CAAD 295/2015-T: Deductibility of Financial Charges for SGPS Under Article 31-2 EBF and Circular 7/2004 in IRC

CAAD: Tax Arbitration

Case No.: 295/2015-T

Subject: Corporate Income Tax – Timing of deductibility of financial charges; Article 31(2)/Tax Benefits Statute of 2005; Holding Companies; Circular No. 7/2004 of DSIRC.

ARBITRAL DECISION

I – REPORT

1. A… Holding Company, S.A., legal entity no. …, with registered office at Place…, hereinafter referred to as Claimant, as the dominant company of group B…, filed an application for constitution of an arbitral tribunal in tax matters and a request for arbitral pronouncement, pursuant to the provisions of articles 2(1)(a) and 10(1)(a), both of Decree-Law No. 10/2011, of 20 January (Legal Regime for Tax Arbitration, hereinafter abbreviated as LRTA), in which the Tax and Customs Authority (hereinafter TA) is respondent, petitioning the declaration of illegality of the acts of partial dismissal of Hierarchical Appeal and, consequently, of the additional assessment of Corporate Income Tax No. 2009…, of 28 May 2009, which resulted in a correction to the taxable income of the group determined in 2005, in the amount of €574,753.01.

2. The application for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority on 22-05-2015.

3. Pursuant to the provisions of article 6(2)(a) and article 11(1)(b) of the LRTA, as amended by article 228 of Law No. 66-B/2012, of 31 December, the Ethics Council designated as arbitrators of the collective arbitral tribunal the signatories, who communicated acceptance of the appointment within the applicable period.

4. On 07-07-2015, the parties were duly notified of this appointment and did not manifest any intention to challenge the designation of the arbitrators, in accordance with the combined provisions of article 11(1)(a) and (b) of the LRTA and articles 6 and 7 of the Ethics Code.

5. Thus, in conformity with the provision of article 11(1)(c) of the LRTA, as amended by article 228 of Law No. 66-B/2012, of 31 December, the collective arbitral tribunal was constituted on 24-07-2015.

6. The Tax and Customs Authority responded to the initial application submitted, arguing that the Claimant's request should be judged unfounded.

7. Given that none of the objectives legally assigned to it were present in the case, the meeting provided for in article 18 of the LRTA was dispensed with.

8. The parties submitted final written arguments.

9. The arbitral tribunal was regularly constituted and is materially competent, in accordance with the provisions of articles 2(1)(a) and 30(1) of Decree-Law No. 10/2011, of 20 January.

10. The parties have legal personality and capacity, are entitled and are duly represented (articles 4 and 10(2) of the same instrument and article 1 of Ordinance No. 112-A/2011, of 22 March).

11. The proceedings are not affected by nullities and no exceptions were raised.

12. Essentially, the Claimant alleges to support its claim:

12.1. In compliance with Service Order No. OI2008…, of 3.11.2008, of partial scope, an external inspection procedure was carried out on the accounting-tax elements of the corporate income tax return (Form 22) of the now Claimant, with reference to the 2005 fiscal year.

12.2. According to the inspection report, the Tax Administration services disregarded certain financial charges, allegedly incurred in the individual sphere of A…, with the acquisition of shares capable of benefiting from the regime provided for in article 31(2) of the Tax Benefits Statute (TBS), in the wording in force at the time, and consequently increased the net profit for the 2005 fiscal year by the amount of €574,753.01 (five hundred and seventy-four thousand, seven hundred and fifty-three euros and one cent), with the consequent alteration of the taxable income declared by the Claimant.

12.3. The Claimant was notified of the Corporate Income Tax assessment statement No. 2009…, issued on 28 May 2009.

12.4. The Claimant, disagreeing with the corrections proposed to the taxable income by the TA, filed a gracious complaint on 21 September 2009.

12.5. The TA partially granted, in gracious complaint proceedings, part of the corrections proposed to taxable profit, according to the decision notified to the now Claimant, by Letter No. …/…, of 15/12/2010, converting, definitively, the draft decision of partial grant of the complaint, which had been notified by Letter No. …/…, of 23/11/2010.

12.6. In the partial grant decision, the TA alleges "that the correction to the taxable profit of 2005 of A… should be maintained by the inclusion therein of financial charges considered incurred in the acquisition of shares and which do not contribute to the formation of taxable profit in accordance with what is established in article 31(2) of the TBS, in the amount of €574,753.01".

12.7. The Claimant continued to disagree with the TA's decision to partially reject the gracious complaint, as the Respondent decided to maintain the correction to the taxable profit of A… and, consequently, to the taxable income of the group, by the inclusion therein of financial charges considered incurred in the acquisition of shares in A… and which in the opinion of the Claimant do not contribute to the formation of taxable profit, and consequently of the taxable income of the group, and therefore filed a Hierarchical Appeal of that decision of partial rejection of the gracious complaint, with the Finance Service of ...-….

12.8. The Claimant was notified by Letter No. …, of 2 February 2015 of the partial grant decision of the aforementioned Hierarchical Appeal, from the Finance Authority of Porto.

12.9. The Tax Authority decided that only part of the arguments presented by the Claimant in the Hierarchical Appeal were admissible, having concluded by maintaining the correction to the taxable profit of the 2005 fiscal year of A…, by the inclusion therein of financial charges considered incurred in the acquisition of shares and which do not contribute to the formation of taxable profit in accordance with what is established in article 31(2) of the TBS.

12.10. The Claimant continues to disagree with the TA's decision for the reasons that are summarized below:

i) Financial charges should not be corrected in the period in which they occur. The rule is their deductibility. Only "at the moment of verification of the suspensive condition and if such suspensive condition is verified would it be appropriate to proceed with the necessary adjustments for the purposes of determining taxable profit in accordance with the provisions of article 31(2) of the TBS (articles 18 to 26 of the Regulation);

ii) Article 31 of the TBS has an underlying direct allocation. The Administration should have proven the direct allocation. The Administration should have determined "whether there was recourse to financing for the acquisition of the alienated shares". The Administration, however, merely applied the indirect quantification method provided for in Circular 7/2004, resorting to presumptions. Article 31 does not establish the possibility of resorting to alternative methods of imputation of non-deductible financial charges. Circular 7/2004 came to establish "criteria and methods through which it defines the incidence of the tax", and therefore suffers from unconstitutionality (articles 18 to 26 of the Regulation).

iii) The "shares resulting from the entry of assets for the realization of the respective share capital, identified in Part I, article 4, could never be considered acquired shares to which the provision of article 31 of the TBS (current article 32) would apply, which in your opinion results from the information issued by the TA Services within the scope of Case No. 2799/2009, of 19.11.2009 (where the concept of 'acquisition' is explained for the purposes provided for in article 31(3) of the TBS" (articles 83 to 88 of the Regulation).

12.11. The Claimant further submits that "financial charges should not be corrected in the period in which they occurred, but should be corrected at the moment of verification of the suspensive condition and if the suspensive condition is verified".

12.12. The Claimant further advances that:

"Given that the wording of article 31(2) (currently article 32(2) of the TBS) was introduced by Law 32-B/2002, of 30 December (State Budget for 2003), (…) this amendment entered into force from 1/1/2003, it should only be applicable to shares acquired from 1/1/2003.

The subjection of financial shares acquired before 1/1/2003 to the new regime would constitute a retroactive application of a tax incidence rule, in violation of the constitutional prohibition as provided for in article 103(3) of the Constitution of the Portuguese Republic".

Response of the Respondent

1. In the Response presented within the applicable terms and period, the Respondent alleges:

13.1. First, the correction made to taxable profit, in the individual sphere of A…, and the consequent assessment is the exclusive responsibility of the Claimant since it did not add to the net profit the financial charges attributable to the acquisition of capital shares.

13.2. The inspection determined that "the taxpayer incurred, in the fiscal year in question, as financial charges incurred with the acquisition of capital shares (shares) - €574,753.02 - which pursuant to article 31(2) (currently 32) of the TBS, do not contribute to the formation of taxable profit, which were added, by application of Circular No. 7/2004, of 30 March, applicable to acts performed from 1 January 2003, even though they relate to financings contracted before that date" (article 5 of the Response).

13.3. The Respondent understands that since article 31(2) of the TBS does not establish which method to use for the purposes of allocating financial charges to shares, Circular No. 7/2004, of 30 March, "merely intends to comply with the law, determining the method and form of calculation of financial charges incurred with the acquisition of capital shares."

13.4. In this sense, as referred to in Case 21/2012-T of the Arbitral Tribunal, "(…) what is important to note here is that the tax act of self-assessment in question is not vitiated or affected by any illegality (by violation of any constitutional principle) that can be attributed to it on the basis of this question of allocation of financial charges, and this is so much so that, as the Respondent argues in the response, associated with the issuance of Circular No. 7/2004, of 30 March, there is no legislative intention on the part of the TA, or at least, we are unable to discern it (…)."

13.5. It is not Circular No. 7/2004 that creates incidence rules, but the law itself, interpreted as described above, which excludes deductibility, for the purposes of determining profit for the fiscal year in which they are incurred, the financial charges incurred with financings linked to the acquisition of alienated shares which realize, even if potentially, capital gains excluded from taxation.

13.6. Therefore, the interpretation contained in Circular No. 7/2004 is in accordance with the letter of the law, insofar as it merely undertakes the discovery of its most precise meaning, in respect, moreover, of the general theory of statutory interpretation and the normative framework that conforms it.

13.7. Thus, Circular No. 7/2004 did not alter or distort the statutory provision of article 31(2) of the TBS, but merely uniformized the interpretation and application of the rule, in the adequate defense of the public interest and respect for the rights and interests of taxpayers – articles 266 of the Constitution and 55 of the General Tax Law.

13.8. Furthermore, the explanation in the circular of the method to be used contributes to the effective realization of the extrafiscal purposes that presided over its creation and prevents taxpayers from using the rule to pursue purposes other than those intended by the law.

13.9. In the concrete case, as the Claimant provided no information relating to the quantification of the reality embodied in the existence, in the period in question, of financial charges attributable to the capital shares held by it, the Tax Inspection Services proceeded to calculate them taking into account the fungible character of money and the consequent difficulty of direct imputation of financial charges, the calculation was made on the basis of the following criteria: remunerated liabilities were imputed, first of all, to remunerated loans granted by the parent company to the subsidiary companies and to other interest-generating investments, allocating the remainder to the other assets, namely shares, proportionally to their respective acquisition cost.

13.10. This is, moreover, the method used by the generality of holding companies that employ it, given the extreme complexity and subjectivity of direct allocation.

13.11. In effect, as referred to in the cited arbitral decision, delivered in Case No. 12/2013-T, "tax law does not contain any concrete rule or specific principle of tax disregard of costs, if the funds obtained from them do not generate taxed income. And it does not contain it for reasons of simplicity and adherence to the truth. Simplicity anchors itself in the difficulty of establishing a direct causal relationship between a cost and a financial benefit, in an organization, such as a commercial company, whose granted financings are intended, as a rule, for the whole of its activity and which resorts indistinctly to own and third-party funds to pursue its purpose and it is impossible to determine whether the funds of the interest-free benefits granted to subsidiaries come from third-party or own financing and in what proportion each occurred… it is this reason that presides, moreover, over Circular 7/2004, for holding companies (…)".

13.12. The use of the allocation method used by Circular 7/2004 aims at taxation as close as possible to actual profit, with no violation of the constitutional principle of taxation on actual profit.

13.13. Regarding the specific constitutional provision of taxation on actual income, article 104(2) admits and encourages – in the name, namely, of the principles of operationality and practicability of the system – the existence of special taxation regimes, such as that of holding companies.

13.14. Thus, the circular determines that if it is concluded, "at the moment of alienation of the shares, that not all the requirements for application of that regime are met, then, in that fiscal year, the financial charges that were not considered as a cost" in the fiscal year in which they were incurred should be considered as a tax cost.

13.15. It reiterates, finally, that, at no time, did the Claimant demonstrate, in concrete terms, the alleged flaws in the calculations carried out by the Respondent, namely in opposition to the values that would actually have to be added to the net profit.

Both parties submitted their respective final arguments in writing, concluding, essentially, in the manner they had already done in their pleadings.

Given all of the foregoing, it is necessary to render a final decision.

II. REASONING

A. FACTS

A.1. Established Facts

Based on the elements contained in the proceedings (administrative proceedings, facts agreed upon by the parties and documents incorporated in the file and which were not challenged), the following facts are considered established as relevant to the decision:

1. In compliance with Service Order No. OI2008… of 3 November 2008, an external inspection procedure was conducted on the accounting-tax elements of the Corporate Income Tax Return (Form 22) of group B…, now referred to as Claimant, with reference to the 2005 fiscal year, for the following reason: "the taxpayer incurred, in the fiscal year in question, financial charges incurred with the acquisition of capital shares (shares) - €574,753.01, which pursuant to article 31(2) (later renumbered 32) of the TBS, did not contribute to the formation of taxable profit, which were added, by application of Circular No. 7/2004, of 30 March, applicable to acts performed from 1 January 2003, even though they relate to financings contracted before that date."

2. In 2005, the Claimant was part, for purposes of Corporate Income Tax, of a fiscal group subject to the special taxation regime for groups of companies (STRGC), provided for in articles 63 et seq. (current 69 et seq.), of the Corporate Income Tax Code, of which it was the dominant company;

3. A…, as the dominant company of the STRGC, was notified through Letter No. …, of 18 May 2009, of the tax inspection report and the corrections made in Corporate Income Tax in the sphere of group B…, resulting from the inspection actions carried out on some of the companies within the fiscal scope of group B…, namely, the corrections made in Corporate Income Tax in the individual sphere of C… and A… (Doc. 1 attached to the Report);

4. As of 31/12/2005, A… held the following shares (in euros):

[Table with shareholdings listing various companies (D…, E…, F…, G…, H…, I…, J…, K…, L…, M… S.A., N…, O…, P…, Q…, R…, S.A., S…, T…, U…, V…, W…, X…, Y…, Z…, AA…, BB…, C…) with their acquisition dates, book values, additional contributions, and totals. The table shows acquisitions from before 1995 through 2005, with a grand total of €98,936,450.19]

1. As a result of the corrections contained in the Tax Inspection Report, the Claimant was notified of Corporate Income Tax assessment No. 2009…, of 28 May 2009, with an amount due of €145,258.94, consisting of €144,672.33 in tax and €586.61 in compensatory interest (Doc. 2 attached to the Report);

2. Disagreeing with the corrections made by the Tax Authority, the Claimant duly filed, on 21 September 2009, a Gracious Complaint regarding assessment No. 2009…, of 28 May 2009 (Doc. 3 attached to the Report);

3. This Gracious Complaint was partially granted, with the Claimant being informed of the draft decision of partial grant of the complaint through Letter No. …/…, of 23 November 2010 (Doc. 4 attached to the Report), having maintained unchanged the correction in question in the present proceedings.

4. This decision of partial grant of the complaint was converted to final and notified to the Claimant by Letter No. …/…, of 15 December 2010.

5. The Claimant filed a timely Hierarchical Appeal (Doc. 5 attached to the Report), for non-acceptance of the financial charges incurred by A…, with the Respondent maintaining unchanged the correction in question in the present proceedings.

6. The hierarchical appeal received partial grant by order that, while maintaining the correction, accepted as the new amount the sum of €571,058.64 (and not €574,753.01 as stated in the inspection report and the gracious complaint);

7. The Claimant incurred expenses or financial charges during the year 2005 (which it considered to be fiscally relevant for the purposes of applying the provision of article 31(1) of the TBS then in force).

8. The shares/capital parts acquired by the Claimant are classified in the accounts under Class 4 - Investments, and recognized in Account 41 - Financial Investments, which reveals that the intention of the holder is not to alienate them in the short term, as in that case they would have been classified in Class 1 - Net Financial Assets.

9. For coercive collection of the aforementioned assessments in item 5 above, the Respondent instituted against the Claimant the Tax Enforcement proceedings No. …2009….

10. The Claimant, to suspend the proceedings of that Enforcement, presented bank guarantee No. …, issued by DD… on 12-11-2012, in the amount of €162,341.24 (Doc. 8, attached to the Report).

A.2. Unestablished Facts

It was not established:

• that part of the financial charges mentioned above, in item 11 of the list of established facts, concerned the acquisition of shares

A.3. Reasoning of Established and Unestablished Facts (cont.)

It is recalled preliminarily that the Tribunal is not required to pronounce on everything alleged by the parties; rather, it has the duty to select the facts that matter for the decision and distinguish established facts from unestablished facts [see article 123(2) of the Code of Tax Procedure and article 659(2) of the Code of Civil Procedure, applicable ex vi article 29(1)(a) and (e) of the LRTA].

In this manner, the facts relevant to the decision of the case are selected and delineated based on their legal relevance, which is established in consideration of the various plausible solutions of the legal question(s) (see article 511(1) of the Code of Civil Procedure, applicable ex vi article 29(1)(e) of the LRTA).

In light of the foregoing, the factual framework relevant in the case sub judice is that which has been described above.

In establishing it, the Tribunal considered the positions of the parties in their respective pleadings as well as all the documentary evidence incorporated in the proceedings, including a copy of the administrative file attached by the TA.

Consideration was also given, in particular, to the fact that the shares held by the Claimant on 31-12-2005 were acquired on dates prior to 2001, leaving it uncertain which specific shares were acquired using the financings or financial charges assumed in 2005 (See above, item 4 of the established facts).

And such burden of proof fell on the TA insofar as these were facts constitutive of the rights of the tax administration – See article 74 of the General Tax Law.

Hence the consideration as unestablished that "(…) the Claimant had incurred expenses or financial charges during the year 2005 (…) that were fiscally relevant for the purposes of applying the provision of article 31(1) of the TBS then in force (…)"

Certainly, in the field of tax law, the burden of proof does not have the subjective dimension of other branches of law, but rather an objective one, in the sense that what matters for the decision of the merits of the case, whether in administrative proceedings or in judicial proceedings, is what emerges from the truth of the facts achieved, regardless of which party bears the burden of such proof, given the predominance of the inquisitorial principle contained in articles 99 of the General Tax Law and 13 of the Code of Tax Procedure; however, when such proof is not achieved and given the impossibility of the tribunal remaining in a state of non liquet – see article 8(1) of the Civil Code – then the case must be decided against the party burdened with such burden of proof (in the present case and as noted, the TA).

Thus, having regard to the foregoing and the positions assumed by the parties, the documentary evidence and the copy of the Administrative File attached to the proceedings, the facts listed above were considered established and unestablished, with relevance to the decision.

II. REASONING

B. The Law

1. As a preliminary approach to the legal reasoning, it should be noted what has long been the understanding of the case law regarding the duty to appreciate the arguments presented by the parties, which is translated into the non-obligation (our emphasis) of the Courts to appreciate all the arguments formulated by the parties (See, inter alia, Judgment of the Plenary of the 2nd Section of the Superior Administrative Court, of 7 June 95, appeal 5239, in Official Gazette – Appendix of 31 March 97, pages 36-40 and Judgment of the Superior Administrative Court – 2nd Section – of 23 April 97, Official Gazette/Appendix of 9 October 97, page 1094).

2. The object of these proceedings comes down to examining the (il)legality of the acts of rejection of the gracious complaint and the hierarchical appeal and the act of additional Corporate Income Tax assessment No. 2009 … of 28-5-2009, relating to the 2005 tax period, designated and specifically whether an adjustment is due (as the TA contends) to the taxable profit for the 2005 fiscal year, in the sphere of the Claimant, in the amount of €571,058.64, relating to financing costs incurred for the acquisition of shares, on the understanding that such costs did not contribute to the formation of taxable profit in light of the provision of article 31(2) of the Tax Benefits Statute (Decree-Law No. 215/89, of 1 July, as worded in 2005).

3. According to the wording of article 31(2) of the TBS, in force at the date of the facts under consideration, "(…) the capital gains and capital losses realized by holding companies and real estate investment companies through the onerous transmission, whatever the title under which it operates, of capital shares of which they are holders, provided that held for a period of not less than one year, and likewise the financial charges incurred with their acquisition do not contribute to the formation of taxable profit of these companies (…)".

4. For its part, article 31(3) of the said statute establishes an anti-abuse rule relating to the taxation of capital gains and financial charges related to financial shares that have been acquired from related entities or entities domiciled, seated or having effective management in territory subject to a more favorable tax regime, contained in a list approved by an ordinance of the Minister of Finance, or residents in Portuguese territory subject to a special taxation regime, when these shares have been held by the alienator for a period of less than three years or, furthermore, when the alienator resulted from the transformation of a company to which the regime provided for in article 31(2) of the TBS did not apply, in relation to the capital gains of the capital shares subject to transmission, provided that, in this latter case, less than three years have elapsed between the date of transformation and the date of transmission.

5. The TA contests the conduct of the Claimant embodied in the adoption of a principle of deductibility, understanding that "considering that, as a general rule, it will not fall to holding companies to proceed with the alienation of shares before one year has elapsed since their acquisition, it seems appropriate to understand that the shares held by holding companies will comply, at the moment of their respective alienation, with the necessary requirements for the applicability of the special regime in question. And, in this manner, it is to be concluded that the adjustment of taxable profit relating to the financial charges incurred with the acquisition of capital shares that are susceptible to benefiting from the special regime established in article 31(2) of the TBS should be carried out in the period in which they occur.

6. In other words and more specifically: underlying the additional Corporate Income Tax assessment now under examination, there is the interpretation and application, by the TA, of the provision of article 31(2) of the TBS (2005 wording) to the effect that "the financial charges incurred with the acquisition of capital shares (shares) - €571,058.64, (…) did not contribute to the formation of taxable profit, which were added, by application of Circular No. 7/2004, of 30 March, applicable to acts performed from 1 January 2003, even though they relate to financings contracted before that date".

7. It being undisputed that the Claimant met the legal requirements necessary to enjoy the tax benefit provided for in article 31(1) of the TBS in force in 2005, the question is whether the assessment act that disregarded, for purposes of formation of taxable profit in Corporate Income Tax, the financial charges incurred in the alleged acquisition of shares held for a period of not less than one year, is affected by illegality due to violation of this rule.

8. The period of time for holding the shares, whenever they had been acquired from a related entity or with domicile in territory subject to a more favorable tax regime, contained in an Ordinance of the Minister of Finance, was three years and no longer one, as resulted from article 31(3) of the same TBS.

9. Now, in the understanding of the Claimant, citing Tiago Caiado Guerreiro (Fiscal Review, No. 26, The New Regime of Holding Companies), the difficulty regarding the moment of definition of the regime "(…) relates to the fact that at the end of the fiscal year in which the financial charges began to be incurred, the requirements that would allow one to affirm that the share will be held in the ownership of the holding company for the minimum period of one year (or three years in the case of being encompassed in the anti-abuse regime) may not yet be met and, consequently, whether the financial charges incurred with the acquisition of the share will or will not be considered in the formation of taxable profit.

In effect, the company will only be able to affirm this with certainty after the period of one year on the acquisition has elapsed, in general terms, or three years in the case of having been acquired from an entity in one of the situations indicated by the anti-abuse rule".

1. Hence, the Claimant concludes, it has always guided its conduct by the adoption ab initio of deductibility, consisting of such conduct in considering, as a general rule, that financial charges are deductible and only at the moment of verification of the suspensive condition and if such suspensive condition is verified, to proceed with the necessary adjustments in accordance with articles 31(2) and (3) of the TBS.

2. There are therefore two issues to be decided: (i) Whether the financial charges incurred by the Claimant are or are not fiscally deductible, pursuant to article 31(2) of the TBS (current article 32(2) of the TBS) and (ii) whether the method of determining non-deductible financial charges can be implemented through Circular 7/2004, of 30 March.

3. As already noted, the Tax Authority added the amount of €571,058.64 to the net profit declared by the Claimant in the 2005 fiscal year, considering that it should have disregarded – for the purpose of determining taxable profit – the financial charges allegedly incurred with the acquisition of shares susceptible of benefiting from the regime provided for in article 32(2) of the TBS (as worded in 2005).

4. The Tax Authority based the Corporate Income Tax acts now in question, relating to the year 2005, as well as its subsequent decision to reject the gracious complaint and the hierarchical appeal, on strict compliance with Circular No. 7/2004, of 30 March, understanding that it should not consider as costs deductible from taxable profit the financial charges attributable to capital shares of subsidiary companies determined in accordance with the rules provided in that circular.

5. Law No. 32-B/2002, of 20 December, which approved the State Budget for 2003, further amended the regime for taxation of capital gains realized by holding companies, which became exempt from contributing to the formation of taxable profit in Corporate Income Tax, and in parallel decided to exclude the deductibility of capital losses and financial charges incurred by such companies, based on their contractual purpose, which in the case of holding companies is the management of shares in other companies, as an indirect form of exercise of economic activities.

6. The reasons underlying this legislative amendment are explained in the Report of the State Budget for 2003. Under the heading "Main amendments in Corporate Income Tax," and the subheading "Expansion of the tax base and measures for moralization and neutrality", the exemption from Corporate Income Tax taxation of capital gains realized by holding companies with the alienation of capital shares held for more than one year is pointed out, accompanied by measures conducive to avoiding abusive tax planning, bringing the national regime closer to the Dutch model, a measure associated with the establishment of a regime of disregard of deductibility, for the purposes of determining the taxable profit of such companies, of charges of a financial nature directly associated with the acquisition of the corresponding capital shares (report accessible at www.dgo.pt).

7. The objective of this new legislative direction was, specifically, to disregard for tax purposes the capital gains/capital losses obtained on the alienation of financial shares by holding companies, disregarding, simultaneously, the financial charges that would come to be incurred as a result of the need to seek financial resources from third parties to finance the acquisition of these shares. This non-consideration of financial charges aimed to counterbalance the tax benefit granted to capital gains of holding companies.

8. The legal basis for supporting the correction made by the Tax and Customs Authority was the provision of article 32(2): "The capital gains and capital losses realized by holding companies and real estate investment companies of capital shares of which they are holders, provided that held for a period of not less than one year, and likewise the financial charges incurred with their acquisition do not contribute to the formation of taxable profit of these companies".

9. This rule sought to ensure a possible balance of the situation, that is, in the non-deduction, on the one hand, of interest in the calculation of taxable profit subject to tax, and, on the other hand, non-subjection to tax on the gain from capital gains resulting from the alienation of shares, so as to ensure non-violation of the principles of contributory capacity, taxation on actual income, and equality and neutrality (these last two by way of comparison with taxpayers who do not assume the legal status of holding companies).

10. The enjoyment of this benefit, under the conditions defined in the law, will impose a limitation on the deductibility of financial charges incurred with the financings necessary for the acquisition of this type of investment.

11. The central question here at issue is, it is reiterated, the disregard of financial charges from the fiscal point of view in light of a tax benefit that the legislator decided to grant to a certain type of legal entity, holding companies.

12. The other issue to be decided concerns the method to be used for determining the financial charges that should be excluded from the determination of taxable profit and, more exactly, whether that method can be implemented, without violation of the Law, through Circular No. 7/2004, of 30 March, of the Tax and Customs Authority.

13. Within the scope of article 32(2) of the TBS, and given the difficulties in its practical application, the TA felt the need to publish a circular – Circular No. 7/2004 – which aimed to clarify the method of allocation of financial charges, taking into account the manner of allocation of the financings that originated the financial charges, considering their application, that is, the assets that had been acquired through these resources by holding companies. In this sense, and according to the TA, the aforesaid Circular merely densifies the provision of article 32(2), allowing the practical difficulties of direct imputation of charges to be overcome.

14. The Claimant, however, challenges the legal role of this Circular, alleging that the TA did not limit itself to interpreting article 32(2) of the TBS, but created a substitute method to the method provided for in the legal rule. In this sense, the rules contained in points 7 and 8 of the DSIRC Circular No. 7/2004, of 30 March, more specifically the formula provided for there, with the claim of mandatory application, for segregation of the financial charges referred to in (at the date of the facts) article 31(2) of the Tax Benefits Statute (current article 32(2)), is unconstitutional, by violation of the principle of legality or the reservation of law, in tax matters, provided for in articles 103(2) and 165(1)(i) of the Constitution.

15. Thus, it is important, first, to ascertain what is the exact scope of the Circular and, then, given the legal role that falls to Circulars, to conclude whether or not the principle of legality was violated.

16. Point 7 of that Circular provides that: "given the extreme difficulty in using, in this matter, a method of direct or specific allocation and the possibility of manipulation that it would allow, such imputation should be carried out on the basis of a formula that takes into account the following: the remunerated liabilities of holding companies and real estate investment companies should be imputed, first of all, to the remunerated loans granted by them to subsidiary companies and to other investments generating interest, allocating the remainder to the other assets, namely shares, proportionally to their respective acquisition cost".

17. Thus, according to the TA, article 32(2) of the TBS would support an interpretation to the effect of the admission of an indirect calculation formula that allows taxpayers to determine the possible allocation of total financial charges incurred, between deductible and non-deductible financial charges for tax purposes, in a holding company, this resulting from the fact that, as a general rule, there is no direct factual relationship between the total funds obtained by the holding company, which involved the payment of interest, and the funds invested in the acquisition of the shares.

18. To this effect, it is stated in case 738/2014-T of the CAAD that: "(…) the Administration understood that it should clarify the manner of estimating the charges that could be attributed to the acquisition of these capital shares, through Circular 7/2004, on the basis of the idea of the fungibility of money. It advances in that circular with the adoption of a very simple mathematical formula – although complicated from the point of view of the assumptions used in the classification of the items to be considered – in order to determine, in the application of article 32(2) of the TBS, which "financial charges incurred" with the acquisition of capital shares, face to the total financial charges incurred by the entity in the accounting period, given that the tax legislator chose its disregard for tax purposes for purposes of determining the taxable profit of each economic period".

19. In a question similar to that raised by the Claimant, within the scope of case no. 21/2012-T, where the appellant questioned the constitutional conformity of the application of a pro rata formula in the determination of financial charges associated with the acquisition of shares, excluded from the formation of taxable profit, as opposed to the method of direct or real allocation, it was discursed in the following sense: "(…) 63. Still, it will always be said that, agreeing with the hermeneutics advocated by the Claimant, nothing in the wording of article 31(2) of the TBS allows the validity and, therefore, necessary application, of the indirect method of allocation of such financial charges to be withdrawn. 64. It is considered that in cases where there is the possibility of direct allocation, it should not be set aside; and that if the ratio legis of the rule provided for in article 31(2) of the TBS is to ensure the validity of a regime of neutrality of income and costs associated with capital gains excluded from taxation, ensuring that income not fiscally relevant should correspond, reciprocally, to a cost that is also not fiscally relevant, then, in this manner, to achieve this goal, any method (direct or indirect) is good as long as the aforesaid ratio legis is safeguarded (…)".

20. See, by way of example, what is referred to in the Judgment of the Central Administrative Court of the South, Case No. 02312/08, in which it is stated: "(…) the Circular, in addition to being illegal for lack of legal authorization to interpret extensively norms of tax incidence, would be illegal, for abusive distortion of Community rule and illegal respective transposition. In this sense, also the aforesaid Circular, by limiting the incidence rule would be unconstitutional by violation of what is provided for in articles 165(1)(i) and 103(2) of the Constitution of the Portuguese Republic, injuring the principle of separation of powers. In this manner, the administration had usurped the functions of the legislator".

21. The Claimant therefore understands that Circular No. 7/2004, of 30 March, used by the Tax Authority to carry out the correction under examination, goes beyond mere interpretation of tax law, having no basis in article 31(2) of the TBS.

22. From the foregoing, it results that the legislator considers that only charges directly incurred with the acquisition of capital shares are excluded from taxation. On the other hand, the legislator did not consider it fit to institute a different criterion that, faced with the real practical difficulties of distinction, would allow to determine, even if indirectly or on an estimated basis, the financial charges with the acquisition of the non-taxable capital shares.

23. Thus, the method applied by the Circular violates the provision of article 31(2) of the TBS, as it does not take into account the charges actually incurred with the acquisition of non-taxed shares, but rather approximate values and presumptions that lack legal foundation.

24. In effect, the application of the formula provided in the Circular does not allow one to perceive which charges are incurred with the acquisition of non-taxed capital shares, but establishes a proportional allocation between the set of remunerated liabilities and loans to subsidiaries and the remainder that finances other assets (including shares), from which results an estimate of the charges (which may or may not correspond to the actual charges).

25. Furthermore – and as decided in the Judgment of CAAD of 21/12/2012, Case 24/2012 – "(…) Circular No. 7/2014, when establishing criteria and methods through which the incidence of tax is verified, is, to the extent that its application has external efficacy, namely in corrective tax assessments, unconstitutional, by violation of the principle of legality embodied in article 103 and the reservation of formal law contained in article 165(1)(i), both of the Constitution. This notwithstanding the mere illegality that would always result from the comparison between that Circular and article 8 of the General Tax Law (…)".

26. In this same sense, the Judgment of the Central Administrative Court of the North, of 15 January 2015, Case No. 00946/09.0BEPRT, in which it is stated: "(…) The fact that in its methodology it used the criteria recommended in circular no. 7/2004, of 30 March, in particular its points 7 and 8, does not save the legality of the operation, as the criteria and assumptions for imputation of remunerated liabilities of holding companies manifestly exceed the content of article 31(2) of the TBS, creating presumptions and proportional determinations that the legislator manifestly did not assume or consent to (…)".

27. In other words: Circular No. 7/2004 cannot translate a valid and acceptable interpretation of the provision of article 31(2) of the TBS to the extent that it does not comply with the basic rules and principles that govern legal hermeneutics in light, specifically, of the principle established in article 11(1) of the General Tax Law ("in determining the meaning of tax rules and in qualifying the facts to which they apply, the general rules and principles of interpretation and application of laws are observed").

28. With the objective of unveiling the true meaning and scope of legal texts, the interpreter resorts to the interpretive factors which are essentially the grammatical element (the text, or the "letter of the law") and the logical element, which, in turn, is subdivided into the rational element (or teleological), the systematic element and the historical element. (See Baptista Machado, Introduction to Law and Legal Discourse, page 181; Oliveira Ascensão, Law – Introduction and General Theory, 2nd Edition, Calouste Gulbenkian Foundation, Lisbon, page 361).

29. It is article 9 of the Civil Code that provides the rules and fundamental elements for the correct and adequate interpretation of rules.

30. From this it follows that if the interpretation must reconstruct the "legislative thought", the interpreter or applicant must, however, always do so starting from the necessary assumption of the existence of a minimum correspondence with the letter of the Law.

31. In other words: the literal or grammatical element (text or "letter of the law") "is the starting point of interpretation. As such, it immediately has a negative function: that of eliminating those meanings that do not have any support, or at least some correspondence or resonance in the words of the law (See Pires de Lima and Antunes Varela, Annotated Civil Code – vol. I, Coimbra ed., 1967, page 16)".

32. Now, from the foregoing, it appears sufficiently evident that Circular No. 7/2004 "interprets" the provision of article 31(2) of the TBS in terms that violate the aforesaid rules of hermeneutics to the extent that therein is found innovative legislative material and not merely a valid interpretation of the text of the Law.

In summary:

1. Faced with the alleged lack of information by the taxpayer, the Respondent proceeded to apply the method provided for in Circular No. 7/2004, of 30 March, taking into account, for that purpose, the information contained in the analytical trial balance and the financial statements.

2. Now, from the analysis of the administrative proceedings and the inspection report, it results that, in the face of the non-existence of any tax correction in the Form 22 return of charges attributable to capital shares that do not contribute to taxable profit, the TA presumed its omission and proceeded to determine the respective charges through the method provided for in Circular No. 7/2004.

3. Without prejudice to the assessment of the legality of the method used, the Tax and Customs Authority, as has already been stated when reasoning the facts, would have to prove the premises of the tax correction carried out, namely the existence of non-taxed financial charges with the acquisition of capital shares.

4. And, in this respect, it should not be argued with the non-existence of tax corrections in the Form 22 return because this does not mean, of itself, the proof of an omission or error attributable to the taxpayer, but only that there are no financial charges not accepted fiscally, given the presumption of veracity and good faith of the taxpayer's declarations (article 75 of the General Tax Law). Where there are indications that such declaration did not correspond to the truth, it fell to the TA to demonstrate and prove the existence of non-deductible financial charges, in accordance with article 74(1) of the General Tax Law, which did not happen in the inspection report.

5. On the contrary, instead of such proof and despite the Claimant not having carried out any financial investments (acquisition of capital shares or formation of new companies) during the year 2005, the TA merely proceeded to correct a certain amount of financial charges, without taking care to prove the existence of the factual premises of its action.

6. Thus, the TA in applying the method provided for in paragraph 7 of Circular No. 7/2004, of 30 March, violated the provision of article 32(2) of the TBS, which provides for the non-deductibility of financial charges of the charges actually incurred with the acquisition of capital shares.

Regarding Compensation for Damages Resulting from the Provision of Bank Guarantee

1. The Claimant provided a bank guarantee in the amount of €162,341.24, on 12 November 2012, intended to ensure payment and suspend the tax enforcement of the aforementioned and now impugned additional assessment [see established facts – "(…) 13. For coercive collection of the aforementioned assessments in item 5 above, the Respondent instituted against the Claimant the Tax Enforcement proceedings No. …2009…. (…) 14. (…) the Claimant, to suspend the proceedings of that Enforcement, presented bank guarantee No. …, issued by DD… on 12-11-2012, in the amount of €162,341.24 (Doc. 8, attached to the Report) (…)"].

2. The General Tax Law provides:

Article 53

Guarantee in Case of Improper Payment

1 - The debtor who, to suspend enforcement, offers a bank guarantee or equivalent shall be indemnified in full or in part for damages resulting from its provision, if he has maintained it for a period exceeding three years in proportion to the time of successful appeal, administrative challenge, or opposition to enforcement that have as their object the debt guaranteed.

2 - The period referred to in the preceding number does not apply when it is verified, in gracious complaint or judicial challenge, that there was error attributable to the services in the assessment of the tax.

3 - The indemnification referred to in paragraph 1 has as its maximum limit the amount resulting from the application to the guaranteed value of the rate of indemnifying interest provided for in the present law and may be requested in the gracious complaint process itself or in judicial challenge, or autonomously.

4 - Indemnification for provision of improper guarantee will be paid by deduction from the revenue of the tax of the year in which payment was made.

49 - This assessment suffers from illegality attributable to the Services: the taxpayer will obtain success in the challenge and the reason for annulment is not attributable to it.

50 - The period of 3 years referred to in article 53(1) of the General Tax Law is thus applicable, in the present case.

51 - Being public and notorious that for the service of providing a bank guarantee, charges/commissions are paid to Banks depending, namely, on the risk, value and period of the guarantee, it must be concluded that, although not alleged, the Claimant incurred [and certainly continues to incur] charges for the maintenance of that guarantee.

52 - In other words: the requirements conferring on the Claimant the right to indemnification under article 53 of the General Tax Law are recognized as met.

53 - It is true that the quantum of indemnification was not specified.

54 - However, this need not necessarily have been alleged because whoever demands indemnification does not need to indicate the exact amount of damages – See article 569 of the Civil Code.

55 - The assessment of indemnification shall thus proceed in execution of judgment.

56 - The request for indemnification may be made in the proceedings in which the legality of the enforceable debt is contested – See article 171 of the Code of Tax Procedure.

III – DECISION

In consequence of the foregoing, this Arbitral Tribunal agrees:

a) To annul the aforementioned orders issued in gracious complaint and hierarchical appeal proceedings to the extent that, as set forth above, they rejected the request now at issue in these proceedings;

b) To annul the additional Corporate Income Tax assessment No. 2009…, of 28 May 2009, which resulted in a correction to the taxable income of group B… determined in 2005, in the amount of €574,753.01 and in the consequent additional Corporate Income Tax assessment with an amount due of €145,258.94 [€144,672.33, relating to tax and €586.61 relating to compensatory interest];

c) To judge the bank guarantee provided in Tax Enforcement proceedings No. …2009… as improper;

d) To judge the request for indemnification for damages resulting from the provision, now judged improper, of that bank guarantee as well-founded;

e) To condemn the Tax and Customs Authority to pay indemnification to the Claimant, in accordance with and within the limits provided for in article 53 of the General Tax Law and to be assessed in execution of judgment, arising from the success of the request to which the preceding items allude; and

f) To condemn the Tax and Customs Authority to pay the costs of these proceedings.

Value of Proceedings: In accordance with the provision of article 306(2) of the Code of Civil Procedure and article 97-A(1)(a) of the Code of Tax Procedure and article 3(2) of the Regulation of Costs in Tax Arbitration Proceedings, the value of the proceedings is fixed at €145,258.94.

Costs: The amount of costs is fixed at €3,672.00 (Table I attached to the Regulation of Costs in Tax Arbitration Proceedings), with payment being the responsibility of the Tax and Customs Authority (article 22(4) of the LRTA).

Lisbon and CAAD, 2-3-2016

The Collective Arbitral Tribunal

José Poças Falcão
(President)

Ana Maria Rodrigues
(Member)

Vasco Valdez
(Member)

[1] Throughout the present decision, reference to applicable legislation will be made by reference to the legislation in force at the date of the tax facts, i.e., in the fiscal year 2005.