Summary
Full Decision
ARBITRAL DECISION
The arbitrators José Baeta de Queiroz (President), Luís M. S. Oliveira and Sérgio Pontes (Members), appointed by the Deontological Council of the Center for Administrative Arbitration to form the Collective Arbitral Tribunal, agree on the following:
1. Report
A…, Lda., taxpayer number …, with registered office at …, …, …, …-…, Carcavelos, filed, on 28 April 2017, a request for arbitral pronouncement, for review of the legality of the additional assessment of Corporate Income Tax (IRC) no. 2016…, of 24 November 2016, relating to the 2012 fiscal year, which determined tax payable in the amount of EUR 92,968.75, as well as, consequently, against the account settlement statement no. 2016…, in the amount of EUR 92,999.85.
The Claimant also requests compensation for damages resulting from the provision of guarantee to suspend the tax enforcement proceedings instituted by virtue of the failure to voluntarily pay the tax assessment challenged by it.
The respondent is the Tax and Customs Authority (AT).
The request to establish the arbitral tribunal was accepted by the President of the CAAD and automatically notified to the AT on the same date, 28 April 2017.
Pursuant to the provisions of subsections a) of article 6(2) and b) of article 11(1) of Decree-Law no. 10/2011, of 20 January (RJAT), the Deontological Council appointed as arbitrators of the collective arbitral tribunal the signatories, who confirmed their acceptance within the applicable deadline. On 14 June 2017, the Parties were duly notified of the appointment, and neither manifested any intention to refuse it. In accordance with the provision of subsection c) of article 11(1) of the RJAT, the Parties were informed that the collective arbitral tribunal was constituted on 30 June 2017.
The request is timely in light of the provision of subsection a) of article 10(1) of the RJAT, and the collective arbitral tribunal is competent to hear it, pursuant to the provision of subsection a) of article 2(1) of the same statute. The parties have legal personality and capacity, are legitimate and duly represented. The proceedings do not suffer from any nullities and there are no exceptions or obstacles to the examination of the merits.
I. In summary, and with relevance to the review and decision of the matter concerning the legality of the additional IRC assessment, the Claimant alleges the following:
(1) It was incorporated in 2003, with the corporate purpose of construction of buildings and purchase and sale of real property.
(2) In accordance with the accounting for the 2012 fiscal year, it had resorted to financing in the total amount of EUR 3,732,002.48, of which EUR 2,732,002.48 were bank financing and EUR 1,000,000 were "contributions and other loans".
(3) In return for such financing, it bore charges in the amount of EUR 308,746.47, which the AT considered not to be fiscally acceptable expenses.
(4) In 2012, it held financial assets in the total amount of EUR 3,087,039.59.
(5) In the Tax Inspection Report, the AT expressed the following understanding, in summary: "(…) the available liquid assets € 3,087,039.59 are manifestly superior to the amounts with which the taxpayer financed itself from credit institutions € 2,732,002.48 and for which it bore charges in the amount of € 308,746.47; (…) the company held sufficient liquid assets that would have allowed its operation, if not at zero cost, certainly with charges manifestly inferior; (…) the requirement of indispensability was not demonstrated by the taxpayer, hence, pursuant to article 23(1) of the CIRC, the financial charges in the amount of € 308,746.47 are not accepted fiscally".
(6) In its pronouncement in exercise of the right to be heard, it stated, in summary: that it needs to resort to financial institutions to finance its activity, or to capital from individual shareholders, whenever justified; that any such form of financing carries financial charges, which should be fiscally recognized, provided they relate to the activity carried out or to the maintenance of the company, as occurred; that in 2012 the country was in full financial crisis, with extreme difficulty in obtaining bank financing, particularly for construction activity, only possible through real guarantees, with banking institutions preferring those made through fixed-term deposits; that its real property assets under development in 2012 had a value of EUR 18,564,326.40 and it held in liquid assets the amount of EUR 3,087,039.59, corresponding to 17% of that property, which in light of maintenance expenses and completion of ongoing works did not seem disproportionate; that, considering there was no forecast regarding the sale period, the elimination of financial assets through bank financing, even partially, was contrary to all principles of prudence; that the loan contract with Santander, with an initial value of EUR 4,000,000, had a capital moratorium period of 48 months and in 2012 was already being amortized in quarterly installments, having, as of December 2016, a value of EUR 243,293.98; that it has managed to sustain itself to the present day, maintaining its productive source, as a result of all management actions, taking into account cost control, minimizing costs and always bearing in mind the principle of prudence.
(7) Its level of liquidity was congruent with the value of assets allocated to the productive activity, with inventory being accounted for at historical cost.
(8) In 2012 and in prior years (from 2008 onwards), it is common knowledge that Portugal was affected by a serious economic-financial crisis, plunging SMEs into extreme difficulties of liquidity, making it very difficult, if not impossible, for these to obtain financing for the development of their activity at that time, and good management, especially for construction companies, which have cash flow needs on a larger scale than companies in other sectors of activity, requires maintaining appropriate liquidity levels not only to cover ordinary expenses but also to enable investment and continued downstream business operations, and should not amortize existing loans, even if able to, and thereby risk survival.
(9) It is logical and inherent to the operational activity of construction and sale of real property that an SME such as the Claimant would contract financing when it had that opportunity in times of crisis, given that it could not have foreseen (particularly given the historical behavior of financial entities in those crisis years regarding credit provision) whether it would be able to obtain it later. These concerns are intensified in SMEs with the corporate purpose of the Claimant, given that they need to make substantial investments in real property assets and corresponding expenses associated with construction contracts, and it is also well known that there is no temporal alignment in this sector between the incurrence of expenses/investments and the recognition of income associated with them.
(10) Starting in 2008/2009, it faced stagnation of the residential property sales market, with enormous difficulties in selling most of the properties it was constructing through 2012/2013. During 2012, it was left with many plots of land and homes that it could only sell at cost price or below.
(11) It is common knowledge that, during the years in question, to obtain credit for home purchase, one could only obtain tolerable spread rates and percentages of financing value if properties were acquired whose construction had been financed by banking entities. Beyond this fact, a customer who contacted a banking entity to request financing to acquire a home, if the construction of that property had not already been financed by that banking entity (and subject to a mortgage), would be encouraged, through the attribution of considerably more advantageous credit conditions, to purchase a similar property whose construction had been financed by that entity, or which was in its ownership through mortgage execution (executed against the default of customers contracting home credit or against construction companies contracting financing).
(12) Thus, potential customers who wished to purchase real property in … (development financed by the bank loan whose interest was disregarded) would have available a spread rate of up to 1.75%, when under normal conditions, and offering the same conditions to the bank, the market value went up to 8%, and they could also obtain 100% financing of the property valuation amount, this being the factor that guaranteed the sales of … occurring during the crisis period.
(13) If it had amortized the entire loan in 2012, the following consequences would very probably have occurred: it would have been left with total liquidity of approximately 300,000 Euros, which would only be sufficient to cover ordinary management expenses over a very short period; even in terms of ordinary expenses, these have considerable weight but coherent with the costs associated with the maintenance and fulfillment of obligations associated to inventory which in 2012 amounted to EUR 18,564,326.40, accounted for and valued at historical cost (it being well known by real property experts that, unless very strong market stagnation occurs, the fair value is always superior to historical cost); the annual fixed costs of ordinary management expenses (wages and worker-related charges of a fiscal nature, water, electricity, supplies and management/accounting control) were approximately EUR 100,000 annually, making it incoherent and illogical from a management and financial perspective that it should proceed with amortization of the financing in order to be left with total liquidity of approximately EUR 300,000; the hypothetical amortization of the loan in question, by causing a reduction in liquidity to approximately EUR 300,000, would also cause stagnation of investment and consequently of business and operational activity, making it impossible to implement projects that generate cash in, given that construction companies need to make substantial investments in real property assets and corresponding expenses associated with construction contracts and inventory maintenance, and it is also well known that there is no temporal alignment in this activity sector between the incurrence of expenses/investments and the recognition of the associated income.
(14) The AT's understanding that the expenses with the financing in question are not indispensable for the pursuit of the activity, by virtue of the existence of sufficient liquid assets, finds no legal basis in article 23(1) of the IRC Code, and further contradicts the freedom of business management.
(15) The criterion of indispensability of expenses was introduced by the legislature with the objective of excluding expenses incurred for objectives external to the business scope, more specifically, external to the pursuit of profit.
(16) It is not within the competence of the AT to make judgments regarding the opportunity, necessity or convenience of expenses incurred by companies. First, because only a posteriori can they know, with total certainty, which expenses actually generated profit – which means that, throughout the fiscal year, expenses are incurred with a view to obtaining profit, but almost always with some degree of uncertainty. Thus, the criterion is based on the potential capacity of a given incurred expense to generate profit. Second, because the freedom of business management prevents the AT from making judgments regarding the management decisions of companies.
(17) It contracted financing from credit institutions with the purpose of providing support to treasury, construction of real property and acquisition of plots of land. Now, any of the purposes aimed at by the financing are oriented towards the obtaining of profit, and moreover are covered by its corporate purpose, which is why there is no reason not to consider the interest borne, as consideration for such financing, as a fiscal expense.
(18) By considering that the Claimant did not need to bear those expenses, since it possessed other sufficient liquid assets to ensure the same level of production, disregarding those financial charges as fiscal expenses, the AT values management decisions, directly infringing upon freedom of business management.
(19) The choice to resort to bank financing constitutes a pure act of management regarding which the AT has no duty to assess.
Regarding this matter, the Tax and Customs Authority (AT) responded, in summary, on matters of relevance to the case, that:
(20) As stated in point III.1.2. and point IX of the RIT, the Claimant bore financial charges, namely interest and bank expenses, through bank loans obtained, for the purpose of "support to treasury, support for construction of real property and acquisition of plots of land", by means of contracts executed with Bank B…, S.A. and Bank C…, S.A.
(21) The financial expenses borne are accepted for fiscal purposes if they comply with the provisions set forth in article 23(1) of the Corporate Income Tax Code (CIRC), which established, in the wording in force at the date of the facts: "Expenses are considered those which are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the productive source (…)".
(22) It appears from the RIT: "The second requirement [of indispensability] makes fiscal deductibility of the cost depend on the verification of a justified relationship with the productive activity of the company. This indispensability is verified insofar as these charges are connected with the obtaining of profit. It is the requirement of connection with taxable gains or to the maintenance of the productive source. […] the financial charges borne are entirely generated by the financing obtained from third parties, however, the company held sufficient liquid assets that would have allowed financing, if not at zero cost, certainly with charges manifestly inferior. In light of the foregoing, it is verified that the financial expenses borne are connected with the activity developed by the taxpayer, however, it is considered that indispensability is not unequivocal, since the entity held other instruments, entirely under its own control, that would have allowed obtaining the same resources, without the burdens involved. It is considered that the requirement of indispensability was not demonstrated by the taxpayer, hence, pursuant to article 23(1) of the CIRC, the financial charges in the amount of € 308,746.47 are not accepted fiscally."
(23) Analysis of the trial balance as of 31 December 2012 allowed the Tax Inspection to verify the existence of a liability through financing from Bank C… SA, in the amount of EUR 2,732,002.48, as well as the existence of liquid assets held by the Claimant, in the amount of EUR 3,087,039.59, and that at Bank C… SA there are fixed-term deposits in the amount of EUR 2,624,841.27. Thus, the Tax Inspection concluded that although it was verified, through the contracts executed, that the financing obtained was requested for construction purposes and treasury support, it was also verified that, during 2012, there are funds from the Claimant applied in fixed-term accounts of similar value at the same Banking Institution, whereby the dispensability of the financing and consequently the financial expenses associated are shown to be proven.
(24) The Claimant asserts (as it had already invoked in the hearing on the draft adjustments) that the ratio of 17%, relating to the relationship between the value in liquid assets and the inventory value, is "entirely congruent", however analyzing the same ratio in 2013, it is found to be less than 0.8% considering that the Claimant's assets total EUR 17,763,306.52 and the value of liquid assets amounts to EUR 135,290.54, and in the following periods the ratio amounts to approximately 5.6% and 4%, according to elements declared by the Claimant in the Simplified Business Information (IES), which demonstrates the incongruence of the argument.
(25) Also regarding the value of financing obtained, the Tax Inspection verified, through analysis of values declared by the Claimant in the IES, that in 2012 such value amounted to EUR 3,732,002.48 and in 2013 amounted to EUR 1,767,182.55, which allows one to verify that the financing shown as debt in 2012 is sharply reduced in 2013 (EUR 1,964,819.93) and the value shown as deposited in fixed-term accounts in 2012 is eliminated in 2013, from which it is concluded that the indispensability of financing expenses in the period of 2012 is not shown to be proven.
(26) Thus, as proven by the RIT, the value of financing obtained shown as debt in 2012 implied for the Claimant financial expenses that are not shown to be indispensable for the realization of income subject to tax in 2012.
(27) In this manner, it is unquestionable that the AT met the burden of proof of the prerequisites of the adjustment, demonstrating the dispensability of financing expenses, as required by article 74(1) of the General Tax Law (LGT).
(28) With the AT meeting the burden of proving the existence of the prerequisites that substantiate the contested adjustment, it was incumbent upon the Claimant to present proof of the indispensability of financial expenses for the realization of income in the period under analysis, which it failed to do. The Claimant would only have met the burden of proof to which it is subject if it had produced the supporting documents relating to movements in fixed-term deposit accounts, so as to demonstrate that the liquidity from the loan contracts was restricted to expenses with construction of real property.
(29) Similarly, the allegation that the properties were sold at cost price or below is not minimally demonstrated, since no documents were attached to the proceedings, namely invoices for acquisition of goods or services, relating to expenses incurred with construction. From documents concerning the advertisement of the properties, it only results that the sale price declined from a value of 355 thousand euros to 320 thousand euros, demonstrating nothing regarding the profit margin obtained.
(30) As to the argument that freedom of business management prevents the AT from "making judgments regarding management decisions of companies", it can only be stated that the Tax Inspection acted, in this case, within the competence assigned to it by article 2 of the RCPITA, which consists of assessing the conformity of elements declared by taxpayers with tax legislation, as well as verifying compliance with formal requirements relating to adequate proof and verification of the requirements necessary for their fiscal eligibility.
(31) The Inspection did not intend, as appears from the RIT, to question the free initiative and private autonomy or to challenge the management choices made by the Claimant's governing bodies, but solely to proceed with the correct fiscal classification of the facts verified through analysis of elements relating to the IRC situation in the period in question. It is not the corporate practice that is at issue, but only its correct fiscal classification in order to ensure verification of the requirements that article 23 of the CIRC requires for the fiscal recognition of declared expenses.
(32) The arguments put forth by the Claimant are not supported by adequate proof, pursuant to article 74 of the LGT.
II. On the Claimant's request for compensation for damages resulting from the provision of guarantee to suspend tax enforcement proceedings instituted by virtue of failure to voluntarily pay the tax assessment:
(33) On 6 February 2017, it filed, in advance, a request for provision of guarantee, offering for attachment the plot of land for construction corresponding to the property registration article … of the parish of …, to suspend the tax enforcement proceedings that would be instituted, on 14/02/2017, for coercive collection of the alleged IRC debt, subject to the present action, identified with the number …2017…,
(34) Combining the norms provided in articles 53(1) and 53(2) of the LGT, it is inferred that, in case of error attributable to the services in the assessment of tax, the debtor is compensated for damages resulting from the provision of guarantee independently of the time for which it had to maintain it. The conditions are met for the Claimant to be compensated for damages resulting from the provision of guarantee to suspend the tax enforcement proceedings instituted by virtue of failure to voluntarily pay the tax assessment here contested.
Regarding this request, the AT responded, in summary:
(35) It follows from the provision of article 53(1) of the LGT that the Claimant would only have the right to be compensated for the charges supported and proven with the provision of bank guarantee or equivalent and not any other, particularly attachment or mortgage of property.
Proceedings and Arguments
On 3 November 2017, a tribunal hearing was held, in which evidence was produced, as requested by the Claimant, through statements from the shareholder and manager of the Claimant, D…, and through witness testimony, from the deposition of E…, certified accountant of the Claimant, and F…, bank manager of Bank C…. The AT did not file a request for evidence at the hearing.
At the same hearing, it was decided that the proceedings would continue with oral arguments, which were immediately presented by the representatives of the Claimant and the AT, in that order, and the Tribunal announced its decision for 29 December 2017.
2. Findings of Fact
2.1. Proven Facts
The tribunal's conviction regarding proven facts was based on critical analysis of all evidence in the proceedings and produced at the hearing, in accordance with common experience judgments and in accordance with the principle of free assessment. The evidence from party and witness statements merited the tribunal's credibility, as they presented with serious demeanor and produced accounts free from contradictions and hesitations, knowledgeable, detailed and consistent with other evidentiary elements brought into the proceedings, evidencing direct knowledge regarding the factual matters.
The following facts are considered proven:
(A) The Claimant was incorporated in 2003, with the corporate purpose of construction of buildings and purchase and sale of real property.
(B) The Claimant needs to resort to financial institutions to finance its activity, or to capital from shareholders, bearing financial charges.
(C) In 2012 the country was still in financial crisis, plunging SMEs into extreme difficulties of liquidity and difficulty in obtaining bank financing for the development of activity, particularly for construction activity, only possible through real guarantees, with banking institutions preferring those made through fixed-term deposits.
(D) In accordance with the accounting for 2012, it had resorted to financing in the total amount of EUR 3,732,002.48, of which EUR 2,732,002.48 were bank financing and EUR 1,000,000 were "contributions and other loans".
(E) In return for such financing, it bore charges in the amount of EUR 308,746.47.
(F) The Claimant's real property assets under development in 2012 had a value of EUR 18,564,326.40 and the Claimant held in liquid assets EUR 3,087,039.59.
(G) The loan contract with Bank C…, with an initial value of EUR 4,000,000, had a capital moratorium period of 48 months and in 2012 was already being amortized in quarterly installments.
(H) The Claimant understood that its level of liquidity was congruent with the value of assets allocated to the productive activity, with inventory being accounted for at historical cost, and also that, with no forecast regarding the sale period of the financed development, the elimination of available liquid assets through bank financing, even partially, was contrary to the principles of prudence.
(I) The Claimant understood as good management, given cash flow needs, to maintain appropriate liquidity levels to cover ordinary expenses and enable investment and continued downstream business operations, and therefore should not amortize, even if able to, existing loans and thereby risk survival.
(J) The Claimant understood as good management to contract financing when it had that opportunity in times of crisis, as it is inherent to the operational activity of construction and sale of real property, particularly when pursued by an SME, given that it could not have foreseen, given the historical behavior of financial entities in those years regarding credit provision, whether it would be able to obtain it later, particularly as it needed to make substantial investments in real property assets and bear expenses associated with construction contracts. There is no temporal alignment in the sector between the incurrence of expenses/investments and the recognition of associated income.
(K) The Claimant faced, starting in 2008/2009, stagnation of the residential property sales market, with difficulties in selling most of the properties it was constructing through 2012/2013. During 2012, it was left with many plots of land and homes.
(L) Banks – such as Bank C…– gave preference to credit for acquisition of assets financed by the constructor, through the loan-to-value ratio (100% versus 70-80% for assets outside those conditions) and spread (1.75% to 2%, versus values around 5% for assets outside those conditions) (testimony of F…).
(M) Thus, potential customers who wished to purchase real property in … (development financed by the Bank C… loan, whose interest was disregarded) would have access to a spread rate around 1.75%, when under normal conditions, and offering the same conditions to the bank, the market value was around 5%. They could also obtain 100% financing of the property valuation amount, above the financing ratio of other properties. These factors supported sales of … during the crisis period.
(N) If it had amortized the entire loan in 2012, the Claimant would have, probably, borne the following consequences: it would have been left with total liquidity of approximately 300,000 Euros, which would only be sufficient to cover ordinary management expenses over a very short time period; ordinary management expenses have considerable weight but coherent with costs associated with maintenance and fulfillment of obligations associated to inventory which in 2012 amounted to EUR 18,564,326.40, accounted for and valued at historical cost (except for very strong market stagnation, fair value is superior to historical cost); the annual fixed costs of ordinary management expenses (wages and worker-related charges of a fiscal nature, water, electricity, supplies and management/accounting control) were approximately EUR 100,000 annually, making it incoherent and illogical from a management and financial perspective for the Claimant to proceed with amortization of the financing, in order to be left with total liquidity of approximately EUR 300,000; the hypothetical amortization of the loan in question, by causing a reduction in liquidity to approximately EUR 300,000, would lead to stagnation of investment and consequently of business and operational activity, compromising the Claimant's capacity to implement projects that generate cash in, given the need to make substantial investments in real property assets and bear expenses associated with construction contracts and inventory maintenance, in a context of no temporal alignment between the incurrence of expenses/investments and the recognition of associated income.
(O) The Claimant contracted financing from credit institutions for the purpose of providing support to treasury and financing construction of real property and acquisition of plots of land.
(P) The expenses in question are duly supported by documentation.
2.2. Unproven Facts
There are no facts that the Tribunal considers relevant to the decision of the case that have not been proven.
3. Legal Matters
3.1. On the illegality of the additional IRC assessment no. 2016…
The legal matter, regarding the principal request, is straightforward, and arbitration is not of full jurisdiction: is there illegality in the additional IRC assessment no. 2016…, of 24 November 2016, relating to the 2012 fiscal year, which determined tax payable in the amount of EUR 92,968.75, as well as, consequently, in the account settlement statement no. 2016…, in the amount of EUR 92,999.85?
The Claimant alleges that such act is tainted with illegality. It proceeds from the following value premises regarding the facts, in summary made by the Tribunal:
The argument used by the AT (by the SIT in the RIT) that the expenses with financing in question are not indispensable for the pursuit of its activity, by virtue of the existence of sufficient liquid assets, finds no legal basis in article 23(1) of the IRC Code. The criterion of indispensability of expenses was introduced by the legislature with the objective of excluding expenses incurred for objectives external to the business scope, more specifically, external to the pursuit of profit, which occurs whenever an expense is not oriented towards the obtaining of profit. As supported by the doctrine and jurisprudence cited or transcribed by the Claimant, it is not within the competence of the AT to make judgments regarding the opportunity, necessity or convenience of expenses incurred by companies. Only a posteriori can companies know, with total certainty, which expenses actually generated profit – which means that, throughout the fiscal year, expenses are incurred with a view to obtaining profit, but almost always with some degree of uncertainty, whereby the factual criterion capable of demonstrating verification of the legal requirement is based on the potential capacity of a given incurred expense to generate profit. Freedom of business management prevents the AT from making judgments regarding company management decisions.
The Respondent argues for the absence of illegality of the act and for the rejection of the request:
The Tax Inspection did not intend, as appears from the RIT, to question the free initiative and private autonomy or to challenge the management choices made by the Claimant's governing bodies, but solely to proceed with the correct fiscal classification of the facts verified through analysis of elements relating to the IRC situation in the period in question. It is not the corporate practice that is at issue but only its correct fiscal classification in order to ensure verification of the requirements that article 23 of the CIRC requires for the fiscal recognition of declared expenses. Tax law does not owe allegiance to all corporate practices, even if they are legal. The financing obtained was requested for construction purposes and treasury support, but during 2012 there are funds from the Claimant applied in fixed-term accounts of similar value at the same Banking Institution, whereby the dispensability of the financing and consequently the financial expenses associated are not shown to be proven. The requirement of indispensability was not demonstrated by the taxpayer, hence, pursuant to article 23(1) of the CIRC, the financial charges in the amount of EUR 308,746.47 are not accepted fiscally.
On Fiscal Deductibility of Financial Charges
In summary, the issue is whether financial charges borne by an IRC taxpayer, when the financial applications held by the taxpayer are sufficient to liquidate the liability generating such charges, are fiscally deductible pursuant to article 23 of the IRC Code, which at the date of verification of the facts established, in subsection c) of its article 23(1), that: "1 – Expenses are considered those which are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the productive source, namely: c) Of a financial nature, such as interest on foreign capital applied in the business, discounts, premiums, transfers, exchange differences, charges with credit operations, collection of debts and issuance of bonds and other securities, redemption premiums and those resulting from the application of the effective interest method to financial instruments valued at amortized cost".
The Claimant alleges that it contracted loans according to its own social interest, with no economic advantage accruing to any of the shareholders, it being consequently not legitimate to call into question the company's management actions, whereby the financial charges are fiscally accepted pursuant to the aforementioned article 23 of the IRC Code.
In a different sense, the Respondent argues that, although there is a connection between financing expenses and the activity developed by the Claimant, such financial expenses, incurred through bank loans obtained, do not satisfy the requirement of indispensability, since the taxpayer held sufficient liquid assets that would have allowed financing, if not at zero cost, certainly with charges manifestly inferior. The Respondent considers that the Claimant held other instruments, entirely under its own control, that would have allowed obtaining the same resources, without the burdens involved.
It therefore considers that the indispensability of expenses is subject to a test of management alternatives, whereby expenses generated by the option allowing obtaining the same resources with the least burden are fiscally deductible. It is not the deductibility of financing expenses per se that is at issue, but rather the Claimant's management choice to contract financing generating expenses, when it had, as shown by its Balance Sheet, other instruments, namely assets, providing it with liquidity.
It is therefore necessary to interpret the provision of article 23 of the IRC Code, in particular in light of the jurisprudence subsequently produced.
In the Judgment of the Supreme Administrative Court, of 29 March 2006, delivered in case no. 01236/05, it is stated that: "the criterion of indispensability was created by the legislature, not to allow the Administration to interfere in company management, dictating how it should apply its means, but to prevent the fiscal recognition of expenses which, although accounted for as costs, do not fall within the scope of the company's activity, were incurred not for its pursuit but for other external interests. Strictly speaking, they are not true company costs, but expenses which, given their object, were improperly accounted for as such. Without the Administration being able to assess the indispensability of costs in light of criteria relating to their opportunity and merit. The concept of indispensability not only cannot be equated to a strict judgment of imperative necessity, as already stated, but also cannot be based on a judgment regarding the convenience of the expense, made necessarily a posteriori. (…) The judgment regarding opportunity and convenience of expenses is exclusive to the entrepreneur. If he decides to make expenses with a view to pursuing the company's purpose, but is unsuccessful and those expenses prove, ultimately, unprofitable, they nonetheless remain fiscal costs. But every expense that is accounted for as a cost and proves external to the company's purpose is not a fiscal cost, because it is not indispensable. (…) And that, under penalty of violating the principle of tax capacity, the Administration can only exclude expenses not directly ruled out by law under strong motivation that convinces that they were incurred beyond the corporate objective, or that is, in pursuit of another interest that is not business-related, or, at least, with clear excess, deviant, in light of the objective needs and capacities of the company".
From the above-cited Judgment, one can infer what may be designated as an interpretive framework of the provision of article 23 of the IRC Code, in the wording in force in 2012, which is systematized in the following main elements: indispensable and, therefore, fiscally deductible, are expenses that fall within the scope of the taxpayer's activity, that is, incurred for the pursuit of the activity and not for other external interests, not being subject to a strict judgment of imperative necessity, nor to a test of convenience made a posteriori. In this way, expenses can only be fiscally excluded when there is demonstrated strong motivation that convinces that they were incurred beyond the corporate purpose. Even if it is revealed that it was not imperative to incur them or that such expenses did not achieve a profitable result, this does not preclude their fiscal acceptance. The jurisprudence that follows it, including arbitral jurisprudence, reinforces and refines this interpretive framework.
In the judgment of the CAAD of 2 December 2013, delivered in case no. 101/2013-T, it is stated that "a conclusion regarding the indispensability of expenses for obtaining profits or gains should only be rejected if it can be stated that such expenses had no potential to positively influence them". And in the same decision, citing Faveiro, it can further be read that the competent administrative agent for determining the taxable matter cannot "arrogate to itself the role of manager and qualify indispensability at the level of good and bad management, according to its own feeling or personal sense".
In the same vein, the decision of the Arbitral Tribunal of 23 February 2015, case 438/2014-T, cites Tavares to conclude that "only costs that do not have causal and justified relationship with the company's productive activity will not be indispensable".
In identical sense, the arbitral decisions delivered in cases nos. 695/2015-T, of 18 May 2015, and 528-2015-T, of 31 May 2016. In the latter, it is stated that "(…) once the orientation of expenses towards the pursuit of the company's activity and, consequently, towards the obtaining of profit, is proven, the criterion of indispensability is understood to be satisfied, being outside the scope of the Tax Authority to make value judgments regarding the quality of business management pursued by the Claimant".
"A cost is indispensable when it is related to the company's activity, whereby costs external to the company's activity will be only those in which it is not possible to discern any causal nexus with profits or gains (or with income, in the current code's expression - cfr. Art. 23, no. 1, of the C.I.R.C.), explained in terms of normality, necessity, congruence and economic rationality" (Judgment of the TCA-South, delivered on 16 October 2014, case no. 06754/13).
In summary, expenses that fall within the scope of the taxpayer's activity, that is, incurred for the pursuit of the activity, even if indirectly or mediately, and not for other external interests, are indispensable and therefore fiscally deductible; in which there is a causal nexus with income, explained in terms of normality, necessity, congruence and economic rationality, not being subject to a strict judgment of imperative necessity, nor to a test of convenience made a posteriori, but rather to a test, a priori, of the potential to positively influence gains.
Although, in the concrete case, the necessity to constitute liquidity may not be imperative, this option is normal and rational, especially from a perspective of prudence, anticipating potential future financing problems. The existence of liquidity, to a greater or lesser degree, therefore presents the potential to positively influence future gains.
On the other hand, if the provision of article 23 of the IRC Code allowed an analysis, a posteriori, of the result of a management decision and its comparison with alternative decisions, as the Respondent did when disregarding financing charges as a fiscal expense based on the assumption that the Claimant could have taken another management option, there would be generated an endless number of alternative decisions to evaluate, increasing the uncertainty of the fiscal result presented by the taxpayer.
By way of conclusion, and preparing the decision, since the bank financing generating financial charges was applied in the Claimant's assets, whether as real property inventories or as liquidity, it was applied within the scope of its activity, and not for other external interests. The decision to, faced with existing liquidity, not liquidate the bank liability is a normal management decision no less rational than the decision to liquidate it.
3.2. On the Claimant's request for compensation for damages resulting from the provision of guarantee to suspend the tax enforcement proceedings instituted by virtue of failure to voluntarily pay the tax assessment
The Claimant filed, in advance, a request for provision of guarantee, offering for attachment the plot of land for construction corresponding to the property registration article … of the parish of ….
This simple statement of the type of guarantee is sufficient for the Tribunal to decide on the rejection of the request made in the present proceedings.
The Claimant may have borne expenses and suffered damages as a direct result of the provision of the guarantee. Such damages, properly alleged and proven, should indeed be compensated. As understood by the STA, in Judgment of 22-06-2011 (Case 0216/11), "(…) the expenses that the taxpayer had to bear with the provision of guarantee to obtain suspension of the enforcement in which the debt from the illegal assessment act was being collected should be viewed as emerging damage from the unlawfulness of that act, bearing in mind that it enjoyed the privilege of enforceability or the privilege of prior enforcement, determining its immediate coercive collection (…), and that suspension of enforcement depended on the provision of guarantee that the taxpayer was thus forced to provide, whereby this constitutes, also, a harmful consequence of illegal administrative action. In this manner, and within the scope of (…) execution of judgment, the compensation of such expenses, necessarily assumed by the taxpayer to obtain suspension of efficacy of the act that was eliminated from the legal order due to its illegality, translates into an operation necessary for the reconstruction of the economic situation in which he would be if the illegal act had not been practiced. In other words, the Tax Administration practiced an illegal act, forcing the taxpayer to resort to judicial proceedings to remove that illegality and to have to bear expenses to obtain suspension of coercive collection of the debt emerging from that act, whereby there is no reason for the reconstruction of the situation that would exist if the act had not been practiced not to pass through compensation of these damages directly caused by it. In sum, from the act of annulment of the assessment (…) made to the Defendant results the duty, for the Administration, to reconstruct the situation that currently would exist if such illegal act had not been practiced, a duty that flows directly from the law, without need of a declaratory decision, it no longer making sense today the doctrine, previously followed, of forcing the taxpayer to arm itself previously with a prior condemning decision regarding payment of such compensation, obtained in the judicial challenge proceedings. And it is this duty of reconstruction that justifies the fact that the indemnification claim provided for in article 53 of the LGT be requested and obtained in execution of judgment proceedings".
However, the compensation of such expenses and damages cannot take place under the provisions of articles 53(1) and 53(2) of the LGT, since it does not concern equivalent cautionment to a bank guarantee. The Tribunal follows, regarding this legal question, the understanding of the STA, in the Judgment of 24-10-2012 (Case 0528/12), as well as of the doctrine cited therein, in particular the impressive explanation of António Lima Guerreiro: "(…) the present provision comprises only the damage suffered from the provision of bank guarantee or equivalent (surety insurance). It does not cover the damage suffered from the provision of another type of guarantee (…), which results from the much greater difficulty in then configuring the existence of actual damage suffered by the defendant in such circumstances, which does not mean that such cannot occur, whereby compensation of the harmed party should then be made by means of general indemnification remedies."
In this same sense, the Judgment of the CAAD in Case 117/2016-T: "compensation for undue guarantee does not cover, in tax litigation, other types of guarantees beyond bank guarantee or equivalent, being expressly excluded, particularly guarantees provided through voluntary mortgage (…)".
Thus, the request formulated by the Claimant is rejected in the present proceedings.
4. Decision
In accordance with the grounds set forth, it is decided:
To uphold the impugnation request, annulling, as illegal, the additional IRC assessment no. 2016…, of 24 November 2016, relating to the 2012 fiscal year, in which the AT determined tax payable in the amount of EUR 92,968.75;
To reject the Claimant's request for compensation for undue guarantee;
To condemn the Respondent for all costs. Although the Claimant partially loses on one of the requests, this is neither quantified nor determined, whereby, applying the regime resulting from the combination of articles 297(2) and 299(4) of the Civil Procedure Code, the value of the only definite request is what determines the value of the case and in this the Claimant obtains complete success.
5. Process Value and Costs
In accordance with the provision of article 97-A(1)(a) of the Code of Tax Procedure and Process, articles 297(2), 299(4), 306(1) and 306(2) of the Civil Procedure Code, article 29(1)(e) of the RJAT and article 3(2) of the Regulation of Costs in Tax Arbitration Proceedings, the value of the process is set at EUR 92,968.75 (ninety-two thousand, nine hundred and sixty-eight euros and seventy-five cents).
Pursuant to article 22(4) of the RJAT and Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, the amount of costs is set at EUR 2,754.00 (two thousand, seven hundred and fifty-four euros), to be borne by the Respondent.
Lisbon, 21 December 2017.
The Arbitrators
(José Baeta de Queiroz)
(Luis M. S. Oliveira)
(Sérgio Pontes)
[i] Vítor Faveiro, Fundamental Notions of Portuguese Tax Law, vol. II, p. 601.
[ii] Tomás Tavares, "On the Relation of Partial Dependence Between Accounting and Tax Law in Determination of Taxable Income of Legal Entities: Some Reflections at the Level of Costs", Science and Tax Technique, 396, pp. 136 et seq.
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