Summary
Full Decision
ARBITRAL DECISION
CAAD: Tax Arbitration
Process No. 271/2014 – T
Claimant/Applicant: BANK A..., S.A.
Respondent: Tax and Customs Authority (hereinafter ATA)
1. Report
On 19-03-2014, BANK A..., S.A., a legal entity no. ..., with registered office at Street ..., registered at the Commercial Registry Office of ... under no. ..., hereinafter referred to as the Applicant, submitted to the Administrative Arbitration Centre (CAAD) an application for constitution of an arbitral tribunal with a view to declaring unlawful the tax acts of additional assessment of Corporate Income Tax (IRC) no. 2014 ... and the assessment act and compensatory interest no. 2014 ..., relating to the fiscal year 2011.
The Applicant requests the annulment of the aforementioned additional assessment acts and IRC and compensatory interest on the grounds that impairment losses established pursuant to general and abstract rules issued by the Bank of Portugal are fully deductible under Article 35(2) and Article 37 of the Corporate Income Tax Code (CIRC) and that Article 45(3) of the CIRC does not apply to Credit Institutions.
The Applicant alleges that the constitutional principle of taxation of companies based on actual profit, established in Article 104(2) of the Constitution of the Portuguese Republic, has been breached.
The Tax and Customs Authority (ATA) filed its response on 02-07-2014, defending the maintenance of the scrutinized tax act and requesting dismissal of the application, alleging in summary that it is not legitimate to exclude the application of Article 45(3) of the CIRC to impairment losses in the banking sector in light of the provisions of Articles 35(2) and 37 of the CIRC.
Suzana Fernandes da Costa was appointed as sole arbitrator on 08-05-2014. In accordance with Article 11(1)(c) of the RJAT, the arbitral tribunal was constituted on 23-05-2014.
The arbitral tribunal hearing took place on 19-09-2014 at 11:30 hours. During the hearing, the representatives of the Applicant and the Respondent declared that they dispensed with the submission of written pleadings. The date of 10-10-2014 was set for the delivery of the arbitral decision.
The parties have legal capacity and standing and are properly constituted (Articles 4 and 10(1) and (2) of the RJAT and Article 1 of Order No. 112-A/2011 of 22 March) and the application is timely.
2. Factual Matters
2.1. Facts Proved:
Having analyzed the documentary and testimonial evidence produced, the following facts are considered proved and relevant to the decision of the case:
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The Applicant is a credit institution, subject to supervision by the Bank of Portugal, responsible for the development of investment banking activities within Group A....
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The Applicant was the subject of a tax audit relating to the fiscal year 2011, which took place between 29-07-2013 and 05-12-2013.
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It was notified, by letter no. ... of 07-01-2014, of the final tax audit report, in which the ATA corrected the taxable income for the year 2011, increasing it by the amount of 12,600 €.
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Following the aforementioned inspection, the Applicant was notified of the additional IRC assessment no. 2014 ..., in the amount of 246,672.17 €, and of the compensatory interest assessment no. 2014 ... in the amount of 64.07 € and of the statement of account settlement no. 2014 ..., in the amount of 3,718.07 €.
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The Applicant made payment of the tax and the respective compensatory interest on 18-03-2014.
2.2. Facts Not Proved:
It was not proved that the Applicant provided any bank guarantee.
2.3. Basis of Proved Factual Matters:
As regards the facts proved, the arbitrator's conviction was based on the documentary evidence produced and on the facts admitted by agreement of the parties.
3. Legal Matters:
The essential question to be determined in these proceedings is whether impairment losses relating to equity interests established pursuant to general and abstract rules issued by the Bank of Portugal are fully deductible under Article 35(2) and Article 37 of the Corporate Income Tax Code, or whether they are only deductible in the amount of 50% of their value, by virtue of Article 45(3) of the Corporate Income Tax Code.
Regulatory Framework:
a) Partial Dependency Between Tax and Accounting
The Corporate Income Tax Code adopts a relationship of partial dependency between accounting profit and taxable profit (On this principle, see Castro Tavares, 1999, "On the relationship of partial dependency between accounting and tax law in determining the taxable income of legal entities: some reflections at the level of costs", Notebooks of Science and Tax Technique, no. 396, 2009, p. 47 and Nina Aguiar: "Normative models of the relationship between taxable profit and commercial accounting", in Taxation no. 13/14, Jan./April, 2003, pp. 39-49).
Article 17(1) of the CIRC provides: "The taxable profit of legal entities and other entities mentioned in Article 3(1)(a) is constituted by the algebraic sum of the net result of the period and the positive and negative variations in equity occurring in the same period and not reflected in that result, determined on the basis of accounting and, where applicable, corrected in accordance with this Code". The acceptance of this relationship with accounting depends on compliance with Article 17(3) of the same article.
It follows from the principle stated above that the legislator accepts classifications and records made in accordance with accounting law unless the CIRC expressly excludes or derogates from the application of accounting rules.
The 2009 accounting reform preserved this relationship between accounting and taxation. Decree-Law No. 159/2009 of 13 July introduced amendments to the CIRC necessary to maintain the relationship of partial dependency between accounting profit and taxable profit. As stated in its preamble:
"Considering that the current structure of the Corporate Income Tax Code is generally adequate for the adoption of the new accounting framework, the close link between accounting and taxation has been maintained, which appears to be an essential element for minimizing the regulatory burden on economic agents, with only the necessary amendments being made to adapt the Corporate Income Tax Code to the rules arising from the new accounting framework and the terminology flowing therefrom. The maintenance of the partial dependency model determines that, whenever specific tax rules are not established, the accounting treatment resulting from the new rules is adopted".
b) Regulatory Autonomy of the Bank of Portugal
The European Union has allowed the adoption of International Accounting Standards in domestic legal orders through Article 5 of Regulation (EC) No. 1606/2002 of the European Parliament and Council of 19 July through its Article 5. (On the evolution of Portuguese accounting law, see our article "New Directions in Accounting Law: comparison between the Spanish Reform and the Portuguese SNC, in the collective work: Accounting and Tax Seminars - Accounting Standards System", ISCAP, Vida Económica, 2010).
Decree-Law No. 35/2005 of 17 February, legitimized, in its Article 13, the regulation by supervisory entities of the individual accounts of enterprises under their supervision, paving the way for regulatory positions by those bodies. As stated in the preamble:
"With regard to enterprises subject to supervision by the Bank of Portugal, the Securities Market Commission and the Insurance Institute of Portugal, it is understood that, given their specific nature, the respective supervisory authorities should be given the power to establish the scope of application of IAS, in line with the approach that has been followed in the issuance of accounting standards applicable to these enterprises."
In turn, in 2006 Law No. 53-A/2006 of 29 December was published, which approved the State Budget for 2007 and established the rules for determining taxable profit adapted to the new accounting regulations applicable to the banking sector.
The regulatory autonomy of the Bank of Portugal was not called into question with the entry into force of the SNC and Decree-Law 158/2009 of 13 July. According to Article 5 of this decree:
"1 - Without prejudice to the provisions of Article 4(1), it is the competence of:
a) The Bank of Portugal and the Insurance Institute of Portugal to define the subjective scope of application of international accounting standards, as well as the accounting standards applicable to consolidated accounts, for entities subject to their supervision;
(...)
2 - The provisions of this decree-law do not prejudice the competence of the Bank of Portugal and the Insurance Institute of Portugal to define:
a) The accounting standards applicable to the individual accounts of entities subject to their supervision;
b) The prudential requirements applicable to entities subject to their supervision"
In the exercise of its power of self-regulation, the Bank of Portugal issues notices that are binding on entities subject to its supervision. Accordingly, entities subject to supervision by the Bank of Portugal are required to apply the Adjusted Accounting Standards (AAS), which generally correspond to International Accounting Standards and International Financial Reporting Standards (IAS/IFRS) as adopted by the European Union, following Regulation (EC) No. 1606/2002 of the European Parliament and Council of 19 July, with some exceptions safeguarded in the notices issued by the Bank of Portugal. (See DURO TEIXEIRA, M. and ALMEIDA, A.: "The Tax Impact of the Adoption of International Accounting Standards in the Financial Sector", Balance Sheet Law and International Financial Reporting Standards, Coimbra Editora, Coimbra, 2007).
c) CIRC Rules on Impairment Losses
Article 23 provides that:
"1 - For the determination of taxable profit, all expenses and losses incurred or borne by the taxpayer to obtain or secure income subject to IRC are deductible.
2 - The following expenses and losses are considered included in the foregoing:
h) Impairment losses;
As regards impairment losses, the general rule provided for in Article 23 of the CIRC is supplemented by the provisions of Article 35 and, especially for enterprises in the banking sector, also by Article 37 of the CIRC.
Article 35(2) of the CIRC, in the version that applied in 2011, provided as follows:
"2 - Impairment losses and other value adjustments recorded in the same tax period or in previous tax periods may also be deducted for tax purposes, when established on a mandatory basis by virtue of rules issued by the Bank of Portugal, of a general and abstract character, by entities subject to its supervision and by branches in Portugal of credit institutions and other financial institutions established in another Member State of the European Union, intended to cover specific credit risk and country risk and for losses on securities and other assets."
In other words: Article 35 of the CIRC, which specifically regulates the discipline governing the tax deductibility of impairment losses, establishes in paragraph (1) a general regime applicable to IRC taxpayers in general – in which there is no possibility of deducting any impairment loss on equity securities that it may hold in its portfolio – and in paragraph (2), which, recognizing the particular characteristics of banking activity, establishes a special regime allowing the tax deductibility of "impairment losses, when established on a mandatory basis by virtue of rules issued by the Bank of Portugal, of a general and abstract character (…) for losses on securities and other assets".
In turn, Article 37 of the CIRC provided that:
"1 - The annual cumulative amount of impairment losses and other value adjustments for specific credit risk and country risk referred to in Article 35(2) may not exceed what corresponds to the application of the mandatory minimum limits set by the notices and instructions issued by the supervisory entity.
2 - Impairment losses and other value adjustments referred to in the foregoing paragraph are only accepted when relating to credits arising from normal activity, not covering credits excluded by the rules issued by the supervisory entity and also the following: (...)
4 - The annual cumulative amounts of impairment losses and other value adjustments referred to in Article 35(2) should not exceed the minimum values resulting from the application of the rules issued by the supervisory entity"
The rule in Article 45(3) CIRC, whose discussion arises in these proceedings and which corresponded to Article 42(3), was added to the Corporate Income Tax Code by the State Budget Law for 2003, Law No. 32-B/2002 of 30 December.
Originally, this rule had the following wording:
"3. The negative difference between gains and losses realized through the paid transfer of equity interests, including their remission and redemption with capital reduction, contributes to the formation of taxable profit at only half its value."
This rule was subsequently amended by the State Budget Law for 2006 (Law No. 60-A/2005 of 30 December), with its scope being broadened to also provide for the non-deductibility of 50% of "other losses or negative equity variations relating to equity interests or other components of equity, namely supplementary contributions".
Subsequently, Decree-Law No. 159/2009 of 13 July adapted the Corporate Income Tax Code to the Accounting Standards System and began to distinguish between impairment losses and provisions in the determination of taxable profit, whereas previously all such matters were generically classified as provisions.
Interpretation of Article 45(3) CIRC
In tax law, the interpretation of rules is found in Article 11 of the General Tax Law. According to paragraphs 1 and 2 of this rule:
"1 - In determining the meaning of tax rules and in qualifying the facts to which they apply, the general rules and principles of interpretation and application of laws are observed.
2 - Whenever terms specific to other branches of law are used in tax rules, they must be interpreted in the same sense as they have there, unless otherwise directly provided by law".
Tax interpretation must take into account grammatical, systematic, historical and teleological elements. Following closely the arguments contained in the opinions attached to the proceedings by the Applicant, issued by Professor Sérgio Vasques and Dr. Fernando Castro Silva, we shall begin by analyzing the elements of interpretation.
a) Systematic Element
As regards the systematic element, we understand that where express rules apply to banking sector enterprises, these are of the nature of special rules and the rule of Article 45(3) CIRC shall not apply. Indeed, the legislator establishes for these impairment losses established pursuant to mandatory rules issued by the Bank of Portugal a special regime in Article 35(2) of the Corporate Income Tax Code, especially safeguarding their deductibility up to the minimum limits established by the supervisory entity. It should be noted that recognition of the aforementioned impairment losses established under Notice No. 3/95 is not unlimited: Article 37 of the Corporate Income Tax Code establishes specific limitations regarding the concrete deductibility of impairment losses and other value adjustments recorded in the same tax period or in previous tax periods established by entities subject to supervision by the Bank of Portugal.
We agree with the Applicant when it asserts that "by establishing the deductibility of impairment losses established pursuant to rules issued by the supervisory entity, the legislator recognizes, in essence, that the accounting of impairment losses is essential to the disclosure of the economic situation of financial institutions and, as such, does not distort the tax interest protected".
The 2009 accounting reform respected the principle of self-regulation of accounting in the banking sector, on the one hand, and the principle of partial dependency between accounting result and tax result. It also took into account the stability and soundness of the financial system, safeguarded in Article 101 of the Constitution of the Portuguese Republic.
b) Historical Element
The expression "impairment losses" first appeared with the terminological changes introduced by Decree-Law No. 159/2009 of 13 July.
Paraphrasing part of the Tax Authority's response:
"Article 45 of the CIRC, under the heading 'Expenses not deductible for tax purposes', lists a series of expenses which, although recorded in the tax period, are not recognized as tax-deductible expenses, or whose deductibility is limited, even if it is shown that 'they are essential for the realization of income subject to tax or for the maintenance of the source of income'; thus, and since it establishes 'a regime contrary to the general rule', Article 45 of the CIRC constitutes an exceptional rule in relation to the aforesaid Article 23 of the CIRC.
More specifically, Article 45(3) provides for a restriction on the deductibility of losses relating to equity interests, which contribute to the formation of taxable profit at only half their value, including both "the negative difference between gains and losses realized through the paid transfer of equity interests" and "other losses or negative equity variations relating to equity interests or other components of equity, namely supplementary contributions".
Article 45(3) was introduced into the CIRC by the State Budget Law for 2003, applying to actual losses resulting from the paid transfer of equity interests, forming part, according to the Budget Proposal Report that introduced it, of a set of measures with the actual objective of combating tax evasion, given the decline in IRC revenue from major enterprises, with the intention of broadening the tax base and introducing measures for the moralization and neutrality of the tax.
Among those measures, as noted on page 34 of the Ministry of Finance Report for the State Budget for 2003, there was the measure that limits the deduction of the negative difference between gains and losses realized from the transfer of equity interests to 50%.
Later, with the State Budget Law for 2006, its scope was broadened to also cover negative components relating to equity interests and other equity items ("other losses or negative equity variations relating to equity interests...").
The 2006 State Budget Law introduced no changes to either Article 35 or Article 37 of the CIRC.
c) Teleological Element
As regards the teleological element, the rule, whether in its original wording resulting from Law 32-B/2002 of 30 December, or in the form given to it by Law 60-A/2005 of 30 December, is explained by the express motivation of the legislator, by needs linked to the fight against tax fraud and evasion and the broadening of the tax base, directed at the consolidation of the public accounts.
If the expansion of the scope of Article 45(3) was determined by the intention to suppress abusive practices, what is at issue is whether impairment losses fall within the purposes targeted by the expansion of that rule.
Now, we understand that it was not the legislator's intention to limit the possibility of deduction of impairment losses already limited under the law by the Bank of Portugal's self-regulation rules.
We agree with the Applicant when it asserts that "only conduct that is within the taxpayer's discretion can be suppressed, which is manifestly not the case with the recording of impairment losses established mandatorily under Bank of Portugal rules".
As was recognized in the arbitral decision issued in the context of case no. 108/2013-T, the expression "other losses or negative equity variations" used in the current Article 45(3) of the CIRC does not have an indiscriminately broad meaning, but rather a precise meaning, defined in Articles 23 and 24.
Impairment losses recorded in accordance with the Bank of Portugal's rules do not result from the will of the taxpayer but rather from the imperative regulatory rules issued by the Bank of Portugal. Thus, as was decided in case 108/2013-T, "the needs to combat tax fraud and evasion clearly cease to exist, not only because the tax relevance of equity variations ceases to be conditioned by an act of will of the taxpayer, but also because the valuation is objectively fixed."
If, on the one hand, when Article 45 CIRC was broadened to other losses, there was also the intention to increase revenues and consolidate the budget, it does not appear to us, from the information provided in the report, that it was the legislator's intention to call into question the self-regulation of accounting in the banking sector or the relationship of partial dependency between the tax result and the accounting result in that sector.
d) Literal Element
As regards the literal element, emphasized by the ATA in its response, we reiterate the understanding set out in the CAAD's decision in case no. 108/2013-T: the expression "other losses or negative equity variations" used in the current Article 45(3) of the CIRC does not have an indiscriminately broad meaning".
Thus, we do not agree with the ATA when it asserts that "the legislator, in referring to 'other losses relating to equity interests', did not typify them, thereby intentionally leaving an 'open door' so that all losses, including consequently, impairment losses of mandatory establishment under the rules issued by the supervisory entity of banking activity, could be subsumed here".
The rule in question should, in our view, have a restrictive interpretation, as explicitly set out above.
Conclusion:
Taking into account the systematic, historical and teleological elements, it is understood that impairment losses relating to equity interests, established pursuant to general and abstract rules issued by the Bank of Portugal, should not be considered to be included in Article 45(3) of the CIRC.
On the Alleged Breach of the Principle of Taxation of Companies Based on Actual Profit
The Applicant alleges that the principle of taxation based on actual profit is being breached. The Constitutional Court (in Decision No. 85/2010 of 3 March 2010 (Case No. 653/09)) and the Supreme Administrative Court (case 204/09 of 20/05/2009) have already ruled on the constitutionality of the aforementioned article, and we understand, in line with the case law, that the aforementioned principle is not being breached.
On the Request for Compensation for Improper Bank Guarantee
The Applicant, certainly by error, requests that the ATA be condemned to pay compensation for improper bank guarantee, in accordance with Article 53(1) of the General Tax Law.
However, it is not established from the facts proved or from the documents attached to the proceedings that the Applicant provided any bank guarantee for a period exceeding three years. Indeed, it is established from the facts proved that the Applicant made payment of the tax and the respective compensatory interest.
Accordingly, the request for compensation for improper bank guarantee must be dismissed.
On Compensatory Interest
Since the additional IRC assessment no. 2014 ... in the amount of 246,672.17 € is unlawful, compensatory interest is due from the date of payment until full reimbursement by the ATA, in accordance with Article 43 of the LGT and Article 61(2) of the CPPT.
4. Decision
In light of the foregoing, it is decided:
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To grant the request for declaration of unlawfulness of the additional Corporate Income Tax (IRC) assessment no. 2014 ... and the compensatory interest assessment act no. 2014 ..., relating to the fiscal year 2011.
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To grant the request for the Tax and Customs Authority to be condemned to reimburse the Applicant the amount of tax paid and the respective compensatory interest, in the total amount of 3,718.07 €, plus compensatory interest in accordance with the law, from the date such payment was made until the date of full reimbursement thereof.
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To dismiss the request for the Tax and Customs Authority to be condemned to pay compensation for improper bank guarantee.
5. Value of the Case:
In accordance with Article 315(2) of the CPC and Article 97-A(1)(a) of the CPPT and Article 3(2) of the Regulation on Costs in Tax Arbitration Proceedings, the value of the action is set at 3,718.07 €.
6. Costs:
In accordance with Article 22(4) of the RJAT and Table I attached to the Regulation on Costs in Tax Arbitration Proceedings, the amount of costs is set at 612.00 €, to be paid by the Tax and Customs Authority.
Notify.
Lisbon, 17 October 2014.
Text prepared by computer, in accordance with Article 138(5) of the Code of Civil Procedure (CPC), applicable by reference to Article 29(1)(e) of the Tax Arbitration Regime, with blank verses and reviewed by me.
The sole arbitrator,
Suzana Fernandes da Costa
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