IRC Group Taxation (RETGS): Deductibility of Financial...

Process: 292/2015-T

Date: November 11, 2015

Tax Type: IRC

Summary

Process 292/2015-T involves A... SGPS, SA, a holding company taxed under the Special Group Taxation Regime (RETGS) for fiscal year 2004, challenging IRC assessment corrections totaling over €1 million. The Tax Authority disallowed financial charges incurred with shareholding acquisitions (€789,746.57 for A... SGPS and €141,860.46 for subsidiary I... SGPS) as tax-deductible costs, citing Article 31(2) of the Estatuto dos Benefícios Fiscais (EBF). This provision, amended by Law 32-B/2002, excludes both capital gains/losses and related financial charges from taxable income of SGPS companies, provided shares are held for at least one year. The Tax Authority applied Circular 7/2004, which clarified that this exclusion applies to charges incurred from 2003 onwards, regardless of when financing was obtained or whether shareholdings met all requirements at the time charges were incurred. Additional corrections of €41,521.60 were made regarding non-deductible daily allowances (ajudas de custo) for subsidiary E... SA under Article 42(1)(f) CIRC, which mandates a 20% non-deductible portion. The holding company initiated arbitration proceedings before CAAD (Centro de Arbitragem Administrativa) seeking partial annulment of the hierarchical appeal decision. The arbitral tribunal, constituted on July 24, 2015, comprised three appointed arbitrators. The case raises fundamental questions about cost deductibility under RETGS, the symmetrical treatment of financial charges and capital gains exclusions for SGPS companies, and the temporal application of tax regime changes affecting group taxation structures.

Full Decision

ENGLISH TRANSLATION

Case No. 292/2015-T

The arbitrators Dr. Jorge Lopes de Sousa (arbitrator-president), Dr. Rui Ferreira Rodrigues and Dr. Artur Maria da Silva, appointed by the Deontological Council of the Centre for Administrative Arbitration to form the Arbitral Tribunal, constituted on 24-07-2015, agree as follows:

1. REPORT

A… SGPS, SA (hereinafter referred to as A… or Applicant), a public company, holder of the Corporate Identification Number (NIPC) …, with registered office at …, Postal Box …, …-…, in its capacity as the holding company of the AA… Group, came, pursuant to the provisions of Article 10 of Decree-Law No. 10/2011, of 20 January ("Legal Regime for Arbitration in Tax Matters" - RJAT) and Articles 102 and 99 et seq. of the Code of Tax Procedure and Process ("CPPT"), Articles 1 and 2, subsection d) of Article 95, of the General Tax Law ("LGT"), to request the constitution of an Arbitral Tribunal, with a view to the partial annulment of the decision on the hierarchical appeal of the Corporate Income Tax assessment No. 2008 …, dated 17-03-2008, relating to the fiscal year 2004.

The respondent is the TAX AND CUSTOMS AUTHORITY.

The request for constitution of the arbitral tribunal was accepted by the President of CAAD on 07-05-2015 and notified on that date to the Tax and Customs Authority.

Pursuant to the provisions of subsection a) of Article 2, Article 6 and subsection b) of Article 1, Article 11 of RJAT, the Deontological Council appointed as arbitrators of the collective arbitral tribunal the undersigned, who communicated acceptance of the appointment within the applicable period.

On 07-07-2015, the parties were duly notified of this appointment, and neither party expressed any intention to refuse the appointment of the arbitrators, in accordance with the combined provisions of Article 11, Article 1, subsections a) and b) of RJAT and Articles 6 and 7 of the Deontological Code.

In compliance with the provision of subsection c) of Article 1, Article 11 of RJAT, the collective arbitral tribunal was constituted on 24-07-2015.

The Tax and Customs Authority responded, defending the lack of merit of the present arbitral action.

By order of 01-10-2015, the meeting provided for in Article 18 of RJAT was dispensed with and it was decided that the case would proceed with written arguments.

The parties submitted their arguments.

The parties have legal personality and capacity, are properly legitimized and are duly represented (Articles 4 and 10, paragraph 2, of the same statute and Article 1 of Ordinance No. 112-A/2011, of 22 March).

The case does not suffer from any irregularities and there is no obstacle to the substantive examination of the case.

2. FACTUAL MATTERS

2.1 Established Facts

The following facts are considered proven:

a) The Applicant A… SGPS, SA is a holding company (SGPS);

b) The Applicant is subject to the general regime of taxation under Corporate Income Tax (IRC), being taxed in 2004 under the Special Taxation Regime for Groups of Companies (RETGS), being itself the holding company, the group consisting of the following companies in that year:

A…, SGPS, SA (NIPC: …),
B…, SA (NIPC: …),
C…, Lda (NIPC: …)
D…, SA (NIPC: …),
E…, SA (NIPC: …),
F…, SA (NIPC: …),
G…, SA (NIPC: …),
H…, SA (NIPC: …),
I… SGPS, SA (NIPC: …),
J…, SA (NIPC: …),
K…, SA (NIPC: …),
L…, SA (NIPC: …)
M…, Lda (NIPC: …),
N…, SA (NIPC: …),
O…, SA (NIPC: …),
P…, SA (NIPC …);

c) As of 31-12-2004, the Applicant held the following financial interests:

[content continues with financial details]

d) In compliance with service order No. … of 27/07/2007, an external tax audit procedure was conducted of the accounting and tax records of the accounts of the "AA… Group", relating to the fiscal year 2004;

e) A…, as the holding company of RETGS, was notified, by Office No. …, of 13-03-2008, of the Tax Inspection Report and the Corporate Income Tax corrections made in the sphere of the AA… Group, resulting from the inspection actions conducted on some of the companies within the fiscal scope of the AA… Group, notably the Corporate Income Tax corrections made in the individual sphere of the companies I… SGPS, SA, E…, SA and of A… itself (document No. 1 attached with the request for arbitral pronouncement, the contents of which are reproduced herein);

f) The Tax Inspection Report further states:

I - 3.1 - Corrections to Taxable Income of the Group

1-3.1.1 - Resulting from corrections made in the individual sphere of the company with NIPC …, A…, SGPS, SA, in the total amount of €855,247.99

(...)

I -3.1.1.2 - Financial Charges Incurred with the Acquisition of Capital Shares

The taxpayer incurred in the fiscal year, as financial charges for the acquisition of shareholdings €789,746.57. In accordance with the provisions of Article 31, paragraph 2 of the EBF, these do not contribute to the formation of taxable income, so they must be disregarded as costs for tax purposes. Thus we made an increase to taxable income of €789,746.57.

I-3.1.2 - Resulting from corrections made in the individual sphere of the company with NIPC …, I… SGPS, SA, in the total amount of €230,665.78

I - 3.1.2.1 - Financial Charges Incurred with the Acquisition of Capital Shares

The taxpayer incurred in the fiscal year, as financial charges for the acquisition of shareholdings €141,860.46. In accordance with the provisions of Article 31, paragraph 2 of the EBF, these do not contribute to the formation of taxable income, so they must be disregarded as costs for tax purposes. Thus we made an increase to taxable income of €141,860.46.

(...)

I -3.1.3 - Resulting from corrections made in the individual sphere of the company with NIPC …, E…, SA, in the total amount of €70,701.28

I - 3.1.3.2 - Non-Deductible Costs for Tax Purposes - Allowances

The taxpayer should have increased, in Field 223 of Table 07 of Form 22 the amount of €50,697.04 [20% * (23,168.48+230,316.75)], having only increased the amount of €9,175.44, so a correction to taxable income will be made in the amount of €41,521.60 under subsection f) of paragraph 1 of Article 42 of the CIRC.

(...)

III -1.1.2- Financial Charges Incurred with the Acquisition of Capital Shares -€789,746.57

From the analysis of the Corporate Income Tax return declaration we verified that the taxpayer in determining the Taxable Income did not make any increase regarding financial charges incurred with the acquisitions of capital shares, as provided in paragraph 2 of Article 31 of the EBF.

In accordance with the provisions of paragraph 2 of Article 31 of the EBF, "the capital gains and losses realized by SGPS and SCR through the onerous transfer, whatever the title by which it operates, of capital shares they hold, provided they are held for a period not less than one year, as well as the financial charges incurred with their acquisition, do not contribute to the formation of the taxable income of these companies". Amendment given by Law No. 32-B/2002, of 30 December (State Budget Law for 2003).

With regard to the tax regime applicable to financial charges provided for in the above-mentioned article, Circular 7/2004, of 30 March, from the IRC Services Division, comes to endorse the following understanding:

Temporal Scope of Application - "it is applicable to financial charges incurred in taxation periods beginning after 1 January 2003, even if they relate to financing obtained before that date." (Point 5).

Fiscal Year in Which Tax Corrections of Financial Charges Should Be Made: financial charges should be disregarded as costs for tax purposes in the fiscal year to which they relate, that is, tax corrections shall be made of those incurred with the acquisition of shareholdings that are likely to benefit from the special regime established in paragraph 2 of Article 31 of the EBF, regardless of whether all conditions for the application of the special taxation regime for capital gains are already met. If it is concluded at the time of sale of the shareholdings that not all requirements for application of that regime are met, in that fiscal year, financial charges that were not considered as cost in previous fiscal years shall be considered as tax costs. (Point 7).

Method to Be Used for the Purpose of Allocation of Financial Charges to Shareholdings: "(...) given the extreme difficulty of using in this matter a direct or specific allocation method and the possibility of manipulation that it would allow, such allocation must be carried out based on a formula that takes into account the following:"

1st Allocate the remunerated liabilities of SGPS to the remunerated loans granted by them to the companies in which they have shareholdings and to other interest-generating investments;

2nd Allocate the remainder to the remaining assets, namely shareholdings, proportionally to their respective acquisition cost.

Using the aforementioned formula we prepared the calculations set out below in order to calculate the value of financial charges incurred by A… with the acquisition of capital shares.

(...)

III -1.2.1 - Financial Charges Incurred with the Acquisition of Capital Shares -€141,860.46

A correction is made at the level of the taxable result of the group, in the amount of €141,860.46, relating to corrections made in individual terms to the subsidiary company "I… SGPS, SA" - NIPC: …, in accordance with the grounds, under the terms of Article 77, paragraph 1 of the General Tax Law combined with Article 125 of the Code of Administrative Procedure, which are contained in the tax inspection report drawn up by the Finance Office of Porto, on 22/01/2008, a copy of which is attached and constitutes Annex I, point 2-A).

(...)

III -1.3 - Resulting from corrections made in the individual sphere of the company with NIPC …, E…, SA, in the total amount of €70,701.28

As a result of the internal inspection action carried out on the taxpayer E…, S.A., NIPC …, by the Finance Office of Porto, under Service Order OI2007 …, purely arithmetic corrections were identified, as appears from the Report a copy of which is attached (Annex II), and which is an integral part of this report.

The taxpayer was notified to exercise the Right to be Heard when the respective Project for Corrections was issued, within the scope of the aforementioned service order, and the taxpayer chose not to exercise that right.

(...)

III-1.3.2 - Non-Deductible Costs for Tax Purposes - Allowances-€41,521.60

A correction is made at the level of the taxable result of the group, in the amount of €41,521.60, relating to corrections made in individual terms to the subsidiary company "E…, SA" - NIPC: …, in accordance with the grounds, under the terms of Article 77, paragraph 1 of the General Tax Law combined with Article 125 of the Code of Administrative Procedure, which are contained in the tax inspection report drawn up by the Finance Office of Porto, on 14/01/2008, a copy of which is attached and constitutes Annex II, point III-2).

(...)

IV - Reason and Exposition of the Facts That Imply Recourse to Indirect Methods

Not applicable.

(...)

IX-1.3.2 - Non-Deductible Costs for Tax Purposes - Allowances-€41,521.60

The taxpayer disagrees with the proposed correction as set out in points 6, 7 and 8 of the petition.

Thus, regarding this matter the taxpayer states that it proved, by sampling that said expenses were allocated to the project that was invoiced.

The taxpayer also alleges that the company's procedure when issuing the invoice follows the understanding contained in Office No. … of 23.09.99, which it attaches, issued by the Ministry of Finance, which states in points 5 and 6 "Thus, companies should provide themselves with elements capable of proving: a) the charges actually incurred with allowances, it being necessary to indicate the name of the beneficiary, the location to which he moved, the date of the displacement. In this way, as long as companies have maps with all the elements referred to above that are essential to a correct application of the provisions of subsection f) of paragraph 1 of Article 41 of the IRC Code, the invoice issued to the client may present the overall price of the service, so it is not necessary to show the various components that constitute it".

The taxpayer also states that "this is, in the company's view, the most correct procedure and the one used in commercial practice."

From the analysis made of the taxpayer's exposition, we must state that, although the taxpayer states that it proved, by sampling that said expenses were allocated to the project that was invoiced, based on the elements made available, we can only prove clearly and unequivocally the values of the allowances and compensation for displacement in the worker's own vehicle, accounted for in the respective cost accounts, the same not occurring with regard to the amounts invoiced, since the invoice and the measurement report do not itemize said expenses, as the taxpayer confirms in its exposition.

The taxpayer alleges that the company's procedure when issuing the invoice follows the understanding contained in Office No. … of 23.09.99, but this office, being a response to a request for binding information made by SS… is of exclusive application to the companies associated with that entity. It does not seem appropriate that the taxpayer sustain the procedure, different from what is legally prescribed, invoking the regime that is being followed by companies in merchandise transport, the possibility of which was admitted, albeit exceptionally, by the aforementioned office, given the specific nature of the activity in question, thus binding, under Article 68 of the LGT, only the concrete situation. This means that for the remaining situations, even if the cost is effective, the possibility of omitting mention of allowances from the invoices is not admissible.

In light of the foregoing, it is clear that the taxpayer, both in the course of the inspection action and in the exercise of the right to be heard, failed to meet the requirements resulting from Article 42, paragraph 1, subsection f), which, as stated on page 6 of the respective Report/Conclusions, in order to be considered that Allowances were invoiced to clients, it is necessary that they are expressly and independently mentioned in the invoices, so we maintain said correction in the amount of €41,521.60.

g) In the Tax Inspection Report of the inspection action carried out on I… SGPS, SA which constitutes Annex I to the Tax Inspection Report concerning the Applicant, which appears in document No. 1, attached with the request for arbitral pronouncement, the following is stated:

Corrections to the Taxable Matter of Corporate Income Tax

A) From the analysis of the Corporate Income Tax return declaration we verified that the taxpayer in determining the Taxable Income did not make any increase regarding financial charges incurred with acquisitions of capital shares, as determined by paragraph 2 of Article 31 of the EBF.

Temporal Scope of Application - "it is applicable to financial charges incurred in taxation periods beginning after 1 January 2003, even if they relate to financing obtained before that date." (Point 5).

Fiscal Year in Which Tax Corrections of Financial Charges Should Be Made: financial charges should be disregarded as costs for tax purposes in the fiscal year to which they relate, that is, tax corrections shall be made of those incurred with the acquisition of shareholdings that are likely to benefit from the special regime established in paragraph 2 of Article 31 of the EBF, regardless of whether all conditions for the application of the special taxation regime for capital gains are already met. If it is concluded at the time of sale of the shareholdings that not all requirements for application of that regime are met, in that fiscal year, financial charges that were not considered as cost in previous fiscal years shall be considered as tax costs. (Point 7).

Method to Be Used for the Purpose of Allocation of Financial Charges to Shareholdings: "(...) given the extreme difficulty of using in this matter a direct or specific allocation method and the possibility of manipulation that it would allow, such allocation must be carried out based on a formula that takes into account the following:"

1st Allocate the remunerated liabilities of SGPS to the remunerated loans granted by them to the companies in which they have shareholdings and to other interest-generating investments;

2nd Allocate the remainder to the remaining assets, namely shareholdings, proportionally to their respective acquisition cost.

Using the aforementioned formula we prepared the calculations set out below in order to calculate the value of financial charges incurred by I… SGPS with the acquisition of capital shares.

(...)

h) Neither the Applicant nor I… SGPS, SA declared in their income tax returns for Corporate Income Tax purposes any increases to taxable income regarding financial charges incurred with acquisitions of capital shares;

i) In the Tax Inspection Report of the inspection carried out on E…, SA, which appears in document No. 1 attached with the request for arbitral pronouncement, the contents of which are reproduced herein, the following is stated:

In the analysis of the Analytical Trial Balance of the fiscal year 2004 we verified that the taxpayer accounted as cost in the sub-accounts of accounts 622272 - Displacement Own Vehicle (Km) and 642205 - Allowances the amounts of €23,168.48 and €230,316.75 respectively, as shown in the following table:

[table with accounting details]

We requested the taxpayer to itemize the values that were the origin of the amount of €9,175.44, increased in Field 223 of Table 07 of Form 22 of the fiscal year 2004, in which it is noted that it was calculated as follows:

[calculation details]

We questioned the taxpayer about the reason why 20% was not increased on the remaining expenses with allowances and compensation for displacement in the worker's own vehicle, and the taxpayer said that the full charges recorded in accounts 62227202 and 64220512 were not increased because these charges are related to certain works and were invoiced to clients.

Despite the Taxpayer stating that the expenses with allowances and compensation for displacement in the worker's own vehicle were invoiced to clients, there is no amount in the invoices issued referring to those expenses.

In this way it is not possible to prove clearly and unequivocally the correspondence existing between the values of those charges accounted as cost and the values that are subject to invoicing to the respective clients.

Thus, and in accordance with the understanding of the Tax Administration conveyed in various Binding Information, stating that, in order to be considered that Allowances were invoiced to clients, it is necessary that they are expressly and independently mentioned in the invoices, we conclude that 20% of expenses with Allowances are not deductible for the purpose of determining taxable income, even when accounted as costs or losses of the fiscal year.

In this way, and in accordance with what is described in the table on page 4, should have been increased, in Field 223 of Table 07 of Form 22 of the fiscal year 2004, the amount of €50,697.04 (20% * (23,168.48 + 230,316.75)). Having the taxpayer only increased the amount of €9,175.44, a correction to taxable income will be made in the amount of €41,521.60.

j) Following the corrections made, assessment No. 2008 …, dated 17-03-2008, was issued, which appears in document No. 2 attached with the request for arbitral pronouncement, the contents of which are reproduced;

k) On 07-08-2015, the Applicant filed a complaint for reconsideration, in the terms set forth in document No. 3 attached with the request for arbitral pronouncement, the contents of which are reproduced, in which it expressed disagreement with the following corrections:

Correction to Taxable Income Made in the Individual Sphere of A….

• €789,746.57: correction to the taxable income for the fiscal year 2004 of A… by the inclusion therein of financial charges deemed incurred in the acquisition of shareholdings that do not contribute to the formation of taxable income in accordance with the provisions of paragraph 2 of Article 31 of the EBF, as drafted in 2004;

Correction to Taxable Income Made in the Individual Sphere of I… SGPS

• €141,860.46: correction to the taxable income for the fiscal year 2004 of I… SGPS by the inclusion therein of financial charges deemed incurred in the acquisition of shareholdings that do not contribute to the formation of taxable income in accordance with the provisions of paragraph 2 of Article 31 of the EBF, as drafted in 2004; and

Correction to Taxable Income Made in the Individual Sphere of E…

• €41,521.60: correction to the taxable income for the fiscal year 2004 of E… by the inclusion therein of 20% of expenses with allowances and compensation for displacement in the worker's own vehicle in relation to which the Tax Authority understood there to be no evidence of its invoicing to clients, resulting in the consequent increase to the fiscal result of the fiscal year, in accordance with subsection f) of paragraph 1 of Article 42 of the IRC Code;

l) By order of 27-05-2010, of the Head of Division, by delegation of the Finance Director of Matosinhos, the complaint for reconsideration was rejected (document No. 4 attached with the request for arbitral pronouncement, the contents of which are reproduced);

m) On 01-07-2010, the Applicant filed a hierarchical appeal of the decision rejecting the complaint for reconsideration, in the terms set forth in document No. 5 attached with the request for arbitral pronouncement, the contents of which are reproduced;

n) By Office No. …, of 02-02-2015, which appears in document No. 6 attached with the request for arbitral pronouncement, the contents of which are reproduced, the Applicant was notified of the decision of partial approval of said Hierarchical Appeal, with the following corrections being maintained:

Correction to Taxable Income Made in the Individual Sphere of A…

• €570,248.50: correction to the taxable income for the fiscal year of A… by the inclusion therein of financial charges deemed incurred in the acquisition of shareholdings that do not contribute to the formation of taxable income in accordance with the provisions of paragraph 2 of Article 31 of the EBF;

Correction to Taxable Income Made in the Individual Sphere of I… SGPS

• €105,835.34: correction to the taxable income for the fiscal year of I… SGPS by the inclusion therein of financial charges deemed incurred in the acquisition of shareholdings that do not contribute to the formation of taxable income in accordance with the provisions of paragraph 2 of Article 31 of the EBF; and

Correction to Taxable Income Made in the Individual Sphere of E…

o) The Tax and Customs Authority issued a "doctrinal sheet", relating to Binding Information regarding case No. …/2009, approved on 19-11-2009, by the Director-General of Taxes, which appears in document No. 7 attached with the request for arbitral pronouncement, the contents of which are reproduced;

p) The decision on the hierarchical appeal expresses agreement with Information No. …/…, the contents of which are reproduced, in which the following is stated:

4.1.2 Grounds of the Appellant

The appeal is summarized to the corrections made in the inspection procedure, regarding financial charges (Articles 17 to 116 of the appeal) and the non-consideration as tax costs of 20% of allowances (Articles 117 to 129 of the appeal).

4.2. EXAMINATION OF THE HIERARCHICAL APPEAL

I) The appeal focuses on the annulment of the corrections made by the Tax Inspection Services, in the amounts mentioned above, on the grounds that, in the case of shareholdings, they were acquired or became its assets, via operations of contributions of assets at a moment prior to the year 2003 or the calculation should be reformulated, and in the calculation full asset value should be considered and not the net asset value.

Also, the correction to the taxable matter of the Group should be annulled with regard to 20% of expenses with allowances and compensation for displacement of the worker of E….

II) Factual Matters

A) From the Tax Inspection Report

A-1) Framing of the Appellant

The appellant is the holding company of the Special Taxation Regime for Groups of Companies (RETGS), in effect in the fiscal year 2004, of which among others I… SGPS, SA and E…, SA are part.

A-2) Basis for the Corrections

The corrections described in 4.1.1 of this petition originated from a Tax Inspection Report (pages 8 to 51 of the proceedings), the grounds of which, among others, consisted of the non-acceptance as cost of financial charges incurred, determined in accordance with the provisions of point 7 of Circular No. 7/2004 of 30 March of the IRC Services Division, as well as the allowances, which were corrected under subsection f) of paragraph 1 of Article 42 (now Article 45) of the CIRC.

Notified to exercise the right to be heard on the Project for Corrections of the Tax Inspection Report, it was exercised, in which, regarding the matter under appeal, the following is alleged:

B) Financial Charges Incurred with the Acquisition of Capital Shares (€789,746.57 (A… SGPS) + €141,860.46 (I… SGPS))

B-1) From the Contribution of Assets

On this matter the appellant alleges in the right to be heard that "the new wording of Article 31 (now Article 32) of the EBF should not be applied to shareholdings held by 'contributions of assets' under tax neutrality, in accordance with Articles 67 and 68 (now Articles 73 and 74) of the CIRC, since assets and liabilities are transferred, receiving shareholdings in exchange, in no way affecting the indebtedness."

The Tax Inspection Services counter that the tax neutrality regime provided for, advocates that, when the respective requirements are met, the operation of merger, division, contribution of assets or exchange of shares, be fiscally neutral, that is, at the time the operation takes place everything happens as if there had been no transfer, with the results to be determined in the future in the sphere of the beneficiary company, as if the merged, divided company or the contributing company had realized such results. Taxation is thus postponed to a later moment, with the operation not being burdened with any tax charge at the time of its performance, in obedience to a principle of continuity of business activity. Thus, there is no sense in the relationship established by the appellant between the tax neutrality regime and indebtedness.

It should also be noted that although the acquisition of financial shareholdings through exchange of assets does not generate indebtedness at the time of its exchange, there may be indebtedness underlying the assets given in exchange.

With regard to this matter, paragraph 7 of Circular 7/2004 of the IRC Services Division of 30 March establishes the method to be used for the purpose of allocating financial charges to shareholdings, stating that "given the extreme difficulty of using in this matter a direct or specific allocation method and the possibility of manipulation that it would allow, such allocation must be carried out based on a formula that takes into account the following: the remunerated liabilities of SGPS and SCR shall be allocated, in the first place, to remunerated loans granted by them to the companies in which they have shareholdings and to other interest-generating investments, with the remainder being allocated to the remaining assets, namely shareholdings, proportionally to their respective acquisition cost."

Thus, the allocation of financial charges to shareholdings should be carried out based on the aforementioned formula, and therefore the direct or specific allocation proposed by the appellant is not accepted.

B-2) From the Total Value of Gross or Net Assets

The appellant further alleges that the method of allocation of financial charges should take into account the gross value of assets and not the net value, given that it is the former that gives rise to the eventual indebtedness and not the net value, that is, the gross value less amortizations and provisions.

The Tax Inspection Services defend that the difference between the values of Net Assets and Gross Assets values corresponds to the amount of amortizations and provisions existing in the company as of the presentation date of the financial statements.

Thus, if hypothetically it were considered in the calculation formula the gross assets, consequently we would also have to consider the value of the loans obtained at their gross value, that is, we would not consider the possible amortizations of capital that would be made over the life of the loans.

Thus, in light of what is stated in Circular 7/2004 of 30 March, which does not distinguish net assets from gross assets, and considering the notions presented and essentially the fundamental equation of accounting (Assets = Liabilities + Net Worth), the notion of assets that should be considered is that of Net Assets.

Therefore, the claim put forward by the appellant in the right to be heard is not accepted, maintaining the correction to financial charges of €789,746.57 and €141,860.46.

C) Non-Deductible Costs for Tax Purposes - Allowances - €41,521.60 (E…)

The appellant alleges that regarding this matter, it proved by sampling that said expenses were allocated to the project that was invoiced, also alleging that the procedure when issuing the invoice follows the understanding contained in Office No. … of 1999.09.23 stating that, possessing the companies maps that identify the beneficiary, the location to which he moved, the date of displacement, among others, essential to correct application of the provisions of subsection f) of paragraph 1 of Article 41 (now Article 45) of the CIRC, the invoice issued to the client may present the overall price of the service, and thus it is not necessary to show the various components that constitute it. The Tax Inspection Services counter that it was only possible to prove clearly and unequivocally the values of allowances and compensation for displacement in the worker's own vehicle through accounting in the respective cost accounts, the same not occurring with regard to the amounts invoiced, since the invoice and measurement report do not itemize said expenses.

III) Analysis of the Facts

A) From the Temporal Application of the Norm (Articles 35 to 57 of the Petition)

Regarding the corrections of financial charges incurred with the acquisition of capital shares (€789,746.57 – A…) + €141,860.46 – I… SGPS), the appellant believes that, if corrections are to be made to the taxable matter, they can only be based on shareholdings acquired from 2003.01.01, given that, if not, the Tax Inspection Services would be applying the norm retroactively regarding the deductibility of financial charges.

It should be noted that, given the impossibility of a direct allocation being made of financial charges incurred in the acquisition of shareholdings, as already duly justified in the tax inspection report (pages 20 to 23 and 27 to 30 of the proceedings), the method to be used for the purpose of allocation is based on a formula, whose breakdown is found in the report mentioned above. The definition of this formula by itself does not constitute a norm of tax incidence, but merely a method that allows the quantification of the value of financial charges to be added. Also, in the complaint for reconsideration, this matter was the subject of analysis, concluding that the Tax Administration by virtue of Article 55 of the CPPT is bound by the implementation of the guidelines contained in the administrative instructions issued by the competent services, and therefore to strict compliance with the understanding sanctioned by Circular 7/2004 of 30 March of the IRC Services Division.

Thus, considering that in the Hierarchical Appeal the appellant alleged nothing new, we understand that the appellant's claim should be dismissed regarding this matter.

B) From the Value of Assets (Articles 58 to 79 of the Petition)

From reading Circular 7/2004 of 30 March, it can be seen that its guidance is that the assets to be considered relate to their acquisition cost, which will indeed make full sense according to the arguments that will be set out below, so it is understood a contrario that any subsequent movements that alter the values of those assets (e.g. amortizations, adjustments, provisions, MEP), should not influence the calculation of that proportion.

It is in this sense that the designation of gross asset is used, that is, free from the adjustments mentioned above, a meaning also given by Information 880/2008 of the IRC Services Division when referring that gross assets should be used but at acquisition costs. Article 32 of the EBF exempts from taxation the gains obtained with shareholdings, consequently, the financial charges incurred with those shareholdings also cannot be accepted as cost, since the income from the sale of those shareholdings will also be completely exempt. Given that in most situations a company presents a liability that is not exclusively related to (identifiable with) the acquisition of shareholdings, it mattered, given the fungibility of monetary means, to obtain a way of allocating proportionally the liabilities capable of generating costs for the company to shareholdings exempt under Article 32 of the EBF.

It is in this sense that Circular 7/2004 of 30 March of the IRC Services Division arises, in which the difficulty of establishing a direct connection between liabilities (loans) subject to financial charges and shareholdings is acknowledged, so it was explained in that guidance that it mattered to calculate that allocation "[...] based on a formula that takes into account the following: the remunerated liabilities of SGPS and SCR shall be allocated in the first place to remunerated loans granted by them (...) with the remainder being allocated to the remaining assets (...) proportionally to their respective acquisition cost[...]".

Now, as is the case with accounting normalization and practice, after the acquisition of those shareholdings, it is possible to alter the value of that shareholding, for example, by accounting for the effects of the application of the equity method, which reflects in the investor the accounting value of the investee to the exact extent of its shareholding percentage, being that, in the limit, that is, in the case where the investor holds all of the share capital of the investee, the value shown in the accounting is nothing more than the accounting value of the investee company, measured by its net worth (or equity).

On the other hand, the value of the financial shareholding recorded in the accounts of the holder of the shareholding is increased or decreased, depending on increases or decreases in the equity of the investees. These latter movements may be a consequence, for example, of the results obtained annually, distribution of profits, coverage of losses, by possible revaluations of tangible fixed assets, or by other increases in equity items.

Although the circular in question does not refer to the specific case of accounting for the equity method, but neither is it necessary to make such mention, it appears clear that it refers to the fact that financing costs will be allocated to assets having regard to their acquisition cost. This is because paragraph 2 of Article 32 of the EBF intends to exclude from taxation the charges incurred with the acquisition of shareholdings whose gains will also be exempt.

In a first analysis the ideal situation would be that each acquisition of a shareholding had an associated loan, in order to be able to allocate in an unequivocal way the costs with that loan to the acquired shareholdings. However, such a situation proves to be completely impossible given reality.

A reality that passes through the assumption of loan(s), or remunerated liabilities, that aim at financing the activity as a whole, making it impossible to establish a direct and objective connection between the assets acquired and the liabilities assumed, making it necessary to establish a formula capable of proportionally dividing those charges.

Now, as is naturally understood, there is no nexus between the recording of the effects of the equity method (or other variations, such as for example amortizations or provisions) and the increase in the liabilities of the company, that is, it is not because the value of the shareholding is increased (which did not result from actual financial expenditure) that financial charges also increase. Therefore Circular 7/2004 clarified that for the calculation of financial charges to be taken into account only with the acquisition cost of financial and other assets. Thus, we are of the understanding that the determination of non-deductible charges will take into account the following calculations:

[calculation table]

This situation will become even more evident if we consider in our reasoning the following merely academic case, but which will make clear the arguments set out above. If we consider a loan granted (in the same amount) for the acquisition of 1,000 units of currency (U.M) of a shareholding, which has associated interest of 100 U.M, we have in year 0 that:

a) Gross Assets (shareholding acquired): 1,000 U.M.

b) Remunerated Liability: 1,000 U.M.

c) Interest: 100 U.M

Applying the provisions of Article 32 of the EBF, we have that the interest of 100 UM, arising from the use of that liability, will not be considered as a tax cost. If we imagine that in year 1, the investor accounted for the effect of the MEP of its investee which amounted to 200 U.M and if we still have as a presupposition and, for simplicity, that no amortizations of the borrowed capital were made, we will have in year 1, the following scenario:

a) Assets-acquisition cost of the shareholding: 1,000

b) Assets other variations (MEP): 200

c) Remunerated Liability: 1,000

d) Interest incurred: 100

Now, as it is easy to understand, it is not because of the existence of an increase in gross assets (by the accounting of the MEP) that the interest incurred with that liability of 100 U.M. cease to be accepted as a tax cost.

Now, inverting the situation, that is, considering that the MEP in year 1 was negative in an amount that amounted to 300 U.M, we will have the following scenario:

a) Assets acquisition cost of the shareholding: 1,000

b) Assets other variations (MEP): - 300

c) Remunerated Liability: 1,000

d) Interest incurred: 100

In this situation, we would have that 142.86 UM would not be accepted as a tax cost (100 / 700 x 1000), a fact that appears impossible given that the company will have only incurred as financial costs the amount of 100 U.M.

In these terms, because it appears that the calculation formula used by the Tax Inspection Services is not in accordance with the principles enshrined in paragraph 2 of Article 32 of the EBF and does not follow the administrative guidance indicated in Circular 7/2004 of 30 March, the assessment should be reformulated, taking into account not the Total of Net Assets, but rather the Total of Gross Assets.

Thus, the value of financial charges allocable to A… and I… SGPS should be €570,248.50 and €105,835.34, respectively, determined as follows in the tables below:

[calculation tables]

In the calculation of financial charges, as shown in the tables above, the cost of shareholdings in the amounts of €57,859,314.64 and €22,461,877.74 of the companies A… and I… SGPS, respectively, was taken into account, different from those initially considered by the Tax Inspection Services. This change is due to the fact that the appellant when informing the Tax Inspection Services of the value of the cost of shareholdings, included the ancillary expenses, which in the Hierarchical Appeal it came to correct, attaching for that purpose the respective analytical trial balances, so in the values determined for financial charges, the requested change was taken into account.

Therefore, the appellant's claim should be granted regarding financial charges, being considered in its calculation, as requested by it, the Total of Gross Assets and not the Total of Net Assets, so new values were determined, namely €570,248.50 (A…) and €105,835.34 (I… SGPS).

C) From Shareholdings Received as Consideration for Contribution of Assets (Articles 80 to 93 of the Petition)

Regarding contributions of assets for the purpose of realization of share capital, it should be noted that at the time the operation is carried out, everything happens as if there had been no transfer, with the results to be determined in the future in the sphere of the beneficiary company, as if the merged, divided company or the contributing company had realized such results, with taxation being deferred to a later moment. It should also be noted that although the acquisition of financial shareholdings through exchange of assets does not generate indebtedness at the time of its exchange, nothing prevents the possibility of indebtedness underlying the assets given in exchange.

The appellant also invokes on this matter the Binding Information regarding Article 32 of the Statutes of Tax Benefits (EBF) - Case …/2009, which contains the definition of the concept of acquisition of shareholdings for the purpose of application of paragraph 3 of Article 32 of the EBF, concluding from the same that "a shareholding held by a SGPS in a company when that shareholding relates to shares received as consideration for contribution in kind for the realization of share capital at the time of constitution of those companies shall not constitute an acquisition for the purposes of application of the provision of Article 31 (now Article 32) of the EBF."(Article 31).

The concept of Binding Information comes defined in Article 68 of the LGT, which states that binding information on the tax situation of taxpayers, including, under the law, the presuppositions of tax benefits, are requested from the highest directing officer of the service, the request being accompanied by the description of the facts whose legal and tax qualification is desired". Also Article 57 of the CPPT states "Notification to interested parties of the response to the request for binding information mandatorily includes the information or opinion on which the tax administration based itself for its provision." From what is described, it is concluded that binding information always has underlying it a request for clarification on a specific matter, the Tax Administration being bound when the same is issued in writing to comply with the precepts defined in it, taking into account that it lapses in case of subsequent alteration of the factual or legal presuppositions on which it was based (paragraph 15 of Article 68 of the LGT), being able to be revoked, with effects for the future (paragraph 16 of Article 68 of the LGT) and the Tax Administration not being able, regarding the object of the request, to proceed in a manner contrary to the information provided, except in compliance with a judicial decision (paragraph 14 of Article 68 of the LGT). Thus, the Binding Information to which the appellant refers applies to a concrete case, namely to capital shares that have been acquired from entities with which there are special relationships, and not to the generality of entities. Thus the appellant has no ground, so the financial charges must be part of the acquisition cost of capital shares.

D) Non-Deductible Costs for Tax Purposes - Allowances - €41,521.60 (Articles 117 to 129 of the Petition)

This point was also analyzed in the Complaint for Reconsideration (point 3.2 of this petition) and in the Tax Inspection Report (point 4.2.II-C of this petition), concluding that they are not accepted as costs due to the fact that allowances were not invoiced to clients in accordance with subsection f) of paragraph 1 of Article 45 of the CIRC, with the appellant not demonstrating in the exercise of the Hierarchical Appeal the contrary, that is, not presenting any fact different from those already presented in the right to be heard in the Tax Inspection Report, as well as in the exercise of the Complaint for Reconsideration. Thus, the correction proposed by the Tax Inspection Services is to be maintained. Since the appellant presented nothing new, the correction to allowances relating to company E… should be maintained.

5 CONCLUSION / PROPOSAL

In conformity with what has been set out, a partial approval is proposed, for the reasons invoked below:

regarding the temporal application of the norm, its rejection for the reasons invoked in point III - A) of this Information;
as to the value of Assets, the appellant's claim should be granted, given that in the calculation of financial charges, the Total of Gross Assets and not the Total of Net Assets has application, with the value of financial charges to be excluded from tax-deductible costs changing from €789,746.57 to €570,248.50 (A…) and from €141,860.46 to €105,835.34 (I… SGPS), that is, the financial charges that do not contribute to the determination of taxable income are only €676,083.84 (€570,248.50 + €105,835.34) and not €931,607.03 (€789,746.57 + €141,860.46) as per point III - B) of this Information. Thus the correction made by the Tax Inspection Services should be annulled in the amount of €255,523.19 (€931,607.03-€676,083.84);
regarding shareholdings received as consideration for contribution of assets, the claim should be rejected, given what is described in point III - C) of this Information;
also the correction of allowances relating to company E… should be rejected, as set out in point III - D) of this Information.

6 RIGHT TO BE HEARD

Considering the instructions on the right to prior hearing conveyed in Circular 13/99 of 8 July of the Tax Justice Services Division, taking into account that the decision now taken is based on facts on which the right to be heard has already been exercised and no new elements or facts have been brought to the proceeding at the present petition, limiting the decision to the interpretation of the applicable legal norms, we are of the view that it is appropriate to dispense with new hearing of the appellant.

q) The Tax Administration issued Circular No. 7/2004, of 30 March, the contents of which are reproduced herein, available at http://info.portaldasfinancas.gov.pt/NR/rdonlyres/25504FA8-CD27-4EA3-A238-E67E6A99ED75/0/circular_7-2004_de_30_de_marco_da_dsirc.pdf;

r) On 05-05-2015, the Applicant filed the request for constitution of the arbitral tribunal that gave rise to the present case.

2.2 Unproven Facts

It was not proven that the Applicant used the financing that generated the financial charges mentioned in the Tax Inspection Report to acquire shareholdings as defined by the Tax and Customs Authority.

2.3 Justification for the Establishment of Factual Matters

The establishment of factual matters is based on the administrative file and the documents attached to the request for arbitral pronouncement.

3. MATTERS OF LAW

3.1 The Act that is the Subject Matter of the Proceeding

Following the decision on the hierarchical appeal, which partially approved the claim formulated in it by the Applicant, the assessment No. 2008 …, dated 17-03-2008, remains in the legal order, with the justification given to it in the decision on the hierarchical appeal, in the parts in which the Applicant's claim was not approved, which are:

– regarding A…, the part of the assessment corresponding to the correction of €570,248.50;

– regarding I… SGPS, the part of the assessment corresponding to €105,835.34;

– regarding E…, the part of the assessment corresponding to allowances not invoiced to clients in the amount of €41,521.60.

3.2 Positions of the Parties

The Applicant defends in the present proceeding, in summary, the following:

– that, as a general rule, financial charges are deductible and only at the moment of verification of the suspensive condition and if such suspensive condition is verified, proceed with the necessary adjustments for the purpose of determining taxable income;

– that the determination of financial charges through the method provided in point 7 of Circular No. 7/2004 is illegal, and only a criterion of direct and actual allocation of financial charges incurred in the acquisition of capital shares can be applicable;

– that the burden of proof of the allocation of certain financial charges to the respective acquisitions of capital shares falls on the Tax and Customs Authority when it differs from that declared by the taxpayer and that, in the case at hand, the Tax and Customs Authority failed to prove that in 2004, financial charges were incurred resulting from financing obtained for the acquisition of shareholdings that had been subsequently alienated;

– the charges incurred with allowances and compensation for displacement in the worker's own vehicle are duly documented by the respective mileage logs, with the link between these charges and the various projects, regarding which invoicing to the respective client was made, also being documented in accordance with documentation already made available during the inspection procedure;

– the Tax and Customs Authority does not challenge these costs nor their respective documentation but only that they are not "expressly and independently mentioned in the invoices", since if the Tax Authority had concluded that the documentation supporting the costs incurred with allowances and compensation for displacement in the worker's own vehicle was insufficient or inadequate for the purposes of supporting its respective deductibility, it would have surely made a correction to the net result of the fiscal year for the purpose of determining the taxable income for 2004 consisting in the increase of the entirety (100%) of such charges by application of the second part of subsection f) of paragraph 1 of Article 42 of the IRC Code (at the time of the facts) and not merely to the increase of 20% of the amount of such charges;

– furthermore, the doctrine of Office No. … of 26-09-1999, issued by the Tax Administration should be applied, in which it is stated that "as long as companies have maps with all the elements mentioned above essential to correct application of the provisions of subsection f) of paragraph 1 of Article 41 of the CIRC, the invoice issued to the client may present the overall price of the service provided, and therefore it is not necessary to show the various components that constitute it";

– as results from the very wording of subsection f) of paragraph 1 of Article 42 of the IRC Code, in referring to expenses "not invoiced to clients" does not establish the obligation that allowances and compensation for displacement in the worker's own vehicle be itemized in the invoices issued to clients, not resulting from the norm the establishment of any rule regarding the formal requirements to be observed to prove that invoicing to clients occurred.

The Tax and Customs Authority defends in the present proceeding the following, in summary:

– regarding the period in which tax corrections of financial charges should be made, what is provided in paragraph 6 of Circular No. 7/2004 is to be applied: "Regarding the fiscal year in which financial charges should be disregarded as costs for tax purposes, tax corrections shall be made in the fiscal year to which they relate of those incurred with the acquisition of shareholdings that are likely to benefit from the special regime established in paragraph 2 of Article 32 of the EBF, regardless of whether all conditions for the application of the special taxation regime for capital gains are already met. If it is concluded at the time of sale of the shareholdings that not all requirements for application of that regime are met, in that fiscal year, financial charges that were not considered as cost in previous fiscal years shall be considered as tax costs"; but in the case at hand all shareholdings were held for more than one year;

– it is not unconstitutional Article 31, paragraph 2 of the EBF, in the part in which it imposes the tax non-deductibility of financial charges incurred with the acquisition of capital shares as soon as these are incurred, regardless of the realization of capital gains exempt from taxation with the alienation of such capital shares;

– the Tax and Customs Authority did not presume any alienation nor would such make sense or be necessary for the correction made;

– in Article 31 of the EBF a link was created between the acquisition of capital shares held and maintained over a given minimum period, in line with the legal regime of the SGPS, and the tax relevance of financial charges incurred with their acquisition, an environment of neutrality between gains with certain financial assets and expenses associated with the liability necessary for the acquisition and maintenance of those assets, which is merely a corollary of the general principle of the essential nature of expenses, that is, the principle according to which tax deduction is conditioned by its connection with the obtaining of income subject to tax and from which results that if certain expenses are related to income not subject to tax they are not tax deductible;

– paragraph 2 of Article 31 of the EBF does not require that the method to be applied for the allocation of financial charges be the direct method, so any adequate method can be used;

– the Applicant did not proceed to a specific allocation of its financial charges, so it would be difficult to apply the direct method and no elements were brought to the knowledge of the inspection that would allow the application of the direct method;

– non-specific allocation is, in that situation, the only one that allows respect for the ratio legis of the regime in question, that is, neutrality between income and costs;

– the acceptance of the normative interpretation of paragraph 2 of Article 31 of the EBF advocated by the Applicant would also result in an unacceptable violation of the principle of equality and also the principle of contributive capacity which expresses and concretizes the principle of tax equality, since only taxpayers who did not perform direct allocation could deduce financial charges;

– also regarding the imputed unconstitutionality of Circular No. 7/2004 the request for arbitral pronouncement is lacking in merit;

– the Binding Information to which the applicant refers applies to a concrete case: the case in which capital shares have been acquired from entities with which there are special relationships, and not to the generality of entities;

– regarding allowances, in light of the law, the taxpayer had to have, for each payment made, a map that would allow effective control of allowances, and without that the entirety of the allowances in question would not be accepted for tax purposes;

– if the taxpayer had such a map for each payment made and had also invoiced the expenses with allowances to the client, it could deduct them (in their entirety) for tax purposes;

– if the taxpayer had, for each payment made, the aforementioned map but had not invoiced the expenses with allowances to the client, 20% of their value could not be accepted for tax purposes;

– thus the Applicant has to prove in each case that it invoiced allowances to clients and did not make this proof, neither during the inspection nor in the complaint for reconsideration, nor in the hierarchical appeal nor in arbitration;

– the office to which the Applicant refers relates to the office in response to a request for binding information made by SS… and which under the terms of the provisions of Article 68 of the LGT is of exclusive application to companies associated with that entity.

3.3 Question of the Regime Applicable to Capital Gains and Losses Obtained by SGPS and Respective Financial Charges

Law No. 32-B/2002, of 30 December, which approved the State Budget for 2003, amended Article 31, paragraph 2, giving it the following wording:

2 - Capital gains and losses realized by SGPS and by SCR through onerous transfer, whatever the title by which it operates, of capital shares they hold, provided they are held for a period not less than one year, as well as financial charges incurred with their acquisition, do not contribute to the formation of the taxable income of these companies.

Subsequently, the Tax and Customs Authority issued Circular No. 7/2004, of 30 March, in which, among other things, the following is stated:

7. With regard to the method to be used for the purpose of allocating financial charges incurred with the acquisition of shareholdings, given the extreme difficulty of using in this matter a direct or specific allocation method and the possibility of manipulation that it would allow, such allocation must be carried out based on a formula that takes into account the following: the remunerated liabilities of SGPS and SCR shall be allocated, in the first place, to remunerated loans granted by them to the companies in which they have shareholdings and to other interest-generating investments, with the remainder being allocated to the remaining assets, namely shareholdings, proportionally to their respective acquisition cost.

Following the tax inspection corrections were made to the taxable matter of the Applicant and to the taxable matter of I… SGPS, SA, because the Tax Authority did not accept as costs, based on Article 31, paragraph 2 of the EBF, the financial charges which it calculated by applying the criterion in point 7 of Circular No. 7/2004, understanding that the new regime is applicable to facts occurring from 01-01-2003 even if they relate to financing obtained before this date.

In the decision on the hierarchical appeal those corrections were maintained in part.

3.3.1 Non-Deductibility of Financial Charges As Soon as They Are Incurred

In the present proceeding, the Applicant begins its arguments on the matters of law saying, in summary, that it has observed the rule that "financial charges are deductible and only at the moment of verification of the suspensive condition and if such suspensive condition is verified, proceed with the necessary adjustments for determining taxable income as provided in paragraphs 2 and 3 of Article 31 of the EBF".

However, examining the request for arbitral pronouncement and the arguments of the Applicant, the approach to this question does not find the attribution of any defect to the act, particularly any assertion that if corrections should be made they should be made in another fiscal year.

In fact the Applicant merely makes an allusion to the difficulties of application of the regime of Article 31, paragraph 2 of the EBF "regarding the concept of financial charges and the moment of definition of the regime regarding the necessity of allocation of financial charges" and affirms that it "always conducted itself by the adoption ab initio of a principle of deductibility" which "consists in considering as a general rule that financial charges are deductible and only at the moment of verification of the suspensive condition and if such suspensive condition is verified, proceed with the necessary adjustments for determining taxable income as provided in paragraphs 2 and 3 of Article 32 of the EBF. (Articles 22 to 25 of the request for arbitral pronouncement).

But at no point in the request for arbitral pronouncement does the Applicant attribute error to the Tax and Customs Authority regarding the question of the fiscal year in which deduction should be carried out, particularly making no reference to violation of the legal norms that regulate the attribution of expenses to fiscal years.

In fact, the suspensive condition to which the Applicant refers, making citation in Article 26 of the request for arbitral pronouncement is that more than one year has elapsed since the acquisition of shareholdings not asserting the Applicant that this condition was not met.

The conclusions of the arguments confirm this interpretation of the request for arbitral pronouncement, since there is no allusion to this question.

Therefore, as to this point there is nothing to decide.

3.3.2 Question of the Illegality of the Determination of Financial Charges Through the Method Provided in Point 7 of Circular No. 7/2004

Article 32, paragraph 2 of the EBF establishes that "capital gains and losses realized by SGPS of capital shares they hold, provided they are held for a period not less than one year, as well as financial charges incurred with their acquisition do not contribute to the formation of the taxable income of these companies".

As referred to, the Tax and Customs Authority determined the financial charges it understood to have been incurred by the Applicant and by I… SGPS, SA to acquire shareholdings through the method provided in point 7 of Circular No. 7/2014 which establishes that "with regard to the method to be used for the purpose of allocating financial charges incurred with the acquisition of shareholdings given the extreme difficulty of using in this matter a direct or specific allocation method and the possibility of manipulation that it would allow, such allocation must be carried out based on a formula that takes into account the following: the remunerated liabilities of SGPS and SCR shall be allocated in the first place to remunerated loans granted by them to the companies in which they have shareholdings and to other interest-generating investments with the remainder being allocated to the remaining assets namely shareholdings proportionally to their respective acquisition cost".

The Applicant defends that neither the CIRC nor the EBF define a rule for determining "presumed" financial charges incurred by SGPS with financing obtained for the acquisition of shareholdings that should be considered tax non-deductible and that Article 31 paragraph 2 presupposes a direct allocation and that recourse to criteria for allocation of non-deductible financial charges created outside the law is not admissible being in the case exigible a formal law or authorized decree-law by virtue of the principle of legality.

In fact paragraph 2 of Article 32 of the EBF establishes that does not contribute to the formation of taxable income the "financial charges incurred with their acquisition" referring to capital shares so it is manifest that it presupposes that the allocation of financial charges to the acquisition of certain capital shares is determined where (in the interpretation assumed by both parties) will have to be held for more than one year.

On the other hand there is not the slightest legal support for instead of determining case-by-case whether or not there exists such allocation of financial resources generating charges to the acquisition of certain capital shares allocating the charges "in the first place to remunerated loans granted by them to the companies in which they have shareholdings and to other interest-generating investments with the remainder being allocated to the remaining assets namely shareholdings proportionally to their respective acquisition cost".

This method would only correspond to what is legally required to determine non-deductible charges if it were proven that in fact the financings to which such financial charges relate had been allocated as provided there and designedly regarding shareholdings had been used proportionally to acquire them. But beyond that lack of proof of correspondence between reality and the allocation criterion used by the Tax and Customs Authority not even is it ventured in that Circular any explanation for using the indicated formula and not another.

On the other hand as the Applicant defends the definition of the presuppositions of taxation is a matter subject to the principle of legality from the outset by virtue of the provisions of Article 103 paragraph 2 of the Constitution of the Portuguese Republic which establishes that "taxes are created by law which determines the incidence the rate the tax benefits and the guarantees of taxpayers".

This principle is reaffirmed and expanded by the LGT in its Article 8.

It is thus clear that the norms relating to the liquidation of taxes particularly those that define incidence and tax benefits are subordinated to the principle of legality being consequently excluded the possibility of by administrative means norms are created from which results an effective burden for the taxpayers.

Norms of incidence in the broad sense are those that "define the plane of incidence that is the complex of presuppositions from whose conjunction results the birth of the tax obligation as well as the elements of that obligation". In this sense norms of incidence are those that determine the active and passive subjects of the tax obligation those that indicate what is the taxable or collectable matter the rate and the tax benefits.

Point 7 of Circular No. 7/2004 constitutes an innovative norm regarding the determination of the taxable matter of Corporate Income Tax and ultimately regarding the scope of a tax benefit and is therefore invalid by violation of the principle of legality.

On the other hand it is evident from the reports of the tax inspections conducted on the Applicant and I… SGPS SA that the Tax and Customs Authority did not even attempt to ascertain whether it was possible to determine the direct allocation of financial resources to the acquisition of shareholdings advancing decisively to the application of the method provided for in the Circular.

Now the principle of legality invoked by the Applicant through citation of the judgment of the Central Administrative Court of the North of 15-01-2015 issued in case No. 00946/09.0BEPRT referred in Article 55 of the LGT also has the aspect relating to the activity of the administration being there indicated as one of the principles of the tax procedure (in concretization of paragraph 2 of Article 266 of the Constitution of the Portuguese Republic which establishes that "organs and administrative agents are subordinated to the Constitution and to the law").

The content of the principle of legality is indicated in Article 3 of the Code of Administrative Procedure of 1991 in force at the time the assessment was issued and subsidiarily applicable to tax procedure by virtue of the provisions of subsection c) of Article 2 of the LGT having the positive formulation that "organs of Public Administration must act in obedience to law and to law within the limits of the powers that are attributed to them and in conformity with the ends for which the same powers were conferred to them".

In this Article 3 of the CPA of 1991 the principle of legality ceased to have "a formulation only negative (as in the period of the Liberal State) to pass to have a positive formulation constituting the foundation the criterion and the limit of all administrative action".

"The law is not just a limit to the action of the Administration it is also the foundation of administrative action. This means that today there is no power free for the Administration to do what it sees fit except when the law prohibits it; on the contrary the rule is that the Administration can only do what the law permits it to do".

Therefore in the case at hand as was understood in the aforesaid judgment of the Central Administrative Court of the North cited by the Applicant "intending the Tax Authority to disregard the costs accounted for by the defendant based on violation of Article 31/2 of the EBF should demonstrate the presuppositions of its right to taxation that is should prove that such costs were not legally deductible either because capital losses were realized with the onerous transfer of capital shares held for less than one year or because were supported and accounted for financial charges with their acquisition". In fact it was this direct method that should have been used since the Tax and Customs Authority cannot make use of an indirect method to determine the taxable matter of the Applicant without the legal requirements being met on which the law makes the use of such method dependent provided for in Articles 85 and 87 of the LGT and cannot use for the quantification of taxable matter criteria not provided for in the law (Article 90 of the LGT).

With regard to the position defended by the Applicant in the wake of the judgment of the Central Administrative Court of the North of 15-01-2015 issued in case No. 00946/09.0BEPRT regarding the burden of proof of allocation of financial charges the Applicant has right only if viewed this burden globally taking into account everything it has to prove to reach the conclusion it reached.

In fact although in matters of tax benefits there are special norms from which it is inferred that the burden of proof of the facts necessary to benefit from them falls on those who invoke them (Articles 14 paragraph 2 and 74 paragraph 1 of the LGT) in the specific situation at hand one is not faced with the invocation of presuppositions of tax benefits since the part of Article 32 paragraph 2 of the EBF that provides for the non-deductibility of financial charges incurred with the acquisition of capital shares does not establish a tax benefit but rather a limitation on the deductibility of financial charges negative for the taxpayer established with the purpose of mitigating the tax-favorable regime enjoyed by SGPS in relation to companies in general.

Therefore when determining the non-deductibility of financial charges the Tax and Customs Authority is carrying out an activity of an unfavorable nature for the taxpayer so it bears the burden of proof of the facts it invokes to justify its action namely when opting for the use of indirect method of determining taxable matter to prove that some or some of the legal presuppositions of its application indicated in Article 87 of the LGT were met as results from paragraph 3 of Article 74 of the LGT. This will be the special rule of the burden of proof applicable to cases of use of indirect methods of determining taxable matter and not the general rule of Article 74 paragraph 1 invoked by the Applicant.

In the case at hand this proof was not made since

– there is no mention in the reports of the tax inspections relating to the Applicant and I… SGPS SA that any action was taken with the Applicant to obtain information on the hypothetical allocation or not of financing to the acquisition of capital shares;

– no explanation is given in the reports of tax inspections relating to the Applicant and I… SGPS SA regarding the reasons why in concrete terms in face of the elements of the accounts of the Applicant it was concluded that it was not possible to directly determine whether and to what extent financing was used for the acquisition of capital shares. Indeed in point IV of the Tax Inspection Report to the Applicant the Tax and Customs Authority on the "facts that imply recourse to indirect methods" merely said "Not applicable".

If facts that imply recourse to indirect methods were not proven in concrete terms indirect methods cannot be used to determine taxable matter as these can only be used when it is demonstrated that use of direct methods is not viable as results from Article 85 paragraph 1 of the LGT.

But in any case there is no direct violation of the rule of burden of proof as if facts were proven that permitted the use of indirect methods it would be the Applicant that would bear the burden of proving the eventual excess in quantification under Article 74 paragraph 3 of the LGT.

With regard to the allegation of the Tax and Customs Authority that this interpretation violates the principle of equality and also the principle of contributive capacity which expresses and concretizes the principle of tax equality "only taxpayers - as is the case of the applicant - who did not perform direct allocation could deduct financial charges" is based on a wrong presupposition as the allocation of financing to the acquisition of capital shares when it occurs is necessarily direct.

The "indirect allocation" created by the Tax and Customs Authority through Circular No. 7/2004 is a mere fiction based on presumptions whose foundation is not explained in it to lead to conclude that there was an allocation (necessarily direct) of financing to the acquisition of shareholdings without ascertaining whether it occurred or not and to what extent.

Now as is obvious to taxpayers in relation to whom it was not proven that they allocated financing to the acquisition of capital shares cannot be given the legal treatment that is given to those for whom such allocation was proven for the purpose of Article 32 paragraph 2 of the EBF as allocation is the necessary presupposition of its enactment.

It is concluded thus that the impugned act suffers from defect of violation of law by not having observed the regime of Article 32 paragraph 2 of the EBF and having infringed the principle of legality in the formal aspects (Articles 103 paragraph 2 of the Constitution of the Portuguese Republic and 8 paragraph 1 of the LGT) and procedural (Articles 55 of the LGT and 266 paragraph 2 of the Constitution of the Portuguese Republic).

Therefore the request for arbitral pronouncement is well-founded in this part.

3.4 Corrections to the Taxable Matter Resulting from the Non-Deductibility of

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Frequently Asked Questions

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What is the Special Group Taxation Regime (RETGS) and how does it apply to SGPS holding companies for IRC purposes?

The Special Group Taxation Regime (RETGS - Regime Especial de Tributação dos Grupos de Sociedades) allows qualifying groups of Portuguese companies to be taxed as a single entity for IRC purposes. Under RETGS, a dominant company (typically an SGPS holding company) consolidates the taxable income of all group members, offsetting profits against losses within the group. To qualify, the dominant company must hold at least 90% of share capital in subsidiaries for over one year. This regime provides cash flow advantages and tax efficiency by enabling immediate loss utilization rather than carrying forward losses individually. For SGPS companies specifically, RETGS interacts with special rules under Article 31(2) of the Estatuto dos Benefícios Fiscais regarding participation exemptions and financial charge treatment.

Are financial charges (encargos financeiros) deductible under Portuguese corporate income tax (IRC) law for group companies?

Financial charges (encargos financeiros) incurred with acquiring shareholdings are generally not deductible for SGPS companies under Article 31(2) of the Estatuto dos Benefícios Fiscais (EBF). This provision, effective from 2003 under Law 32-B/2002, establishes symmetry: just as capital gains from selling qualifying shareholdings (held over one year) are excluded from taxable income, related financial charges must be disregarded as costs. Circular 7/2004 clarified that this exclusion applies to charges incurred from fiscal years beginning after January 1, 2003, regardless of when the underlying financing was obtained or whether shareholdings met all conditions at the time charges were incurred. This represents a significant limitation on deductibility for holding company structures, requiring careful tax planning for acquisition financing arrangements under both standalone and group taxation regimes.

How does Circular n.º 7/2004 affect the deductibility of daily allowances (ajudas de custo) in IRC assessments?

Circular n.º 7/2004 primarily addresses financial charges under Article 31(2) EBF, not daily allowances (ajudas de custo). Daily allowances are governed by Article 42(1)(f) of the IRC Code, which mandates that 20% of allowances and compensation for travel, accommodation, and meal expenses paid to corporate officers, employees, or others are non-deductible for IRC purposes. In Process 292/2015-T, the Tax Authority corrected E... SA's declaration because it only increased taxable income by €9,175.44 when it should have added €50,697.04 (20% of total allowances of €253,485.23), resulting in an additional correction of €41,521.60. Companies must automatically increase taxable income by 20% of allowances paid when computing IRC liability in Table 07, Field 223 of Form 22. This limitation applies regardless of whether allowances are reasonable business expenses under accounting standards.

What is the procedure for challenging an IRC tax assessment through CAAD tax arbitration in Portugal?

To challenge an IRC assessment through CAAD (Centro de Arbitragem Administrativa) tax arbitration, taxpayers must follow procedures under the Legal Regime for Tax Arbitration (RJAT - Decree-Law 10/2011). The process involves: (1) filing a request for arbitration within 90 days of the final administrative decision (typically a hierarchical appeal decision); (2) paying the required fee; (3) CAAD's President accepting the request and notifying the Tax Authority; (4) the Deontological Council appointing three arbitrators for collective tribunals or one for singular tribunals; (5) parties having the right to refuse arbitrators; (6) tribunal constitution upon arbitrator acceptance; (7) the Tax Authority submitting its response; (8) optional hearing or proceeding with written arguments; (9) parties submitting final arguments; and (10) the tribunal issuing a binding decision within six months. This alternative dispute resolution mechanism provides faster resolution than judicial courts while maintaining legal rigor and enforceability.

Can a dominant company in a corporate group claim cost deductions related to subsidiary financing under RETGS?

Under RETGS, the dominant company's ability to claim cost deductions related to subsidiary financing depends on the specific nature of the costs and applicable provisions. For SGPS holding companies, Article 31(2) EBF specifically excludes financial charges incurred with acquiring shareholdings from contributing to taxable income, creating a symmetrical treatment with capital gains exclusions. This exclusion applies at both individual company and group levels—corrections made to individual companies within RETGS flow through to consolidated taxable income. In Process 292/2015-T, financial charges incurred by both the dominant company (A... SGPS) and subsidiary holding company (I... SGPS) were disallowed. However, operational financing costs unrelated to shareholding acquisitions generally remain deductible under normal IRC rules. The key distinction is between acquisition-related financing (non-deductible for SGPS under participation exemption rules) and operational financing (potentially deductible). Groups must carefully document and segregate financing purposes to support proper tax treatment under RETGS consolidation.

IRC Group Taxation (RETGS): Deductibility of Financial Charges and Daily Allowances under Circular 7/2004

Table of Contents

Summary

Full Decision

ENGLISH TRANSLATION

1. REPORT

2. FACTUAL MATTERS

2.1 Established Facts

5 CONCLUSION / PROPOSAL

6 RIGHT TO BE HEARD

2.2 Unproven Facts

2.3 Justification for the Establishment of Factual Matters

3. MATTERS OF LAW

3.1 The Act that is the Subject Matter of the Proceeding

3.2 Positions of the Parties

3.3 Question of the Regime Applicable to Capital Gains and Losses Obtained by SGPS and Respective Financial Charges

3.3.1 Non-Deductibility of Financial Charges As Soon as They Are Incurred

3.3.2 Question of the Illegality of the Determination of Financial Charges Through the Method Provided in Point 7 of Circular No. 7/2004

3.4 Corrections to the Taxable Matter Resulting from the Non-Deductibility of

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Table of Contents

IRC Group Taxation (RETGS): Deductibility of Financial Charges and Daily Allowances under Circular 7/2004

Table of Contents

Summary

Full Decision

ENGLISH TRANSLATION

1. REPORT

2. FACTUAL MATTERS

2.1 Established Facts

5 CONCLUSION / PROPOSAL

6 RIGHT TO BE HEARD

2.2 Unproven Facts

2.3 Justification for the Establishment of Factual Matters

3. MATTERS OF LAW

3.1 The Act that is the Subject Matter of the Proceeding

3.2 Positions of the Parties

3.3 Question of the Regime Applicable to Capital Gains and Losses Obtained by SGPS and Respective Financial Charges

3.3.1 Non-Deductibility of Financial Charges As Soon as They Are Incurred

3.3.2 Question of the Illegality of the Determination of Financial Charges Through the Method Provided in Point 7 of Circular No. 7/2004

3.4 Corrections to the Taxable Matter Resulting from the Non-Deductibility of

Frequently Asked Questions

Tags

FRESH Legal Group

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