the Information dated December 9, 2016 – a copy of which is contained in document no. 4 attached with the request for arbitral pronouncement and is fully reproduced herein – which contains, among other things, the following of relevance to the present proceeding [cf. document no. 4 attached to Initial Submission and PA attached to the record]:
"OF WHAT IS ALLEGED BY THE COMPLAINANT
From the grounds contained in the initial submission (PI), which are fully reproduced herein, the complainant, as parent company, until December 31, 2015, of a group of companies, having opted for taxation in corporate income tax in accordance with the Special Tax Regime for Groups of Companies (RETGS), contests some of the corrections carried out by the Tax Inspection Services (SIT) of this Finance Department, relating to some of its subsidiaries, namely:
A) FINANCIAL COUNTERPARTIES/ADVANCE DISCOUNTS, in the total amount of € 610,683.91, thus distributed:
[Table preserved as in original]
B) IMPAIRMENT LOSSES NOT ACCEPTED, in the amount of € 16,874.08, recorded by the subsidiary C… SA, resulting from a receivable over customer H… .
Requests the partial annulment of the act of additional corporate income tax assessment of said corrections to the taxable matter, as well as the annulment of the state surcharge charged in the amount of € 8,156.60 plus the corresponding default interest.
Also requests the payment of indemnification interest.
OF THE ASSESSMENT OF THE REQUEST
A) FINANCIAL COUNTERPARTIES/ADVANCE DISCOUNTS
The subsidiary companies identified above, which are part of the group of which the complainant is parent company, within the scope of the activity they develop, conclude coffee supply contracts with their customers, ensuring the exclusivity of such supply for a determined period, on the condition that they make available to their customers equipment and advertising material and a financial counterparty for the purchase of said coffee.
The question that is discussed here consists of determining how this financial counterparty should be treated for tax purposes, since the Tax Inspection Services (SIT) did not agree with the accounting made by the subsidiaries, in the sense of allocating the expense incurred with the financial counterparties, in equal parts during the period of validity of the contract.
The complainant argues that the economic benefit obtained is not limited to the minimum quantities of coffee that the customer is obligated to acquire, being especially relevant the exclusivity of supply during the contracted period and the obligation of the customer to advertise the brand, through the use of equipment and advertising material, in order to obtain the so-called "network externalities." It contests the argument of the SIT that this is a mere advance quantity discount, alleging the complexity of the contracts concluded, referring to the other economic benefits it obtains throughout its duration (advertising and exclusivity/customer loyalty).
It also refers to this being the understanding recommended by the AT through Information 371/95, of July 18, 1995, endorsed by the Assistant General Director, regarding the accounting and respective tax treatment applicable to advance discounts granted for exclusivity of consumption and coffee.
Finally, it questions how one should proceed, in light of the understanding of the SIT, when the customer acquired all of the minimum amounts of coffee during the initial phase of the contract, in which case the expense would be fully allocated in the initial phase of the contract, alleging that there would not be a correct balance between expenses and revenues, as provided in the Conceptual Framework of the Accounting Normalization System (SNC).
As to the adjustment to be made in case of contract termination, the complainant argues that the expense still to be recognized, at the date of termination, should be fully recognized in the fiscal year of the respective termination, and the corresponding asset should be derecognized. It disagrees, therefore, with the understanding of the SIT, because it considers that this is not an asset relating to a customer, subject to impairment tests, but rather an indispensable cost, under art. 23 of the Corporate Income Tax Code (CIRC).
From the exhaustive reading of the supply contract that the complainant attaches as exemplary it is extracted the following:
- Second Clause: The customer commits to acquire and resell in its establishments, exclusively, coffee, decaffeinated coffee and sugar marketed by the complainant – paragraph a), and cannot acquire such products from third parties but only from the distributor indicated – paragraph b), not to advertise other brands of coffee – paragraph c) and to acquire, during the period of 60 months, a minimum monthly quantity of 103 kg of a certain coffee, totaling 6,180 kg – paragraph d);
- Third and Fourth Clauses: As consideration for the exclusivity, the complainant loans to its customer the amount of € 25,000.00, without interest, an amount which will be returned in accordance with a pre-determined plan and subject to specific conditions;
- Sixth Clause: Also as consideration for that exclusivity, the complainant advances the amount of € 12,300.00, VAT included, for the purchase of the 6,180 kg of coffee – paragraph a) and grants various equipment, as well as advertising material duly described – paragraph b);
- Seventh Clause: For breach of the contract the customer commits to the payment:
Point 2: of compensation corresponding to 25% of the loaned amount (25% of € 25,000.00);
Point 3: of all outstanding installments;
Point 4: of another compensation corresponding to 1/3 of the amount indicated in paragraph a) of the Sixth Clause of the contract (1/3 of € 12,300.00);
Point 5: of the amount referred to in paragraph a) of the Sixth Clause (€ 12,300.00) less the proportional part to the number of kilos amortized in the supplies already made;
Point 6: € 12.00 for each kilo of coffee not acquired;
Point 7: of an amount equal to the difference between the purchase value at the date of the start of the contract and the value at the date of its termination, relating to the equipment and/or advertising material, jointly with the return thereof, being able to opt, alternatively, for payment of the value attributed to said equipment in the Sixth Clause.
For what is important to analyze here, it is extracted, essentially, that the complainant, at the beginning of the contract, grants to its customers a loan of a certain amount together with the provision of equipment and advertising material, also granting an advance discount in the amount of € 12,300.00 which it makes depend on the acquisition, by its customers, of a certain quantity of coffee, in a certain time horizon (normally 5 years).
Now, with respect to the advance discount, whose method of accounting carried out by the taxpayer differs from what is the understanding of the SIT, it is important to highlight, first and foremost, that the contract does not establish in what terms the customer should acquire the quantity of coffee to which it is obligated, so the same does not necessarily have to be acquired in equal parts throughout the period of duration of the contract.
As such, it is concluded that said advance discount is not altered depending on whether the quantity is fully acquired in an earlier phase or in a later phase of the contract. On the contrary, the customer may even acquire all of the agreed coffee, for example, after 1 year of contract without any breach of contract arising from such fact, as that Clause is concerned. In these terms, once the pre-determined volume of coffee purchases is reached, the right to said discount already granted is consolidated, so in our view it only makes sense that the same be recognized as a deferred cost, which will affect the result of the following fiscal year(s) as the contractually imposed quantities of coffee are being acquired.
In fact, no different understanding is even conceivable considering that, in case of breach, the customer will have to return the value of the discount already received, less the value proportional to the discount already amortized in the acquisitions made up to that point. That is, verifying that the customer does not achieve the initially proposed objective, it is not obligated to return the entire advance discount, but only the value corresponding to the kilos of coffee missing, so it does not make sense that said discount affects, as the complainant claims, the results of the 5 fiscal years of contract validity in equal parts, but rather, as the SIT argues, based on the quantities being acquired.
As to the argument invoked by the complainant that the economic benefit obtained is not limited to the minimum quantities of coffee that the customer is obligated to acquire, being especially relevant the exclusivity of supply and the use of equipment and advertising material, it will always be said that the contract provides for a set of other penalties which, in case of breach, are intended to reimburse the complainant for the investment made, so it seems safe to us to state that this discount, as well as the penalty associated with it, are closely connected only to the quantities to be acquired.
Now, as to Information 371/95, of July 18, 1995, endorsed by the Assistant General Director, regarding the accounting and respective tax treatment applicable to advance discounts granted for exclusivity of consumption and coffee, the complainant understands that the understanding of the AT, set forth in the aforementioned information, resembles its own.
We disagree with the reading and interpretation that the complainant makes of it. Let us see. The said information was provided with the purpose of clarifying whether, from the customer's perspective, the discount should be considered income in the year it is granted or whether it should be allocated to the five years of the contract's validity. According to the opinion issued, the amount advanced as a discount, being associated with the quantity of coffee that will be consumed, should be recognized when obtained or incurred regardless of whether it has already been received or paid, with the allocation to be made on a systematic basis during the period of validity of the contract. It is concluded in the said information that, from the customer's perspective, it should be recorded as a deferred income being allocated a fraction to each fiscal year of the contract's validity.
As to the position assumed in the Information issued, we fully agree, as transposing to the case being considered, we agree that the cost cannot be assumed entirely in the fiscal year in which it is paid, given the logic of balancing revenues and expenses, as well as, in respect of the principle of exercise specialization provided in art. 18 of the CIRC.
In that sense, it was defended, and correctly so, in the said Information that the cost should be deferred and allocated on a systematic basis, on the basis of a fraction to each fiscal year of the contract's validity. However, the said Information does not specify, contrary to what the complainant seeks to make believed, what criterion should be used for purposes of the systematic allocation, on the basis of a fraction to each fiscal year.
In our view, an objective criterion should be established that conveys what cost is borne by the coffee supplier and what profits are associated with it, that is, a factor should be found that allows us to establish the relationship between the cost and the profit.
Now, considering that there is a causal nexus between the discount actually granted and the quantities of coffee acquired, we can safely state that this is a quantity discount, which differs from so-called "normal" quantity discounts, only by having been granted a priori. However, even so, it remains a quantity discount, whose unit value is easily ascertained.
We understand that the practice that best reflects the actual result obtained by the complainant, and on which corporate income tax should be levied, is the deferral of the cost, allocating it systematically to each period of validity of the contract, based on the quantities of coffee supplied; in case the customer acquires all of the agreed coffee before the end of the contract, the total advance discount is consolidated at that moment, so nothing prevents that in a given year a larger fraction of the discount be allocated, all for the reason of the quantities actually supplied. We believe that only in this way can a larger cost incurred be made to correspond to a larger profit obtained, fulfilling the underlying purpose of the principle of exercise specialization. Therefore, neither does the complainant have reason when it invokes the Conceptual Framework of the Accounting Normalization System (SNC), alleging that the logic of balance between expenses and revenues is not assured with the form of allocation proposed by the SIT, because as has already been demonstrated here, it is precisely this form of allocation that best reflects that same balance.
To this end, reference is made to the understanding of the Order of Certified Accountants (then the Order of Official Accounting Technicians) in the magazine "OTC 89 – August 2007, pp. 57 and 58," regarding contracts for exclusivity in the supply of coffee, according to which:
"Contracts for exclusivity, where there is an underlying obligation of consumption of "x" quantity of the product of the brand in question with the attribution of advance discounts – when there are amounts paid with a view to ensuring the exclusive commercialization of a certain brand, within the scope of exclusivity contracts, these may assume the nature of advance quantity discounts if attributed based on estimated future acquisitions.
What distinguishes this type of discount from others is its mere anticipation, that is, being attributed before the supplies.
However, this does not invalidate its qualification as a discount, since there is a connection between the amount attributed and the consumption to be verified in the future. (…)
In accordance with the Official Accounting Plan, discounts granted by reason of the quantity of goods sold, configuring the nature of a commercial discount, should be recognized through the crediting of account 31.8 – Discounts and allowances in purchases, if granted outside the invoice. With respect to sales made in more than one fiscal year, the deferral should be made for the respective fiscal years, accounting for the total amount of the discount in an account 27 and affecting the inventory accounts to the extent that these are sold."
Finally, as to the adjustment to be made in case of contract termination, the complainant argues that the expense still to be recognized, at the date of termination, should be fully recognized in the fiscal year of the respective termination, with the corresponding asset being derecognized. We completely disagree with this interpretation because, in case of termination, what the complainant has is, as contractualized, the right to be reimbursed for the amounts advanced, on a proportional basis, constituting, at that moment, a right against the customer, in the form of an asset, which will be subject to impairment tests, and there is no legal framework for the cost incurred at the beginning of the contract and object of deferral to be assumed as an indispensable cost, under art. 23 of the Corporate Income Tax Code (CIRC).
In conclusion, it will be said that, given that the contract provides for the return of unamortized advance discounts in the supplies made, there is a causal nexus between the value of the advance discount granted and the quantities of coffee that the customer commits to acquire, being such nexus expressed in the existence of a unit quantity discount, obtained by dividing the amount of the advance discount by the number of kilos of coffee whose acquisition is contractually provided for. Given this causal nexus, it is possible to make the balance between the costs incurred and the profits obtained, with a view to the taxation of the actual income of companies.
B) IMPAIRMENT LOSSES NOT ACCEPTED FOR TAX PURPOSES
Regarding the corrections made by the SIT, relating to impairment of customer receivables, the complainant disagrees only with the correction made to the impairment recorded regarding the receivable held against customer H…, in the amount of € 16,874.08, arguing that steps were taken to collect the receivable, attaching for that purpose a copy of the Debt Payment Agreement (Doc. no. 4 of the pi).
After analyzing the document presented by the complainant, it is concluded that it is nothing more than a contract, dated February 15, 2008, through which the customer recognizes being indebted to the complainant in the amount of € 15,000.00, which will become € 13,200.00 once the payment conditions contained therein are fulfilled. However, such document does not prove that the complainant, in fiscal year 2011, the year in which the expense is being challenged, took steps toward its fulfillment, nor that the risk of non-collectability occurred only in that fiscal year, so the conditions cannot be considered as met for the impairment loss to be recognized in fiscal year 2011.
Therefore, with no objective evidence having been presented of the impairment with respect to fiscal year 2011, the requirements for the impairment loss accounted for to be fiscally accepted are not met, in light of arts. 35 and 36 of the CIRC, in effect on the date of the facts.
CONCLUSION
In view of the above, it is proposed that the corporate income tax assessment contested regarding fiscal year 2011 be maintained and, consequently, the request be dismissed."
n) The Claimant was notified, through office no. 2016…, dated December 12, 2016, from the Administrative and Contentious Justice Division of the Finance Department of Porto, sent by registered mail, of the draft decision of the aforementioned gracious complaint. [cf. document no. 4 attached to Initial Submission]
o) By decision of December 30, 2016, by the Division Chief by subdelegation of the Assistant Finance Director of the Finance Department of Porto, the aforementioned gracious complaint was dismissed [cf. document no. 1 attached to Initial Submission and PA attached to the record].
p) The Claimant was notified, through office no. 2017…, dated January 2, 2017, from the Administrative and Contentious Justice Division of the Finance Department of Porto, sent by registered mail with proof of delivery, of the decision dismissing the aforementioned gracious complaint. [cf. document no. 1 attached to Initial Submission and PA attached to the record]
q) On April 5, 2017, the request for constitution of an arbitral tribunal was filed, which gave rise to the present proceeding. [cf. case management system of the CAAD]
*
§2. FACTS NOT PROVEN
With relevance to the assessment and decision of the matter, it was not proven that all necessary steps were taken to collect the credit of company C…, S. A. against its customer H…, in the amount of € 16,874.08 (sixteen thousand eight hundred and seventy-four euros and eight cents), nor that the risk of non-collectability of that credit occurred in fiscal year 2011.
*
§3. STATEMENT OF REASONS AS TO FACTUAL MATTERS
With respect to the factual matters proven, the conviction of the Tribunal was based on the facts articulated by the Parties, whose correspondence with reality was not challenged, on the documents and on the respective administrative file attached to the record.
Regarding the factual matters not proven, they were so considered by virtue of the absence of any probative element capable of proving them.
*
III.2. ON LAW
The question posed to the Tribunal rests, essentially, on determining whether the disputed corrections made to the taxable matter for corporate income tax in fiscal year 2011 are or are not correct, both in the part relating to the non-acceptance of certain expenses, relating to alleged advance discounts, and in the part in which they rest on the non-acceptance of impairment losses arising from receivables against customers allegedly uncollectable; from the answer given to that question will depend the judgment of legality both as to the disputed additional corporate income tax assessment and as to the decision dismissing the aforementioned gracious complaint and, therefore, whether they should or should not be maintained.
§1. OF LEGAL FRAMEWORK
§1.1. OF THE APPLICABLE NORMATIVE BLOC
The legal-tax assessment of the situation sub judice must necessarily begin with the delimitation of the applicable normative bloc, for which it is necessary to invoke the legal norms that appear to be concretely relevant, which must be considered in the text applicable ratione temporis.
Accordingly, the following norms of the Corporate Income Tax Code must be taken into account:
Article 17
Determination of Taxable Profit
1. The taxable profit of collective persons and other entities mentioned in paragraph a) of no. 1 of article 3 is constituted by the algebraic sum of the net result of the period and of the positive and negative patrimonial variations verified in the same period and not reflected in that result, determined on the basis of accounting and possibly corrected in accordance with this Code.
(…)
3. In order to permit the determination referred to in no. 1, accounting must:
a) Be organized in accordance with accounting normalization and other legal provisions in effect for the respective sector of activity, without prejudice to observance of the provisions set forth in this Code;
b) Reflect all operations carried out by the taxpayer and be organized so that the results of the operations and patrimonial variations subject to the general regime of corporate income tax may be clearly distinguished from the others.
Article 18
Periodization of Taxable Profit
1. Revenues and expenses, as well as the other positive or negative components of the taxable profit, are attributable to the taxation period in which they are obtained or incurred, independently of their receipt or payment, in accordance with the economic periodization regime.
2. Positive or negative components considered as relating to earlier periods are only attributable to the taxation period when on the date of closing of the accounts of the one to which they should have been attributed they were unforeseeable or manifestly unknown.
(…)
Article 23
Expenses
1. Expenses are considered those which are demonstrably indispensable for the realization of revenues subject to tax or for the maintenance of the productive source, in particular:
(…)
c) Of a financial nature, such as interest on foreign capital applied in the operation, discounts, premiums, transfers, exchange differences, expenses with credit operations, debt collection, and emission of bonds and other securities, redemption premiums and those resulting from the application of the effective interest rate method to financial instruments valued at amortized cost;
(…)
h) Adjustments in inventories, impairment losses and provisions;
(…)
Article 35
Impairment Losses Fiscally Deductible
1. The following impairment losses recorded in the same taxation period or in earlier taxation periods may be deducted for tax purposes:
a) Those related to receivables arising from normal activity that, at the end of the taxation period, may be considered of doubtful collectability and are evidenced as such in accounting;
(…)
Article 36
Impairment Losses in Receivables
1. For purposes of determining the impairment losses provided for in paragraph a) of no. 1 of the preceding article, receivables of doubtful collectability are considered those in which the risk of non-collectability is duly justified, which is verified in the following cases:
a) The debtor has a pending insolvency and business recovery proceeding or enforcement proceeding;
b) The receivables have been claimed judicially or in arbitral tribunal;
c) The receivables are in arrears for more than six months from the date of their respective maturity and there is objective evidence of impairment and that steps have been taken for their collection.
(…)
*
§1.2. OF THE PRINCIPLE OF EXERCISE SPECIALIZATION: DEFINITION AND APPLICATION
The principle of exercise specialization is posited in no. 1 of article 18 of the Corporate Income Tax Code and is expressed in the rule that gains or losses of a determined exercise must be considered those revenues and costs, as well as the other positive or negative components of the taxable profit, that pertain to that exercise, being irrelevant the exercise in which they materialize.
In no. 2 of that same article 18, an exception is provided for positive or negative components of the taxable profit that, on the date of closing of the accounts of a determined exercise, were unforeseeable or manifestly unknown.
The principle of exercise specialization derives from the periodization of results that is imposed by management and information needs, being "characterized by the division of the life of the company into temporal intervals and by the allocation to each of them of the components, positive and negative, that make it possible to determine the result that corresponds to it," imposing this specialization "the carrying out of an inventory of the end of the exercise, from which derives the necessity of allocating to each exercise all the revenues and costs that are inherent to it and only those."[1]
The importance and reason for the principle of exercise specialization become evident if one keeps in mind that "the temporal specialization of the components of profit is still more important for tax purposes than for accounting purposes, given the conditions in which the determination of the tax to be paid takes place, so as to avoid deviations of results between different exercises with purposes of minimization of the tax burden, (…). In fact, that temporal allocation can be an instrument of a manipulation of results, so as to, in particular:
a) Defer profits in time;
b) Fraction profits, distributing them among different exercises, with the objective of avoiding, in a tax with progressive rates, taxation at higher rates;
c) Concentrate profit in an exercise where more substantial deductions can be realized (e.g., by carry forward of losses or by tax incentives)."[2]
In fact, there are, "in the abstract, two types of tax errors linked to the temporal allocation of positive and negative components of income to the competent exercise:
- omission or forgetfulness (voluntary or involuntary error): the rule is known, which is indisputable, but for some reason (illegitimate or justified) the revenue or cost is not recorded in the year due;
- the lottery or interpretive opening: erroneous temporal recording of a revenue or a cost, carried out, however, on the basis of a plausible interpretation of the rule for tax purposes (general or specific) of exercise specialization, a rule which possesses an ambiguous (or non-conclusive) application content faced with the concrete case."[3]
It is, therefore, forbidden to taxpayers to define as they see fit or according to criteria of opportunity or, further, in accordance with their commercial or management strategy, the timing for declaring the revenues and costs arising from their commercial or industrial activity, because they are legally imposed limits and rules for that purpose, in particular in the sense of obligating them to allocate those revenues and costs to the exercise to which they pertain.
Therefore, all costs and revenues that are recognized on a determined date must be recorded in the exercise to which they correspond so as to produce a faithful image of the position of the company for that period; that is, they must be allocated "to the exercise the charges that arise from operations made in it, even though not borne in it, the same way that one must allocate to an exercise the revenues resulting from operations done in it even though collected in another" (decision of the Supreme Administrative Court, issued on April 2, 2008, in process no. 0807/07, available on www.dgsi.pt).
Notwithstanding what has been said, as noted by Tomás Cantista Tavares, the national courts have already been confronted "with the problem of reconciling the tax interest and the accounting and tax errors of exercise specialization. With the question of the hypothetical acceptance for tax purposes (and, if affirmative, under what conditions) of an erroneous accounting entry, in violation of the formal principle of exercise specialization; with the admissibility of the tax recording of a cost or revenue in a year different (earlier or later) from its correct temporal allocation.
The jurisprudence revolves around two antagonistic theses:
a) the primitive current, of a formal and legalist nature, does not admit any violations of the principle of exercise specialization;
b) the current thesis, of a material nature, accepts the violation of the formal principle of specialization, provided that these erroneous recordings do not result from voluntary and intentional behaviors, with a view to operating the transfer of results between exercises.
(…)
This line of jurisprudence [the primitive thesis] does not accept the violation of the legal rule of exercise specialization. It does not accept the entry of an item (positive or negative) of income, in an exercise different from what is its due. One remains with the mere statement of the principle. It overvalues it in face of the consideration of other factors of material justice, such as the interference in an exercise other than the object of the proceeding or the consideration of exculpatory reasons (action in good faith, sustained in a plausible interpretation of a complex command).
(…)
The jurisprudence consents, currently, to the violation of the formal principle of exercise specialization, provided that they do not result from voluntary and intentional behaviors, with a view to operating the transfer of results between exercises. It accepts the entry of a cost or revenue in an exercise different from what was competent for it, by intervention of exculpatory reasons (action in good faith, sustained in a serious and plausible interpretation of a complex command, based on open and ambiguous interpretations of its enactment).
(…)
The current thesis (…) breaks with the expedience of legalist formalism. It seeks the material and fair solution. It makes a structural principle (capacity to contribute) prevail over an operational rule (exercise specialization). Its point of departure is irreproachable: if the company incurred in a true cost, that decline must necessarily model the tax income. The formal convention of specialization does not have the power to prevent the material effect, nor to make it excessively onerous or complex. The same occurs, mutatis mutandis, with revenues. They contribute only once to profit (…)"[4]
It constitutes, in fact, reiterated jurisprudence of the Supreme Administrative Court that the rigidity of the principle of exercise specialization must be tempered with the invocation of the principle of justice – namely, in situations in which, being already surpassed all periods for revision of the tax act and there being no prejudice to the State, one should avoid falling into an unjustified injustice for the administered – which will then function as a safety valve. In this sense, it was strikingly set forth in the decision issued on November 19, 2008, in process no. 0325/08 (available on www.dgsi.pt)[5]:
"The principle of justice is a basic principle that should inform all the activity of the Tax Administration, as results from the provision in arts. 266, no. 2, of the Constitution of the Portuguese Republic and 55 of the General Tax Code (LGT).
Although these constitutional principles have a primary domain of application concerning the acts taken in the exercise of discretionary powers, introducing into this exercise aspects that are binding whose non-observance is susceptible of constituting a defect of violation of law, their relevance does not end in the acts taken in the exercise of these discretionary powers.
In fact, on the one hand, the text of art. 266 of the Constitution does not reveal any restriction on its application to any type of administrative activity, so, in principle, such application should be made, if its unfeasibility is not demonstrated.
On the other hand, in the application of legality, both by the Administration and by the courts, each norm that frames a determined action by the Administration cannot be considered in isolation, but rather must attend to the totality of the legal system, with primacy for constitutional law, as imposes the principle of the unity of the legal system, which is the primary element of legal interpretation (art. 9, no. 1, of the Civil Code).
It cannot be stated that, in cases of exercise of binding powers, compliance with a determined ordinary law is superior to the referred constitutional principles, because these principles also form part of the applicable normative bloc, they are also definers of legality and, as constitutional norms, are of priority application in relation to ordinary law.
Both the first part of no. 2 of art. 266 of the Constitution, which imposes on the Administration the observance of the principle of legality foresees the principle of legality (…), as well as its second part in which the other principles are provided and which in general impose the models of action of all administrative activity, as well as the provision in a determined specific situation, which foresees a determined action by the Administration, in particular, in the case at issue, the application of the principle of exercise specialization (art. 18, no. 1, of the CIRC).
For that reason, to define the legality to which the Administration is bound, all these norms must be taken into account and a weighing and choice must be made among them if its global application, abstractly compatible, proves unfeasible in a determined concrete situation.
Therefore, (…), from the referred art. 18, no. 1, of the CIRC results a binding commitment for the Administration, which, in general, must apply the principle of exercise specialization in its activity of control of the declarations presented by taxpayers.
However, the exercise of this power of control, predominantly binding, can lead to a situation flagrantly unjust and, in those situations, it is of making the principle of justice, enshrined in arts. 266, no. 2, of the Constitution and 55 of the General Tax Code (LGT), operate to prevent the realization of that situation of injustice repudiated by the Constitution.
In the weighing of the values at issue (on the one hand the principle of exercise specialization which is a legislatively arbitrary rule of temporal separation, for tax purposes, of a fact of taxation of prolonged duration and, on the other hand, the principle of justice, which reflects one of the core concerns of a State subject to the rule of law), it is manifest that, in a situation of incompatibility, prevalence should be given to the latter principle."
In this same sense, the Central Administrative Court of the South had previously pronounced itself as follows[6]:
"I - The principle of specialization or autonomy of exercises imposes that the revenues and costs economically attributable to a determined exercise, be considered only in that exercise, only they being able, therefore, to influence its result.
II - Such principle suffers the exceptions, provided for in law, which are: in cases in which there is unforeseeability or manifest ignorance of the positive or negative components and of works of a multi-annual nature (articles 18, nos. 2 and 5 and 19 of the CIRC); in situations in which the tax administration had no prejudice from the error practiced by the taxpayer and when that error does not result from voluntary or intentional omissions, with a view to operating transfers of results between exercises."
In the tax jurisprudence of the CAAD, we also note the same decision sense, among others, in the awards issued on November 24, 2014, in process no. 367/2014-T and on January 22, 2016, in process no. 262/2015-T (available on www.caad.org.pt/tributary/decisions).
Following this jurisprudential understanding, Diogo Leite de Campos, Benjamim Silva Rodrigues and Jorge Lopes de Sousa[7] recommend the following position as to the application of the principle of exercise specialization:
"When there is divergence between the taxpayer's criterion and that of the tax administration regarding the allocation of a determined gain or loss to a determined exercise, the latter must proceed to correct the taxable matter, making increase the revenue or cost to the year to which it understands it should pertain and, correspondingly, should subtract such revenue or cost from the taxable matter of the year to which the taxpayer allocated it.
With this procedure, there will be no situation of injustice, because to the increase in tax in a determined year will correspond a decrease tending to be similar in another, there being, therefore, no taxation of the same revenue in two exercises or non-deduction in any of them of a cost that should be considered.
However, in certain situations in which the correction is made in the last year in which it can be made and has as its object a cost that should have been...
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