CAAD 269/2015-T: SGPS Tax Benefits on Financial Charges Under Article 32(2) EBF – IRC 2010

ARBITRAL DECISION

The arbitrators Fernanda Maçãs (President Arbitrator), João Sérgio Ribeiro and António Martins, designated by the Deontological Council of the Center for Administrative Arbitration to form the Arbitral Tribunal, constituted on 30/6/2015, agree as follows:

I. REPORT

1. The company "A ..., SGPS, S.A.", Tax Identification Number ..., submitted, on 22/4/2015, a request for constitution of a collective arbitral tribunal, pursuant to the combined provisions of articles 2, no. 1, paragraph a), and 10 of Decree-Law no. 10/2011, of 20 January (Legal Regime of Arbitration in Tax Matters, hereinafter referred to only as RJAT), in which the Tax and Customs Authority (hereinafter also AT) is the Respondent.

2. The claim subject matter of the request for arbitral decision consists in the assessment of the legality of assessment no. 2014..., of 10/11/2014, which gave rise to the statement of account reconciliation no. 2014..., compensation 2014..., in the amount of €630.911,71, relating to Corporate Income Tax (IRC) for the tax year 2010, issued by the Collection Services Directorate of the Tax and Customs Authority on 28/11/2014.

3. The Claimant requests that, following the merits of the request, there be "(…) declared illegal and annulled the assessment sub judice with respect to the correction to taxable profit (in the amount of €2.742.559), modification of the municipal surcharge (to €39.808,63) and compensatory interest (of €32.489,56), with the consequent effects thereof".

4. On 24/4/2015, the request for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority.

4.1. The Claimants did not proceed to appoint an arbitrator, wherefore, pursuant to the provisions of paragraph a) of no. 2 of article 6 and paragraph b) of no. 1 of article 11 of RJAT, the President of the Deontological Council designated the undersigned as arbitrators of the collective arbitral tribunal, who communicated acceptance of the designation within the deadline.

4.2. On 15/6/2015, the parties were notified of the designation of the arbitrators and raised no objection.

4.3. In accordance with the provision of paragraph c) of no. 11 of RJAT, the collective arbitral tribunal was constituted on 30/6/2015.

4.4. Accordingly, the Arbitral Tribunal is regularly constituted to assess and decide the subject matter of the proceedings.

1. The main questions to be decided concern the meaning and scope of article 32, no. 2, of the Tax Benefits Statute (hereinafter also EBF), requiring determination of: i) What is the moment in which financial charges should be considered; and ii) What is the methodology for determining the quantum of charges to be considered.

i) With respect to the question of the moment in which charges should be considered.

To substantiate the request for arbitral decision, the Claimant, which submits various documents and an opinion from Professor Doctor Carlos Baptista Lobo, alleges, in summary:

a) That in section I.4. of the Inspection Report under the item "Brief description of corrections made", the following is stated:

"From the internal analysis carried out on the accounting and tax elements of the 2010 tax year, from the individual accounts of company B..., SGPS, SA ("B..."), "taxable person" or "company"), Tax Identification Number..., the following correction resulted:

Financial charges not tax-deductible - article 32 no. 2 of EBF

The taxable person increased the net result by the amount of 123.122,72 euros referring to financial charges borne in connection with the acquisition of equity stakes which, in accordance with no. 2 of the Tax Benefits Statute ("EBF"), do not contribute to the determination of taxable profit. However, the amount determined by the Tax Authority for charges of this nature amounts to 2.865.681,94 euros, wherefore the amount of 2.742.559,22 euros should be corrected, corresponding to the difference between these two amounts;

b) The said correction, in the amount of €2.742.559,22 results from an erroneous and unlawful interpretation made by the AT, conveyed by Circular no. 7/2004, of 30 March of the IRC Services Directorate, both as to the meaning and scope of article 32, no. 2 of the Tax Benefits Statute, and as to the methodology for determining the quantum of financial charges to be disregarded, through the definition of an indirect method of allocation of financial charges to equity stakes;

c) A SGPS must accept the tax deductibility of those financial charges in the tax year in which it bore them, evaluating any increase thereof, for purposes of determining its taxable profit, only at the moment of disposal of the equity stake held and provided that the requirements underlying the application of the regime are met;

d) To the practical difficulty of relating gains (which are generated at a particular point in time) to financial charges (which may continue over time), the AT, without any legal support or foundation, provides the solution that suits it best, that is, a priori it always disregards financial charges and, a posteriori, it will verify, depending on how gains are treated, whether such charges will have to be considered and accepted as a cost.

e) This procedure finds no minimum basis or support in law, wherefore financial charges should be considered as a tax cost or expense and only if and when gains resulting from the disposal of equity stakes are realised and are, in accordance with article 32, no. 2, of EBF, disregarded.

For its part, with respect to this same question, the AT submitted a response and attached the investigation file, invoking, in summary, the following:

a) The solution adopted by Circular no. 7/2004, as regards the tax year in which corrections to financial charges should be made, reflects the legislature's concern not to influence the taxable profit of the tax year in which financial charges are borne in connection with the acquisition of participations capable of benefiting from no. 2 of article 31 of EBF, without first knowing whether they may or may not contribute to the formation of taxable profit of the company;

b) That circular determines that if it is concluded, at the moment of disposal of the participations, that not all requirements for application of that regime are verified, such provision would, in that tax year, result in the consideration as a tax cost of financial charges that were not considered as a cost in the tax year in which they were borne;

c) Charges that may contribute to the formation of taxable profit will, at most, be recognized in the period immediately following that in which they were borne, and those that cannot be recognized in that immediately subsequent period simply do not meet the requirements to contribute to the formation of taxable profit;

d) The solution recommended by that circular addresses the legislature's concerns regarding the time allocation of taxable profit, especially when combined with the provision of article 23 of CIRC, preventing its recognition in the tax year in which, although borne, it is not yet possible to determine its indispensability to the formation of taxable profit;

e) The Decision of STA no. 269/2012, states:

«For MANUEL H. F. PEREIRA (See "The time allocation of taxable profit", Science and Tax Technique, 1988, no. 349, pp. 80-81.) referring to the importance and rationale of the principle of specialization of tax years, considers that "the temporal specialization of profit components is even more important for tax purposes than accounting purposes, given the constraints in which tax determination occurs, so as to avoid distortions of results between different tax years with purposes of tax burden minimization, (…). Indeed, that temporal allocation may be an instrument of result manipulation, so as to, namely:

a) Defer profits in time;

b) Fragment profits, distributing them among different tax years, with the objective of avoiding, in a tax with progressive rates, taxation at higher rates;

c) Concentrate profit in a tax year where larger deductions can be realized (e.g. through loss carryforwards or tax incentives).»

f) The legal obligation to quantify financial charges not deductible resulting from the articulation of this regime with article 32 of EBF rested on the Claimant within the scope of determining taxable profit and filing the annual return where it self-assessed IRC;

g) The financial charges borne in the tax year in question, in the amount that it understands to be related to the acquisition of the totality of equity stakes, do not, as a result, contribute to the formation of the Claimant's taxable profit, regardless of whether the Claimant, with respect to those equity stakes, realized gains with their disposal;

h) The tax cost of financial charges borne in connection with the acquisition of equity stakes, regardless of whether gains were generated, should not be considered, as there is no nexus between one thing and the other.

ii) With respect to the methodology for determining the quantum of charges to be considered.

The Claimant alleges that:

a) Beyond the disagreement as to the meaning and scope of article 32, no. 2 of EBF, disagreeing with what is attributed to it by the Circular and with what is inherent in the AT's procedure, it also does not agree with the methodology for determining the "quantum" of financial charges to be disregarded, through the definition of an indirect method of allocation of those charges to equity stakes pursued by the Circular and the AT;

b) The AT does not question upfront – as would be imperative – whether the financing obtained was contracted for the acquisition of equity stakes or was used in financing to meet the cash needs of its subsidiaries or whether, even, it was used to pay workers' salaries;

c) The AT did not take any steps to ascertain whether the loans contracted were intended for the acquisition of the equity interests of which the company was a holder;

d) The AT ignores even the time factor, disregarding the dates of acquisition of equity stakes and the dates of contracting of loans, merely fictionalizing that loans must be related to those acquisitions in a logic of "everything is related to everything" and, based on that erroneous and unlawful inducement, applies formulas and establishes proportions.

e) "the AT not only did not develop any type of strategy that would make it possible to mitigate the identified risks, but proposed a method that clearly exceeds the spirit of the legislature underlying article 32, no. 2 of EBF, contrary to the constitutional principles of legality and typicality";

f) The Circular completely departs from the law, as it proceeds from a fear that a method of direct or specific allocation would be to be avoided due to "(…) the possibility of manipulation that it would allow…", always imposing an indirect or pro rata method;

g) The method of direct allocation appears to be the only one that, in addition to being more just and rigorous, finds support in the good and correct interpretation of the text of the law;

h) It is evident that the legislature only intended the tax disregard of financial charges incurred in connection with financing actually related to the acquisition of equity stakes, and only these;

i) The letter and teleology of the norm in question rule out the admissibility of using a pro rata method, requiring respect for the actual allocation of the destination of the loans obtained and only after that determination would it be admissible to use an indirect method, in light of what occurs, for example, in the context of Value Added Tax;

j) By resorting to indirect methods to fictionalize the financial charges supposedly incurred in connection with the acquisition of equity stakes, the AT incurs another serious and frontal unlawfulness – the improper resort to indirect assessment;

k) The AT ended up presuming that with the existence of financial charges and, simultaneously, financial participations, there were financings for the acquisition of equity stakes and, based on the formulas and doctrine of "guessing" contained in the Circular, it also presumes the amount of financial charges attributed to the acquisition of equity stakes, thus determining, at its discretion, the taxable matter;

l) The indirect method advocated by the Circular is manifestly fragile and inconsistent;

m) The amount of equity stakes held by the Claimant during 2010 considered by the AT in the quantitative calculation method of financial charges it uses (map constituting annex 5 to the individual report) throughout the different months of the year is as follows:

• January to March 2010: €275.352.449,70
• April: €275.613.892,40
• May to November: €275.588.952,51
• December: €277.719.140,71;

o) It is, therefore, a sophism, because completely removed from reality, to consider, as the AT does wrongly and unlawfully, that the Claimant bore financial charges in connection with the acquisition of those participations or equity stakes;

p) The AT should have, accordingly, paid attention to the concrete reality of the Claimant, which demonstrates the absence of borrowing in connection with the acquisition of those equity participations and not, based on the unlawful, fragile and incorrect methodology contained in the Circular, have presumed through unlawful recourse to indirect methods, which putative charges were borne by the Claimant in connection with such acquisition;

q) In summary, for the Claimant "The assessment act sub judice is manifestly unlawful due to erroneous qualification and quantification of profits, absence or defect of legally required substantiation and non-compliance with other legal formalities, embodied, moreover, in the violation of articles 32, no. 2, of EBF, 8, 74, no. 1, 85, no. 2, 87 and 90 of LGT, 13, 103, nos. 2 and 3 and 104, nos. 2 and 3 of the Constitution, of the principles of tax legality, specialization of tax years and capacity to pay, requiring its annulment, in accordance with the provisions of articles 2, no. 1, paragraph a) of RJAT, 99, paragraphs a), c) and d) of CPPT and 135 of CPA." (see the 36th Conclusion of the Request).

With respect to that same question, the AT invoked, in summary, the following:

a) After transcribing the content of the legal norm applied, as well as of the Circular whose illegality/unconstitutionality is invoked, it is further necessary to clarify that, notwithstanding what is alleged by the Claimant, the method used in this case, regardless of being recommended by Circular no. 7/2004, of 30/03, is adopted by the generality of equity stake management companies, which employ it according to the extreme complexity and subjectivity of direct allocation of those charges to the various assets;

b) Given the intrinsic characteristics of money, this method is a necessary tool for SGPSs, so as to allow them to effect the allocation of these charges to equity stakes and determine the taxable profit of the tax year in accordance with applicable legislation;

c) As considered in the arbitral decision rendered in Case no. 12/2013-T, referring to the quantification of financial charges allocable to equity stakes:

«... the data of the question do not have this linearity or simplicity: there is no direct factual relationship between the funds obtained (with payment of interest) and the funds provided (without interest) – but only the application of an approximate formula described in Circular 7/2004 (precisely because of the fungibility of money), in order to determine, in the application of article 32, no. 2, of EBF, which "financial charges borne" in connection with the acquisition of equity stakes.» And it proceeds:

«... tax law contains no specific rule or specific principle of tax disregard of costs, if the funds obtained from them do not generate any taxed income.

And it does not contain one for reasons of simplicity and adherence to truth.

Simplicity is anchored in the difficulty of establishing a direct causal relationship between a cost and a financial income, in an organization, like a commercial company, whose financing provided is intended, as a rule, for the totality of its activity and which resorts indistinctly to own and third-party funds to pursue its purpose and it is impossible to ascertain whether the funds of interest-free transactions provided to its subsidiaries come from third-party or own financing and in what proportion each occurred... it is this reason that presides, moreover, over Circular 7/2004, for SGPSs...»;

d) It is therefore evident that the reason for the use of the method of allocation of financial charges to equity stakes used in this case is that of taxation closest to the possible real profit, respecting the provision of no. 2 of article 32 of EBF;

e) Note that the norm contained in no. 2 of article 31 of EBF, in the version given by Law no. 32-B/2002, of 30/12, in determining that financial charges borne in connection with the acquisition of equity interests do not contribute to the formation of taxable profit of SGPSs, did not establish the method to be used for purposes of allocating financial charges to equity interests;

f) In truth, Circular no. 7/2004, in respect for the ratio legis implemented with the legislative change to no. 2 of article 32 of EBF, seeks only to give effect to the law, determining the method and manner of calculating financial charges borne in connection with the acquisition of equity interests;

g) The Arbitral Tribunal pronounced on the legality and constitutional conformity of that Circular. It was decided, in fact, in Case no. 21/2012-T:

«Indeed, we consider that the adequate interpretation of the special regime applicable to SGPSs, provided for in no. 2 of article 31 of EBF, explained above in development, leads us to consider that the purpose of the legislature when it put that regime into effect was to indeed prevent that (on the assumption that potentially the SGPS may come to benefit from the exclusion of taxation applicable to gains realized with the disposal of equity interests) the relevant costs that are related to the obtaining of such gains may have relevance in terms of determining the taxable profit of the taxable person who obtained them.

Whence it is inferred that it is not Circular no. 7/2004 that creates irrebuttable presumptions of non-deductible costs, but it is the law itself, interpreted in the terms above stated, that precludes the deductibility of financial charges (incurred in connection with financings linked to the acquisition of equity interests disposed of and which realize gains excluded from taxation) for purposes of determining the taxable profit of the tax year in which they are incurred, even if prior to that of the realization.

Except as regards the imposition, in no. 7 of Circular 7/2004, of the use of the indirect method of allocation of financial charges (we considered above that nothing prevented, on the assumption that direct allocation were possible, that it could be undertaken, thus contradicting the imposition of the indirect method of allocation of financial charges), we do not see in what way that administrative doctrine may contain rules of tax incidence, rate determination and assessment, thus violating the principle of tax legality provided for in nos. 2 and 3 of article 103 of the Constitution.

(...)

What is important here to draw is that the tax self-assessment act here in question is not vitiated or affected by any illegality (by violation of any constitutional principle) that may be leveled against it based on this question of allocation of financial charges, so much so that, as the Respondent alleges in its response, associated with the issuance of Circular no. 7/2004, of 30 March, there exists no legislative intention on the part of the AT, or, at least, we are unable to discern one.»

h) The disregard of financial charges results solely from the legal framework in force and not from the eventual application of the criteria contained in the aforementioned Circular no. 7/2004, of 30/03;

i) The importance of those orientations results, in the first place, from the fact that "tax activity [is] today a massive activity, involving the processing of thousands of cases, generally translated in tax returns of taxpayers and in this context it is an important element of legal certainty the prior knowledge of the organization implemented to deal with those cases, of the criteria and procedures it adopts, given that, namely, it allows individuals faced with a problem or a doubt to know, if there is internal regulation on that matter, how, in principle, that case will be solved by the officials responsible for applying the law»;

j) Additionally, the explanation, in the circular in discussion, of the method to be used for purposes of charges to equity participations, besides promoting legal certainty, contributes to the effective realization of the extrafiscal purposes above stated (and which presided over the very creation of the special regime for SGPSs) and has the virtue, no less important, of preventing taxpayers from using the normative in question to pursue objectives completely alien to the purposes envisaged in the law and which subvert the justice of the entire tax system;

k) The understanding set forth in Circular no. 7/2004, of 30/03, is limited to attempting to clarify the emerging doubts about the tax regime applicable to SGPSs and SCRs, provided for in article 31 of EBF, in the version given to it by Law 32-B/2002, of 30/12 (State Budget for 2003);

l) For the Respondent, in summary, "the interpretation defended by the Claimant (…)" is "contrary to the Fundamental Law, in that it violates the principles of tax equality, capacity to pay and taxation of real income".

5.2. The Respondent further raised the exception of the Tribunal's lack of material jurisdiction, with respect to the request for recognition of the right, in accordance with articles 11 to 13 of the Arbitral Request.

The respondent entity also contests the value of the case indicated by the Claimant. According to the AT, the value of the case is not that corresponding to the economic utility of the request ("€630.911,71") resulting from the "statement of reconciliation of accounts 2014...", and should "the decision concern only the legality or illegality of the increase to taxable matter in the amount of €2.742.559, as being attributable to equity stakes, in accordance with the provision of no. 2 of article 32 of EBF".

1. By order of 21 September 2015, the Taxable Person was notified to respond, if so desired, to the matter of exception and to specify the articles concerning factual aspects of the arbitral request, regarding which it intended to present witness testimony.

2. By order of 3 October, the request for production of witness testimony was denied, as the articles indicated by the Taxable Person corresponded to matters of law or matters of fact requiring documentary evidence. In that same order, the holding of the meeting provided for in article 18 of RJAT was dispensed with, and 20 December was set as the deadline for rendering the arbitral decision, a deadline which was subsequently changed to 30 December, as it falls within the legal deadline for issuing the arbitral decision.

7.1. Given the complexity of the question and the fact that the six-month deadline for issuing the arbitral decision includes periods of judicial recess, the Tribunal, by order of 27 December 2015, decided to extend the deadline for arbitration by two months, in accordance with the provision of article 21, no. 2, of RJAT, and set 20 February 2016 as the deadline for rendering the decision.

1. The parties dispensed with closing arguments.

II. PRELIMINARY ISSUES

1. As stated above, in its response, the Respondent raised a preliminary exception of absolute material incompetence of the Tribunal to assess the request which it is now necessary to assess and decide.

9.1. The Respondent begins by alleging that it does not fall within the scope of the competence of Arbitral Tribunals to assess the "changes that would result from the consideration of the differences between the previously existing assessment and that resulting from the inspection action, namely:

i) In the taxable matter (from €42.837,73 to 2.798.312,72);

ii) In the correction of international double taxation of C… (from €600.154,45 to €470.961,97);

iii) In the consideration of a tax benefit of €49.244,79, previously not considered due to insufficient tax base;

iv) In the consideration of special payments on account, in the amount of €177.808,92, previously not used due to insufficient tax;

v) In the modification of the municipal surcharge from €3.058,34 to €39.808,63;

vi) In the correction to autonomous taxation from €951.941,94 to €922.606,28, and

vii) In the assessment of compensatory interest of €32.489,56 – see, for all, articles 11 to 13 of PI» since "there exists no legal support that allows judgments of a nature other than those resulting from the powers fixed in RJAT to be rendered, even if they constituted a consequence, at the level of execution, of the declaration of illegality of assessment acts." Indeed, "it follows from the provision of article 24 of RJAT that the definition of the acts in which execution of arbitral judgments should be embodied is the responsibility, in the first place, of the AT, with the possibility of recourse to tax courts to request coercive execution, within the scope of the execution of judgments process, provided for in article 146 of CPPT and articles 173 et seq. of the Code of Procedure in Administrative Courts".

According to the AT, the "material incompetence of the Tribunal to assess the request identified above embodies a preliminary exception that prevents its knowledge of the same, leading to the dismissal of the instance as to the claim in question, in accordance with the provision of articles 576, no. 2, 577, paragraph a) of the Code of Civil Procedure (CPC), applicable ex vi article 29, no. 1, paragraph e) of RJAT".

However, it is considered that the AT is not right in this matter, as we shall demonstrate.

Notwithstanding the Claimant making considerations referring to a previous assessment (articles 10 to 13 of the Request), it did so, as it expressly admits, to better understand its request, without losing sight of the object thereof. In truth, already in article 14 of the Request, it expressly states that "Of these matters, it is important to define and delimit the object of this present request for arbitral decision as relating to the matter of the correction contained in point i) of article 10 above and its respective consequences at the level of the calculation of the municipal surcharge and compensatory interest". Now, the mentioned point i) of article 10 has the following content: "To the taxable profit of the group in that period, it made a correction in the amount of €2.742.559,22".

It thus appears that there is no doubt as to the request of the Claimant, the scope of which the AT expressly recognized.

Indeed, as the same Respondent states in article 13 of the Response, that «The Claimant only contests – in these proceedings – the legality of the tax acts in question insofar as they represent the correction to taxable profit in the amount of €2.742.559, for the tax year 2010, carried out by the Tax Administration following an inspection action, due to disregard of financial charges relating to the acquisition of equity interests, in accordance with article 32, no. 2 of EBF (see article 10 and 14 of PI)».

For its part, the Claimant is also very clear when, in article 166 of the Request, it expressly states that demonstrated is "the manifest illegality of the assessment act sub judice due to erroneous qualification and quantification of profits, absence or defect of legally required substantiation and non-compliance with other legal formalities (….). A claim it repeats in the conclusive part of that same request (see the 36th Conclusion).

Now, the Tribunal's competence is assessed according to the requests formulated, and it is certain that, if that exceeds the scope of these, the question that will arise will be, not one of competence, but of excess (or not) of decision.

Moreover, the AT is also not right as to the alleged incompetence of this Tribunal to decide on eventual condemnation to pay interest. As was established in Decision no. 28/2013-T, of 16 October 2013, "[a]lthough article 2, no. 1, paragraphs a) and b), of RJAT uses the expression «declaration of illegality» to define the competence of the arbitral tribunals operating in CAAD and does not refer to constitutive (annulling) and condemning decisions, it should be understood, in line with the said legislative authorization, that its competencies include the powers which in judicial challenge proceedings are attributed to tax courts with respect to acts whose assessment of legality falls within its competencies".

Similarly, although there is also no express norm in CPPT providing for the right to compensation for undue guarantee, the truth is that, as is emphasized in the Decision we have been following, "it has come to be peacefully understood in tax courts, since the entry into force of the codes of the 1958-1965 fiscal reform, that in judicial challenge proceedings it is possible to combine a request for condemnation to pay compensatory interest with the request for annulment or declaration of nullity or non-existence of the act, for in those codes it is stated that the right to compensatory interest arises when, in a gracious reclamation or judicial proceedings, the administration is convinced that there was error of fact attributable to the services. This regime was subsequently generalized in the Tax Procedure Code, which established in no. 1 of its article 24 that «there shall be a right to compensatory interest in favor of the taxpayer when, in a gracious reclamation or judicial proceedings, it is determined that there was error attributable to the services resulting in payment of the tax debt in an amount superior to that legally due». Subsequently, also the LGT came to establish, in its article 43, no. 1, that «compensatory interest is due when it is determined, in a gracious reclamation or judicial challenge, that there was error attributable to the services resulting in payment of the tax debt in an amount superior to that legally due»".

In the sense of the solution that is advocated also goes article 171 of CPPT, which, with respect to the request for condemnation to pay compensation for undue provision of guarantee, provides that «compensation in case of bank guarantee or equivalent unduly provided shall be requested in the proceedings in which the legality of the exigible debt is disputed».

Not only does judicial challenge proceedings encompass the possibility of condemnation to pay compensation for undue guarantee, but it is, in principle, the appropriate procedural means to file 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 about the legality or illegality of the assessment act". "The request for constitution of an arbitral tribunal has as a corollary the passing of being in the arbitral proceedings that the «legality of the exigible debt» will be discussed, wherefore, as results from the express content of that no. 1 of the said article 171 of CPPT, it is also the arbitral proceedings that is appropriate to assess the request for compensation for undue guarantee." (see the cited Arbitral Decision no. 28/2013-T).

Finally, it is also settled jurisprudence that "the cumulation of requests relating to the same tax act is implicitly presupposed in article 3 of RJAT, when it speaks of «cumulation of requests even if relating to different acts», which makes it clear that the cumulation of requests is also possible with respect to the same tax act", being thus encompassed in this formula, whether requests for compensation for compensatory interest and condemnation for undue guarantee, or the request for condemnation to pay compensatory interest.

In the case at hand, however, it should be noted that, as we have seen, no condemning request for interest is in question.

Indeed, it became clear that the Claimant requests that the Tribunal annul the assessment sub judice (assessment no. 2014..., of 10/11/2014), annulment which will have as legal consequences "namely the correction to taxable profit (in the amount of €2.742.559,22), the modification of the municipal surcharge (to €39.808,63) and compensatory interest (of €32.489,56)".

With respect to compensatory interest, the Claimant reaffirms in article 161 of the Arbitral Request that "the AT in the assessment impugned calculates compensatory interest of €32.489,56 derived from these corrections which, insofar as they are subsidiary or accessory to the prior corrections, should also be annulled".

Consequently, the Claimant makes no condemning request, whether for compensatory interest or for compensatory interest.

In the response, the AT understood, however, erroneously, that there was a condemning request for interest, for which this Tribunal would be incompetent. It further adds, in article 87 of the Response, that "It is not alleged that the tax has been paid, nor is payment of compensatory interest petitioned, and therefore no condemnation to payment of the same may occur".

In any case, it would be said that the AT would not be right, even if there were a condemning request for interest, in accordance, as was stated, with the jurisprudence of the arbitral tribunals.

It is not, however, as stated, that case, given that it became clear that the Claimant merely requests the annulment of the assessment sub judice, as a result of the corrections made to taxable profit, of which compensatory interest is a part, debited by the AT to the Taxable Person, for undue receipt (see documents 1 and 2 attached to the file).

Accordingly, in view of all that has been set forth, the AT is not right.

Given that the Tribunal is, confessedly, competent to assess the requests formulated, the alleged exception of incompetence must therefore be dismissed.

9.2. The AT's argument regarding the value of the case equally fails.

In proceedings in which the assessment of taxes is challenged, the Tax Procedure and Process Code (CPPT) expressly provides that the value of the case be that of the amount whose annulment is sought, in accordance with the provision of article 97-A, no. 1, paragraph a) of CPPT.

In the case at hand, what is being questioned is the "illegality of assessment no. 2014..., of 10/11/2014, which gave rise to the statement of account reconciliation no. 2014..., compensation 2014..., in the amount of €630.911,71, relating to Corporate Income Tax of the tax year 2010, issued by the Collection Services Directorate of the Tax and Customs Authority on 28/11/2014" (in accordance with documents nos. 1 and 2 attached to the file).

The AT is thus also not right on this point.

9.3. In accordance with what has been set forth, it is declared that the Tribunal is regularly constituted and materially competent to hear the present action, in its declaratory phase.

9.4. The parties have legal standing and capacity, are properly legitimated, and are regularly represented (articles 4 and 10, no. 2, of RJAT and article 1 of Order no. 112-A/2011, of 22 March).

9.5. The proceedings are not affected by nullities.

9.6. There are no other circumstances that prevent knowledge of the merits of the case.

III. MERITS

III.1. Factual Matters

1. Proven Facts

10.1. With relevance to the assessment and decision of the questions raised, preliminary and on the merits, the following facts are established and proven:

a) The Claimant is a Limited Company Managing Equity Interests ("SGPS"), constituted under Decree-Law no. 495/88, of 30 December, which leads Group A... and heads the three business areas of the Group: construction, concessions and real estate;

b) The Claimant's corporate purpose is the holding and management of equity interests of Group companies, as an indirect form of conducting economic activities, as well as the provision of technical services of administration and management, communication and social, legal and tax responsibility to the companies in which it holds interests (see the access code to the permanent certificate ...-...-...);

c) The Claimant is thus an equity interest management company (SGPS), heading a group of companies that constitute an economic group, being the dominant company of a group of companies subject to Corporate Income Tax under the special regime for taxation of groups of companies – "RETGS" (see articles 69 et seq. of CIRC);

d) Pursuant to Service Order with number OI2013..., an inspection action was carried out on the group of which the Claimant is the dominant company, with partial scope, by reference to the tax year 2010, with the objective of verifying compliance with accounting and tax obligations inherent to the application of the special regime for taxation of groups of companies, and of reflecting in the taxable profit of the group, in accordance with said legislation, and in the tax payable by the group, the corrections made by the Tax Administration, as a result of inspection procedures relating to companies forming part of the group;

e) As explained from the Inspection Report resulting from OI 2013...:

«Corrections made to the dominant company B... SGPS, SA

Pursuant to Service Order number OI2012... the inspection procedure was carried out on company B... SGPS, SA (Tax Identification Number...).

Following that inspection action, a correction was made to the declared tax result, which was set in the total amount of €2.742.559,22, as set forth below:

Financial charges not tax-deductible (no. 2 of article 32 of EBF)

The total correction made in company B... SGPS, SA to taxable matter amounts to €2.742.559,22 and results from the fact that the taxable person considered, in determining taxable result, the total amount of financial charges borne in the 2010 tax year, without regard to the limitation on the deductibility of such charges provided for in the final part of no. 2 of article 32 of the Tax Benefits Statute (EBF) (annex 1- 33 pages).»

(see pages 6/14 of the Inspection Report);

f) It was concluded in that inspection procedure that the Claimant did not increase the net result of the tax year by the totality of financial charges allocable to equity stakes, demonstrating a deficit in the increase of the amount of €2.742.559, having been made the corresponding correction of a merely arithmetic nature to taxable matter (see Inspection Report);

g) Which gave rise to the "Statement of Account Reconciliation" ("Document 2014..."), "Compensation 2014...", in the amount of €630,911.71, [amount resulting from the difference between the amounts to be reimbursed (of €1.085.317,19 and €454.405,48), in the modification of the municipal surcharge (from €3.058,34 to 39.808,63) and compensatory interest in the amount of €32.489,56] – see documents 1 and 2 attached to the file and Inspection Report.

h) By virtue of the increase made in correction, the amount payable by the Claimant resulted in €630.911,71, relating to the tax year 2010, which embodied the Corporate Income Tax assessment act no. 2014...;

i) In the amount of equity stakes held by the claimant during 2010 are included, among others, the values of the following financial participations (which are, moreover, the fundamental equity stakes held by the Claimant as dominant entity):

• B... X, SGPS, SA - €95.929.852,63;
• B... Y, SGPS, SA - €25.967.526,78;
• B... Z, SGPS, SA - €48.297.642,21;
• B... K, SGPS, SA - €99.393.056,60,

participations whose total value amounts to €269.588.078,22;

j) It being certain that the value of each of those equity interests corresponds exactly to the capital stock and share premium contained in the instruments of constitution and which was fully and entirely realized in kind. That is, those participations were not acquired from third parties, nor was their acquisition carried out with resort to borrowing (see documents attached to the file).

k) Following notification of the Corporate Income Tax assessment act no. 2014..., of 10 November, the Claimant submitted the request for arbitral decision sub judice.

10.2. Substantiation of Factual Matters

The factual matter proven was based on the position taken by each of the Parties and not contradicted by the opposing party, critical analysis of the documents attached to the file by the Claimants (documents 1 to 7, attached with the Request for arbitral decision), whose authenticity and truthfulness were not challenged, as well as the content of the investigation file.

10.3. There are no other facts with relevance to the assessment of the merits of the case that have not been proven.

III.2. Legal Matters

1. As we have seen, the present Request has as its object the illegality of assessment no. 2014..., of 10/11/2014, which gave rise to the "Statement of Account Reconciliation" ("Document 2014..."), "Compensation 2014...", in the amount of €630,911.71, relating to Corporate Income Tax for the tax year 2010, issued by the AT, following and within the scope of inspection of that tax year of the then called "Group B..." (today, A...).

For the Claimant, the said correction results, among other things, from "an erroneous and unlawful interpretation made by the AT (conveyed by Circular no. 7/2004, of 30 March of the IRC Services Directorate), both as to the meaning and scope of article 32, no. 2, of the Tax Benefits Statute ("EBF"), and as to the methodology for determining the quantum of financial charges to be disregarded, through the definition of an indirect method of allocation of financial charges to equity stakes" (Conclusion 3 of the Request).

Therefore, the central question to be decided in these proceedings revolves around the meaning and scope of article 32, no. 2, of the Tax Benefits Statute, more properly in what concerns determining:

a) What is the moment in which financial charges should be considered;

b) What is the methodology for determining the quantum of charges to be considered.

11.a) Moment in which financial charges should be considered

The Claimant argues, opposing the thesis defended by the AT, that "financial charges should be considered as a tax cost or expense and only if and when gains resulting from the disposal of equity stakes are realized and are, in accordance with article 32, no. 2, of EBF, disregarded".

As is well known, article 17 of CIRC establishes a relationship of dependence, albeit partial, between the tax result and the result determined by accounting. The said provision has the following content:

"Article 17
Determination of Taxable Profit

1 — The taxable profit of legal 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 the positive and negative variations in equity verified in the same period and not reflected in that result, determined on the basis of accounting and eventually corrected in accordance with this Code.

2 — For purposes of the provision in the preceding number, the net surpluses of cooperatives are considered as net result of the period.

3 — In order to permit the determination referred to in no. 1, accounting must:

a) Be organized in accordance with accounting standardization and other legal provisions in force for the respective activity sector, without prejudice to compliance with the provisions set forth in this Code;

b) Reflect all operations carried out by the taxable person and be organized so that the results of operations and variations in equity subject to the general regime of Corporate Income Tax can clearly be distinguished from those of the remainder."

For its part, no. 1 of article 18 of the same Code, under the heading "Time Allocation of Taxable Profit" determines the application of the economic period allocation regime in the process of determining taxable results, stating that "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 borne, regardless of their receipt or payment, in accordance with the economic period allocation regime."

Now, not defining in CIRC what such principle consists of, it must be borrowed from accounting norms, establishing, in this respect, the Conceptual Framework of SNC, in its respective § 22 that: "Accrual Basis (Economic Period Allocation) (paragraph 22):

22 — In order to satisfy their objectives, financial statements are prepared in accordance with the accounting basis of accrual (or economic period allocation). Under this basis, the effects of transactions and other events are recognized when they occur (and not when cash or cash equivalents are received or paid), being recorded in accounting and reported in the financial statements of the periods with which they are related."

It must further be added that Accounting Standard and Financial Reporting Standard (NCRF) 10 "Borrowing Costs", provides in its § 1 that (emphasis ours):

"1 — The objective of this Accounting Standard and Financial Reporting Standard is to prescribe the treatment of borrowing costs. This Standard requires that, in general, they be immediately considered as expenses of the period, except as regards borrowing costs that are directly attributable to the acquisition, construction or production of an asset that qualifies, in which case their capitalization is permitted."

Having reached this point, it is clear that the general regime for accounting recognition of financial charges is that they be considered as expenses or losses of the period to which they relate. And, combining articles 17, 18 and 23 of CIRC – the latter in the part in which it is provided: "1 — Expenses are considered those which are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the income-generating source, namely (…) c) Of a financial nature, such as interest on borrowed capital applied in the operations, discounts, premiums, transfers, exchange differences, expenses with credit operations, debt collection and issuance of bonds and other securities, redemption premiums and those resulting from the application of the effective interest method to financial instruments valued at amortized cost; (…)" – there will result that, as a rule, the tax regime of such charges follows the principle of temporal allocation whereby they will be deductible at the moment they are recognized as accounting expenses or losses.

This general principle of allocation of financial charges to the tax years to which they relate may only be departed from if there are tax norms that, in concrete situations, provide otherwise.

Accordingly, this is the essential question that must be analyzed, in order to ascertain whether the Claimant's thesis finds support in the provisions of SNC/CIRC.

Let us see.

As mentioned above, NCRF 10 - Borrowing Costs establishes that "in general, they be immediately considered as expenses of the period, except as regards borrowing costs that are directly attributable to the acquisition, construction or production of an asset that qualifies, in which case their capitalization is permitted."

Now, an asset that qualifies may have, at an accounting level, a different regime of allocation of financial charges. The answer to the definition of an asset that qualifies is found in §§ 4 and 6 which follow:

4 — The terms that follow are used in this Standard with the meanings specified:

-Asset that qualifies: is an asset that necessarily takes a substantial period of time to become ready for its intended use or for sale.

-Borrowing costs: are the costs of interest and others incurred by an entity relating to requests for borrowing of funds.

6 — Examples of assets that qualify are inventories that require a substantial period of time to put in a saleable condition, industrial facilities, power generation facilities and investment property. Other investments and inventories that are routinely manufactured or otherwise produced in large quantities on a repetitive basis over a short period of time are not qualifying assets. Assets that are ready for their intended use or sale when acquired are also not qualifying assets."

The CIRC expressly accepts, in certain cases, this special regime of temporal allocation of financial charges.

Let us see article 26 (emphasis ours), whose content is as follows:

"Article 26
Inventories

1 — For purposes of determining taxable profit, the income and expenses of inventories are those resulting from the application of methods that use:

a) Costs of acquisition or production;

b) Standard costs determined in accordance with adequate accounting techniques;

c) Selling prices deducted from the normal profit margin;

d) Selling prices of harvested products from biological assets at the time of harvest, deducted from estimated costs at the point of sale, excluding transport and others necessary to place the products on the market;

e) Special valuations for inventories held as basic or normal.

2 — In the event that inventories require a period exceeding one year to achieve their condition of use or sale, the costs of borrowing obtained that are directly attributable to them shall be included in the cost of acquisition or production in accordance with the accounting standardization specifically applicable."

As can be seen, the tax legislator is not unfamiliar with special regimes of allocation of financial charges. The SNC enshrines them and the CIRC, in certain situations, accepts them.

A tax application of special accounting rules relating to the allocation of so-called "interest expenses" can also be verified in article 39 of CIRC. There, it is allowed that "interest expenses" resulting from the recognition of a provision at its present or discounted value be, in periods subsequent to that discount, considered tax expenses.

See article 39 of CIRC (emphasis of the tribunal), with the following content:

Article 39
Provisions Tax-Deductible

1 — The following provisions may be deducted for tax purposes:

a) Those intended to meet obligations and charges derived from legal proceedings in progress due to facts which would result in the inclusion of those among the expenses of the taxation period;

b) Those intended to meet charges in respect of warranties to customers provided for in contracts of sale and provision of services;

c) The technical provisions constituted obligatorily, by force of norms issued by the Insurance Institute of Portugal, of a generic and abstract character, by insurance companies subject to its supervision and by branches in Portugal of insurance companies with registered office in another Member State of the European Union;

d) Those constituted with the objective of meeting charges in respect of repair of environmental damage of sites used in operations, whenever such is obligatory under applicable law and after the cessation thereof. (Amended by Law no. 82-D/2014, of 31/12)

(...)

3 — When the provision is recognized at present value, the expenses resulting from the respective discount are equally subject to this regime."

In sum, it is verified that the CIRC is not unfamiliar with special regimes of allocation of financial expenses. But being these, by definition, outside the general regime, those special or particular regimes must be expressly provided for. In our view, the Claimant would only be right if in the tax norms (especially in article 32 of EBF or in another norm related to it) there were determined a regime of tax allocation of financial charges different from that which exists as a general rule.

In that sense points equally article 11 of LGT and article 9 of the Civil Code. Article 11 of LGT provides, in its no. 1, that "In the determination of the meaning of tax norms and in the qualification of facts to which they apply, the rules and general principles of interpretation and application of laws are observed." For its part, article 9 of the Civil Code provides that: "However, it cannot be considered by the interpreter the legislative thought that does not have in the letter of the law a minimum of verbal correspondence, even if imperfectly expressed", and that "In fixing the meaning and scope of the law, the interpreter shall presume that the legislature sanctioned the most correct solutions and knew how to express its thought in adequate terms" (see nos. 2 and 3 respectively).

In particular, article 9 of the Civil Code, in its nos. 2 and 3, excludes the interpretation of the Claimant, since the thesis it advocates has no legal support in the law. Moreover, given that there are in the CIRC particular rules of allocation of financial charges, this constitutes an additional reason to deny the Claimant's argument on this point.

Finally, it is stressed that the principle of balancing between tax costs and income, which would ultimately be what the Claimant's thesis amounts to, was clearly rejected by doctrine and jurisprudence. In that sense, it was established in Case 0779/12 by the Supreme Administrative Court the following:

"I - In the understanding that doctrine and jurisprudence have adopted in order to ascertain the indispensability of a cost (see article 23 of CIRC in the version in force in 2001), the AT cannot judge the soundness and opportunity of the company's management decisions, under penalty of intruding on the freedom and autonomy of the company's management.

II - Thus, a cost will be accepted tax-wise if, in an assessment made at the moment it was made, it is adequate to the company's productive structure and to the obtaining of profits, even if it later proves to be an unprofitable or economically ruinous operation, and the AT can only disregard as tax costs those that do not fall within the scope of the activity of the taxpayer and were incurred, not in the interest of the latter, but for the pursuit of external objectives (when it is to be concluded, based on the rules of common experience, that it had no potential to generate income).

III - The taxpayer being a company engaged in the construction of buildings, the AT cannot disregard the costs relating to the acquisition of two properties on the basis of lack of demonstration of indispensability, even though this business proves to be economically unprofitable as a result of its sale at a price six times lower than the one at which they were acquired having generated a loss."

In truth, jurisprudence has been reiterating, in this manner, that the question of indispensability which, until 2014, appeared in article 23 of CIRC, does not imply any required causal nexus between expenses and income. It is sufficient that the expense falls within the activity or corporate purpose of the taxpayer and is incurred with a purpose of obtaining income or maintaining the income-generating source, thus fulfilling the requirement of said indispensability.

In such a context, it would be absurd to require that company expenses had to be related to businesses that proved to be profitable. Economic risk is felt with particular intensity. Thus, previously incurred expenses do not, in many cases, have the expected contribution to the profitability of the entities that bore them. Such is an economic inevitability, an external risk factor, which is uncontrollable by the management of business organizations.

The STA, in the aforementioned decision, also elucidates the question of the moment to which the assessment of the adequacy of expenses should be reported.

Starting from what was said about business risk, it is clear that the moment should be the one in which the decision to bear those expenses is made. The information that serves as the basis for decisions that induce business expenses can only be that which is available at the moment when those are taken. What happens afterwards is, to a large extent, outside the control of the decision-maker, and cannot be considered as an element to assess the correctness, reasonableness or soundness of the decision.

Now, if in the relationship between expenses and income the nexus of causality and temporal balancing should be excluded, it would also be manifestly inconsistent in the concrete case with which this tribunal is occupied to impose that balancing or equivalence between expenses and income. The tax law does not impose it anywhere, and doctrine and jurisprudence are in consensus on its exclusion.

In conclusion, given what has been set forth, the Claimant is not right on this point. Let us then proceed to the analysis of the second dimension of the problem posed.

11.b) Methodology for determining the quantum of charges to be considered

As stated, the Claimant defends, in summary, "that the legislature only intended the tax disregard of financial charges incurred in connection with financing actually related to the acquisition of equity stakes, and only these", (…) wherefore "The letter and teleology of the norm in question rule out the admissibility of using a pro rata method, requiring respect for the actual allocation of the destination of the loans obtained and only after that determination would it be admissible to use an indirect method (…)".

On the other hand, for the Claimant it was the AT's burden to quantify, with the means it had at its disposal, the amount of expenses to be disregarded, within the scope of article 32, no. 2, of EBF, "namely through the identification of the financings that had been specifically used for the acquisition of equity interests and, likewise, the respective interests acquired (and disposed of)" (see 135 of the Request), which did not happen in the case at hand.

To reach a decision on this point in dispute, the tribunal considers it of particular relevance to clarify the question of whether the formula contained in Circular 7/2004 would have to be applied (as the AT argues), or if a direct method of allocation of financial charges would (as the Claimant argues) be capable of use and would lead to a more sustainable result on the plane of tax legality.

Before addressing such question, it is necessary that the calculation process be known (in the context of using the allocation method contained in the Circular) used by the AT, which is summarized below, based on elements of the Inspection Report.

• the formula used is based on a methodology, expressed in Circular 7/2004, which consists of "allocating the remunerated liabilities of SGPSs to remunerated loans granted to its subsidiaries and other investments generating interest", and (…) "Allocating the remainder to the remaining assets, namely equity stakes, proportionally to the respective cost of acquisition";

• the inspection was based on a period of analysis referred to the "month" and used as a source of data the monthly trial balances of 2010, furnished by the taxable person, as well as the balance sheets reported to that same period, which were constructed based on the trial balances;

• thus, and in accordance with calculations presented in annex 5 of the inspection report, the amount of financial charges determined, and which were considered non-deductible, was 2.865.681,94 euros.

Having the Claimant, in the course of the hearing procedure, contested the application of the said formula, given that, in its opinion, there being a direct relationship between certain capital and the acquisition of equity interests, the automatic application of the formula should be dismissed, the AT responded as follows:

• the taxable person would defend a hypothetical "base exemption" in the application of the method proposed by the Circular, by virtue of there having been capital contributions in kind related to the equity interests held by the claimant;

• such interpretation could not be accepted because this would imply, in the case at hand and in others, a determination of "financial charges not deductible" (…) "almost insignificant", which would not be in accordance with the factual reality in question;

• the notion of financial charges related to the acquisition of equity interests would not be exhausted in charges derived from indebtedness, but also in other types of financial charges provided for in article 23, no. 1, of CIRC;

• the argument that the equity interests would have a genesis prior to the entry into force of the regime set forth in article 32 of EBF would in no way affect the AT's analysis, as such regime would apply to gains realized after 1 January 2003.

The AT's argumentation does not merit acceptance, as we shall demonstrate, through detailed and careful analysis.

To that end, let us assume that a certain entity ALFA begins its activity in year N, and that, by way of capital contributions in kind, it receives patrimonial elements that configure financial investments in the amount of 1000. Its opening balance sheet would be as follows:

If, a year later, entity ALFA borrows 500 to purchase tangible assets (computers, vehicles, etc.), it is judged clear that the said Circular's formula should not be applied, since it is possible to demonstrate that the subsequent indebtedness was not used to acquire equity stakes.

However, let us assume that, not knowing the temporal genesis of the various means of financing of another entity BETA, nor the sequence of application of those funds in the acquisition of assets, this entity presents the following balance sheet, at a certain moment.

| | | | |
| --- | --- | --- |
|BETA's Balance Sheet| | |
| | | |
|Financial investments|1200|Capital stock|1000|
|Tangible assets| |100| |
|Loans to subsidiaries|850|Loans obtained|1200|
|Availability/monetary means|50| | |
| | | |
|TOTAL|2200|TOTAL|2200|

Here it would make sense, exhausted the hypotheses of allocating own capital directly to the acquisition of equity stakes in subsidiaries, to apply the formula intrinsic in the Circular.

But, it is judged clear that, in this latter case, the AT must show that there would not exist, in the concrete situation, a more just, more economically rational or more in accordance with the specific allocation of financial charges to equity stakes manner, than the mentioned formula. That is, the formula constitutes an expedient, understandable, useful and sometimes appropriate to apply quantitatively the norm of article 32 of EBF. But this will not always be so, since in cases where it is proven that equity stakes have specific financing, by own capital, the AT should, before applying the formula, question whether a direct allocation will be the most just course of action.

We are now in a position to confront the answer to the problem posed.

Indeed, it is judged that the case at hand falls within this latter situation, in which the AT, before applying the formula, should have considered whether this constituted the correct solution, given the meaning and scope of article 32 of EBF.

This orientation is corroborated, moreover, by jurisprudence of TCAN (Case 00946/09.0BEPRT, 15 January 2015), whose content is transcribed as the situation is transposable to the case at hand.

"As determined by article 74/1 of LGT, the burden of proof of facts constituting the rights of the tax administration or taxpayers rests on whoever invokes them. This is the wording in force of no. 1 which was also the original wording. The provision was amended by Law no. 55-B/2004 of 30/12 to the following wording: The burden of proof of facts constituting the rights of the tax administration or taxpayers rests on whoever invokes them, except in situations of non-subjection, in which it always rests on the taxpayers. However, Law no. 50/2005, of 30 August restored the original wording, which has remained to the present.

Knowing that the burden of proof of facts constituting the rights of the tax administration or taxpayers rests on whoever invokes them, what does that mean? What does that rule translate to in practical terms? Very simply, as has been peacefully understood, it means that in «the absence of special rules, that is, save for legally established presumptions, it is thus on the tax administration that the burden falls to demonstrate the factual requirements of its actions, namely the existence of the tax facts on which it bases the assessment of the tax it did not declare by the taxpayer» (António Lima Guerreiro, "Annotated LGT", Rei dos Livros, 2001, pp. 329).

Or, stated differently, It is the responsibility of the Tax Administration to demonstrate the legal (binding) requirements of its actions, namely if aggressive (positive and unfavorable), resting, in turn, on the administered to present sufficient proof of the illegitimacy of the act, when those requirements are shown to be verified. (decision of TCAN no. 00624/05.0BEPRT of 12-01-2012, Reporter: Catarina Almeida e Sousa)

This norm, although integrating the set of rules relating to procedure also applies to judicial proceedings, its content being no different from the general criterion of distribution of the burden of proof provided for in article 342 of the Civil Code.

So that, intending the ATA to disregard costs accounted for by the defendant on the basis of violation of article 31/2 of EBF, it should have demonstrated the requirements of its right to taxation, that is, it should have proven that those costs were not legally deductible either because losses were realized with the onerous transmission of equity interests held for less than one year, or because financial charges were borne and accounted for in connection with their acquisition.

But instead of such proof, the ATA proceeded to disregard the costs accounted for by the defendant (dominant company) in the amount of €3.237.838,62 giving for acquired that this amount was relating to financial charges borne in connection with the acquisition of equity interests and that were improperly considered as tax cost. With the same basis were disregarded €56.081,74 referring to the subsidiary S... Management SGPS, SA, which resulted in corrections to the group's taxable profit in the amount of €3.293.920,36 whereby the tax results contained in model form 22 of the group went from €14.017.394,34 declared to €17.311.314,70 corrected.

The ATA gave for acquired that a certain amount of the financial charges accounted for were borne in connection with the purchase of equity interests, but demonstrated nothing in that sense. It did not identify the financings used for that purpose, nor the equity interests that would have been acquired with them, completely failing to fulfill its burden of proof.

We can say that the ATA failed in the requirements of taxation and in the quantifying method used.

It failed in the requirements of taxation because it did not succeed in demonstrating the legal factual requirements of its actions, as mentioned above.

And it failed in the quantifying method because it dissociated itself from the need to ascertain whether there had been a disposal of equity interests and what the amount of the financing used in their acquisition was.

But only in the presence of these two requirements – disposal of interests and respective financing used in their acquisition – could the ATA have disregarded the financing costs.

Ignoring both, the ATA resorted to correction and taxation making use of at least three (at least) presumptions: one, that equity interests were disposed of; another, that costs were accounted for in connection with the financing for the acquisition of those interests and the third constituted by the calculation operations: (1) it allocated the remunerated liabilities of the SGPS to the remunerated loans granted by it to the subsidiary companies and to other investments generating interest and (2) allocated the remainder to the remaining assets, namely equity interests, proportionally to the respective cost of acquisition (3) after obtaining the value of the remunerated liabilities allocable to the remaining non-remunerated assets, ascertained proportionally the value of the remunerated liabilities allocable to equity interests.

With this set of presumptions, the ATA concluded that the taxpayer bore in the tax year, as a title of financial charges in connection with the acquisition of interests, the sum of €3.237.838,62.

The fact that in its methodology it used the criteria recommended in circular no. 7/2004, of 30 March, in particular its nos. 7 and 8 does not save the legality of the operation, since the criteria and requirements for allocation of the remunerated liabilities of SGPSs clearly exceed the content of article 31/2 of EBF creating presumptions and proportional determinations that the legislature clearly did not assume or consent to.

As stressed by Júlio Tormenta (in Management Companies of Equity Interests as an Instrument of Tax Planning and Its Limits, Coimbra Editora, pp. 145) «A question that arises concerning what is established in article 32 of EBF in its nos. 2 and 3 is how to ascertain or what are the financial charges directly related to the acquisition of equity interests (in their majority made up of current interest on servicing the debt relating to a loan or other form of credit used by the SGPS for acquisition of equity interests) from those that are used by the SGPS in the pursuit of its purpose which has nothing to do with acquisition of interests.

The Tax Administration has been arguing that that allocation should be carried out in respect for the "principle of financial balance" (cf. the Memorandum of I September 2003 of the Director-General of IRC Services), which advises that one should finance an asset with capital of maturity compatible with the economic life of that asset and capacity for generating monetary means.

For the Tax Administration financial charges should be allocated on the basis of a formula that attends to the following: the remunerated liabilities of SGPSs should be allocated, in the first place, to the remunerated loans granted by them to the subsidiary companies and to other investments generating interest, allocating directly and automatically the remainder to the remaining assets, namely equity interests, proportionally to the respective cost of acquisition.

In Portugal the principle of legality prevails having as a corollary according to classical doctrine the principle of closed typicality being the matter of tax incidence of relative reserve of Law of the Assembly of the Republic. In the present case the law does not establish criteria for allocation of financial resources to the acquisition of equity interests and cannot the tax administration, by way of administrative create rules of incidence (through the so-called "circulation right"), under penalty of being faced with a material unconstitutionality, since such norms must emanate from law (of the Assembly of the Republic) or Decree-Law (of the Government) duly authorized.

Taxpayers are not obligated to follow the procedures set forth in Circular 7/2004 of 30.3.2004 (hereinafter referred to as circular 7/2004) as to the same only the tax officials are bound by their supervision and nothing more.

We cannot agree with what is stated in Circular 7/2004 in its point 7 where it refers to "given the extreme difficulty of use, in this matter, of a method of direct or specific allocation and the possibility of manipulation that it would allow": due to the development and sophistication of management information systems available in the market, the method of direct allocation should be privileged and only in the impossibility of use of the same; it is that it would be advanced as an alternative method the one recommended in Circular 7/2004»

If the legislature did not establish any criterion that makes it possible to distinguish within the total financial costs of SGPSs which are due to the purchase of equity interests and which were used for other purposes, the ATA could only move within the scope of a method that respected direct or specific allocation, because only that would be compatible with the principle of legality and impartiality to which it is subject (article 55 LGT) and which results from the wording of article 31/2 EBF in excluding from the formation of taxable profit the financial charges borne in connection with the acquisition of the interests disposed of.

Admitting however that it is not possible from the company's records to know the purpose for which the financing was obtained, this may question the legal control by the ATA. But even so, the ATA cannot complete the norm through a circular which institutes a regime of proportional, indirect or presumptive determination, creating conditions more burdensome for the taxpayer than those provided for in law, disrespecting the legal framework in force. With such interpretation, circular 7/2004 proposes to complete the norm of article 31/2 EBF creating a method of calculation different from that of direct and specific allocation of the remunerated liabilities of SGPSs that the legislature did not contemplate and which drastically exceeds mere interpretation of the norm.

As referred to in the decision of this TCAN no. 00997/12.8BEPRT of 14-03-2013 (Reporter: Pedro Marchão Marques) VIII – Given the supremacy of law over administrative guidance (principle of legality), the rules established in the circulars of the Tax Administration must respect the legal regulatory framework of reference – primary legal norms –, which is prevalent to it. And when those establish a normative meaning that does not have reception in the legal norm which it purports to interpret, they are in fact derogating it and creating invalid innovative legal norm.

Thus, either by having failed its burden of proof, or by having gone beyond what article 31/2 of EBF required, it is not in a position to sustain the legality of the impugned assessment. And neither can it divert to the defendant the burden of proving that financial charges do not result from the acquisition of equity interests, because nowhere in the law is it provided – for this case - the inversion of the burden of proof (article 344/1 of the Civil Code). Additionally, having the ATA not questioned the reliability of accounting, the defendant's tax return benefits from the presumption of truthfulness and good faith in accordance with article 75 of LGT, wherefore also by force of this statute the ATA was burdened with dispelling that presumption".

Applying the jurisprudence just exposed to the case at hand, it is verified, as is visible in annexes 1 to 5 of the inspection report, (in particular in the table 3 of annex 5 of the said Report) that the AT applies the formula of Circular no. 7/2004 as if, after withdrawing the loans to subsidiaries from the total amount of remunerated liabilities, the remaining value of financial debt were allocated to the assets, in an indirect manner. That is, without caring to know whether there would be equity interests whose acquisition had been sustained in own capital.

Against this orientation, the Claimant argues (and rightly, in the tribunal's view), in articles 122 et seq. of the Arbitral Request, that: "The amount of equity interests held by the Claimant during 2010 considered by the AT in the quantitative calculation method of financial charges it uses (map constituting annex 5) to the individual report is, throughout the different months of the year, as follows: - January to March 2010: €275.352.449,70 - April: €275.613.892,40 - May to November: €275.588.952,51 - December: €277.719.140,71

That is, the value of the equity interests held by the Claimant undergoes very slight changes throughout the year.

Now, in these amounts are included, among others, the values of the following financial participations (which are, moreover, the fundamental equity interests held by the Claimant as dominant entity): - B... X, SGPS, SA - €95.929.852,63; -B... Y, SGPS, SA - €25.967.526,78; - B... Z, SGPS, SA - €48.297.642,21; - B... K, SGPS, SA - €99.393.056,60, participations whose total value amounts to €269.588.078,22.

The mentioned four interests have been part of the Claimant Group since the act of constitution of each one of them, all executed notarially on 30 December 2002 (see Documents 4 to 7 hereafter attached, whose content is hereby given as fully reproduced).

It being certain that the value of each of those equity interests corresponds exactly to the capital stock and share premium contained in the instruments of constitution and which was fully and entirely realized in kind.

That is, those interests were not acquired from third parties, nor was their acquisition carried out with resort to borrowing."

The documentary evidence attached to the file shows that this is so. That is, the equity interests in question were not acquired with resort to borrowing, wherefore, in face of the law's provision, it is judged unlawful the correction made by the AT, as it did not pay attention to the concrete situation, in which an absence of connection between equity interests and borrowing was evident, such as this connection appears in the Circular.

This should thus have been dismissed, and a method of allocation with a more sustainable, just and adapted economic-financial logic to the legal text should have been used.

The interpretation now upheld as to the meaning and scope of article 32, no. 2, of EBF is that which results, moreover, contrary to the Respondent's thesis, in accordance with the constitutional principles of tax equality, capacity to pay, and taxation of real income.

Thus, given what has been set forth, the alleged violation of law by the Claimant is sustained, with respect to the manner in which the financial charges relevant in the context of article 32, no. 2, of the Tax Benefits Statute were calculated.

Accordingly, the present Request should be upheld and, as a result, assessment no. 2014..., of 10/11/2014, which gave rise to the statement of account reconciliation no. 2014..., compensation 2014..., in the amount of €630.911,71, relating to Corporate Income Tax for the tax year 2010, should be annulled.

1. Questions Rendered Moot

The request being upheld...

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