CAAD Case 272/2018-T: IRC Inventory Adjustments, Impairment Loss Reversals & Burden of Proof

ARBITRAL DECISION

I – REPORT

1. A..., S.A., taxpayer no. ..., with registered office at ..., no. ..., ..., Lisbon, hereinafter referred to as the Claimant, filed on 28/05/2018 a request for constitution of an arbitral tribunal and for an arbitral decision regarding the dismissal of the gracious appeal no. ...2017... and, ultimately, assessment no. 2016... of Corporate Income Tax (IRC), on the grounds that, in its judgment, it suffers from the defect of violation of law, concerning the IRC assessment arising from the correction of tax losses in the amount of 3,927,327.00 euros, by means of disregarding reversals of impairment losses.

2. The Esteemed President of the Ethics Council of the Administrative Arbitration Centre (CAAD) appointed on 16/07/2018 Francisco Nicolau Domingos as arbitrator.

3. On 06/08/2018 the arbitral tribunal was constituted.

4. In compliance with the provision of article 17, nos. 1 and 2 of Decree-Law no. 10/2011, of 20 January (RJAT), the Respondent was notified on 06/08/2018 to, if it so wished, present a reply, request the production of additional evidence and to remit the administrative file (PA).

5. On 01/10/2018 the Respondent presented its reply in which it defends the lack of merit of the request for arbitral decision, given the legality of the IRC assessment and compensatory interest.

6. By order of 02/10/2018, the tribunal determined the waiver of the meeting to which article 18, no. 1 of RJAT refers, based on the absence of exceptions to be determined and the unnecessary nature of inviting the parties to correct the procedural documents, granted eight days for the parties, if they so wished, to present their final written submissions and fixed the deadline for issuing the arbitral decision.

7. The final submissions, in which the parties maintained, in essence, their initial positions, were presented by the Claimant on 11/10/2018 and by the Respondent on 17/10/2018. It transpires that, as the Claimant attached two documents to the final written submissions and the Respondent raised a matter of exception (allegation of a new subsidiary claim not contained in the request for arbitral decision), the tribunal, on 17/12/2018, determined, pursuant to the principles of the autonomy of the arbitral tribunal in conducting the proceedings and in determining the rules to be observed with a view to obtaining, within a reasonable period, a decision on the merits of the claims presented and of the right to be heard, that the Claimant should respond to the matter of exception raised by the Respondent in its written submissions.

8. The Claimant, on 21/12/2018, made submissions regarding the matter of exception, arguing that it did not file a new subsidiary claim, but merely highlighted facts that make up its request for arbitral decision.

9. On 03/04/2019, by order, the tribunal determined the inadmissibility of the extension of the request for arbitral decision, as the judgment delivered in the context of the special administrative action in which the maintenance of the Special Taxation Regime for Groups of Companies (RETGS), with reference to the tax year 2012, was decided, by the date of submission of the request for arbitral decision, was already known to the Claimant.

POSITION OF THE PARTIES

1. The Claimant objects to the decision to dismiss the gracious appeal no. ...2017... which concerns the additional assessment no. 2016... of IRC for the year 2012, which determined an amount to be paid of 792.82 euros, including compensatory interest.

The gracious appeal was presented on the grounds that the deduction of the amount of 1,940,990.00 euros relating to "reversals of adjustments in inventories taxed", entered in line 762, of table 07 of form 22 declaration, should be maintained for the tax year 2012, because: i) The assets – in particular the periodic housing real estate rights (DRHP) of the project "..." belong to the Claimant; ii) The adjustments in inventories are fiscally and accountably justified; iii) The cost associated with losses in inventories is fiscally deductible, as it meets the requirements of article 23 of the Corporate Income Tax Code (CIRC) and iv) The adjustments in inventories were increased in prior years, specifically in the tax year 2010, which legitimates their deduction in 2012, according to the following table:

Property Deduction model 22

... 1,893,370.00 euros

... 47,620.00 euros

Total to be deducted in 2012 1,940,990.00 euros

However, it notes that in the order dismissing the gracious appeal it is stated that: i) for the assets in question – "..." and "..." – the Claimant should have recorded the revenue or made the increase to the taxable income of the amount corresponding to the deduction made; ii) fiscal acceptance of expenses must comply with the general rule provided in article 23 of CIRC and, in that scope, the most important means of proof is documentary. The absence of any one of the requirements implies that it is not considered as a fiscal expense, as in IRC self-determination of accounting profit prevails and iii) with regard to the deductibility of the expense associated with loss in inventories, it states that as to the documents in question – Agreement and Revocation of DRHP – it is verified that, in addition to not containing any reference to the valuation of the DRHP, they also do not prove their existence and ownership.

The Claimant accepts that, for the tax year 2007, the increase in field 270, in the amount of 1,976,327.00 euros, was not made in that year, as was also the case for the tax years 2006, 2008 and 2009. Whereby it states it expressly accepts the correction of the amount of 1,976,327.00 euros, with reference to the adjustment made in 2007, in relation to the project "...".

Secondly, it maintains its disagreement with the position of the Tax Inspection Services when they sustain that: "...with regard to the increase in the amount of 2,645,938.00 euros, the taxpayer does not prove that this increase concerns the impairment losses in question".

Additionally, it also objects to the understanding of the Respondent to the effect that the reversals of the adjustments in inventories relating to the property "...", which was recorded in revenues, as well as the reversal of the DRHP of "...", made only in the balance sheet, do not meet the conditions for deduction, and as such, the reversal of impairment losses (adjustment in inventories) declared in field 762, in the amount of 4,169,647.00 euros, is not proved.

That disagreement with respect to the DRHP of the project "...", in the amount of 3,869,697.50 euros is based on the position of the Respondent to the effect that the use of adjustment in inventories is excluded, since for the latter the taxation in the exercise of constitution of impairment loss (adjustment) and the deductibility of the expense at the time of deduction to taxable income were not proved.

In summary, in its opinion, the elements attached to the case throughout the inspection procedure allow the conclusion of fiscal admissibility of the deductibility in the tax year 2012 of reversals of impairment losses relating to the immovable properties "..." and "...".

Its annulment claim is based, in the first place, on the fact that the tax inspection report violates the distribution of the burden of proof between the TA and the taxpayer, provided in articles 75 and 76 of the General Tax Law (LGT).

It alleges that if it is the Tax and Customs Authority (TA) that bears the burden of proof of the prerequisites of the facts constitutive of the rights it seeks to exercise in the procedure, the taxpayers will bear the burden of proving the facts that may serve as support for the realization of those rights. A duty that the Claimant understands it has fulfilled throughout the entire tax inspection procedure, presenting all documentary evidence capable of concretizing its right to deduction of impairment losses, namely, evidence that the impairment loss of 2,645,938.00 euros was constituted in the tax year 2010 – Report and Accounts for 2010.

Further in this respect, it maintains that the evidence presented is documented in light of what is established in commercial, fiscal and accounting legislation. Therefore, it understands that it presented all accounting documentation and auxiliary records, confirming the values relating to impairment losses deducted in the year 2012, whereby it was proved that the increase of 2,645,938.00 euros relates to impairment losses.

In the second place, it states that in accordance with article 28, no. 1 of CIRC (in the version in force at the date of the taxable event) adjustments in inventories recognized in the tax period are deductible in determining taxable profit, up to the limit of the difference between the acquisition cost of inventories and their respective net realizable value referred to as of the date of the balance sheet.

However, when the concrete adjustments in inventories were made: i) 47,620.00 euros and 3,869,697.00 euros, it did not proceed with the deduction because the legal prerequisites were not met, the definition of net realizable value. Similarly, only the reversal, partial or total, of adjustments that were initially deductible concurs toward the formation of taxable profit.

It argues that this was the logic that was observed when in 2012 it proceeded with the deduction of the reversal of adjustments in inventories, that is, at the moment when the legal prerequisites, on which the deductibility depends, were verified.

Field 718 of the IRC declaration – model 22 – concerns adjustments in inventories at the moment of their constitution, as they do not meet the legal prerequisites on which their deduction depends – the factual situation at issue. In fact, as it is not a deductible adjustment in inventories, the taxpayer should make the respective correction in determining the net result of the exercise, placing the value of the adjustment to increase in table 07.

In the tax year 2010, the Claimant proceeded with the increase of the amount of 2,645,938.00 euros in field 718 of the IRC declaration – model 22, whereby it does not agree with the correction made by the Tax Inspection Services. Therefore, it considers that it observed the principles of deductibility of adjustments in inventories and taxation of their respective reversals, proceeded with the increase of the said amount in 2010 and deduction in 2012. It argues that it has always followed the accounting and fiscal principles established in the law and, thus, all increases and deductions made in table 07 of the IRC declarations – model 22 of the various tax years were a reflection of the accounting principle followed by the company, as evidenced in note 6 – inventories, of the Report and Accounts for 2010, which obtained a favorable opinion from the Official Auditor.

Thus, the reversal due to impairment relating to the DRHP was not recorded in the revenue account, but rather in the balance sheet.

The Claimant also does not accept the conclusion of the Tax Inspection Services that with regard to impairment losses that were supposedly reversed in 2012 reference is made only to "..." and to the "shop on ... Street", with no reference to the property "...". However, one of the headings (entitled "Other") of note 6 – inventories, of the Report and Accounts for 2010, encompasses the property "...".

And as to the building "...", the Tax Inspection Services state that the documents presented for inspection do not allow validation of either the value of the asset purportedly recorded in 2007, or the value of impairment losses purportedly constituted between 2007 and 2012. In the said table of note 6 is indicated as the value on 31 December 2009, the amount of 1,893,370.00 euros, with impairment loss in the amount of 1,893,370.00 euros and the value on 31 December 2010 of 0.00 euros. In turn in the table presented by the taxpayer at the first request for clarification it is indicated on 31 December 2011, a gross value of 3,869,698.00 euros and impairment losses of 3,869,697.00 euros, which makes a net value of 1.00 euros.

Thus, the Claimant understands that it should be considered proven the record of impairment loss of the building "...", albeit partially, in the amount of 1,893,370.00 euros, as that part was unequivocally proved.

In this way, the Claimant seeks to be recognized the right to deduction in 2012 of the amount of 1,940,990.00 euros, as the increase in 2010 in the amount of 2,645,938.00 euros was proved, which includes 242,330.00 euros relating to the property of ... Street (recognized by the Tax Inspection Services); 1,893,370.00 euros, relating to the building "..."; 47,620.00 euros referring to the property "..." and 462,618.00 euros referring to other assets. As well as making clear the accounting record in 2010, of 242,330.00 euros, relating to the property of ... Street (recognized by the Tax Inspection Services), 1,893,370.00 euros relating to the building "..." and 47,620.00 euros relating to the property "..." – included in the "other" heading.

As to the asset of DRHP "...", that which for the Respondent there is no evidence of its ownership in the legal sphere of the Claimant, it sustains that the registration of rights in the Property Registry is not constitutive, but merely declarative. Reason by which it understands that it is proved that the DRHP are part of its assets.

As also, the Claimant understands that the adjustments in inventories, recorded accountably in 2010, in the amount of 2,645,938.00 euros respected the accounting rules in force, with their economic substance being proved.

Moreover, as adjustments in inventories constitute a cost for companies, in order for them to be deductible they must respect the general principle of deductibility of expenses provided in article 23 of CIRC and from the moment when the assets are accepted as an integral part of taxable profit, the question of whether or not they are indispensable to the productive source does not arise, nor whether they are intended to obtain the profit subject to taxation.

However, in its judgment, it appears clear that the immovable properties in question are indispensable to the activity of the Claimant, as indeed results from its corporate purpose, real estate development. As also, the immovable properties are intended to obtain profit, although they do not always originate it – being a risk associated with economic activity, which does not prevent their deductibility.

The position of the TA to the effect that abandonment of the legal transaction originates from the fact that it ceased to interest the parties configures a violation of the principle of freedom of business management, given that this position involves a judgment of opportunity regarding the revocation of the partnership agreement.

Therefore and on the grounds that the adjustments in inventories are properly documented, also as regards the expense associated with the resolution of the agreement of DRHP of the project "...", the general prerequisites of article 23 of CIRC are met.

Finally, it petitions the condemnation of the TA for payment of indemnity interest, as there exists "error attributable to the services" that determined the payment of undue tax debt.

1. The Respondent presents a defense with the following grounds:

i) Reversal of adjustments in inventories and impairment losses taxed

The tax inspection procedure that gave rise to the disputed assessment had as its objective the analysis of the legality of accounting record movements in revenues of the exercise related to the deductions entered in fields 762 (reversal of adjustments in inventories taxed and impairment losses taxed) of table 07 of the IRC declaration – model 22, tax year 2012.

Regarding the verification of reversals of adjustments in inventories already taxed, it states that the Claimant declared in field 762 of table 07 of the IRC declaration – model 22, the amount of 4,169,647.00 euros with the purpose of deducting from taxable matter and argues that: "... the reversal of adjustments in inventories which at the moment of their constitution did not meet the prerequisites to be accepted fiscally, pursuant to article 28 of the IRC Code". It further states that the Claimant seeks to demonstrate the prior taxation of the values deducted in the IRC declaration – model 22, through the following table:

Constitution effected in 2007 – field 270 1,976,327.00 euros

Constitution effected in 2010 – field 718 2,645,938.00 euros

Reversal effected in 2011 – field 762 - 190,948.00 euros

Balance on 01/01/2012 4,431,317.00 euros

Reversal effected in 2012 – field 762 - 4,169,647.00 euros

Balance on 31/12/2012 261,670.00 euros

As to the legal framework, it sustains that: article 28 of CIRC (in the version in force at the date of the taxable event) provides that adjustments in inventories recognized in the tax period are deductible in determining taxable profit up to the limit of the difference between the acquisition or production cost of inventories and their respective net realizable value referred to as of the date of the balance sheet, when the latter is lower than the former. As also, the total or partial reversal of the adjustments provided for in no. 1 of article 28 of CIRC concurs toward the formation of taxable profit.

Therefore it argues, the deduction in table 07 operates whenever such impairment loss has already been previously taxed, at the moment of constitution. Now, in the clarifications presented by the taxpayer it is assumed that such impairment losses did not meet the prerequisites to be accepted fiscally, pursuant to the said article 28 of CIRC. It falling to the Claimant to prove the increase in table 07 in the year of constitution of impairment loss (article 75 of LGT, articles 123 and 130 of CIRC), the truth is that despite the presentation of a table making reference to "purported" increases made in table 07 on account of impairment losses, it is not proved, for the tax year 2007, the increase referred to by the taxpayer in field 270 of the IRC declaration – model 22, in the amount of 1,976,327.00 euros.

It further adds that, as regards the increase in the amount of 2,645,938.00 euros, it is not proved that this concerns the impairment losses in question.

Therefore, it argues that the prior taxation of such impairment losses is not proved.

In parallel, it states that the deduction in table 07 requires that in the exercise of deduction it be proved that such revenue concurred toward taxable income. However, it argues that, from the analysis of the financial statements and clarifications provided by the Claimant, only the reversal of impairment losses relating to the rural property situated in the place ..., in the value of 47,620.00 euros and to fraction C of the urban property with article number..., in the value of 252,330.00 euros were recorded in revenues – account (SNC) 762.

With regard to the remaining value of the deduction, which corresponds to the reversal arising from the waiver of DRHP in favor of B..., Lda., according to the Claimant, recorded in the balance sheet and not revealed in revenues, the reversal of impairment losses (adjustments in inventories) declared in field 762 of the IRC declaration – model 22, of the tax year 2012, in the amount of 4,169,647.00 euros is not proved.

The Respondent understands that the use of adjustments in inventories of 3,869,697.50 euros is further excluded, in that any adjustment/impairment loss only concurs toward taxable income (via the record of an expense or a fiscal deduction) if it is proved: i) the taxation, via the increase in table 07 of the IRC declaration – model 22, in the year of constitution of impairment loss; ii) the deductibility of the expense (or fiscal deduction) at the moment of deduction to taxable income, pursuant to article 23 of CIRC. That is, the prior taxation in prior years of the amount 3,869,697.50 euros relating to the asset – DRHP over "..." not being proved, its use is precluded.

Fiscal and accounting regulations require that the record of impairment losses in inventories depends on the identification of the causes that contribute to the verification of loss of value and a process of quantification of the loss through estimates of net realizable value. Or, in other words, it advocates that the economic or market circumstances capable of justifying the devaluation of inventories must be identified and using for proof – documents whose content should provide clear information about the origin, nature and estimates of the prices considered relevant and quantification of adjustments in inventories – articles 123, no. 2, al. b) and 23, no. 1, both of CIRC.

It transpires that, in its judgment, it was demonstrated that the Claimant should have recorded the revenue or made the increase to taxable income of the amount corresponding to the deduction made, which did not occur. In this line, it observes that the Claimant itself informed that it made the reversal using only the movement of Balance Sheet accounts – 32 Merchandise and 329 Accumulated Impairment Losses.

With regard to the prerequisites for deductibility of expenses, pursuant to article 23 of CIRC (in the version in force at the time), the regulation requires: i) documentary proof (escritural support for accounting entries); ii) justified connection with the company's productive activity and this indispensability is verified provided that these charges connect with the obtaining of profit and iii) that the expenses incurred by the taxpayer must be limited to either obtaining the gains subject to taxation or maintaining the productive source.

In its judgment, the documents delivered by the Claimant are irrelevant in the face of the requirements of the said regulation, as the documentary evidence of the charges was not attached. That is, as this did not make the proof that was incumbent on it, its annulment claim must fail.

In particular, regarding the property "...", it is verified that abandonment of the business occurred, presenting itself as the sole justification the circumstance that there existed loss of interest to the parties. Although a "Partnership Agreement" was presented, dated 11 May 2007, in which it is stated that the parties will diligently act in order to alienate to third parties the fractions with respect to which they already have between them the totality of DRHP and with respect to the remaining fractions they will promote their acquisition, with a view to subsequent sale, the truth is that in 2012 the Claimant presented a document entitled "Revocation of Partnership Agreement", altering the business strategy. Or, in other words, the Agreement and Revocation contain no reference to the valuation of the DRHP, nor do they prove the respective acquisition and ownership, when article 8 of the Legal Regime of Periodic Housing requires it.

It also argues that from the analysis of the property matrices there is no record of DRHP in the name of the Claimant, nor of the revocation of the agreement with B..., Lda., with tax number ....

In sum, the act of express dismissal of the gracious appeal must be maintained in the legal order and, consequently, the additional IRC assessment.

ii) Right to indemnity interest

If in the present case there exists no "error attributable to the services" the Respondent cannot be condemned to payment of indemnity interest.

ISSUES TO BE DECIDED

In this sequence, having regard to the claims and positions of the Claimant and the Respondent contained in their procedural documents, summarized above, the following are the issues that the tribunal must consider (without prejudice to the solution given to a certain issue being able to prejudice the determination of one or other issues – article 608, no. 2 of the Code of Civil Procedure (CPC), applicable ex vi article 21, no. 1, al. e) of RJAT):

a) Whether the express dismissal of the gracious appeal which, ultimately, concerns the IRC assessment no. 2016..., suffers from error regarding the factual and legal prerequisites;

b) Whether the Claimant should be reimbursed for the tax paid and whether it is entitled to indemnity interest.

CLARIFICATION OF THE RECORD

The case does not suffer from nullities, the arbitral tribunal is regularly constituted and is materially competent to determine and decide the claim, with the conditions for issuing the final decision being met.

II - GROUNDS

FACTUAL MATTER

1. Facts that are considered proved

1.1. The Claimant's main activity is real estate development, having as secondary activity the purchase and sale of immovable property (tax inspection report contained in PA).

1.2. On 27/05/2013 the Claimant, in the IRC declaration – model 22, of the tax year 2012, in table 07, field 762, entered to be deducted as reversal of adjustments in inventories taxed and impairment losses taxed, the amount of 4,169,647.00 euros (Document attached in the gracious appeal under no. 3 and contained in PA).

1.3. The Claimant was subject to an internal inspection action, of partial scope carried out by the Tax Inspection Services of the Lisbon Finance Directorate, relating to the tax year 2012, with a view to assessing the legality of accounting record movements in revenues of the exercise, related to the deductions entered in fields 762 (reversal of adjustments in inventories taxed and impairment losses taxed), of table 07 of the IRC declaration – model 22, especially their framework in article 28 of CIRC (tax inspection report contained in PA).

1.4. In the course of the inspection, the Claimant declared that the reversal of adjustments made in 2012 corresponds to the following inventories:

a) Rural property, situated in the place ..., registered in the property matrix of the parish of ... under article ...., of section "AB", whose impairment corresponded to 47,620.00 euros, which was alienated on 20 March 2012, for the amount of 70,000.00 euros;

b) Urban property – fraction "C" (registered in the property matrix of the parish of ... under article ...), situated on ... Street, whose impairment corresponded to 252,330.00 euros, which was alienated on 10 October 2012, for the amount of 230,000.00 euros;

c) Periodic Housing Real Estate Rights over "...", whose impairment corresponded to 3,869,697.50 euros, with a contract of Revocation of these rights being signed on 30 November 2012, which revoked the partnership agreement concluded on 11 May 2007 between the Claimant and the companies C... SGPS, S.A. and B..., Lda. (tax inspection report contained in PA).

1.5. The Claimant declared in the inspection procedure that impairments recorded in inventories were made accountably in the years 2007 and 2010 as follows:

a) Adjustment made in 2007, in the amount of 1,976,327.00 euros, relating to the project "...";

b) Adjustment made in 2010, in the amount of 2,645,938.00 euros, which encompasses, namely, the projects "...", in the amount of 1,873,379.00 euros; ... Street, in the value of 242,330.00 euros and "...", in the value of 47,620.00 euros, included in the "other" heading (tax inspection report contained in PA).

1.6. The Claimant sent to the TA, during the inspection, a reply in which it alleges that the prior taxation of the values deducted in the IRC declaration – model 22, of the tax year 2012, occurred as follows:

Constitution effected in 2007 – field 270 1,976,327.00 euros

Constitution effected in 2010 – field 718 2,645,938.00 euros

Reversal effected in 2011 – field 762 - 190,948.00 euros

Balance on 01/01/2012 4,431,317.00 euros

Reversal effected in 2012 – field 762 - 4,169,647.00 euros

Balance on 31/12/2012 261,670.00 euros

1.7. The TA, in the final tax inspection report, concluded that the reversal in the amount of 242,330.00 euros, relating to the urban property situated on ... Street (fraction "C" of the urban property registered in the property matrix of the parish of ..., with property article no. ...) was proved.

1.8. The Claimant was notified of the tax inspection report, with order of 30/09/2016, which determined the following corrections:

Description Value

Tax Loss (declared) 3,984,172.33 euros

Corrections 3,927,317.00 euros

Tax Loss (corrected) 56,855.33 euros

1.9. In the grounds of the corrections made by the TA the following appears:

"– That the taxpayer deducted in determining the fiscal result of the exercise in question, as reversal of adjustments in inventories and/or impairment losses already taxed (articles 28, no. 3 and 35, no. 3, both of CIRC) the amount of 4,169,647.00 euros, entering it in table 07, field 762, of the respective model 22 of IRC;

– However, the elements available to the TA, combined with those provided by the taxpayer in response to the request for clarification directed to it by the Tax Inspection Services, did not allow confirmation of prior taxation of the said amount in previous years;

– That of the said amount, the amount of 3,689,697.50 euros, purportedly corresponding to Periodic Housing Real Estate Rights (DRHP), did not concur toward the formation of taxable income of the exercise in question. That is, that requirement (article 28, no. 3 of CIRC) was only met with respect to two immovable properties in the value of 299,950.00 euros, and

– That no proof was made of the quantification of the value of the DRHP asset nor of the corresponding impairment loss, nor was the economic rationality of the operation underlying the same loss justified, that is, the waiver of those real rights.

In light of these conclusions and taking into account the provision of article 75 of LGT, combined with the provision of articles 123 and 130 of CIRC and further the tenor of article 23 of the latter diploma, the proposal for total correction of the aforesaid reversals considered by the taxpayer in determining the fiscal result of the exercise in question (4,169,647.00 euros) was projected".

However, following the notification that was made to it for that purpose (...) having brought to the case elements that allowed confirmation of prior taxation of part of the value of the reversals deducted, specifically 242,330.00 euros. Consequently, the aforementioned proposal for correction was revised (...), being proposed the alteration of the tax loss declared by the taxpayer for the tax year 2012, from 3,984,172.33 euros to still a tax loss of 56,855.33 euros...".

1.10. Based on the aforesaid corrections in the amount of 3,927,317.00 euros the TA made the additional IRC assessment no. 2016..., relating to the tax year 2012 and statement of compensation interest, in the total value of 792.82 euros (document attached by the Claimant under no. 2).

1.11. The Claimant paid the amount of 700 euros of the additional assessment, with the compensatory interest of 92.82 euros being cancelled (document attached by the Claimant under no. 1).

1.12. As it did not agree with the corrections which have their source in the impossibility of deduction, for purposes of determining taxable profit, of reversals of impairment losses; as it was not proved that they had been previously taxed, it presented a gracious appeal on 11/04/2017, in which it attributes to the IRC assessment no. 2016... the defect of violation of law, requests reimbursement of the tax and petitions condemnation of the TA for payment of indemnity interest at the legal rate (tax inspection report contained in PA).

1.13. The gracious appeal was expressly dismissed by order of the Assistant Finance Director of Lisbon by letter dated 26/02/2018 (PA).

1.14. The Claimant was notified of such order on 27/02/2018 (PA).

1.15. The request for arbitral decision was presented on 28/05/2018.

1. Facts that are not considered proved

2.1. The Claimant was the owner of the DRHP that affect fractions DQ, DG, DH, DN, EG, ET, GI, GJ, GL, GM, GV, GZ, HI, HA, HJ, HL, HM, HS, HX, HZ, IH, II, IJ, IA, IX, IL, IM, IN, IT, IZ, JL, JA, JB, JC, JV, JZ, JM, JO, JP, LJ, LM, LA, LB and LC of the building called "...", in the period between 2007 to 2012.

2.2. The reference to "other" and respective monetary value entered in note 6 – inventories, of the Report and Accounts also refers to the property called "...".

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

1. Grounds for the factual matter considered proved

The facts relevant to the judgment of the case were selected and distinguished according to their legal relevance, in light of the plausible solutions of the legal issues, in accordance with the combined application of articles 123, no. 2 of the Code of Tax Procedure and Process (CPPT), 596, no. 1 and 607, no. 3 of the Code of Civil Procedure (CPC), applicable ex vi article 29, no. 1, letters a) and e) of RJAT.

With regard to the facts proved, the arbitrator's conviction was based on the positions assumed by the parties and on critical analysis of the documentary evidence attached to the case, describing in the facts proved the documents that support them.

1. Grounds for the factual matter not considered proved

No documents were attached to the case by the Claimant that would allow the matter indicated in 2 to be considered established. As regards the DRHP, such proof would be made with the attachment of property certificates and the reference to "other" in note 6 - inventories, of the Report and Accounts for 2010 does not allow, without room for doubt, proof of connection to the property called "...".

LEGAL MATTER

First and foremost, it is important to describe the regulations relevant to the assessment of the merits and develop, from a theoretical point of view, the issue of adjustments in inventories.

For the determination of taxable profit, accounts must be organized in accordance with accounting standards, without prejudice to the particularities provided in CIRC and must reflect all operations carried out by the taxpayer, so that the results of operations and changes in assets subject to IRC can be distinguished from others – article 17, nos. 1 and 3, letters a) and b) of CIRC.

Entries must be supported by justified, dated documents capable of presentation whenever necessary – article 123, no. 2, al. a) of CIRC.

Regarding inventories, article 26 of CIRC (in the version in force at the date of the taxable event) provided that: "1 — For the purpose of determining taxable profit, inventories revenues and expenses are those resulting from the application of methods that use:

a) Acquisition or production costs;

b) Standard costs ascertained in accordance with appropriate accounting techniques;

c) Sales prices deducted from the normal profit margin;

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

e) Special valuations for inventories considered basic or normal.

2 — In the event that inventories require a period of more than one year to reach their condition of use or sale, the costs of loans obtained that are directly attributable to them in accordance with applicable accounting standards are included in the acquisition or production cost.

3 — Whenever the use of standard costs leads to significant deviations, the Directorate General of Taxes may make the appropriate corrections, taking into account the field of application of the same, the amount of sales and final inventories and the degree of inventory rotation.

4 — Sales prices are considered those contained in official documents or the last ones that under normal conditions were practiced by the taxpayer or those that, at the end of the tax period, are current in the market, provided that they are considered suitable or of unequivocal control.

5 — The method referred to in letter c) of no. 1 is only accepted in sectors of activity where the calculation of acquisition or production cost becomes excessively costly or cannot be ascertained with reasonable accuracy, and the normal profit margin, in cases where it is not easily determinable, may be replaced by a deduction not exceeding 20% of the sales price.

6 — The use of special valuations provided for in letter e) of no. 1 requires prior authorization from the Directorate General of Taxes, requested in a petition in which the methods to be adopted and the reasons that justify them are indicated".

As to adjustments in inventories, article 28 of CIRC provided that: "1 — Adjustments in inventories recognized in the tax period are deductible in determining taxable profit up to the limit of the difference between the acquisition or production cost of inventories and their respective net realizable value referred to as of the date of the balance sheet, when the latter is lower than the former.

2 — For the purposes of the preceding number, net realizable value is understood to mean the estimated sales price in the normal course of the taxpayer's activity in accordance with no. 4 of article 26, deducted from the necessary costs of completion and sale.

3 - The total or partial reversal of the adjustments provided for in no. 1 concurs toward the formation of taxable profit.

4 — For taxpayers carrying out editorial activity, the annual accumulated amount of adjustment corresponds to the loss of value of editorial funds constituted by works and complementary elements, provided that two years have elapsed after the date of respective publication, which for this purpose is considered to coincide with the date of legal deposit of each edition.

5 — The devaluation of editorial funds must be assessed based on the elements contained in the records that show the movement of works included in the funds".

Article 123, nos. 1 and 2 of CIRC provided that: "1. Commercial or civil companies in commercial form, cooperatives, public companies and other entities that carry out, as main title, a commercial, industrial or agricultural activity, with registered office or effective management in Portuguese territory, as well as entities that, although not having registered office or effective management in that territory, have a permanent establishment there, are required to have accounting organized according to the law that, in addition to the requirements indicated in no. 3 of article 17, allows control of taxable profit. 2. In the execution of accounting, the following must be observed in particular: a) All entries must be supported by justified, dated documents capable of being presented whenever necessary; b) Operations must be recorded chronologically, without amendments or erasures, and any errors must be subject to accounting adjustment as soon as they are discovered".

Article 23, no. 1, al. h) of CIRC provided for the possibility of fiscal deductibility of impairment losses, provided they are recognized or recorded in the same tax period.

It is also important to add that in order for an expense to be fiscally deductible in IRC, the presentation of justified documents, contained in the taxpayer's accounting, that have actually served as the basis for the operations and transactions carried out and are indispensable for the realization of revenues is required. To this purpose the case law sustains: "In fact, although it results from the case that the said amount is duly documented (see fls. 72 to 161) and contrary to what is stated in the appealed judgment, since it is settled case law of this Section of the STA that the requirements of invoices contained in article 35, no. 5 of CIVA, are not a condition of the formal validity of invoices for purposes of IRC, but only for purposes of IVA deduction, in accordance with article 19, no. 2 of CIVA, the fact is that if such tickers and receipts demonstrate that the defendant purchased goods and made certain expenses, nothing in the case demonstrates what the specific purpose to which they were put was, so as to allow the conclusion that they were indispensable for the realization of taxable revenues or for the maintenance of the productive source and, in fact, it was also incumbent on it to make such burden". Or, in other words, proof of the connection of expenses with business activity.

Impairment loss is subject to regulation in accounting and financial reporting standard 12 (NCRF 12) – Impairment of Assets, which has its source in International Accounting Standard IAS 36 – Impairment of Assets.

The concept of impairment loss comprises the excess of the carrying amount of an asset, or of a cash-generating unit, over its recoverable amount.

NCRF 12 - Impairment of Assets prescribes the procedures that an entity must apply to ensure that its assets are carried at no more than their recoverable amount. That is, an asset is carried at more than its recoverable amount if its carrying amount exceeds the amount to be recovered through use or sale of the same. If this condition is verified, the asset is described as being impaired and the Standard determines that the entity shall recognize an impairment loss. It transpires that the Standard also specifies the hypotheses in which an entity shall reverse an impairment loss and prescribes disclosures.

Impairments in inventories constitute one of the exceptions to the treatment of NCRF 12 – Impairment of Assets, this matter being addressed in NCRF 18 – Inventories.

The practice of reducing the cost of inventories to net realizable value is in harmony with the rule that assets should not be carried at amounts exceeding those that would result from their sale or use.

Impairment losses in inventories are ascertained by the difference between the cost of purchase or production and their net realizable value, when the latter is lower.

The cost of inventories may also not be recoverable if estimated costs of completion have increased, if inventories have been damaged, or if estimated costs to be incurred to complete the sale have increased.

But how is net value ascertained?

NCRF 18 in its §§ 30 and 31 determines that estimates of the net value expected to be realized must be based on the most reliable evidence available at the time the estimates are made and must assess the purpose for which the inventory is held. The said estimates must take into consideration variations in prices or costs directly related to events occurring after the end of the period, as such events confirm conditions already existing at the end of the period.

At the end of each reporting period, the net realizable value must be reassessed and, if the circumstances that previously resulted in an adjustment to the value of inventories no longer exist, or when there is clear evidence of an increase in net realizable value due to change in economic circumstances, the amount of the adjustment shall be reversed, so that the new carrying amount is the lower of cost and the revised net realizable value.

In this way, taxpayers must continuously measure the net realizable value of inventories held, and it is certain that in those cases where historical cost is higher than net realizable value, it is necessary to make the accounting entry for impairment.

Reversals of impairment losses concur toward the determination of taxable income, a conclusion which coincides with NCRF 18, whereby the reversal of the adjustment must be disclosed in the income of the exercise.

Furthermore, adjustments in inventories (impairment losses) must be contained in the entity's tax documentation process, not only through the completion of model 30 – statement of provisions, impairment losses on receivables and adjustments in inventories, but also of supporting documentation, namely, evidence of impairment and certificates of legal proceedings, article 130 of CIRC.

In summary, deduction in the IRC declaration – model 22, operates when impairment loss has already been previously taxed, at the moment of constitution and it is also required that in the exercise of deduction it be proved that the revenue concurred toward taxable income.

The burden of proof of the facts constitutive of the rights of the tax administration or of taxpayers falls on whoever invokes them, as is expressly and concretely provided in article 74 of LGT. Thus, it is incumbent upon the TA to bear the burden of proof of the verification of the legal prerequisites binding and legitimizing its action, for which it must prove the constitutive facts on which the decision with a certain content and sense legally depends. In turn, it is incumbent upon the taxpayer to prove the facts that operate as support for the claims and rights it invokes.

The challenged corrections relate to the non-deductibility of adjustments in inventories, with the tax assessment at issue being embodied in the non-recognition of deduction to taxable profit sought by the Claimant, namely, due to lack of proof of the prerequisites that legitimate it.

In this way, it is incumbent upon the Claimant, pursuant to article 74, no. 1 of LGT, the demonstration of the factual situations that underpin the adjustments, reversals that it promoted and whose tax relevance it defends, clarifying, proving and documenting the operations carried out.

Moreover, in accordance with article 75, no. 1 of LGT, declarations by taxpayers presented in accordance with the manner prescribed by law, as well as data and calculations in their accounting or records, when they are in accordance with fiscal or accounting legislation, are presumed to be true. It transpires that the aforesaid presumption ceases when such declarations, accounting or records, or their supporting data, present omissions, errors and inaccuracies or when well-founded indications are gathered that they do not reflect or prevent knowledge of the real tax matter of the taxpayer, article 75, no. 2, al. a) of LGT. It is further added that in accordance with article 75, no. 3 of LGT, the "... evidentiary value of taxpayers' data processing depends, unless otherwise provided by special law, on the provision of documentation relating to their analysis, programming and execution and the possibility for the tax administration to confirm them".

The Claimant itself acknowledges that the part of the deduction corresponding to the reversal arising from the waiver of DRHP was made "directly in the balance sheet" and was not recorded in revenues. Or, in other words, it used only the movement of balance sheet accounts – 32 merchandise and 329 accumulated impairment losses. That is, the presumption ceases. In the same line, note 6 – inventories, of the Report and Accounts for 2010 does not allow the establishment, for purposes of the increase of impairment loss, at the moment of its constitution, of a connection with the property "...".

As Jorge Lopes de Sousa observes with regard to article 75, no. 2 of LGT: "The unequivocal scope of the cessation of the presumption in these situations is to determine that, when they occur, it will be on the taxpayer that the burden of proof of the facts declared or entered in its accounting or records falls regarding which there are evidentiary doubts. This rule being applicable also in the judicial process, by what has been said, and harmonizing it with the rule of no. 1 of article 100 of CPPT, it should be concluded that, in cases where one of these situations in which in the tax procedure the burden of proof is attributed to the taxpayer occurs, doubts that in the judicial process subsist regarding the factual matter cannot be considered well-founded doubts for purposes of, in accordance with that provision, justifying the annulment of the impugned act", Code of Tax Procedure and Process. Annotated and commented, vol. II, 6th ed., Áreas Publisher, 2011, p. 133.

Thus, it is incumbent on the Claimant to bear the burden of demonstrating the facts entered and the reasons for the adjustments made in accounting, with it not being sufficient to leave doubt regarding the relevance of the respective justification. In summary, the proof produced must ensure, with the certainty required, that the adjustments and reversals of adjustments made possess consistency and materiality sufficient in light of the justifications that underlie them.

Well then, the essential point here under consideration in order to assess the legality of the disputed corrections concerns the circumstance that adjustments in inventories are fiscally and accountably justified, as well as the reversal of impairment losses.

To conclude on the legitimacy of the deduction of impairment losses in the determination of taxable profit it is necessary to prove the taxation, at the moment of constitution of the loss and, secondly, the deduction requires that in the exercise in which it is made it be proved that such revenue concurred toward taxable income.

In particular, the issue arises, in the first place, with proof of taxation of impairment losses with respect to the DRHP of "..." and the property "...".

As to impairment losses where proof of prior taxation is required, the TA puts in issue, with respect to the increase of 2,645,938.00 euros, the connection with the impairment losses in question. On the other hand, as regards the requirement that in the exercise of deduction it be proved that revenue concurred toward taxable income, it argues that this does not happen.

With regard to the project "..." it argues that the taxation in the exercise of constitution of impairment loss is not proved and the deductibility of the expense at the moment of subtraction from taxable income, pursuant to article 23 of CIRC. As well as it sustains that the reversal of impairment with respect to the DRHP was not recorded in the revenue account, but in the balance sheet.

Thus, with respect to "...", there arises, from the outset, the issue of verifying proof of the acquisition of the DRHP and its valuation. To this end, the Claimant argues that its registration is not necessary, however, the constitution of DRHP is made by deed of sale and is subject to property registration, it being incumbent on the Property Registry Office to issue a certificate that titles the DRHP and legitimizes its transmission, being delivered to the holder of the registered right - article 10 of Decree-Law no. 275/93, of 5 August (in the version in force at the date of the taxable event).

On the question the case law observes: "Being the possibility of inhabiting an accommodation unit, during a period of time annually, previously established, the essential and distinctive faculty, attributed to the holder of DRHP, we have that such lesser real right, of enjoyment, over the property of another, worth erga omnes, if it is constituted by unilateral legal transaction, subject to deed of sale, article 7, of DL 275/93.

The constitutive title is, in turn, subject to entry in the property register, article 9 of DL 275/93, becoming, by effect of registration, opposable to third parties. Once such definitive registration is carried out the issuance of the property certificate is made by the property registry office, which titles the right and legitimizes the transmission or encumbrance of this, nos. 1 and 2, of article 10, of DL 275/93. Now in terms of transmission or encumbrance of DRHP, by act between living persons, the same are made by declaration of the parties in the property certificate, with presential recognition of signatures of the constituent of the charge or of the alienator, being subject to registration in accordance with general terms, no. 1, of article 12, of DL 275/93, with transmission by death also being subject to entry in the property certificate, no. 3, of the said provision. Thus, and despite DRHP being easily negotiable, as titulated by a property certificate, transmissible or encumberable by simple endorsement or abutment, which will certainly not be unrelated to the extreme mobility, in terms of market, of tourism activity, it cannot but be stressed that, in addition to the mentioned protection to be granted to the acquirer, subjection to registration was not left out of account, so that proper publicity is given to the legal situation of the property, in terms of DRHP, with a view to the necessary security of legal commerce, article 1, and article 2, b), of the Property Register Code, being known that definitive registration constitutes presumption that the right exists and belongs to the registered holder, in the precise terms in which the registration defines it, article 7, of the same diploma".

However, the case does not document the existence of such certificates, titulated in the name of the Claimant. In this way, the Claimant does not prove, as was incumbent upon it, the ownership of such DRHP, proof that was necessary for the fiscal purposes sought by it. Thus, for all the more reason, with no documentary evidence existing that justifies recognition of the deduction of 3,869,697.50 euros, the amount does not concur toward determination of taxable profit, with the remaining issues being prejudiced with respect to this waiver. In sum, there is no correspondence between the accounting records and the documents which, in theory, should support the same, e.g. proof of ownership of the DRHP, as the records and certificates were not attached.

As to the property "...", the Respondent argues that in the impairment losses hypothetically reversed in 2012 there is no reference to the property, the Claimant alleging that one of the headings of note 6 – Inventories, of the Report and Accounts for 2010, encompasses the said property.

On this issue, the tribunal understands that the taxpayer proved in the exercise of deduction that the value of the reversal was recorded as revenue. But should one ask: what about the increase of impairment loss at the moment of its constitution?

The burden of proof is, in the present hypothesis of the Claimant, having made express reference to note 6 – inventories, of the Report and Accounts for 2010. It transpires that, the tribunal, upon analysis of the document, sees that the property in question is not included in the impairment losses that the Claimant defends were reversed in 2012, as there is no express reference to the same, not allowing the establishment, without room for doubt, of the connection of the increase of impairment loss with the property here in question. And one should not argue that such increase is in the "other" heading of the said note 6, as this connection with the property "..." is not demonstrated.

In summary, the claim for annulment of the decision to dismiss the express gracious appeal fails and the determination of the remaining issues raised is prejudiced.

III – DECISION

In such terms it is decided:

a) To judge as lacking in merit the claim for annulment of the IRC assessment, relating to the tax year 2012, on which the decision to dismiss the express gracious appeal was based.

b) To judge the claims for reimbursement of the amount paid and for payment of indemnity interest as prejudiced.

VALUE OF THE CASE

The value of the case is fixed at 700 euros, in accordance with article 97-A of CPPT, applicable by force of the provision of article 29, no. 1, al. a) of RJAT and article 3, no. 2 of the Regulation of Costs in Tax Arbitration Proceedings (RCPAT).

COSTS

Costs to be borne by the Claimant, in the amount of 306 euros, cf. article 22, no. 4 of RJAT and Table I attached to RCPAT.

Notify.

Lisbon, 21 June 2019

The arbitrator,

Francisco Nicolau Domingos