CAAD Case 292/2017-T: IRC Depreciations, Investment Subsidies & Financial Costs Deductibility

ARBITRAL DECISION

The arbitrators Fernanda Maçãs (arbitrator-president), Dr. João Taborda da Gama and Dr. Luís Ricardo Farinha Sequeira (arbitrators-members), appointed by the Deontological Council of the Centre for Administrative Arbitration to form the Arbitral Tribunal, hereby agree as follows:

REPORT

1. A..., SA, Tax Identification Number ..., with registered office at ..., ..., ...-... ... municipality of ..., hereby submits, in accordance with article 2, no. 1, paragraph a), article 10, no. 1, paragraph a) and no. 2 of Decree-Law no. 10/2011, of 20 January, and articles 96 et seq. of the Code of Tax Procedure and Process (CPPT), a request for constitution of an arbitral tribunal and for an arbitral pronouncement against part of the additional corporate income tax (IRC) assessment no. 2016..., for the fiscal year 2013, the total amount of which was €566,452.12, already including €45,645.28 in compensatory interest, "with the subject matter of the present arbitral request being the amount of €307,957.01, which already includes the corresponding compensatory interest, calculated by the Tax and Customs Authority (hereinafter ATA) in ID. Document no. 2016..., Compensation no. 2016...".

1.1. The claim subject to the request for arbitral pronouncement also includes the annulment of the decision denying the administrative appeal, which was processed in the Finance Department of ... under case no. ...2016..., denial issued by order of the Finance Director of ..., dated 20-01-2017, notified to the now challenging party through an unnumbered official letter dated 26-01-2017 (see copy attached as DOC 2).

1. The request for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority on 28-04-2017.

3.1. The Claimant did not appoint an arbitrator, therefore, pursuant to paragraph a) of no. 2 of article 6 and paragraph b) of no. 1 of article 11 of the Legal Regime of Tax Arbitration (RJAT), the President of the Deontological Council appointed the signatories as arbitrators of the collective arbitral tribunal, who communicated their acceptance of the appointment within the prescribed period.

3.2. On 14-06-2017, the parties were notified of the appointment of the arbitrators and did not raise any objections.

3.2. In accordance with paragraph c) of no. 11 of RJAT, the collective arbitral tribunal was constituted on 30-06-2017.

3.3. In these terms, the Arbitral Tribunal is regularly constituted to consider and decide the subject matter of the case.

1. To support the request for arbitral pronouncement, the Claimant alleges, in summary, the following:

Regarding the allocation of subsidies based on the minimum depreciation quotas subject to the present arbitral request, the Claimant contests the date considered by the ATA (January 2013) for the completion and commencement of operation of the investment projects, arguing that, in addition to these having been completed much later, "there was a need for experimental periods before their commencement of operation, among other facts that clearly contradicted the inspection report project";

For the Claimant, "the ATA asserts, but provides no credible evidence of the assertion": i) "that billing was done according to the needs of managing the investment projects with the C... and not according to their material execution"; ii) "that the investment projects were being used from the beginning (January) of 2013 but does not demonstrate how it sustains this assertion;"

For example, "the ATA refers to the signing of contracts with the C... and waiting 48 months for their recognition, without, however, and once again, informing and proving when the said 48-month period started and ended, what the objectives were and what concrete advantages such alleged delay brought to the company";

Analyzing the documents attached as Annex II, the Claimant argues that "The listings attached (See pages 52 to 54, pages 66 to 68, pages 82 to 84, and pages 88 and 89), with the title of 'Investment Listings' referring to each of the 4 projects mentioned", (…) "the tables in question (which moreover do not indicate the source nor explain the information they incorporate) not only do not allow conclusions to be drawn to support the corrections regarding the allocation of subsidies, but demonstrate that, contrary to what the ATA says, the projects could not have been completed and in operation from at least January 2013;"

"Indeed, many dates indicated therein as equipment acquisition dates within the scope of the investment projects are dates from the year 2013, demonstrating that at the beginning of that year the investment projects could not yet have been completed and in operation given that goods and services continued to be acquired for their incorporation";

The said Annex II further contains "copies of 30 invoices relating to the supply of consulting and inspection services for the projects in question during the years 2011, 2012 and 2013, but the majority of the invoices attached are, it is repeated, dated in the year 2013";

"On the other hand, do not say that if such invoices were issued to A... (now challenging party) not by B..., which was the one who contractually executed the investment projects, but by a third entity, then it is because in 2013 the now requesting party A... was already operating those projects and was contracting services with other companies";

For the Claimant "this conclusion would be totally inconsistent given that the project execution contracts provided for the possibility of contracting with independent entities, particularly in more specialized areas, as was the case with supervision";

Thus and in conclusion, "the ATA presented no credible evidence that the tax fact on which it based itself – commencement of operation of the investment projects in January 2013 – had actually occurred, resulting from the documents it attached that, on the contrary, in 2013, those projects were still under execution";

For the Claimant, the ATA did not comply with the burden of proof to sustain its assertions and to disregard various documents with indications contrary to what the ATA claims;

Notwithstanding that the burden of proof does not fall on the Claimant, the Claimant further attaches, by way of example, "a set of invoices issued by B..., SA (the company that executed a significant part of the projects), dated September 2013 and January 2014, concerning the BS... and V... projects (See DOC 4)";

The Claimant also attaches, "a copy of 3 reports drawn up by C..., concerning the V..., BS... and P... projects (using the RI terminology), an entity that carried out physical verification on site, which records the dates of commencement of execution and the date of completion of the projects (DOC 5.1)";

The Claimant further attaches "the summaries of the closure reports drawn up by the same official body where the dates of commencement and completion of each of the four investments in question are recorded, namely, (using the RI terminology), P..., BS..., BC... and V... (DOC 5.2)";

Regarding the corrections relating to financial charges, according to the Claimant "The ATA presents another type of corrections, these relating to financing costs (See III.2.1.3 of the RI) with the following reasoning: a) A... (A...) "frequently resorts to bank loans, consequently bearing a high amount of financial charges. In this way, interest borne on loans, expenses with discounts of securities, stamp duty and other charges related to the level of indebtedness, in the fiscal year 2013, total the amount of EUR 2,218,502.21." (See page 18 RI.); b) Adding next that "At the same time that it contracts these loans and bears the said charges, the company presents globally debtor balances in the accounts of Other Debtors and Creditors (Accounts 27), clients (Accounts 21) and shareholders (Accounts 26), of group or related companies, in high amounts. Regarding these it also presents creditor balances in suppliers (accounts 22), although of much lower values." (See page 18 RI);

The Claimant contests this reasoning, alleging that the ATA presents no credible and substantiated evidence on the conclusions it draws;

On the contrary, it would be sufficient for the ATA to resort to the Cash Flow Statement, which identifies the sources of financing of the company during the year in question and the application given to those funds, to conclude that "it is not true that the financing contracted by A... is financing deferrals to clients; on the contrary, the cash flows generated by operating activities – specifically, customer receipts – have a very positive balance, which is used to remedy the shortcomings identified above at the level of financing activities";

The Claimant concludes, among other things, that: a) "That the financing contracted by A... was not used for the granting of credit and deferrals to clients"; b) "The allocation made by the ATA as to the destination of the financing contracted by the company generating financial charges is wrong"; c) "It is not correct to establish a relationship between the value of credits contracted from third parties and amounts receivable from clients resulting from the sale of products; d) The overvaluation of the balances considered by the ATA as to the amounts receivable recorded in account 26601 – D... SGPS is manifest; e) "That the financial charges considered by the ATA as the basis for calculating the amount to be corrected include expenses with bank guarantees, which cannot be considered for this purpose"; f) There is, therefore, an incorrect quantification of the amount of financial charges to be considered in the adjustment that the ATA intends to make and as to the amount that could be considered more appropriate in the specific case";

In sum, for the Claimant, "the correction to taxable profit proposed by the ATA relating to financial charges borne with financing used in financing related entities should be reduced from €957,778.62 to €329,474.75, as per the table mentioned in article 126 of the arbitral request and which is hereby reproduced;

The Claimant concludes, reproducing jurisprudence to that effect, that it was incumbent upon the ATA to bear the burden of proof as to the indispensability of costs, which is not the case in the present proceedings;

The Claimant concludes by requesting: "that the present challenge be declared well-founded and proven, determining the annulment of the additional IRC assessment, relating to the fiscal year 2013, in the amount of €307,957.01, also requesting that the ATA be condemned to pay indemnificatory interest, at the legal rate in force, counted from the date of payment until the date when the competent refund title is processed".

1. The Tax and Customs Authority presented a reply and attached the inspection file, invoking, in summary, the following:

"With regard to the issue of the allocation of subsidies relating to investment projects – minimum quotas, contained in point III.2.1.1.2 RIT, the tax inspection verified that the investment projects P..., BS..., BC... and V..., despite the execution of the works by B..., S.A., being completed and the corresponding assets being used from the beginning of 2013, the assets in question were only recognized as ceasing to be under construction in the months in which the 48-month period was completed, counted from the date of signing the financing contract with C.../PRODER, with the depreciations accounted for in that fiscal year, being calculated using the duodecimal method";

For the Defendant, the assets were being used from the beginning of the fiscal year 2013, based on the fact that "B... S.A., rebilled to the Claimant, in this fiscal year, charges relating to expenses with staff and security, "since in that fiscal year it was no longer its responsibility to manage the equipment subject to the work" and, also, because operating costs and expenses with quality certification were borne by the Claimant in the same period";

"Which means that in light of the provision in no. 3 of article 29 of the CIRC and paragraph a) of no. 2 of article 1 of Regulatory Decree no. 25/2009, that the commencement of operation and use of the assets occurred at the beginning of the fiscal year 2013, from which it follows that the depreciation quota should have been calculated on an annual basis and not by duodecimals covering only part of that same fiscal year";

"In accordance with this understanding, the allocation of subsidies granted by C..., also by force of the provision in paragraph a) of no. 1 of article 22 of the CIRC, should have been effected in the same proportion of the annual depreciation calculated on the acquisition cost", which means that "the determination of the value of subsidies associated with each of the four investment projects, to be allocated to the fiscal year 2013, was based on the value of asset depreciations reported from January 2013 to the date considered by the Claimant as the commencement of use, but taking into account the minimum depreciation quotas provided for in no. 6 of article 30 of the IRC Code";

As for the arguments of the Claimant, the Defendant argues that "the mere mention of the conclusion dates in the C... Reports does not, by itself, constitute irrefutable proof of the commencement of operation of the assets on those same dates, in that, formally the projects were considered completed, but, in reality, nothing prevented their use from having been initiated at an earlier date";

On the other hand, "the Claimant's allegation about the existence of experimental periods clarifies nothing about whether all the assets were covered and what their respective duration was", being certain that "the Claimant began to assume, from the beginning of the fiscal year 2013, charges connected with the said investments, such as operating costs and expenses with quality certification, which "can only mean that the assets were already at its disposal".

"Thus", the Defendant concludes that "the correction made with respect to the allocation of subsidies, based on the provision in paragraph a) of no. 1 and no. 2 of article 22 of the IRC Code, is not subject to any defect of illegality".

As regards the non-acceptance of the deductibility of financing costs, "corrections relating to financing costs not accepted remain in dispute in the amount of €628,303.87.";

The Defendant argues that "the reason that triggered the correction of financing costs was induced by the verification, by the tax inspection services, of a practice adopted by the Claimant that was evident in the fact that, at the same time as it contracted loans and bore the corresponding costs, the balances of the accounts that reflected the movements resulting from the commercial and financial relations established with related companies - namely: Account # 21 – Clients, Account #22 - Suppliers, Account # 26 – Shareholders and Account # 27 – Other Debtors and Creditors - evidenced high debtor balances, extended payment periods and absence of remuneration of those same credits";

"Which is equivalent to saying that the Claimant's financing needs were increased, as a consequence of the payment facilities granted to related entities, that is, of the financial support granted to them without any remuneration, in that, being deprived of the financial means owed by the related entities, it had to avail itself, to obtain liquidity, of resorting to loans";

"From this asymmetrical situation results an imbalance in the expenses/income ratio resulting from the Claimant's assumption of financial charges that had repercussions in benefits or advantages in the sphere of related entities;

"It is, therefore, possible to establish a nexus of causality between the financing obtained and the high balances of the accounts that reflect the movement with the related entities, hence the methodology followed by the tax inspection for the calculation of non-deductible financing costs, described in point III.2.1.3 of the RIT which is hereby reproduced";

"Pursuant to no. 1 of article 23 of the IRC Code, financial charges are deductible when it is demonstrated that they are indispensable for the realization of income or gains subject to tax or for the maintenance of the income-producing source, concretizing the provision of this rule that such requirement was met, whenever the third-party capital that gives rise to interest is applied in the operation, i.e., in the business activity conducted";

"Being certain that the operation or activity referred to in paragraph c) of no. 1 of article 23 is that conducted by the taxpayer that bears the financial charges and not the activities conducted by related entities, since, as clarified by case law (See, among others, Court of Appeal Decision of 10.07/2002, in case 0246/02): "their respective activities are autonomous, having distinct legal personality and tax capacity";

In summary, if the debtors in question had not benefited from the deferral of payment dates, funds would have flowed to the Claimant that would have made the contraction of loans in such high amounts unnecessary and this would logically cause a relief of financial charges;

Wherefore it is to be concluded that it would not have been indispensable to maintain the same level of indebtedness had the receipts of debts of related entities not benefited from deferral, whereby it is considered that the charges in question are not deductible for the formation of taxable profit because they are not qualified as indispensable for the realization of the Claimant's profits subject to tax or for maintenance of the Claimant as an income-producing source.

1. Finding no reasons to justify it, the tribunal waived the holding of the first meeting, provided for in article 18 of RJAT, which it did pursuant to the principles of the Tribunal's autonomy in the conduct of the proceedings.

2. By order of 12 October, the Tribunal set 22 November 2017, at 14:00, for the holding of the judgment hearing.

3. On 22 November 2017, the judgment hearing took place, where the witnesses listed by the Claimant were examined (E..., F... and G...).

The Tribunal set 28 February as the date for the issuance of the Arbitral Decision and the Parties agreed to submit successive written allegations within the period of fifteen days. The deadline for the issuance of the Arbitral Decision was extended, by order of 22 February 2018, to 28 April 2018 and, by order of 21 April, to 28 June.

1. The Claimant and the Defendant submitted arguments reiterating the arguments presented in the earlier procedural documents.

CASE MANAGEMENT

9.1. The parties have legal personality and capacity, are shown to be duly empowered and are regularly represented (articles 4 and 10, no. 2, of RJAT and article 1 of Ordinance no. 112-A/2011, of 22 March).

9.2. The tribunal is competent and is regularly constituted.

9.3. The case is not subject to any nullities.

9.4. No exceptions were raised.

9.5. There are no other circumstances that prevent the tribunal from ruling on the merits of the case.

MERITS

III.1. Factual Matter

1. Proven Facts

10.1. With relevance to the consideration and decision of the issues raised, preliminary and on the merits, the following facts are taken as established and proven:

a) A tax inspection action was carried out, credentialed by Service Order no. OI2015..., of 2015.05.26, and with order of 2015.05.27, motivated by information from the Finance Department of ... that pointed to indications of irregularities in the recognition of tangible fixed assets and corresponding allocation of subsidies, as well as regarding the deductibility of financial charges borne by A....

b) According to the factuality contained in the RIT, which is hereby fully reproduced, the Claimant submitted several applications for investment projects potentially eligible for PRODER, specifically:

1. ...- BC...

2. ...- BS...

3. ....- P...

4. ...– 30 rooms – V...

5. ...– 13 rooms – V1...

6. ...– 9 rooms – V9

7. ...– VI.... – cfr. page 11 of RIT.

In this context, the signing of the financing contracts for the said projects with C... was carried out in previous years, with most of the subsidies being received by the end of 2010, and the support being recognized in the accounts in equity (through account 59) in consideration of Other Various Debtors (account 2781), with the latter being credited as the subsidies were received, finding itself at the end of 2013, with a globally debtor balance of €9,896,901.33, in accordance with the table contained in pages 12 of the RIT.

As stated in the RIT, the said investments were framed within the Projects of Regional Interest (PIR), a requirement being, among others, that the material execution of the project be completed within 48 months following the signing of the financing contract with C.../PRODER.

As stated in point III.2.1.1.2 of the RIT ("Investment projects - allocation of subsidies – minimum quotas), "[f]or the realization of the said investment projects, turnkey project management contracts were entered into "with the company B... S.A., which has the same capital holders as A... (D...SGPS SA).

Thus, notwithstanding the conditions established in the contracts executed for the performance and billing of work to be carried out by B... SA, these were only billed according to the management needs of the projects with C.../PRODER and not according to their material and contractual execution.

The facts described resulted in that, notwithstanding the execution of the four aforementioned works being completed and the corresponding assets being used from at least the beginning of 2013, these were only recognized as such in the months in which the said 48-month period was completed from the signing of the contract with C...

Proof of this is the rebilling, in the fiscal year 2013, of charges by B... SA to A..., relating to staff and security, since in that fiscal year it was no longer its responsibility to manage the equipment subject to the work.

Also proof of such use are the operating costs and quality certification expenses recorded in the accounting of the taxpayer, which evidence the use of the equipment already at the beginning of the fiscal year 2013.

Thus, for the purpose of depreciations, the provision in paragraph a) of no. 2 of article 1 of RD 25/2009 of 14 September combined with no. 3 of article 29 of the CIRC, as worded at the time, establishes that only depreciations are accepted from the commencement of operation or use of Tangible Fixed Assets.

Being so, in accordance with paragraph a) of no. 1 of article 22 of the CIRC, the inclusion in profit of subsidies with non-current assets, when it is depreciable assets, must be effected in the same proportion of the depreciation calculated on the acquisition cost, without prejudice to no. 2 of the same article which provides for these cases that the calculated depreciation has as its minimum limit the one that proportionately corresponds to the minimum depreciation quota provided for in no. 6 of article 30 of the IRC Code.

Additionally, some costs were identified that were recognized and classified as development expenses, being depreciated at 33.33%.

The said costs are related to advisory services aimed at implementing different norms (ISOS) so that the competent entity could subsequently proceed with their certification.

Now, the identified expenditure should be recognized as a cost when incurred, since it is not expected that economic benefits will flow to the entity that exceed the accounting period, not meeting the conditions to be qualified as an asset in accordance with NCRF 6.

Thus, the associated subsidies are also, from the outset, to be recognized in full, in the proportion of the percentage of coverage of each of the projects.

In these terms, in order to be able to determine the allocation of subsidy associated with each of the investments and not yet considered, since the taxpayer practiced depreciations by duodecimals, the calculation of depreciations and reversals of assets/costs contained in the four investment projects was carried out, reported from January 2013 to the date considered by A... as the commencement of use, but only taking into account the minimum depreciation quotas provided for in no. 6 of article 30 of the CIRC (Annex II).

Thus, the following amounts were obtained calculated in the said annex:

From this calculation it results that depreciations were not accounted for for the investments and periods indicated, in the amount of €1,794,248.82 (taking into account the minimum depreciation quotas and the assets/costs referenced), whereby having not been recognized the subsidies, the allocation to results is lacking in accordance with paragraph a) of no. 1 of article 22 of the CIRC, of the subsidies allocable to each investment, in the global amount of €629,931.55.

• cfr. pages 15 et seq. of RIT.

As stated in the RIT, under the point "III.2.1.3 – FINANCING COSTS NOT ACCEPTED", the services considered the following:

"Within the scope of the present audit, it was further noted that the company frequently resorts to bank loans (Annex IV – Accounts 25), consequently bearing a high amount of financial charges. In this way, interest borne on loans, expenses with discounts of securities, stamp duty and other charges related to the level of indebtedness, in the fiscal year 2013, total the amount of €2,218,502.21 (Annex V – Accounts 68 and 69). At the same time that it contracts these loans and bears the said charges, the company presents globally debtor balances in the accounts of Other Debtors and Creditors (Annex VI - Accounts 27), clients (Annex VII - Accounts 21) and shareholders (Annex VIII - Accounts 26), of group or related companies, in high amounts. Regarding these it also presents creditor balances in suppliers (Annex IX - accounts 22), although of much lower values.

In view of the foregoing, the financial charges borne, in particular interest and expenses with discounts of securities, will only be considered as an expense for tax purposes when the loans contracted are necessary to the development of the activity, given that pursuant to paragraph c) of no. 1 of article 23 of the CIRC, costs are considered to be those which demonstrably are indispensable for the realization of profits subject to tax or for the maintenance of the income-producing source, in particular, charges of a financial nature.

This article establishes the general principle relating to the tax deductibility of expenses borne by entities subject to IRC and states in its no. 1, paragraph c) (heading "expenses"), that "Costs are considered to be those which demonstrably are indispensable for the realization of income subject to tax or for the maintenance of the income-producing source", subsequently listing a list of costs where financial charges are included, such as "interest on third-party capital applied in operations, discounts, premiums, transfers, exchange differences, charges on credit operations, debt collection and issuance of shares, bonds and other securities, redemption premiums and those resulting from the application of the effective interest method to financial instruments valued at amortized cost".

It is thus considered that the acceptance as a tax expense of interest and other charges should comply with the same rules that are generally applicable to other charges borne by companies, being, therefore, its deductibility conditioned upon the observance of the basic principle that they will only be fiscally deductible when they are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the income-producing source of the respective taxpayer.

In fact, the capital obtained, generating financial charges, when channeled to the granting of loans or deferrals to related entities are not manifestly used in the activity of the company that bears the charges, for which taxable income does not flow back that would compensate the expenses, in that such uses are not remunerated.

Now, if the company contracts loans to then "grant" them to group companies, this amount of loans does not become necessary to the activity of the company, thus, the amount of charges related to the level of indebtedness will not be considered as an expense, in the proportion that the debtor balances of the said accounts represent in relation to the loans contracted.

Thus, it was compiled, monthly, for the year 2013, the value of loans, the amount of the globally debtor balance contained in the sub-accounts of accounts 21, 22, 26 and 27 of related entities and the amount of charges borne with the level of indebtedness, having subsequently calculated the monthly percentage of the amount of loans not necessary to the activity of the company (resulting from the debtor balances of group companies) and consequently the amount of charges borne not considered as an expense.

It should also be added that no charges of this nature reflected to third parties were identified and consequently not taken into account, that is, no amounts were rebilled to debtors for these credits/deferrals.

Moreover, the accounting does not record financial income associated with or motivated by the allocation to group companies of the costs borne resulting from the level of indebtedness, whereby the same cannot be considered as tax expenses.

In this context, the calculation of non-accepted financial costs was effected, in the amount of €957,778.62, which are evidenced in the following table:

NOTE: amounts resulting from annexes IV, V, VI, VII, VIII and IX" - cfr. pages 18 to 20 of RIT.

c) For the purposes of article 60 of RCPITA, the Claimant was notified of the draft report, through Official Letter no. ..., of 06 May 2016, to exercise the right to prior hearing, which it exercised in accordance with the provisions of Annex XVII of the RIT, presented within the fixed period and which received from the services the assessment contained in pages 34 et seq. of the RIT, which are hereby fully reproduced, for all purposes.

d) The ATA made corrections to taxable profit, in the global amount of €945,756.32, resulting in the additional IRC assessment and compensatory interest now challenged: i) correction contained in point III.2.1.1.2 of the RIT – Allocation of subsidies based on minimum depreciation quotas, in the amount of €317,452.45; and ii) disallowance of the deduction of financing costs (point III.2.1.3 RIT), in the amount of €628,303.87, following the denial of the administrative appeal registered in SICAT with the no. ...2016...

e) With regard to the issue of the allocation of subsidies relating to investment projects – minimum quotas, contained in point III.2.1.1.2 RIT, the tax inspection verified that the investment projects PC..., BS..., BC... and VR..., despite the execution of the works by B..., S.A., being completed and the corresponding assets being used from the beginning of 2013, the assets in question were only recognized as ceasing to be under construction in the months in which the 48-month period was completed, counted from the date of signing the financing contract with C.../PRODER, with the depreciations accounted for in that fiscal year, being calculated by the duodecimal method.

f) For the inspection services, the assets were being used from the beginning of the fiscal year 2013.

g) This conclusion is supported by the fact that B... S.A., rebilled to the Claimant, in this fiscal year, charges relating to staff and security expenses, "since in that fiscal year it was no longer its responsibility to manage the equipment subject to the work" and, also, because operating costs and quality certification expenses were borne by the Claimant in the same period.

h) As described in the RIT, the determination of the value of subsidies associated with each of the four investment projects, to be allocated to the fiscal year 2013, was based on the value of asset depreciations reported from January 2013 to the date considered by the Claimant as the commencement of use, but taking into account the minimum depreciation quotas provided for in no. 6 of article 30 of the IRC Code.

Wherefore it results that the total subsidies not allocated by the Claimant (cfr. point B1 of the RIT) is €539,475.00, being that €317,552.35 are related to subsidies associated with depreciable assets, in the proportional part of the minimum depreciation quota and €222,022.55 are related to intangible assets (development expenses).

i) The Claimant began to assume, from the beginning of the fiscal year 2013, charges connected with the said investments, such as operating costs and quality certification expenses.

j) The Claimant attached a copy of three reports drawn up by C..., concerning the V3..., BS... and PC... projects, which record the dates of commencement and completion of the projects (Doc 5.1).

l) The Claimant attached summary of the closure reports drawn up by C... which records the dates of commencement and completion of each of the four investments in question (PC..., BS.., BC... and V3...) - Doc 5.2.

m) The projects BC..., VR... and BS... were not in operation in July 2013 and the project PC..., which was the one that was most advanced, despite the constructions being completed at that date, was in a testing phase (testimony of witness E...).

n) According to the inspection report, the Claimant, at the same time as it contracted loans and bore the corresponding charges, the balances of the accounts that reflected the movements resulting from the commercial and financial relations established with related companies - namely: Account # 21 – Clients, Account #22 - Suppliers, Account # 26 – Shareholders and Account # 27 – Other Debtors and Creditors - evidenced high debtor balances, extended payment periods and absence of remuneration of those same credits.

o) The Claimant brought this challenge only against the denial decision issued in case no. ...2016..., by the Finance Director of ..., notified to the Claimant by official letter of 26.01.2017.

n) The Claimant submitted the request for arbitral pronouncement on 25.04.2017.

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

10.3. Reasoning of the Factual Matter

The judgment of factual matters was based on the critical analysis of the position adopted by the parties, the documents attached by the Claimant and the inspection file. Critical analysis of the witness evidence produced at the judgment hearing was also taken into account, in particular that produced by witness E..., especially regarding the clarification of the fact referred to in point m) of the proof. That witness, who personally accompanied the four projects in his capacity as an employee, from July 2013, of company H..., which was responsible for the supervision and monitoring of the projects, demonstrated perfect knowledge of the projects.

III.2. Legal Matter

III.2.1. As Regards the Issue of the Allocation of Subsidies

The issue to be decided concerns the initial moment from which subsidies received by a company must be allocated to taxable profit. The Claimant received subsidies from C... to finance a set of investment projects and initiated their allocation by duodecimals, for the months elapsed between the month of commencement of operation of each of the 4 investment projects and the end of the year 2013. This allocation is based on the Claimant's consideration of the following commencement of operation dates for each of the projects:

... (BS...): June 2013;

... (BC...): October 2013;

... (PC...): April 2013; and

... VR...): January 2014.

The ATA, for its part, believes that "notwithstanding the execution of the four aforementioned works being completed and the corresponding assets being used from at least the beginning of 2013, these were only recognized as such in the months in which the said 48-month period was completed from the signing of the contract with C..." and, therefore, corrected the depreciations between the month of January 2013 and the dates considered by the claimant as the effective commencement of operation of the assets and, consequently, the allocation of subsidies to results.

That is, the question is whether, as the ATA alleges, the assets were in operation "from at least the beginning of 2013", or whether the commencement of operation occurred only at a later date as the Claimant contends, a question that is fundamental having regard to the applicable legal framework.

In fact, in accordance with article 22 of the CIRC in force at the time of the facts, subsidies are included in taxable profit in accordance with paragraph a) of the same article: "when subsidies relate to depreciable or amortizable assets, part of the allocated subsidy must be included in taxable profit, regardless of receipt, in the same proportion of the depreciation or amortization calculated on the acquisition or production cost, without prejudice to the provision of no. 2". According to no. 2 then in force "in cases where the inclusion in taxable profit of subsidies takes place, in accordance with paragraph a) of the preceding article, in the proportion of the depreciation or amortization calculated on the acquisition cost, it has as its minimum limit the one that proportionately corresponds to the minimum depreciation or amortization quota in accordance with no. 6 of article 30.". And article 30, no. 6 referred at that time that "for the purposes of the preceding article, the minimum depreciation or amortization quotas are those calculated on the basis of rates equal to half of those fixed according to the constant quota method, unless the General Tax Office grants prior authorization for the use of quotas lower than these, following the submission of a request indicating the reasons that justify them".

Article 29, no. 1, of the CIRC considered accepted as an expense the depreciation or amortization of tangible fixed assets, stating in no. 3 that "except for duly justified reasons accepted by the General Tax Office, elements of assets are only considered subject to deterioration after they come into operation or use".

These norms should be read in combination having regard to Regulatory Decree no. 25/2009, of 14/9, according to which, "except for duly justified reasons accepted by the General Tax Office, depreciations and amortizations are only considered (…) for tangible fixed assets and investment properties, from their commencement of operation or use" (article 1, no. 2, paragraph a), and it is also that moment, the moment of commencement of operation, that is the relevant moment for determining the beginning of useful life (article 3, no. 4).

Tax law is thus concerned with not allowing taxpayers to anticipate the depreciation of their assets for tax reasons in a matter in which accounting, as is common, gives the company a margin for evaluation as to the moment at which it considers that the asset is available for use. According to Accounting and Financial Reporting Standard no. 7 – Tangible Fixed Assets, "the depreciation of an asset begins when it is available for use, that is, when it is in the location and condition necessary for it to be capable of operating in the intended manner" (NCRF 7, 55). That is, tax law safeguards cases of possible abusive anticipation of depreciation by imposing the authorizing intervention of the ATA in cases where the taxpayer intends to anticipate the initial moment of amortization.

In the remaining cases, as is the one we are dealing with here, it is the commencement of operation or use that is determinant for the definition of the initial moment of amortization, and by reference to this, the allocation of subsidies in taxable profit.

The ATA based its conclusion that the assets were in operation at least from the beginning of 2013 – which is the determining point for being able to make the corrections we address in this section – on the fact that "B... S.A., rebilled to the Claimant, in this fiscal year, charges relating to staff and security expenses, "since in that fiscal year it was no longer its responsibility to manage the equipment subject to the work" and, also, because operating costs and quality certification expenses were borne by the Claimant in the same period." (thus summarized in article 24 of the Reply).

As results from the provision in article 74 of the LGT, "the burden of proof of the facts constituting the rights of the tax administration or of taxpayers falls on whoever invokes them", whereby it was on the Defendant that the duty to prove the fact subject to tax fell, that is, the verification of the prerequisites of the scope of the tax in question.

More specifically, in the case at hand, the burden falls on the Defendant to demonstrate that the assets were in operation "at least from January 2013.

It appears, however, that the ATA did not succeed in creating the conviction in the Tribunal that the assets, on that date, were indeed in operation.

Let us see.

(i) In the first place, the elements that the ATA indicates do not permit the conclusion of whether the asset was or was not in operation at least in January 2013. On the one hand, the fact that there are expenses relating to an asset does not mean that it is without any doubt in operation, falling within the freedom of contractual execution of the parties to decide whether it is the contractor or the owner of the work that bears specific costs. But in any case, these elements never permit the conclusion that the four projects would already be in operation in January 2013 (for example, security costs are pointed out, but an unfinished work has associated security costs; staff costs are mentioned, but these are a type of normal cost before a project is in full operation in the case of assets that are being constructed as is the case with the assets in question). That is, the ATA bases its evidentiary claim on merely circumstantial facts and which present no direct nexus that would allow us to conclude that the asset was already in operation in January 2013.

(ii) In the second place, the Claimant attaches reports from C... (docs 5.1 and 5.2 with its Request) that expressly refer to "completion dates" of the investments all of them after January 2013 and all coinciding with the accounting option of the taxpayer. This is documentary evidence, from a public body intimately linked to the projects in question through the subsidies granted, and which carried out inspective actions on the projects, documentary evidence this that, for all that has been said, cannot be disregarded; rather it must be valued, in conjunction with the remaining evidence, particularly since the ATA itself attempted to obtain evidence from this body that it ultimately chose not to attach.

(iii) In the third and final place, in accordance with the witness evidence produced at the hearing, specifically by witness E..., who personally accompanied the four projects in his capacity as an employee, from July 2013, of company H..., company responsible for the supervision and monitoring of the work, it cannot be concluded that any of the four projects was in operation in January 2013.

The witness was absolutely categorical as to projects BC..., VR... and BS... not being in operation in July 2013, the date on which he began service with company H... As for project PC..., which was the one that was most advanced when he began service, the witness stated that despite the constructions being completed on that date, in his view it could not be considered in operation, but only in a testing phase running in one or two of the rooms, with a series of problems being detected in those tests that needed resolution. Indeed, he said, these tests in project PC... also served to avoid errors in the other three projects that were in a more advanced stage of development.

Before the foregoing, in a situation of doubt, the decision should always be made in favor of the Claimant, that is, against the party on whom the burden of proof falls.

In sum, from the joint assessment of the probative elements brought by the Claimant and the Defendant to the Tribunal, it results that it was not proven, as the ATA intended, that the assets in question were in operation "at least from the beginning of 2013", whereby the additional assessment should not, on this point, stand, and the accounting previously made by the taxpayer should be considered correct.

III.2.2. As Regards the Issue of the Deduction of Financing Costs

The question here is whether certain financing costs incurred by the Claimant are or are not fiscally deductible. The ATA considers, in its RIT, subsequently repeated in its procedural documents that "it was further noted that the company frequently resorts to bank loans (Annex IV – Accounts 25), consequently bearing a high amount of financial charges. In this way, interest borne on loans, expenses with discounts of securities, stamp duty and other charges related to the level of indebtedness, in the fiscal year 2013, total the amount of €2,218,502.21 (Annex V – Accounts 68 and 69)" Founded the corrections arguing, "at the same time that it contracts these loans and bears the said charges, the company presents globally debtor balances in the accounts of Other Debtors and Creditors (Annex VI - Accounts 27), clients (Annex VII - Accounts 21) and shareholders (Annex VIII - Accounts 26), of group or related companies, in high amounts. Regarding these it also presents creditor balances in suppliers (Annex IX - accounts 22), although of much lower values." As it further sustains in its Reply, in summary, "the Claimant's financing needs were increased, as a consequence of the payment facilities granted to related entities, that is, of the financial support granted to them without any remuneration, in that, being deprived of the financial means owed by the related entities, it had to avail itself, to obtain liquidity, of resorting to loans".

The ATA argues that of the financing obtained by the Claimant, part of it was channeled directly, without any remuneration to group companies; and that another part was indirectly allocated to these other companies by the existence of unpaid commercial debts, which were thus also a cause of the need for the loans it bore. In both cases, I concluded, based on the interpretation it makes of article 23 of the CIRC, that financing charges are not deductible "because they are not qualified as indispensable for the realization of the Claimant's profits subject to tax or for maintenance of the Claimant as an income-producing source".

It is therefore necessary to ascertain whether the charges should or should not be considered indispensable.

Of the financial charges accounted for in 2013 (€2,218,502.21), the ATA did not consider deductible €957,779.82. However, the Claimant partially accepted this correction in the amount of €329,474.75 (the amount it considered to be related to direct financing), with the remaining amount of €628,303.87 therefore being in dispute. The Tribunal will therefore not directly enter into the issue of whether financing costs from unremunerative loans made to subsidiaries should or should not be considered deductible.

As posed by the Claimant, the remaining issue under review is therefore whether "it would be indispensable to maintain the same level of indebtedness, had receipts of debts of related entities not benefited from deferral". To answer this issue the Tribunal considers it fundamental to make some brief notes on the current state of doctrine and case law on the matter of deductibility of expenses.

As is known, the "cost is an expense with a business purpose, which does not mean an expense that has an immediate and directly profitable purpose; what is indispensable is that it has, in its origin, and in its origin and cause, the specific interest of the company". "It is not a question of knowing whether or not it corresponds to the most effective defense of the interests of the company: this is a question that cannot be resolved by granting a power of intervention to the State – neither in the guise of Administration, nor even in the guise of the judge - so that it can make a judgment of merit on a certain option of business management. Nor can it depend on validation by verification a posteriori of the actual generation of profit." (…) "From the point of view of the acceptance of loss as fiscally attendable cost, it is thus assumed that the requirement of the indispensability of costs for the formation of profits should be assessed by criteria of economic rationality in light of statutory objectives, and taking into account, therefore, the reasonableness and foundation of management decisions at the moment and in the circumstances in which they are made – and not, evidently, the adequacy of the decision to any duty of good, or prudent, or, even less, efficient administration of the company that may be subject to a judgment by a public authority." (J. L. Saldanha Sanches and João Taborda da Gama, Manual of Angolan Tax Law, Coimbra Editor, 2010, p. 330-331). This path had already been opened among us by authors such as António Moura Portugal (the indispensability "(…) must be assessed on the basis of a positive judgment of subsumption in corporate activity. This, in turn, should not be scrutinized by the Tax Administration or by the courts, because this is required by the freedom of economic initiative." António Moura Portugal, The Deductibility of Costs in Portuguese Tax Case Law, Coimbra: Editor, 2004, p. 279) and before that by Tomás Cantista Tavares ("The legal notion of indispensability among the positive and negative components of income, on the other hand, only demands a relationship of economic causality, in the sense of the fiscal admissibility of charges deemed indispensable by the management body, given that they contribute, even if indirectly or mediately, to the perception of profits or to the maintenance of the income-producing source. Now, this objective is met whenever - by the operation of the theory of the specialty of purpose of legal persons - corporate operations fall within its capacity, by subsumption in its respective statutory scope and, in particular, as long as they are connected to the obtaining of profit, even if in an indirect or mediate manner". (Tomás Cantista de Castro Tavares, "On the Relationship of Partial Dependence between Accounting and Tax Law in the Determination of the Taxable Income of Legal Persons: Some Reflections at the Level of Costs", Science and Tax Technique, Lisbon: Tax Science and Technique Notebooks, no. 396, October-December, 1999, p. 167).

Case law has also gathered a criterion of indispensability centered on corporate interest viewed as a direct or indirect profit objective, drawing the line in abusive, fraudulent or artificial situations, always depending on the concrete evidence elements of each case.

As recently stated in Case 313/2017-T of CAAD, which we follow:

"Indeed, as regards the criterion of indispensability, we agree with the broad interpretation of article 23 of the IRC Code, defended by the Claimant and which has been adopted by the case law of CAAD and judicial courts. We follow, therefore, the understanding expressed, for example, in the Court of Appeal decision of 24-09-2014, issued in the context of case no. 0779/12, in which it was held that:

"In the understanding that doctrine and case law have been adopting for the purpose of ascertaining the indispensability of a cost (cfr. art. 23 of the CIRC in the wording in force in 2001), the ATA cannot scrutinize the quality and opportunity of the company's management economic decisions, under penalty of interfering with the freedom and autonomy of the company's management.

II - Thus, a cost will be accepted fiscally if, in a judgment made with reference to the moment when it was effected, it is appropriate to the company's productive structure and to the obtaining of profits, even if it turns out to be an unfruitful or economically ruinous economic operation, and the ATA can only disregard as fiscal costs those that do not fall within the scope of the taxpayer's activity and were incurred, not in the interest of the latter, but for the pursuit of extraneous objectives (when it is to be concluded, in light of the rules of common experience that it had no potential to generate profits)." An absolute causal nexus is not required between the costs incurred and the development of the activity of the taxpayer understood as the pursuit of his corporate purpose. It is sufficient that the cost be appropriate to the company's productive structure and to the obtaining of profits and that it is not intended for the pursuit of extraneous objectives (that is, of the shareholders or of third parties). With regard, in particular, to costs resulting from the obtaining of loans (interest) by a company that aims at the granting of loans to invested companies, members of the same tax group (subject to RETGS), see the arbitral tribunal decision issued in case no. 587/2014-T, in which it was held that:

"Thus, in the issue discussed in this point, the deductibility of interest borne by the investor will depend on the fact that such financing contributed to, according to normal management rules, increase the expectation of future benefits or maintain the income-producing source (financial asset) of ALFA (which grants the advances to the invested company). This means that the charges resulting from the financing obtained by ALFA and which was subsequently applied to the financing of BETA must satisfy one (or both) of the following conditions:

a) Be associated with the expectation of increased benefits to the investor;

b) Allow the maintenance of the income-producing source of the income (that is, contribute to the continuity of the activity of the invested companies and the consequent continued recognition of the financial asset in the investor's sphere)."

Let us further emphasize that acceptance should be global and not only partial because there is a need to separate cash flows from economic flows"

Indeed, as to free advances made by a company that is not an SGPS to invested entities, the Court of Appeal recently held that "in the case at hand the financial charges borne by the appellant cannot, however, be considered indispensable expenses for the purpose of their deductibility under article 23 of the CIRC. For the simple reason that such charges are incurred and borne by force of the free advances granted to the companies associated with it and dominated by it and in the interest of the same. Which, being autonomous taxpayers, do not cease for tax purposes to be third parties in relation to the appellant and being like it equally taxpayers subject to IRC" (Court of Appeal Decision in Case 325/16, of 19-04-2017).

In both decisions there is a more complex problem than the one we have to solve here, in that there had been direct financing to the invested company - which, as we saw, in the case at hand, the Claimant ultimately understood should not have the tax effects initially sought (that is, ultimately considered as non-deductible the financing costs associated with the amounts that were considered as having been directly delivered to other group companies).

Thus, what remains for us to judge, in this case, is related to amounts that the ATA considers should have identical treatment, but which result not from amounts directly contributed to group companies, but from there being commercial debts of Group entities. As the ATA itself clarifies in its Reply, "when the tax inspection refers to financing generating financial charges being "channeled" to the granting of credits or deferrals to related entities, it is important to retain the useful sense of the statement, clarified, moreover, in point B.2.2 of the RIT regarding the causal nexus between financing costs and the balances of the accounts of operations with related entities, and which is, in reality, the following:" part of those charges results indeed from those transfers, but another part results from the lack thereof, that is, from the lack of receipt of operations with group entities" (emphasis ours). (…) It is that, although the balances of the Clients and Suppliers accounts may not properly have any associated use of credit, the ATA understands that the deferrals granted are only possible because "it obtains liquidity resulting from loans that are not used for the purposes they are intended for but, on the contrary, to provide liquidity to group companies, without passing on to them the financing charges.""

Unlike the Defendant, it is understood that the business activity that gave rise to those debts is included, without any doubt, in the normal activity of the company, a criterion that should be used to assess the indispensability of the expense. The corporate purpose of the Claimant company is the "production and commercialization of fresh and canned mushrooms" and the customer debts in question here result from the practice of that same corporate purpose and its specificities.

On the other hand, the method used by the ATA to find the amount of non-deductible financing costs, through the balances of the accounts with related entities as counterpart (which the ATA itself in the case admits that "may not properly have any associated use of credit") is a method that abstracts in a manner that is not legally admissible from the fact that we are dealing with payment delays in normal commercial relations within the object and activity of the company. By seeking to apply to the payment delays of clients a decision matrix developed regarding non-remunerated transfers of money to subsidiaries by companies that are not SGPS based on the analysis of accounting balances, the ATA takes it too far, and to a plane of profound abstraction the application of the criterion of indispensability of expenses as concretized by the best higher case law.

If it is true that the Court of Appeal has already decided that in a given case a company that is not an SGPS cannot deduct the financing costs with free advances and supplementary benefits that it makes to associated companies, in that same decision the criterion of activity and corporate purpose was reiterated as the key to assessing the indispensability of expenses ("the ATA can only disregard as fiscal costs those that do not fall within the scope of the taxpayer's activity and were incurred, not in the interest of the latter, but for the pursuit of extraneous objectives (when it is to be concluded, in light of the rules of common experience that it had no potential to generate profits). Being that the potential for profit realization in our understanding should only be restricted to profits resulting from the exercise of the company's activity, in the pursuit of its corporate purpose" - Court of Appeal Decision in Case 325/16, of 19-04-2017, with references to the Court of Appeal Decision in Case 779/12, of 24-09-2014).

But as the Court of Appeal stated "the control to be carried out by the ATA on the verification of this requirement of indispensability must be by the negative, that is, the ATA should only disregard as fiscal costs those that clearly have no potential to generate an increase in gains, with the competent administrative agent not being able to 'set himself up as a manager and qualify the indispensability at the level of good and bad management, according to his feeling or personal sense; it is sufficient that it be an operation carried out as a management act, without entering into the appreciation of its effects, positive or negative, of the expense or charge assumed for the results of the realization of profits or for the maintenance of the income-producing source» (VÍTOR FAVEIRO, Fundamental Notions of Portuguese Tax Law, volume II, page 601.). (…) That is, the ATA cannot interfere with the freedom and autonomy of the company's management, scrutinizing the quality and opportunity of the company's management economic decisions. A cost will be accepted fiscally if it is appropriate to the company's productive structure and to the obtaining of profits, even if it turns out to be an economically unfruitful or even ruinous operation. Which means that, pursuant to the cited article 23 of the CIRC, all expenses that are assumed in accordance with a business purpose will be considered fiscal costs, that is, in the interest of the company and with a view to the pursuit of its corporate purpose" (Court of Appeal Decision in Case 779/12, of 24-09-2014)

Indeed, the correct remark made by the Court of Appeal to the ATA in the aforementioned case also applies in our case: "if the ATA has any reason to suspect that the real values at which the said transactions were entered into are not those stated in the deeds or that any of them was carried out with the intention of illegitimately manipulating the taxable matter, it should have chosen another path than that of the partial disregard of the cost on the ground of failure to verify the required indispensability" (Court of Appeal Decision in Case 779/12, of 24-09-2014).

In fact, commercial relations and debts that may arise from them when between related entities should respect market conditions and the ATA always has the power to effect corrections based on the transfer pricing regime, with the specificities and safeguards provided therein, and attempt, through that procedure, to demonstrate that there is an increase in costs in an entity caused by the fact that it has not practiced market conditions with an associated company (article 63 of the IRC Code and Ordinance no. 1446-C/2001, of 21 December). What it cannot do is replace the application of this transfer pricing regime with the blind application of article 23, considering the expense as non-deductible based on a chain of reasoning that is too abstract, conjectural and indirect.

Thus, and in conclusion, the ATA failed to demonstrate the connection between the financing obtained and the commercial operations that generated debtor balances, which it would have had to do to, in a second moment, demonstrate that those operations and their regime do not fall within a concept of normal activity of a company that is precisely dedicated to those commercial operations (production and sale of mushrooms), which it also failed