Process: 274/2015-T

Date: November 6, 2015

Tax Type: IRC

Source: Original CAAD Decision

Summary

Process 274/2015-T addresses the critical distinction between advertising costs and representation expenses under Portuguese Corporate Income Tax (IRC) law. A Portuguese branch of a foreign company challenged IRC additional assessments for fiscal years 2009-2012, where the Tax Authority reclassified advertising expenses as representation expenses subject to autonomous taxation at 10% (2009-2011) and 20% (2012). The taxpayer offered promotional trips to clients who achieved specific sales targets, arguing these constituted advertising costs indispensable to business operations and product promotion. The company contended that representation expenses typically arise from activities of corporate bodies or senior management, while advertising expenses stem from marketing and sales departments. The trips were accompanied by commercial staff to promote brand awareness and product knowledge, directly correlating to increased sales. The taxpayer invoked Article 23(1)(b) of the IRC Code, which permits deduction of costs indispensable for income generation or maintaining the productive source. Additionally, the company argued that denying deductibility violates Article 104(2) of the Portuguese Constitution, which enshrines the principle of taxation based on real profit. A key procedural argument centered on burden of proof: the taxpayer maintained that once properly documented in organized accounting records, the Tax Authority bears the burden of proving costs were not indispensable, per Articles 100(1) of the Administrative Tax Procedure Code and 74 of the General Tax Law. The case was brought to the CAAD arbitral tribunal after administrative appeals were rejected, following procedures under Decree-Law 10/2011. This case highlights the importance of properly classifying business expenses and understanding the autonomous taxation regime applicable to representation expenses in Portuguese tax law.

Full Decision

PROCESS No. 274/2015-T

I – Report

1.1. A... – Branch in Portugal, legal entity no. ..., with registered office at Avenue ..., no. ..., ...th D, ...-... ..., hereinafter referred to as the "Applicant", having been notified of the decisions rejecting the administrative appeals against the additional assessment acts nos. 2014 ..., 2014 ..., 2014 ... and 2014 ..., relating to Corporate Income Tax for the fiscal years 2009, 2010, 2011 and 2012, filed, on 27/4/2015, a request for constitution of an arbitral tribunal and arbitral decision – pursuant to the provisions of article 10 of Decree-Law no. 10/2011, of 20/1 (Legal Framework for Arbitration in Tax Matters, hereinafter referred to as "LFATM") and articles 132 and 99 et seq. of the Code of Administrative Tax Procedure, as well as article 95, nos. 1 and 2, paragraph d), of the General Tax Law – in which the Respondent Entity is the Tax and Customs Authority ("TA"), with a view to, in summary: "the annulment of the rejection decision rendered in the administrative appeal identified above", the "annulment of the corporate income tax additional assessment acts for the years 2009, 2010, 2011 and 2012, in the corrected amounts of €5,152.73, with reference to the year 2009, €4,716.77 in the year 2010, €3,807.54 in the year 2011 and €3,740.00 in the year 2012 and the compensatory interest paid", and the "payment to the Applicant of indemnifying interest, for the deprivation of the aforementioned amounts, pursuant to article 43 of the General Tax Law."

1.2. On 17/7/2015, the present Singular Arbitral Tribunal was constituted.

1.3. On 17/7/2015, the TA was cited, as respondent party, to submit a reply, pursuant to article 17, no. 1, of the LFATM. The TA submitted its reply on 2/10/2015, arguing, in summary, for the complete dismissal of the Applicant's request.

1.4. By order of 2/11/2015, the Tribunal considered the hearing provided for in article 18 of the LFATM to be unnecessary, as well as the production of testimonial evidence requested by the Applicant, because the process contained the necessary elements for decision. The date for rendering the decision was also set for 6/11/2015.

1.5. The Arbitral Tribunal was regularly constituted, is materially competent, the process does not suffer from defects that would invalidate it, and the Parties have legal personality and capacity, being duly legitimized.

II – Allegations of the Parties

2.1. The Applicant now alleges, in its initial petition, that: a) "the corrections [...] made on the grounds that the costs accounted for as advertising were considered by the Tax Inspection Services as representation expenses, taxed autonomously at the rate of 10% (20% in the fiscal year 2012) [result] from an erroneous interpretation and application of the law to the concrete facts"; b) "the Applicant will prove the indispensability of such costs for the formation of income, thereby removing their classification as representation expenses"; c) "In accordance with the activity carried out by the Applicant, the products it commercializes can only reach their recipients through the choice made with the collaboration of specialized technicians and commercial staff. And, in that sense, it is manifest that there is a close correlation between advertising expenses and the commercial activity of the company, and it is unacceptable to confuse the concept of representation expenses with the concept of advertising, based on the activity of communication carried out within the scope of commercial activity, with the objective of promoting the supply of goods or services"; d) "While representation expenses traditionally emerge from the activity of holders of corporate bodies or senior management of the company, advertising expenses are inherent to the activity carried out by the marketing or sales department of the company, i.e., by middle management"; e) "Only clients who met the objectives established by the Applicant benefited from the trips, as a way to encourage increased sales"; f) "the sole objective of offering trips was the promotion of sales through the incentive of clients, aiming to increase sales, as well as profits (these, in turn, subject to taxation)"; g) "the trips offered to clients, in exchange for substantial purchases of products commercialized by the Applicant, conducted by its employees, are nothing more than a form of promotion of the products sold"; h) "all costs incurred by the Applicant, so as to provide clients with greater knowledge of the brand and products commercialized by it, through the accompaniment on the aforementioned trips by commercial staff, as well as their advantages compared to other similar products, could translate, even if not in an immediate manner, into an increase in its sales"; i) "the costs corrected and at issue are, thus, absolutely indispensable for the activity of the company, constitute this same activity and the sale of its products depends directly on them"; j) "one cannot expect, nor predict with any degree of certainty, that a certain promotional cost will have its effective return assured, and that this return be measurable in a determined quantity"; l) "the understanding set forth in the conclusions report, of classifying the costs at issue as representation expenses, would imply the absurdity of removing all utility from the marketing function for profit-making entities"; m) "it is unequivocal the conclusion that the costs challenged by the Tax Authority contributed to the maintenance of the productive source, and were indispensable to it"; n) "the notion of indispensability must be assessed from a positive judgment of subsumption in corporate activity, and this should not be scrutinized by the Tax Authority or the courts, because this is required by freedom of economic initiative"; o) "The tax deductibility of the cost depends only on a causal and justified relationship with the productive activity of the company, and this indispensability is verified whenever corporate operations – participation in trips for clients and employees, with the objective of promoting products commercialized by it – fall within its capacity, by subsumption to its respective corporate scope, and in particular whenever related to profit generation, even if indirectly"; p) "the interpretation advocated by the Tax Authority, in the sense of refusing as fiscally deductible the costs incurred with the trips offered to clients/employees, is tainted with unconstitutionality, by violating the Principle of Taxation of Companies by their Real Profit, enshrined in no. 2 of article 104 of the Constitution of the Portuguese Republic"; q) "the execution of the correction at issue is tainted with the defect of violation of law and unconstitutionality, which are invoked with the due legal effects"; r) "in the case at issue, the Tax Authority does not question that the amounts paid were paid as advertising, it merely questions the classification of these payments"; s) "the question of the burden of proof of the indispensability of the cost is sidestepped by the presumption of the veracity of correctly organized accounting records, because in the case at issue the veracity (existence, amount and nature) of the expense accounted for is not questioned"; t) "it is quite another matter to know whether the purpose of that amount was essential for the realization of income or gains or for the maintenance of the productive source, as required by the aforementioned article 23, no. 1, paragraph b). However, the burden of such proof did not rest with the Applicant, but rather with the Tax Authority, as results from the provisions of articles 100, no. 1, of the Code of Administrative Tax Procedure, and 74 of the General Tax Law, which did not occur"; u) "in conclusion, it is the Tax Authority's burden to prove that the purpose of the amounts accounted for as advertising was not essential for the realization of the Applicant's income or for the maintenance of the productive source, and to substantiate its understanding that such expenses are classified as representation expenses, which it clearly did not do, limiting itself to asserting it"; v) "the allowance of the present application should not only determine the reimbursement to the Applicants of the improperly paid tax [...] but also the payment of what is provided in article 43 of the General Tax Law and article 61 of the Code of Administrative Tax Procedure".

2.2. The Applicant concludes that, in light of the above, the following should be determined: a) "the annulment of the rejection decision rendered in the administrative appeal identified above"; b) the "annulment of the corporate income tax additional assessment acts for the years 2009, 2010, 2011 and 2012, in the corrected amounts of €5,152.73, with reference to the year 2009, €4,716.77 in the year 2010, €3,807.54 in the year 2011 and €3,740.00 in the year 2012 and the compensatory interest paid"; and c) "the payment to the Applicant of indemnifying interest, for the deprivation of the aforementioned amounts, pursuant to article 43 of the General Tax Law."

2.3. For its part, the TA alleges, in its reply, that: a) "During the inspection action, with the objective of obtaining some clarifications regarding certain accounting items, the taxpayer was notified, and as a result thereof expenses subject to tax correction were detected, namely expenses with trips offered to clients, inventory shortfalls and expenses with bank guarantees for certain clients and borne by the taxpayer, and for the present proceedings only the corrections relating to expenses with trips offered to clients are relevant"; b) "In fact, in the years 2009 to 2012 the taxpayer considered as tax expenses, expenses with trips offered to clients/distributors, based on sales objectives"; c) "The aforementioned expenses are, in 2009 and 2011, documented with invoices from the Spanish company B... (...), S.A., VAT no. ES ..., which re-invoices to the Portuguese taxpayer expenses with trips (including shows, outings, stays, lunches and dinners), attributed as «incentives to clients»"; d) "In the year 2011 there are also invoices from national suppliers relating to transfers and the production of material related to incentive trips. With regard to the years 2010 and 2012, these expenses are documented with invoices from travel agencies"; e) "The expenses in question were recorded by the taxpayer in account 6222360 – Channel Promotions, as if they were advertising"; f) "However, the aforementioned trips offered to clients have the nature of representation expenses, pursuant to article 88, no. 7, of the Corporate Income Tax Code [...]. That is, the same type of expenses made by the taxpayer and recorded in account 6222360 – Channel Promotions, and it should also be noted the accompaniment by persons from A..."; g) "Thus, the Tax Inspection Services understood that the aforementioned expenses fall within the concept of representation expenses and not the concept of advertising, and are therefore subject to autonomous taxation, pursuant to the provisions of articles 81 or 88 of the Corporate Income Tax Code, depending on the period"; h) "Not having the taxpayer proceeded to autonomous taxation of these expenses (cf. Annex 6 to the Inspection Report, which contains an identification map of autonomous taxes effected by the taxpayer in each period), the corresponding arithmetic corrections were made by the Tax Inspection Services"; i) "The corrections proposed for autonomous taxes under Corporate Income Tax relating to incentive trips that were classified as representation expenses, resulting in tax due, in the global amount of €17,417.04"; j) "The aforementioned corrections gave rise to the Corporate Income Tax additional assessments nos. 2014 ..., 2014 ..., 2014 ... and 2014 ... (respectively for the fiscal years 2009, 2010, 2011 and 2012) and respective compensatory interest assessments and account settlement statements"; l) "It results from the administrative process now attached to the present proceedings, as from the documents attached by the Applicant itself to its Request for Arbitral Decision, and likewise from the facts above explained, that, in the periods 2009 to 2012, the Applicant recorded in account 622236 – Channel Promotions, expenses incurred with trips offered to clients/distributors, based on sales objectives, as if they were advertising expenses"; m) "it results unequivocally from the administrative file, from the documents provided by the Applicant itself and likewise from the facts above stated, that the aforementioned costs respect representation expenses"; n) "there can be no doubt that the expenses in question were borne by the Applicant, and considered by the Respondent, pursuant to the terms and for the effects provided in article 23 of the Corporate Income Tax Code (notwithstanding having been considered as representation expenses, subject to autonomous taxation, covered by the provisions of article 88, no. 7, of the Corporate Income Tax Code) [...] [whereby] all the legal argumentation set forth by the Applicant in articles 60 to 95 of the petition is based on factual assumptions that do not occur in this proceeding, which is why they do not apply to it, and are therefore objected to in their entirety"; o) "contrary to what the Applicant alleges, the expenses in question constitute representation expenses and not advertising expenses"; p) "it is unquestionable that, in the case at issue, the expenses in question (although recorded as advertising expenses) correspond entirely to the provision of the norm contained in no. 7 of article 8 of the Corporate Income Tax Code"; q) "This results clearly from the documents contained in the accounting of the Applicant itself, as well as from the documentary collection that it provided to the Respondent, within the scope of the inspection carried out by the latter [...]. From the analysis of the aforementioned documents it results unequivocally that: the Applicant «considered as tax expenses expenses with trips offered to clients/distributors, based on sales objectives». In the period 2009, a Mediterranean cruise, in the period 2010, a trip to Cuba, in the period 2011, a trip to Punta Cana and in the period 2012, a trip to Cape Verde. «(…) expenses with trips (including outings, stays, lunches and dinners), attributed as incentives to clients.» «In the year 2011, there are also invoices from national suppliers, relating to transfers.»"; r) "with regard to the burden of proof, it is important to clarify [...] [that] there are no doubts that the TA proved the nature of the expenses in question, based not only on documents supporting the accounting of the Respondent, but also on documents provided by the Respondent itself, at the request of the Tax Inspection Services, documentary elements which by their content reveal unequivocally that one is dealing with representation expenses and not advertising"; s) "Thus, in accordance with the rules of allocation of the burden of proof (cf. Articles 342, no. 1 of the Civil Code and 74, no. 1 of the General Tax Law), it is incumbent on whoever invokes a right to allege and prove the constitutive facts of their right, reserving to the Respondent the burden of proof of the imperative, modifying or extinctive facts of the counterparty's right. In these terms, it is incumbent on the Applicant, in these proceedings for arbitral decision, to prove the facts it alleges [...] [which] in the case at issue, the Applicant failed to do"; t) "In light of the above, there is no doubt that the correction made by the Tax Inspection Services (contested in these proceedings) is valid and legitimate, constituting in itself a correct subsumption of the facts to the applicable law, whereby all the grounds argued by the Applicant fall (entirely)"; u) "it is clear that none of the prerequisites conferring the right to indemnifying interest are present, namely, because the tax act at issue is entirely valid and legal, because it is in accordance with the legal framework in force at the date of the tax facts, hence, no error attributable to the services occurred, in this case. Thus, the legal prerequisites conferring the right to the requested indemnifying interest are not met."

2.4. The TA concludes that "the present action should be judged inadmissible, as unproven, and, in that way, the rejection of the administrative appeals maintained, and, as a consequence, the additional assessments in the exact terms decided by the TA, with all legal consequences."

III – Proven, Unproven Factuality and Respective Substantiation

3.1. The following facts are considered proven:

i) The Applicant is the branch in Portugal of the company B... (...), S.A., and is classified in the Statistical Classification of Economic Activities under the main activity 46510 "Wholesale trade in computers, computer peripheral equipment and computer software".

ii) The Applicant's activity consists of the commercialization of equipment of the brand «A1..», namely printers, faxes, photocopiers and multifunction devices, proceeding to after-sales assistance, through it or through third parties.

iii) Following the service orders nos. OI2013 ..., OI2013 ..., OI2014 ... and OI 2013 ..., notified to the Applicant by letter no. ..., of 30/4/2014, a general scope inspection was carried out for the fiscal year 2009 and a partial scope inspection was carried out for the periods 2010 to 2012, resulting in corrections to the tax calculation of the Applicant in accordance with the Inspection Report, which are hereby considered reproduced (see document 2 attached to the proceedings, particularly pages 8 to 10 of the Inspection Report).

iv) Consequently, the Applicant was notified of additional assessments nos. 2014 ..., 2014 ..., 2014 ... and 2014 ..., relating to Corporate Income Tax for the aforementioned fiscal years.

v) Disagreeing with the aforementioned assessments, the Applicant filed administrative appeals against them (see document 3 attached), and was notified of the rejection thereof (and of the respective substantiation) through letters nos. ..., ..., ... and ..., all of 21/1/2015 (see document 1 attached).

vi) Disagreeing with the aforementioned decisions, the Applicant filed the present request for arbitral decision on 27/4/2015.

vii) With reference to the fiscal years 2009 to 2012, the Applicant accounted for in account 6222360 – Channel Promotions – costs associated with trips offered to its clients, in the amounts of €51,527.25, €47,167.67, €38,075.43 and €18,700.00, respectively. The TA questioned, in the Inspection Report (see pages 8 to 10), the indispensability of the costs in question, referring, in sufficient manner, to the elements on which it based its conclusion that such costs fall within the concept of representation expenses (article 88, no. 7, of the Corporate Income Tax Code), having thus proceeded with the correction relating to autonomous taxation, in the amount of €5,132.73 (as to 2009), €4,716.77 (2010), €3,807.54 (2011) and €3,740.00 (2012) – see attached administrative file.

viii) Although the Applicant asserts that the allocation of trips was dependent on the fulfillment, by clients, of the "objectives established by the Applicant, as a way to encourage increased sales", it is the Applicant itself that also acknowledges that "it is undeniable that the costs corrected, at issue, do not [have] an absolutely indispensable character for the formation of the Applicant's income".

3.2. Fact not proven: the assertion of the Applicant, according to which, without the "such promotion activities, the company could not, even, subsist in the market". The necessary proof of this allegation does not appear in these proceedings nor can it be derived from the analysis of the documents contained therein.

3.3. The facts considered pertinent and proven (see 3.1) are substantiated by the analysis of the positions exposed by the parties and the documentary evidence attached to these proceedings. The fact considered unproven (3.2) is substantiated by the absence of documentary evidence demonstrating the allegation made.

IV – On the Law

The essential question [1)] that arises in the present proceeding consists of knowing whether the costs accounted for as advertising by the Applicant – and considered by the Tax Inspection Services as representation expenses – are, effectively, advertising expenses, classifiable under article 23, no. 1, paragraph b), of the Corporate Income Tax Code, or, rather, representation expenses, pursuant to the then article 88, no. 7, of the Corporate Income Tax Code (currently, article 81, no. 7). Subsequently, an analysis will be made of the question relating to the indemnifying interest requested by the Applicant [2)].

  1. On the Deductibility of the Accounted Costs

On the aforementioned essential question, observe, for example, what is stated in the following recent decision of the Administrative Court of the South, of 7/5/2015 (case 8534/15), which proves appropriate to the present case, in view of the extensive and detailed legal and doctrinal framework that is made, and with which full agreement is expressed:

"The taxable base of Corporate Income Tax is enshrined in article 3 of the Corporate Income Tax Code, and in accordance with its no. 2, the taxable profit is defined as that resulting from 'the difference between the values of net assets at the end and at the beginning of the tax period, with the corrections established in this Code'.

On the other hand, it is in article 17 et seq. of the same statute that the general rules for determining taxable profit are enshrined, and article 23 specifies which costs, as such, must be considered by law.

For the concept of tax cost, the definition contained in the aforementioned article 23 of the Corporate Income Tax Code applies, which, after providing us, in a broad manner, the notion of costs or losses as encompassing all expenses incurred by the company that, demonstrably, are indispensable for the realization of income or for the maintenance of the productive source, proceeds to a merely exemplificative enumeration of various expenses of this type. We are dealing with a concept of cost that can be considered common to the tax balance sheet and the commercial balance sheet. The tax definition of cost, as a concept broader than production and acquisition costs, is based on a broad perspective of the activity and needs of the company, thus establishing an objective connection between the activity thereof and the expenses that, inevitably, will result therefrom. And it does so with a clearly fiscal purpose, which consists of distinguishing between costs that can be accepted for tax purposes and that, therefore, will influence the calculation of taxable profit and those that cannot be accepted for such purposes (cf. decision Administrative Court of the South–2nd Section, 7/2/2012, case 4690/11; decision Administrative Court of the South–2nd Section, 16/4/2013, case 5721/12; decision Administrative Court of the South–2nd Section, 29/5/2014, case 7524/14; decision Administrative Court of the South–2nd Section, 16/10/2014, case 6754/13; J. L. Saldanha Sanches, The Quantification of the Tax Obligation, Lex, Lisbon, 2000, 2nd Edition, page 237 et seq.; António Moura Portugal, The Deductibility of Costs in Portuguese Tax Jurisprudence, Coimbra Editora, 2004, page 101 et seq.).

The costs or losses of the company constitute, therefore, the negative elements of the income statement, which are tax deductible when, being duly proven, they are indispensable for the realization of income or for the maintenance of the productive source of the company in question. The absence of any of these requirements implies the non-consideration of the aforementioned elements as costs, thus the respective amounts should be added to the accounting result (cf. decision Administrative Court of the South–2nd Section, 7/2/2012, case 4690/11; decision Administrative Court of the South–2nd Section, 16/4/2013, case 5721/12; decision Administrative Court of the South–2nd Section, 29/5/2014, case 7524/14; decision Administrative Court of the South–2nd Section, 16/10/2014, case 6754/13; F. Pinto Fernandes and Nuno Pinto Fernandes, Code of Corporate Income Tax, annotated and commented, Rei dos Livros, 5th edition, 1996, page 206 et seq.).

The requirement of indispensability of a cost has been jurisprudentially interpreted as an indeterminate concept requiring case-by-case analysis, as a result of an economic-business perspective analysis, in the perception of a relationship of economic causality between the assumption of an expense and its realization in the interest of the company, in view of the corporate object of the commercial entity in question, while forbidding the Tax Authority actions that place in crisis the principle of freedom of management and autonomy of the will of the taxpayer. Notwithstanding, if the Tax Authority reasonably doubts the insertion in the corporate interest of a determined expense, the burden of proof rests with the taxpayer to prove that such operation is inserted in the respective corporate scope (cf. decision Supreme Administrative Court–2nd Section, 29/3/2006, appeal 1236/05; decision Administrative Court of the South–2nd Section, 17/7/2007, case 1107/06; decision Administrative Court of the South–2nd Section, 16/4/2013, case 5721/12; decision Administrative Court of the South–2nd Section, 16/10/2014, case 6754/13).

It should further be noted that it is the understanding of jurisprudence and doctrine that the Tax Authority cannot evaluate the indispensability of costs in light of criteria concerning the opportuneness and merit of the expense. A cost is indispensable when it relates to the activity of the company, and costs unrelated to the company's activity will only be those in which it is not possible to discern any causal nexus with the income or gains (or with the income, in the current expression of the code - cf. article 23, no. 1, of the Corporate Income Tax Code), explained in terms of normality, necessity, congruence and economic rationality (cf. decision Supreme Administrative Court–2nd Section, 21/04/2010, appeal 774/09; decision Supreme Administrative Court–2nd Section, 13/02/2008, appeal 798/07; decision Administrative Court of the South–2nd Section, 17/11/2009, case 3253/09; decision Administrative Court of the South–2nd Section, 16/10/2014, case 6754/13).

[...]. Reverting to the case at issue, the appealing party believes that the expenses incurred by the appealed company [...], not being able to be considered as advertising and classifiable under article 23 of the Corporate Income Tax Code, should be viewed as representation expenses to be classified under article 81, no. 7, of the same statute (current article 88 of the Corporate Income Tax Code) and subject to a rate of autonomous taxation in accordance with no. 3 of the same provision.

On the contrary, the Court "a quo" understands that such expenses should be qualified as advertising charges, classifiable under article 23, no. 1, paragraph b), of the Corporate Income Tax Code, thus not being representation expenses on which an autonomous tax rate is imposed.

In accordance with the former article 37, paragraph a), of the Industrial Contribution Code, representation expenses were not considered as costs or losses of the fiscal period, being recorded under any heading and even if duly documented, to the extent that the General Directorate of Contributions and Taxes deemed them excessive. In view of the regime provided for in the aforementioned article 37, paragraph a), of the Industrial Contribution Code, doctrine defined representation expenses as those aimed at bearing the costs of displacements of the managers of companies or their representatives, whenever such displacements were in the service of the same and should be duly documented to be considered costs by the Tax Administration (cf. Prof. Raúl Dória and António Álvaro Dória, Practical Dictionary of Commerce and Accounting, Livraria Cruz-Braga, 3rd edition, 1975, Volume I, page 489). The Corporate Income Tax Code, approved by Decree-Law 442-B/88, of 30/11, in the original text of article 41, no. 1, paragraph g), determined that representation expenses are not tax costs, being recorded under any heading, to the extent that the General Directorate of Taxes deemed them excessive.

[...]. With Law 39-B/94, of 27/12 (Budget Law/95), regime in force from 1/1/1995, article 41, no. 1, paragraph g), of the Corporate Income Tax Code, ceased to consider representation expenses, recorded under any heading, as tax costs, in the proportion of 20%. With this legislative amendment, in quantifying at 20% the non-consideration as tax cost of representation expenses, the legislator aimed to resolve the aforementioned subjective problems inherent to the reasonableness criterion to be analyzed by the Tax Administration.

As we have already mentioned, the Chart of Accounts did not conceptualize representation expenses, so for their accounting recognition, the concept provided for in the Corporate Income Tax Code has been considered. Thus, article 41, no. 3, of the aforementioned statute, prescribed that representation expenses were considered, namely, the expenses borne with receptions, meals, trips, outings and shows offered in the country or abroad to clients or suppliers or to any other persons or entities.

Subsequently, article 41, no. 5, of Law 3-B/2000, of 4/4 (Budget Law/2000), came to repeal, among other things, article 41, nos. 3 and 4, of the Corporate Income Tax Code, integrating these expenses in article 4 of Decree-Law 192/90, of 9/6, further establishing, in its no. 3, that representation expenses are taxed autonomously in Personal Income Tax or Corporate Income Tax, as the case may be, at the rate of 6.4%. With Law 30-G/2000, of 29 December (the so-called "Tax Reform Law"), which entered into force on 1 January 2001, in its article 6, it added article 69-A to the Corporate Income Tax Code, and in no. 3 of this new provision, representation expenses came to be taxed autonomously at the rate corresponding to 20% of the highest normal tax rate, by virtue of the autonomous taxation of representation expenses came to be included in article 81, no. 3, of the same statute, pursuant to Decree-Law 198/2001, of 3/7, which renumbered the articles of the Corporate Income Tax Code, maintaining the autonomous taxation rate at 20%. In this manner, greater tax revenue in Corporate Income Tax is ensured, since the autonomous taxation of such expenses is characterized by the fact that the company pays tax, independently of the obtaining of a profit or tax loss.

[...]. [...] only are deductible as representation expenses the costs duly documented and recorded, thus having to satisfy the requirement of indispensability provided for in the aforementioned article 23 of the Corporate Income Tax Code, so that they are as such considered (cf. F. Pinto Fernandes and Nuno Pinto Fernandes, Code of Corporate Income Tax, annotated and commented, Rei dos Livros, 5th edition, 1996, page 346).

Also with regard to the concept of representation expenses, in view of the provisions of article 81, no. 7, of the Corporate Income Tax Code (cf. previously article 4, no. 6, of Decree-Law 192/90, of 9/6; current 88, no. 7, of the Corporate Income Tax Code), should be considered as encompassing such concept, namely, the expenses borne with receptions, meals, trips, outings and shows offered, in the country or abroad, to clients or suppliers or to any other persons or entities (cf. decision Administrative Court of the South–2nd Section, 16/10/2014, case 6754/13; Rui Duarte Morais, Notes on Corporate Income Tax, Almedina, 2009, page 202 et seq.)." [End of quotation.]

Having completed the analysis of the legal and doctrinal framework of the essential question at issue here, it is now necessary to ascertain whether, in the case under analysis and as a result of the proven facts, we are in the presence of expenses that – quoting once again the aforementioned decision – "are intended [...] to represent the company challenging them where it is not present (thus, outside its main activity), [or if, conversely, we are before expenses that are intended to] ensure the normal development of its corporate object, within the economic circuit where this naturally manifests itself."

This distinction is decisive because, if the analysis of the aforementioned facts concludes that we are before expenses intended to ensure the normal development of the corporate object of the company, within the economic circuit where this naturally manifests itself, then such costs cannot be qualified as representation expenses. If the assessment of the factual matter results in the opposite conclusion, the qualification as representation expenses will be considered justified.

Note in this regard what is stated in the following Supreme Administrative Court decision, in the context of an (alleged but, in the end, judged not to exist) opposition of decisions: "[in this alleged case of opposition of decisions,] we are not dealing with diverse interpretation of the same law, but rather with diverse assessment of the factual matter. In fact, in the appealed decision, it was understood that the tax administration had duly substantiated the decision of assessment, rejecting the thesis of the appellant regarding the nature of the aforementioned costs as advertising expenses and the classification as representation expenses being correct. In the founding decision, however, it was understood differently because it was considered that the tax administration should have justified the reason why it rejected the expenses as advertising costs." (Supreme Administrative Court Decision of 11/12/2013, case 1239/13).

In the present case, and in light of the examination of the proven facts, it can be concluded that: 1) the TA questioned, in the Inspection Report (see, in particular, pages 8 to 10), the indispensability of the costs in question, referring, in sufficient manner, to the elements on which it based its conclusion that these are representation expenses and not advertising expenses; 2) the costs in question do not constitute costs inherent to the normal development of the Applicant's activity, inasmuch as, taking into account its corporate object, these costs consist of expenses not directly linked to the economic circuit in which the aforementioned corporate object manifests itself.

The Applicant alleges that the costs in question relate to expenses of "displacement of company representatives to the facilities of possible economic, social or any other kind partners" and to "activity carried out by the marketing or sales department of the company", carried out by "employees" thereof, which "accompanied clients" on "incentive trips promoted", in "fulfillment of objectives previously fixed by the Applicant (and reflected in the «Commercial Conditions» contained in document 5 attached to the proceedings).

But (and as was stated in point viii) of the proven facts), even though the Applicant says that the allocation of trips was dependent on the fulfillment, by clients, of the "objectives established by the Applicant, as a way to encourage increased sales", it is also the Applicant itself that acknowledges that "it is undeniable that the costs corrected, at issue, do not [have] an absolutely indispensable character for the formation of the Applicant's income".

Effectively, it is not possible to see how such expenses could have a character of indispensability for the formation of the income of the Applicant – although it may be considered that such expenses may contribute (although they are not vital and this contribution is not "immediately measurable", as the Applicant itself admitted) to the formation of income.

Notwithstanding the foregoing, the Applicant also states, in its petition, that, without "such promotion activities, the company could not, even, subsist in the market". However, the proof of this assertion was not made – nor can it be inferred from the reading of the documents contained in the proceedings – so there is no basis to rebut the substantiation exposed by the TA.

In summary: the indispensability of the costs in question was not demonstrated, because, after it was factually and substantively contradicted by the TA, the Applicant did not make the necessary demonstration of the alleged indispensability of the operations in question for the formation of the company's income.

Note, lastly, what is stated, for example, in the Decision of the Administrative Court of the South of 20/6/2006 (case 365/03): "there are two indispensable requirements for costs to be accepted for tax purposes. That they be proven with documents issued in accordance with legal terms and that they be indispensable for the realization of income. The absence of any of these requirements implies their non-consideration, so the respective amounts should be added to the accounting result. To the Tax Authority rests the burden of proof of the prerequisites of its right to proceed with corrections and to the taxpayer rests the burden of proving that the respective costs were indispensable for the realization of income or gains subject to tax or for the maintenance of the productive source, in light of the letter of the law, article 23, no. 1, paragraph b), of the Corporate Income Tax Code."

Now, verifying that the costs at issue here are legally documented (the TA also did not allege otherwise), it would remain only, in this case, to verify the fulfillment of the requirement of indispensability, i.e., to ascertain whether such costs were (or were not) indispensable for the realization of income or gains subject to tax or for the maintenance of the productive source. As this latter requirement is not, for the reasons already exposed above, fulfilled, the costs at issue here cannot be considered as advertising expenses, but rather, and as was defended by the TA, representation expenses, classifiable under article 88, no. 7, of the Corporate Income Tax Code.

  1. On the Right to Indemnifying Interest

The declaration of illegality and consequent annulment of an administrative act confers on its recipient the right to the reintegration of the situation in which the same would have found itself before the execution of the annulled act. However, as the acts at issue here do not suffer, for the reasons already exposed in 1), from any illegality or error attributable to the services, there is no reason for their annulment and, therefore, it is concluded that no indemnifying interest is due to the Applicant.

V – DECISION

In light of the foregoing, it is decided:

  • To judge the request for arbitral decision inadmissible, keeping entirely in the legal order the impugned acts, and accordingly absolving the respondent entity from the request.

  • To judge the request also inadmissible in the part relating to the recognition of the right to indemnifying interest in favor of the applicant.

The value of the case is set at €17,417.04 (seventeen thousand four hundred and seventeen euros and four cents), pursuant to articles 32 of the Code of Administrative Procedure and 97-A of the Code of Administrative Tax Procedure, applicable by virtue of the provisions of article 29, no. 1, paragraphs a) and b), of the Legal Framework for Arbitration in Tax Matters, and article 3, no. 2, of the Regulation on Costs in Tax Arbitration Proceedings.

Costs to be borne by the Applicant, in the amount of €1,224.00, in accordance with Table I of the Regulation on Costs in Tax Arbitration Proceedings, and in compliance with the provisions of articles 12, no. 2, and 22, no. 4, both of the Legal Framework for Arbitration in Tax Matters, as well as with the provisions of article 4, no. 4, of the aforementioned Regulation.

Let notice be given.

Lisbon, 6 November 2015.

The Arbitrator,

Miguel Patrício

Text prepared by computer, in accordance with the provisions
of article 131, no. 5, of the Code of Civil Procedure, applicable by referral of article 29, no. 1, paragraph e), of the Legal Framework for Arbitration in Tax Matters.

The drafting of this decision is governed by the spelling prior to the Orthographic Agreement of 1990.

Frequently Asked Questions

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What is the difference between advertising costs and representation expenses for IRC deductibility purposes?
Under Portuguese IRC law, advertising costs and representation expenses differ fundamentally in their origin and purpose. Advertising costs are expenses incurred by the marketing or sales department (middle management) directly related to promoting products or services to increase sales and revenue. These include promotional campaigns, client incentives tied to sales objectives, and brand awareness initiatives. In contrast, representation expenses typically arise from activities of corporate bodies or senior management and relate to business representation and hospitality. Advertising costs, when properly documented and demonstrated as indispensable for income generation under Article 23(1)(b) of the IRC Code, are generally fully deductible. However, representation expenses are subject to autonomous taxation at specific rates (10% in 2009-2011, 20% from 2012 onwards), meaning they generate additional tax liability regardless of whether the company has taxable profit. The distinction is crucial because misclassification can result in additional tax assessments and autonomous taxation charges.
How does the autonomous taxation rate apply to representation expenses under Portuguese IRC rules?
Autonomous taxation rates for representation expenses under Portuguese IRC rules operate as a special taxation regime that applies independently of the company's actual taxable profit. According to the case, representation expenses were subject to autonomous taxation at 10% for fiscal years 2009-2011 and 20% for 2012 onwards. This autonomous taxation is levied on the gross amount of the expense, not on profit, meaning companies must pay this tax even if they have losses or no taxable income. The rationale is that representation expenses are considered to have a personal consumption component and potential for abuse. The autonomous taxation is calculated by applying the applicable rate to the total amount of expenses classified as representation. This regime ensures the State collects revenue on certain categories of expenses regardless of business results. It's important to note that autonomous taxation is in addition to regular IRC taxation and is non-deductible. Companies must carefully classify expenses to avoid unexpected autonomous taxation liabilities that can significantly increase their effective tax burden.
Can a taxpayer challenge the reclassification of advertising costs as representation expenses through tax arbitration at CAAD?
Yes, taxpayers can challenge the reclassification of advertising costs as representation expenses through tax arbitration at CAAD (Centro de Arbitragem Administrativa), as demonstrated in Process 274/2015-T. The procedure requires first exhausting administrative remedies by filing a gracious complaint (reclamação graciosa) against the assessment. If the administrative appeal is rejected, the taxpayer can then file a request for constitution of an arbitral tribunal under Article 10 of Decree-Law 10/2011 (Legal Framework for Arbitration in Tax Matters - RJAT) and Articles 132 and 99 et seq. of the Administrative Tax Procedure Code. The taxpayer must request annulment of both the rejection decision and the underlying tax assessments. CAAD arbitration offers advantages over judicial courts, including faster resolution (typically within 6 months), specialized tax arbitrators, lower costs, and binding decisions. To succeed, the taxpayer must demonstrate that the expenses were properly classified as advertising costs indispensable for income generation under Article 23(1)(b) of the IRC Code, supported by documentation showing the business purpose, connection to sales activities, and commercial rationale.
What legal grounds support the deductibility of business costs under Portuguese Corporate Income Tax (IRC)?
The primary legal ground for deductibility of business costs under Portuguese IRC is Article 23(1)(b) of the IRC Code, which requires costs to be indispensable for the realization of income or gains or for the maintenance of the productive source. This indispensability test is fundamental and requires demonstrating a causal connection between the expense and business operations or revenue generation. Additionally, Article 104(2) of the Portuguese Constitution enshrines the principle that companies should be taxed based on their real profit, not fictitious amounts, supporting broad deductibility of genuine business expenses. Article 23(2) of the IRC Code establishes that costs must be properly documented in organized accounting records that comply with accounting standards. The burden of proof is governed by Article 74 of the General Tax Law and Article 100(1) of the Administrative Tax Procedure Code, which provide that properly documented expenses in organized accounts benefit from a presumption of veracity. Once this presumption is established, the Tax Authority bears the burden of proving the expenses were not indispensable. Freedom of economic initiative, a constitutional principle, also supports that tax authorities should not second-guess legitimate business decisions about necessary expenses.
What is the procedure for filing a tax arbitration request after an unfavorable outcome in a gracious complaint (reclamação graciosa)?
After receiving an unfavorable outcome in a gracious complaint (reclamação graciosa), the taxpayer has two options: judicial appeal to administrative courts or tax arbitration at CAAD. For tax arbitration, the procedure involves filing a request for constitution of an arbitral tribunal within the legal deadline (generally within 90 days from notification of the administrative decision, or within the general statute of limitations). The request must be submitted through the CAAD platform, identifying the disputed acts, the legal grounds for challenge, and the requested relief (typically annulment of assessments and payment of compensatory interest). The filing must cite Article 10 of Decree-Law 10/2011 (RJAT) and relevant provisions of the Administrative Tax Procedure Code (Articles 132 and 99 et seq.). Upon receiving the request, CAAD appoints an arbitrator or constitutes a panel, and the Tax Authority is cited to submit a reply (typically within 30 days per Article 17(1) RJAT). The tribunal may schedule a hearing under Article 18 RJAT if necessary for evidence or clarification. The arbitral decision must be rendered within legally established timeframes and has the same force as a judicial court decision, being enforceable and binding on both parties.