CAAD Case 292/2018-T: VAT Deduction on Sponsorship Expenses - Arbitral Decision on IVA Corrections

ARBITRAL DECISION[1]

The Arbitrator, Dr. Sílvia Oliveira, designated by the Ethics Council of the Administrative Arbitration Centre (CAAD) to form the Arbitral Tribunal, constituted on 28 August 2018 with respect to the process identified above, decided as follows:

REPORT

A..., Lda. (hereinafter referred to as the "Claimant"), legal entity no. ..., with registered office at ..., ..., no. ..., ..., in ..., submitted a request for arbitral pronouncement and constitution of a Single Arbitral Tribunal on 18 June 2018, pursuant to the provisions of article 4 and no. 2 of article 10 of Decree-Law no. 10/2011 of 20 January [Legal Regime for Arbitration in Tax Matters (RJAT)], against the Tax and Customs Authority (hereinafter referred to as the "Respondent").

The Claimant seeks that the Arbitral Tribunal declare the illegality of corrections effected in VAT and respective tax assessments, identified as follows:

"Assessment no. ..., of 16/03/2018, relating to the last quarter of 2015, which imposed a correction in the amount of €2,680.38 (…);

Assessment no. ..., of 16/03/2018, relating to the first quarter of 2017, which imposed a correction in the amount of €3,923.71 (…);

Assessment no. ..., of 16/03/2018, relating to the second quarter of 2017, which imposed a correction in the amount of €546.79 (…);

Assessment no. ..., of 17/03/2018, relating to the third quarter of 2017, which imposed a correction in the amount of €288.91 (…) and respective compensation of 20-03-2018".

1.3. The request for constitution of the Arbitral Tribunal was accepted by the President of CAAD on 19 June 2018 and notified to the Respondent on the same date.

1.4. Given that the Claimant did not proceed to nominate an arbitrator, pursuant to article 6, no. 2, subparagraph a) of the RJAT, the undersigned was designated as arbitrator on 6 August 2018 by the President of the Ethics Council of CAAD, with the nomination being accepted within the timeframe and terms legally foreseen.

1.5. On the same date, the Parties were duly notified of this designation and did not manifest any intention to challenge it, in accordance with the combined terms of article 11, no. 1, subparagraphs a) and b) of the RJAT and articles 6 and 7 of the Ethical Code.

1.6. Thus, in accordance with the provision in subparagraph c) of no. 1 of article 11 of the RJAT, the Arbitral Tribunal was constituted on 28 August 2018, with an arbitral order being issued on the same date, to notify the Respondent to, in accordance with the provisions of article 17, no. 1 of the RJAT, submit a Reply within a maximum period of 30 days and, should it wish, request the production of additional evidence.

1.7. Additionally, it was also stated in that arbitral order that the Respondent should remit to the Arbitral Tribunal, within the timeframe for the Reply, a copy of the administrative file.

On 1 October 2018, the Respondent submitted its Reply (notified on 2 October 2018), defending itself by way of challenge, concluding that "(…) the present request for arbitral pronouncement should be judged unmeritorious, as unproven, the tax assessment acts challenged being maintained in the legal order and the requested entity being accordingly absolved of the claim".

In the Reply presented, the Respondent undertook to attach the respective administrative file.

By arbitral order of 8 October 2018, this Arbitral Tribunal decided, in accordance with the principles of the autonomy of the Arbitral Tribunal in conducting the process, of expedition, of simplification and procedural informality (articles 19, no. 2, and 29, no. 2, of the RJAT), as well as taking into account the principle of limitation of unnecessary acts provided for in article 130 of the Code of Civil Procedure (CPC), applicable by virtue of the provisions of article 29, no. 1, subparagraph e) of the RJAT (…):

To dispense with the holding of the meeting referred to in article 18 of the RJAT;

To forgo the examination of the testimonial evidence presented by the Claimant;

To determine that the process proceed with optional written submissions, to be presented within the simultaneous period of 10 days, counting from notification of the said order;

To designate 9 November 2018 as the date for purposes of delivering the arbitral decision.

In the same order, the Claimant was further warned that "up to the date of delivery of the arbitral decision it should proceed to pay the subsequent arbitral fee, in accordance with the provisions of no. 3 of article 4 of the Regulation of Costs in Tax Arbitration Processes and communicate that payment to CAAD", which it carried out on 19 October 2018.

The Claimant submitted submissions on 19 October 2018, concluding in the same sense as the arbitral request.

Additionally, and with respect to the content of article 11 of the Reply presented by the Respondent, the Claimant came to argue that it states "(…) something entirely new up to now (…)", inasmuch as the Respondent therein insinuates that "no link is established between the Claimant and Mr. B..." but "(…) from the Tax Inspection Report it follows that the TA understood well the invocation by the Claimant of the existence of a sponsorship contract between the Claimant and the son of the managing partner thereof (…)", the Claimant coming to attach to the proceedings, for purposes of clarifying this doubt, a copy of the said contract.

By arbitral order of 24 October 2018, the Respondent was notified to (a) attach the Administrative File and to (b) if it so wished, pronounce itself within the period of 5 days, in accordance with the principle of due process, on the document attached to the proceedings by the Claimant with its submissions.

The Respondent submitted submissions on 2 November 2018, referring to the content of its Reply, arguing that this "(…) should be considered as proven and, consequently, the Respondent absolved of the claim".

The Respondent, although notified to do so, did not pronounce itself on the document attached to the proceedings by the Claimant with its submissions, nor did it attach the Administrative File.

By arbitral order of 8 November 2018, the Arbitral Tribunal pronounced itself regarding the admission of the document attached by the Claimant with its submissions, admitting its attachment to the proceedings, in accordance with the provisions of article 423, no. 3 of the CPC.

CAUSE OF ACTION

2.1. The Claimant begins by clarifying that it was the subject of a tax procedure which "(…) commenced with a request for VAT refund (…) in the amount of 26,317.42 €, which led to the corrections effected (…) of which (…) the correction of €7,439.78 is contested".

2.2. In fact, according to the Claimant, "following the refund request submitted (…), the Finance Directorate of Porto of the Tax Inspection Services (…), through Office 2018..., notified the Claimant of the draft corrections of the inspection report, as well as to exercise its right of PRIOR HEARING (…)", having the Claimant exercised this right.

From the Object of the Request for Arbitral Pronouncement – On Sponsorship Expenses

2.3. The Claimant states that from the "(…) two points of the inspection report (…)", "(…) in the present Request for Arbitral Pronouncement (…)" the Claimant "(…) contests only the second (…)".

2.4. In this matter, the Claimant understands that "the TA considered that the Claimant would not be entitled to deduct €7,439.78 of VAT incurred with sponsorship expenses", a position with which the Claimant does not agree.

2.5. For purposes of explaining the factual situation, it is important for the Claimant to "(…) distinguish 2 moments:

2.5.1. A moment relating to the "initial phase" in which it states that "the company was established in mid-2015 and incurred in the said expenses with the objective of publicizing/making the company known in an initial phase of its activity" and "thus, it took advantage of this medium where it enjoys some notoriety due to the good sports results of the pilot B..., who is the son of the managing partner of the requesting company".

2.5.2. A second moment relating to the "current phase" given that "since the beginning of 2017 the company has increased the activities that constitute its corporate purpose and has come to include: "Production and promotion of sports events, athletes and independent sportspeople; marketing and advertising agency, design and production of advertising material and campaigns; printing and purchase and sale of advertising material", as set out in its commercial registry certificate".

2.6. Thus, according to the Claimant, "within the scope of this new activity the company intends to obtain income from advertising made to its clients through the pilot B..., having, as consideration for such income, to incur expenses inherent to participation in championships of the sport", "that is, instead of contracting for the placement of advertising (…) on billboards, the company proposes to place such advertising on the pilot's clothing and on the kart", clarifying that "this activity is recent and the venture into these expenses is not yet generating the expected income (…).

2.7. However, the Claimant reiterates, "(…) due to the business contacts that have occurred and also due to the good sports results of the pilot, his media exposure is increasing (…)" originating, according to the Claimant, "(…) the growing interest of sponsors in contracting advertising services from the Claimant", whereby this "(…) has been progressively reaping the fruits in terms of billing, having managed to invoice more advertising services (…)", and "(…) expects that this advertising investment will present significant growth (…)", arguing that "(…) this business investment of the company [is] perfectly framed within its corporate purpose".

2.8. Thus, the Claimant understands that "(…) it is not acceptable to consider the expenses listed in the Final Report of the TA – because necessary to the activity that the company is developing – as mere liberalities" inasmuch as "the objective of incurring these expenses was always commercial and to obtain future economic benefits for the company, and not merely to associate the company with the sport through donations/patronage to a kart pilot" (emphasis added).

2.9. The Claimant reiterates that being the "request for VAT refund (…) relating to the 3rd quarter of 2017 (…) is not yet totally representative of the activity that the company is developing (…)", but "(…) these tax questions cannot constitute an obstacle to the commercial activity to which the company legitimately dedicates itself (…)".

2.10. However, taking into account that "for deduction to be possible, the expense must be deductible (…)" and that "only operations (not exempt or benefiting from complete exemption) provided for in (…) the VAT Code confer the right to deduction, and the goods and services in question must be directly related to the passive subject's activity" (the Claimant concluding that "such is the case" [2]), the Claimant understands that "it is demonstrated that the incurrence of these expenses had as its purpose business/professional ends of the goods/services acquired inasmuch as directly related to the passive subject's activity and not excluded from the right to deduction".

2.11. Accordingly, the Claimant reiterates that "the VAT on the expenses in question was correctly deducted" and understands that "the request for arbitral pronouncement should proceed regarding the declaration of illegality of the corrections effected in VAT and respective assessments described (…)", "(…) with all legal consequences".[3]

REPLY OF THE RESPONDENT

3.1. The Respondent in the Reply presented referred to the factuality described in the Tax Inspection Report (TIR), arising from the identified Service Orders, defending itself by way of challenge.

3.2. In this context, the Respondent cites and transcribes parts of the TIR, according to which it is stated that "from the analysis of the elements submitted by the taxpayer, there was found to exist various documents relating to expenses with karting races, such as promotional event, competition assistance, track rental, vehicle expenses (…), whose VAT amounts were considered as deductible in the accounts and respective periodic declarations", and that the inspection services understood that "(…) the taxpayer is sponsoring the sportsman B..., son of the managing partner, C..., assuming the expenses with the competition vehicle, race registration, etc., with the only consideration that the passive subject appears in the specialized news as a sponsor (among others) of the said pilot" (emphasis added).

3.3. However, according to the said TIR, "these liberalities fall within the concept of sponsorship, in accordance with the instructions conveyed through Circulars no. 12/2002 of 19 April of the Directorate of Services for Income Tax and Directorate of Services for VAT and no. 2/2004 of 20 January of the Directorate of Services for Income Tax (…)", concluding that "to gratuitous transfers of goods, article 3, no. 3, subparagraph f) of the VAT Code shall apply, which determines that a gratuitous transfer of goods of the company is considered a transfer of goods when total or partial deduction of tax has occurred in relation to them. The taxable value of the transfer is determined in accordance with subparagraph b) of no. 2 of article 16 of the VAT Code, and corresponds to the acquisition price of the goods or, in its absence, to their respective cost price, reported to the moment of realization of the operations. It is also worth noting that for the assessment of VAT on operations carried out gratuitously, no. 3 of article 37 of the VAT Code establishes that the passing on of tax is not mandatory, the passive subjects who carry out such operations being able to bear themselves the amount of tax due and proceed with its payment to the State coffers, without obligation to make the respective charge to the acquirers of the goods or recipients of the services" (emphasis added).

3.4. The Respondent continues by stating that the Tax Inspection Services (TIS) "having gathered the documents sent by the taxpayer relating to sponsorship expenses and evidencing the VAT amount deducted in them (…)" drew up a summary table according to which they concluded that "(…) the passive subject should have proceeded to the assessment of VAT in the total amount of 7,439.78€, in the corresponding tax periods:" (emphasis added)

3.5. The Respondent states that "the expenses whose right to tax deduction, relating (in general) to the participation of Mr. B... in Karting competitions, have as recipient of the services the Claimant" and "no link is established between the Claimant and Mr. B..., either through the latter being his employee or administrator, or even that they have concluded any contract whatsoever", concluding that "(…) it is not found anywhere, either in the procedure or in the proceedings, proven, nor even alleged, that the Claimant is the holder/promoter of any karting racing team of which Mr. B... is its pilot (contracted/invited, etc.)" (emphasis added).

3.6. Thus, the Respondent reiterates that "in the period under analysis, the Claimant bore the costs (…) of whose services and goods, Mr. B... must be considered the beneficiary, since he was the one who raced, and (…) it is not found anywhere alleged (and much less proven) that he did so on behalf and for the benefit of the Claimant herein".

3.7. On the other hand, the Respondent argues that "(…) it is not alleged nor proven that Mr. B... ever transferred his image rights, namely the sums he receives as sponsorship from other persons, to the Claimant herein", concluding that "(…) by absence of any better description and in the absence of executed contracts to which [the documents attached by the Claimant] refer [they] do not permit the conclusions that [the Claimant] draws from them, that is, that it began to sell advertising/image rights on Mr. B...'s kart in the races which the latter performs".

3.8. The Respondent continues by adopting the position presented in the TIR, adding that "(…) if we did not consider that the expenses effected bear the character of sponsorship, and given that the company did not exercise the economic activity for which it is registered (…) the passive subject would not have the right to deduct the tax incurred in the acquisitions, whereby still such a correction would be made in the same amount, but in the aspect of deducted VAT", "that is, the correction effected was with regard to VAT whose assessment was lacking" (emphasis added).

3.9. The Respondent concludes thus that the Claimant "(…) neither alleges and as such much less manages to prove (…) to have ever begun to operate a karting team and/or to have become the holder of the image rights of pilot B...", without which "(…) it would become impossible (…) to make the operation of such rights, deducting the tax incurred and assessing the tax due".

3.10. And, "(…) proceeding with what is petitioned by the Claimant, the result would be the deduction of improperly deducted tax", the Respondent arguing that "(…) the right to deduction by the Claimant determines that the latter must prove its assumptions (…), which it did not do", reiterating that "allowing the Claimant the deduction of tax without the due proofs supporting such a right would place it in a position of advantage relative to the other operators", "thus confirming the accuracy of the framing made by the inspection services", stating that "only in this way is the neutrality of the tax (…) guaranteed" and concluding for the unmeritoriousness of "(…) all the defects attributed to the administrative action".

PROCEDURAL MATTERS

4.1. The request for arbitral pronouncement is timely, because submitted within the timeframe provided in subparagraph a) of no. 1 of article 10 of the RJAT.

The parties have personality and legal capacity, are legitimate as to the request for arbitral pronouncement and are duly represented, in accordance with the provisions of articles 4 and 10 of the RJAT and article 1 of Ordinance no. 112-A/2011 of 22 March.

The Tribunal is regularly constituted, in accordance with article 2, no. 1, subparagraph a), articles 5 and 6, all of the RJAT and is competent to hear the request for arbitral pronouncement formulated by the Claimant.

4.4. No nullities in the process were identified, there are no exceptions or preliminary questions to be decided, whereby nothing prevents knowledge of the merits of the case.

MATTER OF FACT

Of facts proven

The Claimant is a limited liability company whose corporate purpose is, since 2017, the "production and promotion of sports events, athletes and independent sportspeople; marketing and advertising agency, design and production of advertising material and campaigns; printing and purchase and sale of advertising material".

The Claimant entered into, on 2 November 2015, a "Sponsorship Advertising Contract" with karting pilot B..., in force since that date, for a period of ten years, renewable for equal periods, according to which it is stated that the Claimant "B - (…) intends to sponsor and as such associate itself with the pilot (…) and, by implication, with the sports competitions and karting training carried out by him, so as to benefit from the notoriety and exposure thereby resulting; C – Sponsorship consists of an exchange of considerations between entities, aimed, on the part of the sponsored entity, at an increase in visibility with the public and, on the part of the sponsor, an opportunity to bear the costs of their sports activity; D – In accordance with the definition of sponsorship, the considerations offered by the sponsor may be financial, of services or products; (…)"

In this contract it is further stated, in Clause 1, that the Claimant "1. (…) intends to advertise the commercial firm and promote its image and that of its clients, the First Party [pilot B...] accepting to carry out such promotion and advertising, in accordance with the present Contract" and, in accordance with no. 2 of that Clause, it is stated that "2. The sponsorship advertising, (…) has as consideration the obligation of the First Contracting Party [pilot B...] to advertise the image and commercial firm of the Second Contracting Party [Claimant] and its clients in a manner associated with the image and sports activities developed by the First Contracting Party [pilot B...]".

In accordance with the provisions of Clause 4 of the said contract, "as consideration for the advertising provided by the First Contracting Party [pilot B...], the sports goods acquired by the Second Contracting Party [Claimant] by indication of the First shall be allocated to the latter".

The Claimant incurred, between November 2015 and September 2019 (months relating to the VAT periods subject to the corrections under analysis - 201512Q, 201703Q, 201706Q and 201709Q), expenses with karting races, namely promotional event, competition assistance, track rental, vehicle expenses (tires, oil, chassis, etc.), in accordance with the table presented in the TIR, which is here considered as wholly reproduced, having deducted the VAT incurred with such expenses, in the total amount of EUR 7,439.78.

The Claimant, in the VAT periods referred to in the previous point (that is, 201512Q, 201703Q, 201706Q and 201709Q) did not issue any invoice for provision of advertising services to its clients, only beginning to issue such invoices in December 2017 for provisions of services of that nature.

The Claimant was subject to an inspection action carried out within the scope of internal Service Orders no. OI2017... (issued on 20/11/2017) and nos. OI2018... and OI2018... (issued on 30/01/2018).

The issuance of the Service Orders identified in the previous point had as its objective the analysis of the request for VAT refund requested by the Claimant in the tax period 201709Q, in the total amount of EUR 26,317.42, as well as the collection of the corrections to be effected in the respective tax periods.

The inspection action carried out was of partial scope, in the matter of VAT, and focused on the tax periods 201506Q, 201512Q, 201703Q, 201706Q and 201709Q.

From the inspection action carried out resulted corrections to the tax credit in the total amount of EUR 10,965.57, relating to the following periods (amounts expressed in Euros):

With regard to the corrections that gave rise to the request for arbitral pronouncement (properly speaking), in a total of EUR 7,439.78, and relating to the periods 201512Q, 201703Q, 201706Q and 201709Q, the TIS presented in the draft TIR the following arguments and conclusions:

"III.3. Lack of tax assessment
III.3.1. Invoices with Sponsorship Expenses"

From the analysis of the elements submitted by the taxpayer, there was found to exist various documents relating to expenses with karting races, such as promotional event, competition assistance, track rental, vehicle expenses (tires, oil, chassis, etc.), among others, whose VAT amounts were considered as deductible in the accounts and respective periodic declarations.

It was thus noted that the taxpayer is sponsoring the sportsman B..., son of the managing partner, C..., assuming the expenses with the competition vehicle, race registration, etc., with the only consideration that the passive subject appears in the specialized news as a sponsor (among others) of the said pilot.

These liberalities fall within the concept of sponsorship (…). Thus, to gratuitous transfers of goods, article 3, no. 3, subparagraph f) of the VAT Code shall apply, which determines that a gratuitous transfer of goods of the company is considered a transfer of goods when total or partial deduction of tax has occurred in relation to them. The taxable value of the transfer is determined in accordance with subparagraph b) of no. 2 of article 16 of the VAT Code, and corresponds to the acquisition price of the goods or, in its absence, to their respective cost price, reported to the moment of realization of the operations.

It is also worth noting that for the assessment of VAT on operations carried out gratuitously, no. 3 of article 37 of the VAT Code establishes that the passing on of tax is not mandatory, the passive subjects who carry out such operations being able to bear themselves the amount of tax due and proceed with its payment to the State coffers, without obligation to make the respective charge to the acquirers of the goods or recipients of the services.

In this way, the passive subject should have proceeded to the assessment of VAT in the total amount of 7,439.78€, in the corresponding tax periods:

III.4. Conclusion

In light of the above, it is concluded that the passive subject (…) should have proceeded to the assessment of tax in the amount of 7,439.78€, whereby the tax credit shall be corrected and the refund request partially rejected.

Thus, the passive subject shall be notified to (…) proceed to voluntary correction (…). If upon expiration of that period the situation is not duly regularized, the respective correction documents shall be issued for purposes of VAT (…)".

By Office no. 2018... of 31/01/2018 the Claimant was notified of the said Draft Inspection Report, as well as to exercise the right of prior hearing relating to it.

The Claimant exercised its hearing right by email of 19/02/2018, disagreeing with the content of the proposed correction stated above in point 5.11., having presented identical argument to that subsequently presented in this request for arbitral pronouncement, to the effect that "the objective of incurring these expenses was always commercial and to obtain future economic benefits for the company, and not merely to associate the company with the sport through donations/patronage to a kart pilot", concluding that "(…) the VAT on the expenses in question was correctly deducted".

By Office no. 2018... of 01/03/2018 the Claimant was notified of the Final Inspection Report, in accordance with which the corrections proposed in the Draft Report were confirmed inasmuch as the TIS understood that, as to the matter in question, "having analyzed the submissions of the taxpayer (…) ii) Although what is alleged by the passive subject that the expenses incurred with karting races were carried out within the scope of the activity exercised by the company, the taxpayer objectively did not exercise that activity, inasmuch as it did not carry out active operations, having presented no sales values and/or services provided, having only limited itself to acquiring the goods and services for the sports practice of B..., son of the managing partner of the company.

It should further be noted that the pilot is sponsored by several other entities (…), as disclosed by the press and can still be ascertained from the logos displayed on the vehicle. However the passive subject did not issue any invoice to these companies for advertising services.

(…)

Thus, the lack of exercise of that economic activity leads to the impossibility of tax deduction (…).

(…)

In this way, if we did not consider that the expenses effected bear the character of sponsorship, and given that the company did not exercise the economic activity for which it is registered (…) the passive subject would not have the right to deduct the tax incurred in the acquisitions, whereby still such a correction would be made in the same amount, but in the aspect of deducted VAT.

In light of the above, it is concluded that the taxpayer has brought no information nor documents proving the alleged, which would permit calling into question the legitimacy and amount of the proposed correction".

In consequence, the following VAT Correction Documents were issued for the years 2015 and 2017, which served as support for the change to the tax credit (amounts in Euros):

No other facts were proved capable of affecting the decision on the merits of the request.

Reasoning as to the matter of fact

5.17. With respect to the proven matter of fact, the conviction of the Arbitral Tribunal was based, beyond the free assessment of the positions assumed by the Parties (in matters of fact), on the content of the documents attached to the proceedings and on the facts not contested.

Of facts not proven

No other facts were verified as not proven with relevance to the arbitral decision.

1. GROUNDS OF LAW

6.1. With the matter of fact being established as proven, the Arbitral Tribunal understands that in the proceedings the essential question to be decided concerns the need to determine whether the corrections in VAT that gave rise to the tax assessments subject to the request for arbitral pronouncement, effected in March 2018 and relating to the tax periods 201512Q, 201703Q, 201706Q and 201709Q, are or are not affected by illegality and, in consequence, to determine whether the same should be annulled.

6.2. Thus, for purposes of the above, it will be necessary to preliminarily state the position of each of the Parties and analyze them in order to ascertain which of them is right.

6.3. As is known, the Claimant was subject to an inspection action in VAT matters, which had as its objective the analysis of the request for VAT refund relating to the tax period 201709Q, in the total amount of EUR 10,965.57 (of which EUR 7,439.78 are subject to this request for arbitral pronouncement), as well as the collection of the corrections to be effected in the respective tax periods.

6.4. The said inspection action, insofar as this process is concerned, focused on the periods 201512Q, 201703Q, 201706Q and 201709Q and therefrom resulted corrections to the tax credit in VAT matters relating to those periods [201512Q (EUR 2,680.39), 201703Q (EUR 3,923.71), 201706Q (EUR 546.79) and 201509Q (EUR 288.91)], in accordance with points 5.9 to 5.11., above.

6.5. Within the scope of the said inspection, the TIS verified "(…) the existence of various (…) expenses with karting races (…) whose VAT amounts were considered as deductible in the accounts and respective periodic declarations" and, from the analysis of the documentation submitted by the Claimant, understood that it "(…) is sponsoring the sportsman (…) son of the managing partner (…), assuming the expenses with the competition vehicle (…) with the consideration that the passive subject appears in the specialized news as a sponsor (among others) of the said pilot" (emphasis added).

6.6. Still in accordance with what was presented in the draft TIR, "these liberalities fall within the concept of sponsorship (…)" and, in consequence, the TIS came to conclude in the TIR that the Claimant should "(…) have proceeded to the assessment of VAT in the total amount of 7,439.78€, in the corresponding tax periods (…)", thus determining that there be "(…) corrected the tax credit and the refund request partially rejected" (emphasis added).

6.7. In the Final Report, the TIS came to state that "having analyzed the submissions of the taxpayer (…)" produced under the right of hearing, the exercise of the right to deduction is limited to the tax "(…) incurred for the realization of transfer of goods and provision of services subject to tax and not exempt from it (…)", it being the case that "the lack of exercise of that economic activity (…)" by the Claimant "(…) leads to the impossibility of tax deduction (…)", concluding that "if we did not consider that the expenses effected bear the character of sponsorship, and given that the company did not exercise the economic activity for which it is registered (…) the passive subject would not have the right to deduct the tax incurred in the acquisitions (…)" (emphasis added).

6.8. The Claimant, in the arbitral request presented, petitions the declaration of the illegality of the corrections effected in VAT and the respective tax assessments, alleging that "the TA considered that the Claimant would not be entitled to deduct €7,439.78 of VAT incurred with sponsorship expenses" a position with which it disagrees inasmuch as it understands that "(…) it is not acceptable to consider the expenses listed in the Final Report of the TA (…) as mere liberalities" inasmuch as "the objective of incurring these expenses was always commercial and to obtain future economic benefits for the company, and not merely to associate the company with the sport through donations/patronage to a kart pilot" (emphasis added).

6.9. In these terms, the Claimant develops its argumentation around considerations relating to the right to deduction, stating that "(…) only operations (…) provided for in article 20 of the VAT Code confer the right to deduction, and the goods and services in question must be directly related to the passive subject's activity", which in its view "is the case", concluding that "(…) the VAT on the expenses in question was correctly deducted" (emphasis added).

6.10. In the Reply, the Respondent comes to argue that "the expenses (…) relating (…) to the participation of Mr. B... in Karting competitions have as recipient of the services the Claimant" and "no link is established between the Claimant and Mr. B..., either through the latter being his employee or administrator, or even that they have concluded any contract whatsoever".

6.11. Thus, the Respondent reiterates that "(…) the Claimant bore the costs (…) of whose services and goods, Mr. B... must be considered the beneficiary (…)" and "(…) it is not found alleged nor proven that Mr. B... ever transferred his image rights (…)" to the Claimant, the Respondent concluding that "(…) by absence of (…) better description and in the absence of executed contracts to which [the documents attached by the Claimant] refer [they] do not permit the conclusions that [the Claimant] draws from them, that is, that it began to sell advertising/image rights on Mr. B...'s kart in the races which the latter performs" (emphasis added).

6.12. For the rest, the Respondent in its Reply reiterates the position presented in the Final Report of the TIS, concluding to the effect that the "(…) correction effected (…)" is correct inasmuch as it concerns "(…) VAT whose assessment was lacking" (bold and emphasis added).

6.13. As can be seen, the Claimant focuses on the legitimacy of the deduction of VAT associated with the expenses incurred and the Respondent (characterizing such expenses as sponsorship expenses and, therefore, as liberalities to which the VAT regime for gratuitous transfers should be applied) argues that the Claimant should have assessed VAT, this being the actual foundation for the corrections effected.

6.14. Preliminarily, it is to be stated that with respect to the right to deduction (which is not in question in the said assessments), the same is a central element in VAT, its exercise being dependent on the cumulative verification of objective requirements (related to the type of expense), subjective requirements (relating to the passive subject), formal requirements and temporal requirements, the same being regulated in the VAT Code (approved by Decree-Law no. 394-B/84 of 26 December, through which the transposition of the Sixth Directive of the Council into internal law was effected).[4] [5]

6.15. On the other hand, and in accordance with the rules of European Union Law, there is required a causal nexus between the good or service acquired (input) and the taxable output, in order for VAT to be susceptible of being deductible (emphasis added), that is, the VAT borne upstream in a given operation is only deductible to the extent that it may be related downstream with an operation effectively taxed, the relationship to be ascertained on the basis of the reporting and inclusion of the cost borne in the price of the taxable operation.

6.16. Thus, in accordance with the case law of the Court of Justice of the European Union, whenever a passive subject exercises economic activities intended to carry out exclusively taxable operations, it is not necessary, in order to be able to deduct in full the tax, to establish, as to each upstream operation, the existence of a direct and immediate relationship with the specific taxable operation, inasmuch as what the legislator merely requires is that the goods and services be used or susceptible to being used "for the purposes of the taxable operations themselves", there not being necessary the existence of a relationship with a specific taxable operation, it being sufficient that there exists a relationship with the company's activity.[6]

6.17. At the domestic level, regarding the right to deduction of VAT, the case law of the Supreme Administrative Court has come to understand that the deductibility of costs revealing a direct and immediate nexus with the entirety of the passive subject's economic activity is to be admitted.

6.18. That is, in order for VAT to be deductible, the operations effected upstream must have a direct and immediate relationship with the downstream operations with the right to deduction and presupposes that the expenses incurred with their acquisition have been part of the constitutive elements of the price of the taxable operations downstream with the right to deduction.[7]

6.19. Thus, in the case, it must be analyzed whether the Respondent is right in arguing that the Claimant should have assessed VAT on the expenses which it considers as liberality, there being no foundation for what the Claimant invokes (legitimacy of the deduction of VAT associated with the expenses incurred), inasmuch as that is not the reasoning of the corrections effected in the TIR or, in consequence, of the VAT assessments in question, as will be demonstrated below.

Position of the Claimant – On the right to deduction in VAT

6.20. But, in the case, within the scope of the corrections effected by the TIS, was or was not limited the exercise of the right to deduction relating to the expenses recorded in the Claimant's accounts and relating to expenses with karting races (namely incurred with promotional event, competition assistance, track rental, vehicle expenses – tires, oil, chassis, etc.), on the ground that the TIS considered that right limited to the tax "(…) incurred for the realization of transfer of goods and provision of services subject to tax and not exempt from it (…)", it being the case that "the lack of exercise of that economic activity leads to the impossibility of tax deduction (…)", as the Claimant alleges?

6.21. In accordance with the TIR, whose content was taken as proven in points 5.11. and 5.14., above, the TIS did not question the right to deduction of VAT relating to those expenses on the ground stated in the previous point, inasmuch as having framed the same as sponsorship expenses they accepted the deductibility of VAT associated with such expenses.

6.22. However, as a consequence of such framing, the TIS determined there to be VAT to be assessed by the Claimant in the amount of EUR 7,439.78, incident on expenses qualified as sponsorship expenses (framing as gratuitous provision of services).

6.23. The Claimant, as we have seen, understands that "(…) it is not acceptable to consider the expenses listed (…) – because necessary to the activity that the company is developing – as mere liberalities" and, in that sense, develops an argument to the effect of justifying that "(…) the objective of incurring these expenses was always commercial and to obtain future economic benefits for the company, and not merely to associate the company with the sport through donations/patronage to a kart pilot"", concluding to the effect of understanding to be "(…) demonstrated that the incurrence of these expenses had as its purpose business/professional ends of the goods/services acquired inasmuch as directly related to the passive subject's activity and not excluded from the right to deduction" (emphasis added).

6.24. But the Claimant ends up also implicitly agreeing with the Respondent when it states that "the expenses with such expenses did not have as their only consideration that the Claimant appeared as sponsor of the pilot (…)" admitting that there were, among others, the consideration of appearing as sponsor of pilot B..., even referring to the conclusion with the latter of a sponsorship contract, exhibited and discussed with the TA official who carried out the tax inspection.[8]

6.25. Additionally, and in the same sense, the Claimant states that "(…) the TA always demonstrated having no doubts that the expenses in question were framed in a sponsorship contract between the Claimant and pilot B... (…)", that is, "the TA never doubted the existence of the sponsorship contract, it simply alleges that the expenses in question did not generate future economic benefits for the Claimant" (emphasis added).

6.26. Thus, the Claimant does not accept the position assumed by the Respondent in the Reply when it states that "no link is established between the Claimant and Mr. B...", in an attempt which the Claimant understands to be to the effect of "(…) altering the reasoning of the tax act in question (…)", reason for which the Claimant came to attach, in the course of submissions, a copy of the said sponsorship contract, whose attachment to the proceedings was admitted (see point 1.17., above).[9]

Position of the Respondent – Sponsorship Expenses

6.27. The Respondent, as we have seen, did not question the right to deduction on the expenses under analysis but in framing the said expenses as liberalities, while sponsorship expenses, the TIS came to refer in the TIR to the framing in VAT, clarified both by Circular no. 12/2002 of 19 April and by Circular 2/2004 of 20 January, both of the Directorate of Services for Income Tax and the Directorate of Services for VAT, to the effect of concluding that "(…) the passive subject should have proceeded to the assessment of VAT in the total amount of 7,439.78€ (…)".

6.28. In fact, it is to be reiterated that the TIS understood that "(…) the taxpayer is sponsoring the sportsman B..., son of the managing partner, C..., assuming the expenses with the competition vehicle, race registration, etc., with the only consideration that the passive subject appears in the specialized news as a sponsor (among others) of the said pilot" and "these liberalities fall within the concept of sponsorship (…)", concluding that "to gratuitous transfers of goods, article 3, no. 3, subparagraph f) of the VAT Code shall apply, which determines that a gratuitous transfer of goods of the company is considered a transfer of goods when total or partial deduction of tax has occurred in relation to them" (emphasis added).

6.29. Let us then focus on the tax framing set out in the aforementioned Circulars.

6.30. In fact, Circular no. 2/2004 of 20 January, which is partially transcribed here, came "(…) with respect to the framing of certain realities within the scope of the Status of Patronage (…)","(…) to review the content of Circular no. 12/2002 (…)", to the effect of "(…) clarifying doubts relating to the legal-tax framing of donations, in the context of Personal Income Tax, Corporate Income Tax and VAT, namely in cases where to them is associated the attribution to the donors, by the beneficiaries of the donations, of certain benefits in kind (…)", as well as to clarify what the guidelines to be followed are to distinguish what is donation from what is sponsorship, for purposes of tax framing.

6.31. In this context, and insofar as the arbitral process may be concerned, the said Circular came to systematize that, in accordance with the terms of (since repealed) no. 2 of article 1 of Decree-Law no. 74/99 of 16 March[10], only have tax relevance "donations in cash or in kind granted without considerations that configure obligations of a financial or commercial character to public or private entities provided for in it, whose activity consists predominantly in the realization of initiatives in the cultural, environmental, scientific or technological, sports and educational areas" being, "in accordance with this rule, (…) covered by the Status of Patronage donations, that is, gratuitious prestations in which the spirit of liberality of the donor prevails".

6.32. However, given that "to the realization of donations is frequently associated the attribution to the donor of certain benefits in kind (…)" and "in these situations, we may be (…) in the domain of gratuitous transactions in light of the rules of common private law", whereby "for the purpose of refusing the prestation the character of gratuitousness it is not sufficient that the benefit associated with it be desired by the donor, it is necessary to ascertain whether that benefit was desired as financial consideration of the donation in such a way that one may say the spirit of liberality of the donor is undermined" (emphasis added).

6.33. According to what is stated in Circular 2/2004, "(…) when it is a question of the association of the respective name with an event promoted by the beneficiary, as the spirit of liberality of the donor subsists", it is considered that "(…) the mentioned benefits do not constitute (….) considerations of a financial or commercial character when their market value does not exceed, annually, the limit of 5% of donations attributed".

6.34. That is, "in cases where the benefit is translated into a public association of the name of the donor with a certain initiative, account must be taken of the manner in which this association is produced, admitting that to donations granted within the scope of patronage legislation be associated the benefit of disclosure of the sponsor's name, provided that it does not present a commercial nature but merely an institutional one".

6.35. And as criteria for distinction, the Circular states that "(…) the following guidelines may be established:

• If the benefit consists in the association of the name of the donor with a certain initiative, having as its aim the search for a personal or institutional image of civic responsibility, which identifies the donor with the general public, because the spirit of liberality of the donor is preponderant, one will be faced with donations framing within the Status of Patronage.(…)

• If, instead, the benefit consists in the association with a certain initiative of the products commercialized by the donor, or even of its name but having as its aim its promotion with the respective consumers (…)" (which is considered verified when none of the criteria stated in the Circular are observed), "(…) because the spirit of liberality of the donor is secondary, one will be faced with sponsorship, not contemplated in the Status of Patronage" (emphasis added).

6.36. However, "contrary to what occurs in Personal Income Tax and Corporate Income Tax (…)", in the matter of VAT "due to the nature of the tax itself and to the type of economic realities that it taxes (…)", "(…) the possible occurrence of considerations carried out by the beneficiary does not remove from the prestation of the patron its character as donation, as this is defined by common private law, whereby its respective treatment in VAT will always be that resulting from a gratuitous contract, except in cases no longer wholly patronage due to the absence of animus donandi in which the prestations of both parties are equivalent" (bold and emphasis added).

6.37. Thus, in the case of operations carried out gratuitously "(…) the subjection to tax depends on the possible subsumption of the operations flowing from those relationships in the rules of the VAT Code (…) which assimilate, for purposes of taxation, certain gratuitous operations to onerous operations".

6.38. In the case of onerous operations "(…) in which the considerations associated with a donation reflect, in their value, an absence of spirit of liberality and therefore an intention of enrichment on both sides, one will be faced with an onerous contract, the corresponding transfers of goods or provision of services, carried out by either or both of the parties, being submitted to the general rules of taxation in VAT of operations carried out on an onerous basis".

6.39. Finally, it is stated in the Circular above "from the point of view of the tax situation of the passive subjects who grant donations within the scope of patronage, there must be distinguished depending on whether they are donations in cash or in kind" inasmuch as "in the case of donations in cash, their attribution is found outside the scope of VAT" but "in the case of donations being granted in kind, there shall be place to subjection to tax of the transfers of goods or provision of services carried out gratuitously by the patrons, in accordance with, respectively, subparagraph f) of no. 3 of article 3 and subparagraphs a) and b) of no. 2 of article 4, both of the VAT Code" (bold and emphasis added).

6.40. And "whenever there is place to assessment of VAT for operations carried out gratuitously, no. 3 of article 36 of the VAT Code establishes that the passing on of tax is not mandatory, the passive subjects who carry out such operations being able to bear themselves the amount of tax due and proceed with its payment to the State coffers, without obligation to make the respective charge to the acquirers of the goods or recipients of the services".

6.41. It was in these terms that the Respondent based the necessity for the Claimant to have assessed VAT on the expenses identified in the TIR, inasmuch as it framed them as sponsorship expenses, borne by the Claimant for the benefit of the identified pilot.

6.42. Notwithstanding the Claimant understanding that "(…) it is not acceptable to consider the expenses listed (…) as mere liberalities" inasmuch as "the objective of incurring these expenses was always commercial and to obtain future economic benefits for the company, and not merely to associate the company with the sport through donations/patronage to a kart pilot", this Arbitral Tribunal cannot follow this position of the Claimant inasmuch as, in accordance with point 6.36., above, in the matter of VAT "due to the nature of the tax itself and to the type of economic realities that it taxes (…)", "(…) the possible occurrence of considerations carried out by the beneficiary does not remove from the prestation of the patron its character as donation (…)", "(…) whereby its respective treatment in VAT will always be that resulting from a gratuitous contract (…)" (bold and emphasis added).

6.43. In fact, unlike patronage, sponsorship is an eminently commercial relationship between the two parties, through which the sponsoring entity offers a product, a service or financing to the sponsored entity, which benefits from it and guarantees it a consideration generating financial return.

6.44. That is, the objective of sponsorship is commercial promotion with consumers inasmuch as sponsorship usually aims to cement the notoriety of a company or institution or to valorize a product, image, brand or service.

6.45. And it is this objective that results from the content of the sponsorship contract attached, without this removing the characterization, for VAT purposes, of the associated expenses.

6.46. Thus, given that what was put in question by the Respondent was not the right to deduction of VAT incurred with such expenses (as the Claimant alleges) but rather the lack of assessment of VAT associated with the underlying gratuitous provision of services, in accordance with the terms set out above, a framing which the Claimant failed to eliminate, this Arbitral Tribunal considers that the corrections effected in VAT, arising from lack of assessed VAT and the respective tax assessments thereupon, in the amount of EUR 7,439.78, are not affected by any illegality, deciding in favor of their maintenance in the legal order.

On responsibility for payment of arbitral costs

6.47. In accordance with the above point and in accordance with the provisions of article 527, no. 1 of the CPC (ex vi 29, no. 1, subparagraph e) of the RJAT), it should be established that the Party that gave rise to such costs shall be condemned in costs or, there being no success of the action, whoever of the process drew benefit.

6.48. In this context, no. 2 of the said article specifies the expression "gave rise to", in accordance with the principle of unsuccessful party, understanding that the unsuccessful party gives rise to the costs of the process, in the proportion in which it is unsuccessful.

6.49. In these terms, having in consideration the analysis above, responsibility in the matter of arbitral costs should be exclusively imputed to the Claimant.

1. DECISION

7.1. In these terms, having in consideration the conclusions presented in the previous Chapter, this Arbitral Tribunal decided:

7.1.1. To judge the arbitral request presented by the Claimant unmeritorious, the VAT assessments challenged being maintained in the legal order, with the consequences flowing therefrom;

7.1.2. To condemn the Claimant in the payment of the costs of this process.

Value of the process: In accordance with the provisions of articles 306, no. 2 of the CPC, article 97-A, no. 1 of the Code of Procedure and Tax Process (CPPT) and article 3, no. 2 of the Regulation of Costs in Tax Arbitration Processes the value of the process is fixed at EUR 7,439.78.

In accordance with the provisions of Table I of the Regulation of Costs of Tax Arbitration Processes, the value of the costs of the Arbitral Process is fixed at EUR 612.00, at the charge of the Claimant, in accordance with article 22, no. 4 of the RJAT.

Notify the parties.

Lisbon, 9 November 2018

The Arbitrator

Sílvia Oliveira

[1] The composition of this decision is governed by the orthography prior to the Orthographic Agreement of 1990, except for transcriptions made.

[2] Cites for this purpose Margarida Reis in "The Right to Deduction in Value Added Tax - Case Law of the Court of Justice of the European Union", published in the journal "JULGAR", no. 15 of the year 2011, namely to the effect that "(…) any norm or administrative practice that imposes a general restriction on the right to deduct when there is use for business or professional purposes of goods or services acquired constitutes an inadmissible violation of art. 17 of the Sixth Directive (cf. cases Commission / France, proc. 50/87 [1988]; Lennartz, proc. 97/90 [1991]; Gabalfrisa SL, proc. joined C-110/98 to C-147/98 [2000])" (emphasis of the Claimant).

[3] In this sense, cites Arbitral Decision of 2017-09-25, pronounced within the scope of process no. 58/2017-T, according to which "in VAT, the right to deduction is the rule, with limitations being the exception. In fact, the exercise of the right to deduction is an emanation of a nuclear principle in VAT, the principle of neutrality. Thus, limitations to such exercise may only occur on an exceptional basis and duly justified, this being the consensual guidance in European and national case law".

[4] On these rules see Xavier de Basto and Maria Odete Oliveira, in "Undoing Misunderstandings in Value Added Tax Deduction Law: Recent Amendments to Article 23 of the VAT Code", Journal of Public Finance and Tax Law, Year 1, Rita La Feria, in "The Nature of Activities and Right to Deduction of Holdings in VAT", Journal of Public Finance and Tax Law, Year 4, no. 3, 2012, pp. 171-197, Rui Laires, in "Decision of the Court of Justice of the European Communities (CJEC), of 13 March 2008 (Case c-437/06, Securenta Case)", Science and Tax Technique, no. 421, January-June, 2008, pp. 209-264, "Decision of the Court of Justice of the European Communities (CJEC), of 12 February 2009 (Case C-515/07, VNLTO Case)", Science and Tax Technique, no. 423, January-June, 2009, pp. 253-294, Alexandra Martins in "Operations relating to corporate holdings and the right to deduction in VAT. The SKF case law", Studies in memory of Prof. Doctor J. L. Saldanha Sanches, Coimbra Editora, Volume IV, 2011 and EMANUEL VIDAL LIMA, in "Two cases on the right to deduction in VAT", book in honor of Dr. Teresa Graça Lemos, Notebooks of Science and Tax Technique, June 2007, pp. 113 to 122.

[5] Also this Directive was repealed by Directive 2006/112/CE of the Council of 28 November, effective from 1 January 2007, "without prejudice to the obligations of Member States relating to the transposition and application deadlines (…)" of the said Directive.

[6] Cfr. Jean-Pierre Maublanc, in "Deduction of upstream VAT: is the requirement of a direct and immediate link justified ?", Review of the Common Market and European Union, no. 494, 2005.

[7] With respect to the analysis of the case law of the Court of Justice the SAC, in the above cited Decision, makes express reference to the understanding established in the Kretztechnik Decision (Cfr. on this subject the Decision Kretztechnik, proc. C-465/03; Decision CJEC, 2nd Section, of 8/06/2000, in proc. C-98/98; Decision CJEU of 6/9/2012 in proc. C-496/11 and AB SKF, of 29/10/2009, in proc. C-29/08.

[8] In fact, the Claimant states in its submissions that the sponsorship contract was provided during the inspection action, having been "(…) discussed with (…) the TA official who did not put it in question but (…) may not have attached it to the tax procedure".

[9] In this context, the Claimant also cites the content of the Decision of the Superior Administrative Court of 22-01-2015 (Case 05327/12), in accordance with which it is stated that "(…) in light of the structuring of a certain tax act, grounds produced in the course of a subsequent decision of the administrative appeal cannot be brought into question, the same not being relevant, as it is a posteriori reasoning, as it is not an integral part of the act itself and coeval with it".

[10] Decree which approved the Status of Patronage, where the regime of tax incentives in the scope of social, environmental, cultural, scientific or technological and sports patronage was defined and which was in force until 31 December 2006. Law no. 53-A/2006 of 29/12 came to add to the Status of Tax Benefits, effective from 1 January 2007, the dispositions that regulate benefits relating to Patronage, with subsequent legal amendments, repealing the Status of Patronage but saving all legal effects resulting from recognitions already made.