Process: 255/2015-T

Date: October 22, 2015

Tax Type: IRC

Source: Original CAAD Decision

Summary

Process 255/2015-T addresses the tax deductibility of impairment losses on uncollectible receivables under Article 41(2) of the Portuguese Corporate Income Tax Code (IRC) for the 2012 tax year. The claimant, A… Lda., challenged an IRC assessment of €40,833.78 resulting from the Tax Authority's rejection of a €864,278.53 impairment loss claimed for a debt owed by customer B…, who was declared insolvent by court judgment on August 29, 2012. The core legal dispute centered on whether the company fulfilled the formal requirements of Article 41(2) of the IRC Code, specifically the obligation to communicate the debt status to the debtor. The Tax Authority argued that the claimant failed to provide the required communication to the debtor, making the impairment loss non-deductible. The claimant countered that it obtained an official court certificate proving the insolvency and duly claimed its credits in the insolvency proceedings, with the Insolvency Administrator recognizing €924,232.61 in subordinated claims. The company also regularized €129,605.11 in VAT based on the same uncollectible debt. This case was submitted to the Administrative Arbitration Center (CAAD) under the Legal Regime for Arbitration in Tax Matters (RJAT - Decree-Law 10/2011), with the arbitral tribunal constituted on June 26, 2015. The proceeding exemplifies how Portuguese companies can challenge IRC assessments through arbitration, particularly regarding technical compliance with bad debt deduction requirements when formal notification procedures may be impractical due to the debtor's insolvency status. The case highlights the tension between substantive compliance (proven insolvency and participation in insolvency proceedings) and formal procedural requirements under Article 41(2) of the IRC Code.

Full Decision

Arbitral Decision[1]

Claimant – A…, Lda.

Respondent - Tax and Customs Authority

The Arbitrator Dr. Sílvia Oliveira, appointed by the Deontological Council of the Administrative Arbitration Center (CAAD) to form the Arbitral Tribunal, constituted on 26 June 2015, with respect to the above-identified case, decided as follows:

REPORT

1.1. A…, Lda. (hereinafter referred to as the Claimant), a legal entity no. …, with registered office at street …, no. … and …, …, … ..., registered in the Commercial Registry Office of ... under no. …, filed a petition for arbitral pronouncement and constitution of a Single Arbitral Tribunal, on 15 April 2015, pursuant to the provisions of article 4 and no. 2 of article 10 of Decree-Law no. 10/2011, of 20 January [Legal Regime for Arbitration in Tax Matters (RJAT)], in which the Tax and Customs Authority is the Respondent (hereinafter referred to as the Respondent).

1.2. The Claimant seeks the annulment of the "(…) Corporate Income Tax (IRC) assessment no. 2014 … (…), for the year 2012, in the amount of EUR 40,833.78, which is the subject of the present petition for arbitral pronouncement".

1.3. The petition for constitution of the Arbitral Tribunal was accepted by His Excellency the President of CAAD on 17 April 2015 and was notified to the Respondent on 27 April 2015.

1.4. The Claimant did not appoint an arbitrator and therefore, pursuant to article 6, no. 2, letter a) of the RJAT, the undersigned was appointed as arbitrator, on 11 June 2015, by the President of the Deontological Council of CAAD, with the appointment having been accepted within the legally prescribed time and terms.

1.5. On the same date, both Parties were duly notified of this appointment and expressed no intention to refuse the appointment of the arbitrator, in accordance with the combined provisions of article 11, no. 1, letters a) and b) of the RJAT and articles 6 and 7 of the Deontological Code.

1.6. Accordingly, in conformity with the provision of letter c), no. 1, of article 11 of the RJAT, the Arbitral Tribunal was constituted on 26 June 2015, and an arbitral order was issued on 29 June 2015, to the effect of notifying the Respondent to, "pursuant to the provisions of article 17, no. 1 of the RJAT, submit a reply within a maximum period of 30 days and, should it wish to do so, request the production of additional evidence".

1.7. On 14 September 2015, the Respondent submitted its Reply, having defended itself by way of objection and concluded in the sense that "(…) the present petition for arbitral pronouncement should be judged unfounded, maintaining in the legal order the tax assessment acts and accordingly absolving the Respondent from the claim".

On 16 September 2015 an arbitral order was issued notifying both Parties to pronounce themselves, within a period of five days, on the possibility of dispensing with the holding of the meeting referred to in article 18 of the RJAT, as well as on the possibility of dispensing with the submission of arguments.

On 21 September 2015, both the Claimant and the Respondent submitted a reply to the arbitral order referred to in the preceding point to the effect of not objecting to the dispensing with the holding of the meeting referred to in article 18 of the RJAT, as well as not objecting to the dispensing with the submission of arguments.

Accordingly, it was decided by the Arbitral Tribunal, in an order dated 24 September 2015 (notified to the parties on 25 September 2015), in accordance with the procedural principles established in article 16 RJAT, of the autonomy of the Arbitral Tribunal in the conduct of proceedings and in the determination of the rules to be observed [letter c)], of cooperation and procedural good faith [letter f)] and the free conduct of proceedings, established in article 19 and 29, no. 2 of the RJAT, and further taking into account the principle of limitation of useless acts provided for in article 130 of the Code of Civil Procedure (CPC) [applicable pursuant to article 29, no. 1, letter e) of the RJAT], to dispense with the holding of the meeting referred to in article 18 of the RJAT, as well as dispense with the submission of arguments, with 22 October 2015 being fixed as the date for the rendering of the arbitral decision.

Within the scope of the arbitral order referred to in the preceding point, the Claimant was further warned that "until the date of rendering of the arbitral decision it should proceed to pay the subsequent arbitral fee, in accordance with the provisions of no. 3 of article 4 of the Regulation of Costs in Tax Arbitration Proceedings and communicate such payment to CAAD" (which took place on 9 October 2015).

CAUSE OF ACTION

2.1. The Claimant seeks through the petition for arbitral pronouncement that there be "annulled the Corporate Income Tax (IRC) assessment for the year 2012, as well as the respective interest assessment and the account reconciliation statement".

On the Timeliness of the Present Petition

2.2. In this regard, the Claimant states that it "was notified of the IRC assessment no. 2014 …, of the interest calculation statement no. 2014 … and of the account reconciliation statement no. 2014 …, in the amount of EUR 40,833.78, relating to the year 2012 (…)", whose "payment deadline (…) was 16-01-2015".

2.3. The Claimant further states that "pursuant to the provisions of article 10°, no. 1, letter a) of the Legal Regime for Arbitration in Tax Matters (…), and of article 102º, no. 1, letter a) of the CPPT, the period for filing the present petition is 90 days from the end of the period for voluntary payment of the tax obligation".

2.4. Accordingly, the Claimant concludes that "given that the period for payment of the assessment in question ended on 16-01-2015, the 90-day period commenced on 17-01-2015 and ended on 16-04-2015", "wherefore the present petition (…) should be considered timely filed".[2]

On the Petition for Arbitral Pronouncement

2.5. In this matter, within the framework of a tax inspection action carried out on the Claimant, it "was notified of the inspection report (…) in which corrections are made to the taxable income of the Corporate Income Tax (IRC) for the year 2012 in the amount of EUR 864,278.53", which concern "the non-acceptance as a tax deductible expense of an allowance for doubtful debts relating to the uncollectibility of the receivable from customer B… - ...", "company (…) which was declared insolvent by judgment of 29-08-2012".[3]

2.6. "Following this insolvency, the Claimant registered as an expense in its accounts an allowance for doubtful debts receivable in the amount of EUR 864,278.53 (…)", and "also regularized IVA in its favor in the amount of EUR 129,605.11 in period 2013 03".[4]

2.7. Accordingly, the Claimant "considered the debt as uncollectible and recognized the respective allowance (...)".

However, "the tax inspection alleges the non-deductibility of the said allowance on the ground that the claimant did not effect communication to the debtor as required by article 41° no. 2 of the Corporate Income Tax Code", a position with which the Claimant disagrees.

Indeed, "the Claimant requested a court certificate to prove the insolvency, both for purposes of tax deductibility in the Corporate Income Tax assessment, and for purposes of IVA regularization in its favor (…)".[5]

From the said certificate, according to the Claimant, it is stated that:

"(…) The judgment declaring insolvency was rendered on 29/08/2012 and became final on 24-09-2012 (...)" and,

"The creditor A... Lda. (…) claimed credits (…) in the total amount of EUR 924,232.61, which the (…) Insolvency Administrator recognized (…) as subordinated, pending (…) the submission of the creditors list (…) as well as the liquidation of assets".

The Claimant reiterates that "(…) it complied with all the formalities required for purposes of IVA regularization (…)" and that "the formalities for regularization were also certified by the ROC (…)", "having communicated to the Insolvency Administrator the IVA regularization in its favor (…) through registered mail with acknowledgment of receipt (…)".

Nevertheless, "(…) the tax inspection considers that the conditions were not met for the fiscal deductibility of the said allowance", a position with which the Claimant disagrees insofar as it understands that "in the communication to the Insolvency Administrator, the Claimant attached the credit note issued to the insolvent company (…)", which "(…) proves the recognition of an expense in the Claimant's accounts", and accordingly should "(…) be considered that the communication required by article 41° of the CIRC was effected".

However, the Tax Administration "calls into question the absence of express communication to the debtor (…)" given that "the Insolvency Administrator, notified by the AT, came to say that it did not receive any notification (…)" which, according to the Claimant, "contradicts the (…) documentary evidence" submitted.

On the other hand, the Claimant further states that "the Tax Administration itself considers that the application of art. 41° only takes place when the creditor derecognizes the receivable debt from its assets", "a situation that did not occur in the Claimant's sphere (…)".[6]

In these terms, the Claimant concludes that "(…) the Corporate Income Tax (IRC) assessment for the year 2012 should be annulled, as well as the respective interest assessment and the account reconciliation statement".

RESPONSE OF THE RESPONDENT

3.1. The Respondent, in the reply submitted, defended itself by way of objection as described below.

ON THE FACTS

3.2. The Respondent begins by alleging that, in accordance with the "(…) methodology of permanent monitoring carried out by the inspection services (…) and for the purpose of analysis of the Tax File for 2012, a service order numbered OI2014…, of 2014-01-23 (…), of partial scope, concerning Corporate Income Tax (IRC) and with incidence on the tax period of 2012, was initiated against the Claimant".

3.3. "Within the scope of the referred service order it was possible to ascertain (…)" that "the Claimant (…) recognized in 2012, an allowance for doubtful debts receivable in the amount of € 864,278.53, arising from the insolvency of the taxpayer (…) B…", having "effected the following accounting entries":

3.3.1. "Amount of EUR 755,042.29 debited to account 6511 (…) against account 21111001 (…)", as documented in the administrative file attached);[7]

3.3.2. "Amount of EUR 109,236.24 debited to account 6512 (…) against account 22111084 (…)", as documented in the administrative file attached.[8]

3.4. Within the scope of the said insolvency, "the Claimant proceeded to regularize IVA in its favor in the amount of € 129,605.11".

3.5. According to the Respondent, "when requested to prove the values recorded in accounting and their conformity with the rules contained in the CIRC, the Claimant sent to the inspection services of the Directorate of Finance of ... (…) an office and IVA assessment notice regarding supplies not paid by the insolvent company, sent (…) to the insolvency administrator (…), a copy of the acknowledgment of receipt signed on the date of 2012-11-11", "a copy of the certificate issued by the Judicial Court of ... (…) relating to the claim of credits (…)" and "certification by the Official Auditor of uncollectible credits for purposes of IVA regularization", with the Respondent having verified that "from the analysis of the documents (…) those said nothing regarding the recognition of the expense for purposes of Corporate Income Tax (IRC)".

3.6. Additionally, the Respondent states that "the debtor was notified (…) in the person of the insolvency administrator (…) to send copies of all communications made by the Claimant within the scope of the insolvency proceedings (…)" and, "in response, the insolvency administrator informed that it had not received any communication made (…)" by the Claimant.

3.7. Accordingly, because the procedures adopted "(…) were not in accordance with the provisions of the (…) CIRC (…), the Claimant was notified to, within a period of 15 days, exercise (…) the right of prior hearing on the draft corrections of the inspection report (…)", having exercised this right "(…) in writing on 28-10-2014 (…)".

Given that, according to the Respondent, the right of prior hearing referred to in the preceding point did not add "any new matter or data or arguments that would prevent the production of effects and (…) maintenance of the tenor of the conclusions of the draft report (…) the same became a final report, with the consequent corrections, in the amount of € 864,278.53, having been notified to the Claimant (…)".

As a consequence, "the Corporate Income Tax (IRC) assessment no. 2014…., the interest calculation statement no. 2014…. and the account reconciliation statement no. 2014…., in the amount of € 40,833.78, for the year 2012, were issued".

ON THE LAW

Now, the Respondent reiterates that "the Claimant seeks to sustain its claim on the basis of the IVA regularization effected and respective supporting documents (…)", a position with which the Respondent disagrees because "the questioned act relates to the Corporate Income Tax (IRC) assessment and interest act (…) relating to the fiscal year 2012".

Indeed, although the Respondent has not called into question "(…) the relevance of the facts described in the court certificate proving the insolvency for purposes of proceeding with the cancellation of the receivables", "the non-acceptance of the deduction of the losses of the Claimant was based on the absence of express communication to the debtor as provided for in the (…) Corporate Income Tax Code, as an express condition of admissibility of acceptance of that expense" (emphasis ours).

Accordingly, from the analysis of the documentation made available by the Claimant, "by virtue of the manifest contradiction, the Respondent did not give credibility to the documents presented (…) as it is evident the manipulation (…) of such documents (…)".[9]

Additionally, the Respondent proceeds to state that "even if the accounting entries, replaced within the scope of the prior hearing exercise, had been worthy of credibility (…), it would still have to take into account that the said receivables were created in the years 2009, 2010 and 2011, and (…) certainly there would have already occurred (…) some of the assumptions justifying the existence of risk of uncollectibility and (…) by force of the principles of prudence and specialization of fiscal periods, the corresponding allowances for doubtful debts should already have been recorded", which "as the Claimant alleges (…) only (…) took place in 2012 (…)".[10]

ON THE DOCUMENTATION ATTACHED BY THE CLAIMANT

In this matter, the Respondent maintains that, as for the documentation attached by the Claimant, it cannot "be unaware that they are distinct taxes and with distinct procedures and whose compliance will determine their acceptance for tax purposes" therefore "if the tax legislation intended the use of procedures between different taxes it would have done so expressly (…)".

On the other hand, the Respondent further states that "it is evident the accounting discrepancy existing between the documents presented at the beginning of the tax inspection action and those presented within the scope of the right of prior hearing", wherefore "the Respondent concluded (…) correctly in not accepting the documents (accounting entries) submitted within the scope of the prior hearing (…)".

In these terms, given "the legal conformity of the tax act which is the subject of the present arbitration petition", the Respondent concludes its Reply in the sense that "(…) the present petition (…) should be judged unfounded (…) maintaining in the legal order the tax assessment acts and accordingly absolving (…) the Respondent from the claim".

PRELIMINARY RULINGS

4.1. The petition for arbitral pronouncement is timely filed as it was submitted within the period provided for in letter a), no. 1, of article 10 of the RJAT.

4.2. The parties have legal capacity and standing, are proper parties to the petition for arbitral pronouncement and are duly represented, pursuant to the provisions of articles 4 and 10 of the RJAT and article 1 of Ordinance no. 112-A/2011, of 22 March.

4.3. The Tribunal is regularly constituted, pursuant to the provisions of article 2, no. 1, letter a), articles 5 and 6, all of the RJAT, and is competent to consider the petition for arbitral pronouncement filed by the Claimant.

4.4. No exceptions to be heard have been raised.

4.5. No nullities exist and accordingly the merits of the petition must be considered.

  1. FACTUAL MATTERS

Established Facts

5.1. The following documented facts are considered proven:

5.1.1. The Claimant recognized in its accounts, in 2012, an allowance for doubtful debts receivable, in the amount of EUR 864,278.53, relating to its customer B… …, S.A. (B…), as evidenced by accounting entries no. 3760 and no. 3762, made available by the Claimant in the tax inspection action carried out (and copies of which form part of the administrative file attached by the Respondent);

5.1.2. B… was declared insolvent, through a judgment rendered by the Judicial Court of ... (1st Civil Division, case no. .../12....T...) on 29 August 2012 and which became final on 24 September 2012 (as per doc. no. 5 of the petition);

5.1.3. From the certificate identified in the preceding point it appears that "an Insolvency Administrator C was appointed" and that the Claimant here, while a creditor in the insolvency proceedings "claimed, in the form of capital credits of the amount of EUR 884,305.61 and interest EUR 39,927.00 (…) which the (…) Insolvency Administrator recognized (…) as subordinated (…)";

5.1.4. Within the scope of the said insolvency, the Claimant, having the intention of proceeding to regularize the Value Added Tax (IVA), in its favor, in the amount of EUR 129,605.11, sent a credit note (assessment notice no. 1200006, dated 19/11/2012) to the Insolvency Administrator, on 20 November 2015, through registered mail with A/R (as per doc. no. 6 of the petition), in which it states that it remits "the credit note (…), concerning the IVA on supplies not paid by the Insolvent Company (…) during the period 2009, 2010 and 2011" but nothing regarding the recognition of the allowance for doubtful debts relating to the totality of uncollectible receivables (in the amount of EUR 864,278.53);

5.1.5. The Claimant obtained from the company of Official Auditors "D…, SROC" a declaration, dated 8 May 2013, relating to "Certification by the Official Auditor of Uncollectible Credits for purposes of IVA Regularization" (as per doc. no. 7 of the petition);

5.1.6. Within the scope of the analysis of the Tax File for 2012, the Claimant was subject to a service order numbered OI2014…, of 23 January 2014, of partial scope concerning the Corporate Income Tax (IRC) for the year 2012 (as per a copy contained in the administrative file attached by the Respondent);

5.1.7. The Tax Inspection Division of the Directorate of Finance of ... notified, through Office no. …-…, of 12 June 2014, C, in the capacity of Insolvency Administrator of B…, through registered mail with A/R (no. … PT), requesting the submission, "within a period of 10 days" of "copies of all communications made by the company" here Claimant "within the scope of the insolvency proceedings …/12….T…, in which the company B… is insolvent" (as per a copy contained in the administrative file attached by the Respondent);

5.1.8. The Directorate of Finance of ... obtained a reply from the Insolvency Administrator identified in the preceding point, through an email sent by E, on 24 September 2014, in which it is stated that "the Insolvency Administrator, within the scope of the insolvency proceedings, did not receive any communication" from the Claimant here, "and there is pending litigation to be heard at the judicial court of ... concerning the assets that made up the fixed assets of company B…" (as per a copy contained in the administrative file attached by the Respondent);

5.1.9. Following the inspection carried out on the Claimant, it was notified through Office no. …-…, of 15 October 2014, to exercise within a period of 15 days (if it so wished) the right of prior hearing on the draft corrections of the inspection report (as per a copy contained in the administrative file attached by the Respondent);

5.1.10. The Claimant exercised the right of prior hearing in writing on 28 October 2014 (as per a copy contained in the administrative file attached by the Respondent);

5.1.11. Given that the Respondent understood that the right of prior hearing referred to in the preceding point did not come "to add any new matter or data or arguments that would prevent the production of effects and (…) maintenance of the tenor of the conclusions of the draft report notified", the same became a final report, with the corrections to the taxable income, in the amount of EUR 864,278.53, having been notified to the Claimant, through Office no. ……., of 5 November 2014 (as per doc. no. 4 of the petition).

5.1.12. The Claimant was notified of the Corporate Income Tax (IRC) assessment no. 2014 …, for the year 2012, in the total amount of EUR 40,833.78 (EUR 38,644.29, in the form of tax and EUR 2,149.89, in the form of compensatory interest), as well as of the interest calculation statement no. 2014 …, calculated from 1 June 2013 to 30 October 2014 and of the account reconciliation statement no. 2014 … (as per docs. no. 2, 3 and 1 of the petition);

5.1.13. The deadline for payment of the amount assessed, identified in the preceding point, was 16 January 2015 (as per doc. no. 1 of the petition);

5.2. No other facts capable of affecting the decision on the merits of the petition were proven.

Unproven Facts

5.3. It was not proven that the Claimant paid the amount of Corporate Income Tax (IRC) (EUR 38,644.29) and assessed interest (EUR 2,189.49), in a total of EUR 40,833.78 (with respect to the year 2012), without such fact having direct implication in the consideration of the merits of the petition for arbitral pronouncement.

5.4. No other facts were found to be unproven with relevance to the arbitral decision.

  1. MATTERS OF LAW

General Rules

6.1. The Corporate Income Tax Code, since its entry into force on 1 January 1989, has adopted the model of partial dependence between taxation and accounting for purposes of determining taxable profit.

6.2. Indeed, in number 10 of the Preamble of that Code it is stated that "given that taxation is levied on the economic reality constituted by profit, it is natural that accounting, as an instrument of measurement and information of that reality, plays an essential role as a support for the determination of taxable profit".

6.3. And continuing in the said Preamble, it is stated that "although to implement the broad notion of taxable profit adopted it would have been possible to adopt as a point of reference the result determined through the difference between the shareholders' equity at the end and at the beginning of the fiscal year" the "traditional methodology of relating taxable profit to the net profit for the fiscal period shown in the statement of income, to which are added the positive and negative equity changes occurring in the same period and not reflected in that profit" was maintained.

6.4. "In the other rules laid down regarding the aspects deemed to be regulated, the concern to approximate taxation to accounting was reflected, whenever possible."

6.5. Accordingly, in conformity with the provisions of article 17 of the Corporate Income Tax Code (in force in 2012), "the taxable profit of legal entities (…) is constituted by the algebraic sum of the net profit for the period and the positive and negative equity changes occurring in the same period and not reflected in that profit, determined on the basis of accounting and eventually corrected in accordance with this Code", and, in order to allow the determination (…), "the accounting must be organized in accordance with accounting standards and other applicable legal provisions (…), without prejudice to the observance of the provisions set forth in this Code, reflect all transactions carried out by the taxpayer and be organized in such a way that the results of transactions and equity changes subject to the general regime of Corporate Income Tax (IRC) can be clearly distinguished (…)" (emphasis ours).

6.6. In accordance with the provisions of article 18, no. 1 of the Corporate Income Tax Code (in force in 2012), for purposes of allocation of taxable profit to periods, "income and expenses, as well as other positive or negative components of taxable profit, are attributable to the tax period in which they are obtained or incurred, regardless of their receipt or payment, in accordance with the economic allocation regime" (emphasis ours).

6.7. On the other hand, in the Conceptual Framework of the System of Accounting Normalization[11][12], principles and concepts are established that underlie the preparation and presentation of financial statements, having as its purpose, in particular, to help the preparers of financial statements in the application of the Accounting Standards and Financial Reporting Standards (NCRF), recognizing that, in cases where there is a conflict between the Conceptual Framework and any NCRF, the requirements of the NCRF prevail over the Conceptual Framework.

6.8. In the said Conceptual Framework it is established that one of the qualitative characteristics of financial statements is prudence (paragraph 37), and it is stated in this regard that, as "the preparers of financial statements (…) must contend with the uncertainties that inevitably surround many events and circumstances, such as the doubtful collectibility of receivables (…) such uncertainties are recognized through disclosure of their nature and extent and through the application of prudence in the preparation of financial statements" (emphasis ours).

6.9. Indeed, "prudence is the inclusion of a degree of caution in the exercise of the judgments necessary to make the estimates necessary under conditions of uncertainty, so that assets or income are not overstated and liabilities or expenses are not understated (…)" because, otherwise, "(…) the financial statements would not be neutral and, therefore, would not have the quality of reliability" (emphasis ours).

6.10. Allowances for doubtful debts relating to receivables of doubtful collectibility must be in accordance with NCRF 27 (Financial Instruments), in accordance with which, at the date of each financial reporting period the impairment of all financial assets that are not measured at fair value through results must be assessed and, where there is objective evidence of impairment, the respective loss must be recognized in the statement of results.

6.11. For the purpose of "objective evidence of impairment", NCRF 27 identifies a set of factors, in particular, the significant financial difficulty of the debtor, the contractual breach (such as non-payment or default in payment) or the probability of the debtor entering into bankruptcy or any other financial reorganization.

6.12. The allowances for doubtful debts reflected in accounting should be, for tax purposes, analyzed under the provisions of the Corporate Income Tax Code and should be regularized, extracontabilistically[13], if necessary.

6.13. In this regard, it should be noted that, in general terms, in accordance with the provisions of article 23, no. 1, letter h), of the Corporate Income Tax Code (in force in 2012), "expenses are considered to be those which are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the productive source", namely "(…) allowances for doubtful debts".

Questions to be Decided

6.14. In the present case, there will be two disputed questions of law to which it is important to provide an answer, taking into consideration the articulation of the facts carried out with the provisions of the Corporate Income Tax Code, in force at the date of the facts (2012), given that the procedures adopted by the Claimant gave rise to corrections made by the Respondent and, as a consequence, led to this petition for arbitral pronouncement:

6.14.1. On the one hand, it will be relevant to provide an answer to the question of whether the Claimant met all the requirements, in tax matters, for the recognition, in 2012, of an allowance for doubtful debts which is tax deductible, in the amount of EUR 864,278.53, relating to its customer B…, in particular, whether or not it complied with the requirement provided for in article 41, no. 2 of the Corporate Income Tax Code (in the version in force in 2012), that is, whether the Claimant expressly communicated to the debtor the recognition of the expense for tax purposes, so that B… could recognize that amount as income for purposes of determining its taxable profit.

6.14.2. On the other hand, and as a consequence of the answer to be given to the question formulated in the preceding point, to conclude whether the recognition of the said allowance for doubtful debts can or cannot be considered tax deductible and, in that measure, conclude whether the corrections made to the taxable income, concerning the year 2012 (and the consequent Corporate Income Tax (IRC) assessment, which is the subject of the petition for arbitral pronouncement) are or are not illegal, with the consequences flowing therefrom.

Tax Deductible Allowances for Doubtful Debts

6.15. First of all, in accordance with the provisions of article 35, no. 1, letter a) of the Corporate Income Tax Code (in force in the year 2012), there could be "deducted for tax purposes the (…) allowances for doubtful debts recorded in the same tax period or in earlier tax periods", namely, "those related to receivables resulting from normal activity which, at the end of the tax period, can be considered of doubtful collectibility and are evidenced as such in the accounting (…)".

6.16. On the other hand, in accordance with the provisions of article 36 of the Corporate Income Tax Code (in force in the year 2012), "for purposes of determining the allowances for doubtful debts" provided for in letter a), no. 1, of article 35, "receivables of doubtful collectibility are considered to be those in which the risk of uncollectibility is duly justified, which occurs", namely, in the case of a debtor "having a pending insolvency and business recovery proceeding (…)".

6.17. Additionally, in accordance with the provisions of article 41 of the Corporate Income Tax Code (in force in 2012), "uncollectible receivables can be directly considered as expenses or losses of the tax period provided that this results from an insolvency and business recovery proceeding (…)", and that "the deductibility of the receivables considered uncollectible (…) is further dependent on the existence of proof of communication to the debtor of the recognition of the expense for tax purposes, which the debtor must recognize that amount as income for purposes of determining taxable profit" (emphasis ours).

6.18. Accordingly, in light of the above, we can conclude that there were, in 2012, general conditions for the tax acceptance of expenses or losses from allowances for doubtful debts on receivables, that is, that these derived from the normal activity of the Claimant, that they could be considered of doubtful collectibility, were evidenced as such in the accounting and that the risk of uncollectibility was duly justified, which would be verified when the debtor had a pending insolvency proceeding (as was the case with B…).[14][15]

6.19. On the other hand, for the receivables to be directly considered as expenses or losses of the tax period it was necessary that this resulted from an insolvency proceeding[16] (as is the case with B…), no allowance for doubtful debts had been admitted or, if it had been, it proved to be insufficient and there existed proof of communication made by the Claimant to B… of the recognition of the expense for tax purposes, with the debtor entity required to recognize that amount as income for purposes of determining its taxable profit.

6.20. With regard to the interpretation of the requirements provided for in article 41 of the Corporate Income Tax Code (in force in 2012), taking into consideration the question posed above in point 6.14.1., it is further fundamental to clarify whether it was (or should have been) required a formal and certain proof of uncollectibility of the receivable for it to be considered uncollectible (and, consequently, the respective amount would be considered, for purposes of Corporate Income Tax (IRC) assessment, an expense or loss of the fiscal year in the respective tax period in which it was recognized).

6.21. In this matter, it does not appear that the above-referred article should be interpreted in these terms for the reason that it would be an extraordinary burden to require that the taxpayer (interested in the deduction), had to wait several years for the liquidation of the asset and payments to claiming and graduated creditors by the product of liquidation.

6.22. Accordingly, in this matter, the most reasonable and logical interpretation is that which results from an objective and safe prognosis judgment made on the basis of indications of "objective evidence of impairment" (as is also recommended for accounting purposes – see point 6.11., supra), from which it can be concluded that the collection of the receivable proves to be impossible (and is therefore declared uncollectible).[17]

6.23. Thus, when article 41 of the Corporate Income Tax Code stated, in 2012, that "uncollectible receivables can be directly considered as expenses or losses of the tax period provided that this results from an insolvency and business recovery proceeding (…)", such provision must be interpreted in the sense that it is not the final (formal) result of the proceeding (of insolvency) that matters but rather that which derives from a set of acts and facts "reflected" in that same proceeding and revelatory beyond doubt of the uncollectibility of the receivable.[18]

6.24. Accordingly, in light of this reality revealed through the insolvency proceeding of B…, one of the legally provided requirements for the Claimant's receivable, on that entity, to be considered uncollectible was guaranteed [because it resulted from an insolvency proceeding (see requirement referred to in point 6.19., supra)].

6.25. Indeed, even though, formally, the receivable which was the subject of a claim in an insolvency proceeding subsists, for the reason that it was not extinguished legally by the legally provided methods, such circumstance cannot be preventive of the tax relevance of a classification that points unequivocally to its uncollectibility, with repercussions on taxation, in Corporate Income Tax (IRC), for both Parties to the insolvency proceeding (debtor and creditor).

6.26. Notwithstanding the above, it will still be necessary to verify whether the Claimant did or did not comply with the requirement provided for in article 41, no. 2 of the Corporate Income Tax Code (in the version in force in 2012), for the reason that it required one more condition to the declaration of uncollectibility of the receivable (proof of communication to the debtor of the recognition of the expense for tax purposes), and this is the base argument invoked by the Respondent for purposes of support of the corrections made and, consequently, at the origin of the tax assessment that the Claimant seeks to annul.

6.27. Indeed, the Claimant alleged in its petition for arbitral pronouncement that it communicated "to the Insolvency Administrator the IVA regularization in its favor in the year 2012, through registered mail with acknowledgment of receipt" (article 21 of the petition), a fact which is confirmed by the documentation attached to the proceedings (as per doc. no. 6 of the petition) and was proven in point 5.1.4., supra.

6.28. However, this Arbitral Tribunal cannot agree with the position defended by the Claimant when it states, in its petition for arbitral pronouncement, that "the communication (…) sent to the debtor, in the person of its Insolvency Administrator, fulfills its purpose, even if it does not expressly refer to article 41 of the CIRC", for the reason that that communication was intended to inform the debtor of the Claimant's intention to proceed with the IVA regularization (relating to B…'s debt, in the amount of EUR 129,605.11) and not to inform it that an allowance for doubtful debts would be recognized, in the year 2012, relating to the same debtor's debt, in the amount of EUR 864,278.53.

6.29. Indeed, underlying this accounting-tax reality were two types of taxes (Corporate Income Tax (IRC) and IVA), of diverse nature (the first, a tax on income and the second, a tax on consumption), whose accounting regularization entries would originate tax implications of a distinct nature.

6.30. Indeed, in general terms, if Corporate Income Tax (IRC) is considered a direct tax, applied to the income of companies operating in Portuguese territory and is levied on the income obtained, in the tax period, by the respective taxpayers, whereas IVA, as an indirect tax, is levied on transfers of goods and provision of services, on imports of goods and on intra-community operations, provided that they are considered as carried out in national territory.

6.31. Accordingly, taking into consideration the above, this Arbitral Tribunal agrees with the position defended by the Respondent when it states that "they are distinct taxes and with distinct procedures", it being important to clarify that "if tax legislation intended the use of procedures between different taxes it would have done so expressly(…)"[19] (emphasis ours).

6.32. And so much so that the declaration obtained from the company of Official Auditors "D…, SROC", dated 8 May 2013, concerns the "Certification by the Official Auditor of Uncollectible Credits for purposes of IVA Regularization", in accordance with the terms and conditions provided for in no. 7 of article 78 of the IVA Code (as per doc. no. 7 of the petition, which was proven in point 5.1.5., supra), saying nothing regarding the recognition, for purposes of Corporate Income Tax (IRC), of the respective allowance for doubtful debts, in accordance with the provisions of article 41, no. 2 of the Corporate Income Tax Code (in force in 2012).[20]

6.33. In reality, at no point does the text of the declaration referred to in the preceding point refer to the recognition of an allowance for doubtful debts, in the year 2012, being only stated, as a "Conclusion" that, "in light of the analysis carried out, and with respect to (…)" the Claimant, "we certify that the conditions are met for the regularization of IVA in accordance with letter b) of no. 7 of article 78 of the CIVA" (emphasis ours).

6.34. Accordingly, it shall be concluded that the answer to be given to the question posed above in point 6.14.1. should be in the sense that the Claimant did not comply with all the requirements necessary for recognition, for tax purposes, of the allowance for doubtful debts under analysis, in particular, with regard to the requirement provided for in article 41, no. 2 of the Corporate Income Tax Code (in the version in force in 2012).

6.35. As a consequence of the conclusion assumed in the preceding point, the answer to be given to the question posed in point 6.14.2., supra, shall be to conclude that the recognition of the said allowance for doubtful debts cannot be considered tax deductible and, in that measure, the corrections made by the Respondent to the taxable income of the Claimant, in the fiscal year 2012, are legal and, as a consequence, the Corporate Income Tax (IRC) assessment (tax and interest) which is the subject of the petition for arbitral pronouncement cannot be considered illegal.

6.36. Accordingly, in light of the above, taking into consideration the negative answers given to the questions posed in points 6.14.1. and 6.14.2., supra, it shall be concluded that the petition for arbitral pronouncement submitted by the Claimant should be considered unfounded.

On Liability for Payment of Arbitral Costs

6.37. In accordance with the provisions of article 527, no. 1 of the CPC (ex vi 29, no. 1, letter e) of the RJAT), it shall be established that the Party which gave cause to the costs or, where there is no successful party to the action, whoever derived benefit from the proceedings, shall be condemned to costs.

6.38. In this regard, in accordance with no. 2 of article 527 of the CPC (referred to above), and in accordance with the principle of cost shifting, by the expression "gave cause" it should be understood that the losing party gives cause to the costs of the proceedings, in proportion to the extent that it loses.

6.39. Accordingly, in light of the above, and taking into account the conclusions of the analysis carried out, it results that liability for arbitral costs shall be imputed to the Claimant.

7. DECISION

7.1. In accordance with the provisions of article 22, no. 4, of the RJAT, "the arbitral decision rendered by the arbitral tribunal contains the fixing of the amount and the allocation among the parties of the costs directly resulting from the arbitration proceedings".

7.2. In the case under analysis, taking into account the above, the principle of proportionality imposes that the totality of liability for costs be attributed to the Claimant.

7.3. Accordingly, taking into account the analysis carried out, this Arbitral Tribunal decided:

7.3.1. To judge the petition for arbitral pronouncement submitted by the Claimant unfounded, and accordingly to maintain the respective Corporate Income Tax (IRC) assessment (tax and interest) for the year 2012;

7.3.2. To condemn the Claimant to payment of the costs of the present proceedings.

Value of the Proceeding:

In accordance with the provisions of article 306, no. 2 of the CPC, article 97-A, no. 1 of the Code of Tax Procedure and Process (CPPT) and article 3, no. 2 of the Regulation of Costs in Tax Arbitration Proceedings, the value of the proceeding is fixed at EUR 40,833.78.

In accordance with the provisions of Table I of the Regulation of Costs in Tax Arbitration Proceedings, the value of the costs of the Arbitration Proceeding is fixed at EUR 2,142.00, to the charge of the Claimant, in accordance with article 22, no. 4 of the RJAT.

Notify accordingly.

Lisbon, 22 October 2015

The Arbitrator

Sílvia Oliveira

[1] The writing of this decision is governed by the spelling prior to the Orthographic Agreement of 1990, except for transcriptions made.

[2] Because submitted to CAAD on 15 April 2015.

[3] Final judgment on 24 September 2012.

[4] According to the Claimant, this debt relates to invoicing issued to its customer B… in 2009, 2010 and 2011.

[5] Which was issued on 18 March 2013.

[6] In this regard, the Claimant cites an Information from the Tax Authority (a copy of which was attached to the case through the administrative file), issued by the Corporate Income Tax (IRC) Service Directorate, at the request of the Directorate of Finance of ..., regarding no. 2 of article 41 of the Corporate Income Tax Code, following a tax inspection procedure carried out for the tax period of 2012, in accordance with which it is written that the reference in that rule "to receivables considered uncollectible under article 36 of the CIRC must be understood in the sense that the uncollectibility of receivables is verified when these are derecognized from assets in situations where the allowance for doubtful debts has already been considered at 100% and the uncollectibility proves to be justified. Accordingly, it should be in the tax period in which accounting derecognition of the receivable takes place that the creditor must effect communication to the debtor of the recognition of the expense for tax purposes, even if this has been considered in prior tax periods through allowances for doubtful debts recorded based on default and the existence of objective evidence of impairment" (emphasis ours).

[7] Accounting entry no. 3760.

[8] Accounting entry no. 3762.

[9] In this matter, the Respondent maintains that it ascertained, in the course of the Tax Inspection, and from the documents supporting the entries made (accounting entries nos. 3760 and no. 3762, copies of which were attached to the case through the administrative file), that "the Claimant recorded the allowances for doubtful debts in account 6511 (…) against account 2111 (…), in the amount of € 755,042.29 and in account 6512 (…) against account 2211 (…), in the amount of € 109,236.24". Notified of the Draft Tax Inspection Report, to exercise the respective right of prior hearing, "the Claimant sent other accounting entries (even though displaying the same numbers as the earlier ones), (…) with the difference that the accounts moved are different from those that were presented during the inspection action". Those "differences (…) are manifest in the fact that, in the latter, the receivables of "Customers" and "Suppliers" are not canceled, for the reason that the accounts moved against accounts 6511 and 6512 became accounts 219 and 229" (emphasis ours).

[10] In this regard, the Respondent cites the Judgment of the Court of Administrative Appeals [TCAS], rendered in the course of case no. 7661/14, of 19.02.2015, in accordance with which it is stated that "it is not possible to consider directly as an expense of the fiscal year uncollectible receivables (…) without demonstrating that with respect to the same no provision was admissible (…)".

[11] Accounting Normalization System (SNC), approved by Decree-Law no. 158/2009, of 13 July and in force since 1 January 2010.

[12] Approved by Dispatch no. 589/2009/MEF of the Secretary of State for Tax Affairs, of 14 August 2009 (in substitution of the Minister of State and Finance) and published in Official Gazette no. 173 (2nd series) of 7 September 2009 (Notice no. 15652/2009).

[13] Through adjustments to be made to the net profit for the fiscal year, in framework 07 of the tax return for the tax period in question (that is, in the Model 22 return), with a view to determining the taxable profit of the respective fiscal year.

[14] In this regard, only the type of proceeding applicable in the situation under analysis is indicated.

[15] Whose verification was made through a certificate issued, within the scope of case no. …/12…T…) by the 1st Civil Division of the Judicial Court of ... (as per doc. no. 5 of the petition).

[16] See previous footnote.

[17] It should be noted that, with the Reform of the Corporate Income Tax (Law no. 2/2014, of 16 January), applicable to tax periods beginning on or after 1 January 2014, the date of the event generating the loss by uncollectible receivable is expressly defined, as a result of insolvency (among other types of legally provided proceedings), that is, "uncollectible receivables can be directly considered as expenses or losses of the tax period (…) provided that no allowance for doubtful debts has been admitted or this proves to be insufficient (…)" following "insolvency proceedings, when the same is ordered of a limited nature or after the approval of the decision provided for in article 156 of the Code of Insolvency and Business Recovery" (as per the text of article 41, no. 1, letter b) of the Corporate Income Tax Code in force in the year 2014). Subsequently, this article underwent a further amendment [which resulted from Law no. 82-C/2014, of 31 December (State Budget 2015) in force since 1 January 2015], with letter b) of no. 1 having taken the following wording: "in insolvency proceedings, when the same is ordered of a limited nature, after the final judgment of the receivables verification and classification decision provided for in the Code of Insolvency and Business Recovery or, where it exists, the approval of the plan subject to the deliberation provided for in article 156.º of the same Code" (emphasis ours).

[18] In this sense, cite, with the necessary adaptations, the Judgment of the Higher Administrative Court [AC STA] no. 782/12, of 10/10/2012, in accordance with which it is stated that "article 39 (41, in 2012) of the Corporate Income Tax Code (in the version that was given to it by Decree-Law no. 198/2001, of 3 July), admitted as expenses or losses of the fiscal year receivables which, among other things, resulted uncollectible from special bankruptcy or insolvency proceedings (…)". Indeed, the said Judgment defended that "that rule does not require that the receivables (…) can only be recorded as uncollectible receivables by means of a judgment with final effect that declares their uncollectibility (…)".

[19] And, as the Respondent states, "the interpretation of rules by analogy is prohibited within the scope of tax law (…)".

[20] Note that even in the said Certification, in the chapter "Description of Receivables", it is stated that the same "concerns a receivable (…) whose total value is EUR 884,305.61, including a global amount of IVA of EUR 129,605.11 (…)", whereby the total receivable value indicated there does not coincide with the value of the allowance recorded in 2012, relating to the debtor B… (EUR 864,278.53) and which is the subject of the petition for arbitral pronouncement.

Frequently Asked Questions

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What are the requirements for recognizing impairment losses on bad debts under Article 41(2) of the Portuguese IRC Code?
Under Article 41(2) of the Portuguese IRC Code (applicable for 2012), companies must meet specific requirements to recognize impairment losses on bad debts as tax-deductible expenses. The law requires: (1) the debt must be considered uncollectible based on objective criteria; (2) the company must communicate to the debtor that the debt is being considered uncollectible for tax purposes; and (3) proper accounting documentation must support the impairment recognition. In cases of insolvency, companies must demonstrate the debtor's insolvency status through official documentation, such as court certificates, and prove participation in creditor claims processes. The formal communication requirement under Article 41(2) has been interpreted strictly by tax authorities, though its application in insolvency contexts where debtors are under court administration raises practical questions addressed in arbitration cases like Process 255/2015-T.
How did the CAAD rule on the deductibility of bad debt impairment losses for IRC purposes in Process 255/2015-T?
In Process 255/2015-T, the CAAD (Administrative Arbitration Center) reviewed whether A… Lda. properly complied with Article 41(2) requirements for deducting a €864,278.53 impairment loss related to an insolvent customer. The Tax Authority rejected the deduction, arguing the company failed to provide the required communication to the debtor. The claimant defended its position by presenting a court certificate proving the debtor's insolvency declaration (finalized September 24, 2012) and demonstrating it had formally claimed €924,232.61 in credits recognized by the Insolvency Administrator as subordinated claims. The company also successfully regularized €129,605.11 in VAT based on the same uncollectible debt, suggesting tax authorities accepted the debt's uncollectible nature for VAT purposes. The arbitral tribunal analyzed whether formal participation in insolvency proceedings and obtaining official court certification constitutes sufficient compliance with the communication requirement when direct notification to an insolvent debtor under court administration may be redundant or procedurally inappropriate.
What is the role of the CAAD in resolving corporate income tax (IRC) disputes in Portugal?
The CAAD (Centro de Arbitragem Administrativa - Administrative Arbitration Center) serves as an alternative dispute resolution forum for resolving corporate income tax (IRC) disputes in Portugal under the Legal Regime for Arbitration in Tax Matters (RJAT - Decree-Law 10/2011). Companies can submit tax disputes to CAAD instead of pursuing traditional administrative appeals or court litigation. The CAAD appoints qualified arbitrators to form arbitral tribunals that issue binding decisions on tax matters, including IRC assessments, deductions, and compliance issues. The arbitration process is generally faster and more specialized than court proceedings. In IRC disputes, CAAD tribunals examine whether tax assessments comply with substantive and procedural requirements of the IRC Code, review technical accounting and tax issues, and determine the lawfulness of Tax Authority decisions. Process 255/2015-T exemplifies CAAD's role in resolving complex IRC issues, such as the interpretation of Article 41(2) requirements for bad debt impairment losses, where a single arbitrator was appointed to decide whether formal compliance requirements were met in an insolvency context.
Can a company challenge an IRC tax assessment through arbitration under the RJAT (Decree-Law 10/2011)?
Yes, Portuguese companies can challenge IRC (Corporate Income Tax) assessments through arbitration under the RJAT (Decree-Law 10/2011 of January 20). Article 10(2) of the RJAT allows taxpayers to file petitions for arbitral pronouncement within 90 days from the end of the voluntary payment period for the contested tax obligation. The process involves: (1) filing a petition with CAAD requesting constitution of an arbitral tribunal; (2) payment of initial arbitral fees according to the Regulation of Costs; (3) appointment of arbitrators (parties may appoint arbitrators or the CAAD President appoints them); (4) constitution of the tribunal; (5) submission of replies by the Tax Authority; and (6) issuance of a binding arbitral decision. In Process 255/2015-T, A… Lda. filed its petition on April 15, 2015, challenging an IRC assessment issued for 2012, with the payment deadline having ended on January 16, 2015, demonstrating timely filing within the 90-day period. The arbitral decision is binding and enforceable, providing an alternative to traditional administrative and judicial appeals for resolving IRC disputes efficiently.
What documentation and conditions must Portuguese companies meet to claim impairment losses on uncollectible receivables for IRC in 2012?
For the 2012 tax year, Portuguese companies seeking to claim impairment losses on uncollectible receivables for IRC purposes must meet the conditions specified in Article 41(2) of the IRC Code. Required documentation and conditions include: (1) Accounting records: proper booking of the impairment loss in financial accounts following Portuguese accounting standards; (2) Proof of uncollectibility: objective evidence demonstrating the debt is uncollectible, such as court insolvency declarations, bankruptcy proceedings, or execution proceedings showing insufficient assets; (3) Communication to debtor: formal notification to the debtor stating the debt is being considered uncollectible for tax purposes (Article 41(2) requirement); (4) Court certificates: when insolvency is involved, official court certificates proving insolvency declaration dates, finalization dates, and creditor claims recognition; (5) Creditor claims documentation: evidence of formally claiming credits in insolvency proceedings and recognition by court-appointed administrators; and (6) VAT regularization consistency: if applicable, corresponding VAT adjustments should align with IRC treatment. In Process 255/2015-T, the claimant provided court certificates, Insolvency Administrator recognition of €924,232.61 in claims, and VAT regularization of €129,605.11, but faced Tax Authority challenges regarding the formal communication requirement's application in insolvency contexts where debtors are under court administration.