IRC Deductibility of Expenses, SNC Transition Adjustments & Fair Value – CAAD 30/2015-T

ARBITRAL DECISION

The arbitrators Fernanda Maçãs (President Arbitrator), Paulo Lourenço and Maria Manuela do Nascimento Roseiro, hereby agree to the following:

I. REPORT

A…, SGPS, SA., Tax Number (NIPC) …, presented on 19/1/2015 a request for constitution of a collective arbitral tribunal, in accordance with the combined provisions of Articles 2.º and 10.º of Decree-Law No. 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter referred to only as RJAT), in which the Tax and Customs Authority is Respondent.

The claim subject to the request for arbitral pronouncement consists of the assessment of the legality of two additional IRC (Corporate Income Tax) assessments, relating to the tax year 2011, No. 2014…, of 2014-09-10, which resulted in IRC amount payable of €1,392,593.45, which includes €106,582.00 of compensatory interest, and relating to the tax year 2012, No. 2014…, of 2014-09-10, which resulted, after compensation, in the total amount payable of €172,035.87, which already includes €6,512.11 of compensatory interest.

On 20-1-2015 the request for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority.

3.1. In the request for arbitral pronouncement, in compliance with the provision of Article 10.º, n.º 2, paragraph g), of Decree-Law No. 10/2011, of 20 January (hereinafter, Legal Framework for Tax Arbitration or RJAT), the Claimant expressed the intention to appoint an arbitrator in accordance with paragraph b) of n.º 2 of Article 6.º of the aforementioned RJAT.

3.2. Consequently, the constitution of the arbitral tribunal was carried out in accordance with the provision of paragraph b) of n.º 2 and n.º 3 of Article 6.º and n.ºs 2, 4, 5 and 6 of Article 11.º of the RJAT, with the parties having proceeded to appoint their respective arbitrator, Dr. Paulo Lourenço, appointed by the Claimant, and Dr. Maria Manuela do Nascimento Roseiro, appointed by the Respondent, who, in turn, in compliance with the provisions of Article 3.º, n.º 2, paragraph b), of Regulation No. 112-A/2011, of 22 March, appointed the President Arbitrator, Counsellor Fernanda Maçãs.

In accordance with and for the purposes of the provision of n.º 7 of Article 11.º of the RJAT, the Honourable President of CAAD informed the Parties of this appointment on 31-03-2015.

In compliance with the provision of n.º 7 of Article 11.º of the RJAT, with the wording introduced by Article 228.º of Law No. 66-B/2012, of 31 December, after the deadline provided for in n.º 1 of Article 13.º of the RJAT had elapsed, it was communicated that the collective Arbitral Tribunal was constituted on 17-04-2015.

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

To support the request for arbitral pronouncement, the Claimant alleges the following:

a) It was subject to a tax inspection action aimed at verifying, for the tax years 2010 and 2011, the legality of tax expenses relating to transition accounting adjustments resulting from the introduction of the Accounting Normalization System (SNC), within the scope of the transitional regime provided for in Article 5º of Decree-Law No. 159/2009, of 13 July;

b) In the Report corrections of three types were made, relating to: a) transition adjustments regarding the effects on equity resulting from the adoption, for the first time, of accounting and financial reporting standards, which have an impact, given the provision of Article 5.º of Decree-Law No. 159/2009, of 13 July, on the tax years 2011 and 2012; b) tax effects of adjustments resulting from the application of fair value, in the tax years 2011 and 2012; c) losses resulting from the onerous transfer of financial instruments (shares) recognized at fair value, in accordance with paragraph a) of n.º 9 of Article 18.º of the CIRC;

c) The fundamental question in dispute in these proceedings concerns the interpretation and application of the provision of n.º 3 of Article 45.º of the CIRC, and the Tribunal should consider incorrect the interpretation that the Tax Authority made of the aforementioned rule and decide that it does not include adjustments resulting from the application of fair value to financial instruments that are relevant to the formation of taxable profit nor losses resulting from the onerous transfer of financial instruments recognized at fair value that are relevant to the formation of taxable profit in accordance with paragraph a) of n.º 9 of Article 18.º;

d) The strictly literal interpretation of n.º 3 of art. 45º of the CIRC made by the Tax Authority is based on the doctrine sheet issued in Process No. 39/2012, without taking into account the ratio legis of the provision and ignoring the historical element of interpretation;

e) Until the inclusion by the State Budget for 2003 of n.º 3 of (then) art. 42º of the CIRC, no rule was established regarding the non-deductibility of capital losses, considering costs or losses "capital losses realized" (art. 23º, paragraph i) of the CIRC);

f) Although the limitation of deductibility introduced raises questions about taxation on actual profit, the treatment of capital losses can still be justified precisely in light of the principle of proportionality, as a symmetrical treatment to that resulting from the positive difference between gains and losses, taking into account cases of reinvestment of realization values;

g) As regards the amendment of the second part of the rule, by the State Budget for 2006, it aimed only to clarify existing doubts regarding the equivalence of the treatment of supplementary contributions to capital shares, regarding their inclusion in the concept of capital contributions and not to create another component consisting exclusively of losses or negative variations contributing to the formation of taxable profit in half their value;

h) The treatment to be given should not be autonomous but in concurrence with the gains and losses of the first part of the provision, that is, the rule should be applied as a whole: "only the negative result given by the algebraic sum of the gains, losses and other losses is covered by the provision of n.º 3 of the aforementioned Article 45.º" (n.º 37 and 41 of the request), according to the formula "Negative difference = Gains – Losses – Losses – Negative patrimonial variations";

i) According to this interpretation, in the case at hand, even considering n.º 3 of Article 45º applicable, there is no correction to be made because there is no negative overall result;

j) Even if the aforementioned rule were applicable, the positive adjustments would also be considered in 50%;

k) In any case, given that the ratio of n.º 3 of Article 45.º of the CIRC is the limitation of the deduction of charges that are considered borne, resulting from transfers, non-reversible, that is, which have been consolidated in the legal order, which is manifestly not the case of losses resulting from the reduction in fair value of capital shares - by nature reversible and dependent on the evolution of the respective stock exchange quotations - the inclusion of fair value reductions in the provision of that n.º 3 of Article 45.º could only be made by analogical application (if there were analogy between losses actually borne and mere potential losses resulting from the fluctuation of the stock exchange value of securities, which is manifestly not the case);

l) The application, within the framework of the SNC, to cases in which the variation in quotation became relevant for tax purposes in certain circumstances (articles 18º, n.º 9, paragraph a), 20º, n.º 1, paragraph f) and 23º, n.º 1, paragraph j), of the CIRC) is susceptible to violating basic principles of our tax system – such as equality, legality and material justice - contained in n.º 2 of Article 5º of the LGT because gains resulting from the application of the fair value model (because its stock exchange quotation fell), would contribute to the formation of taxable profit in half its value, while increases in fair value (because its stock exchange quotation rose) would be taxed in full (combination of article 18, 9, a) and article 20º, n.º 1, f), both of the IRC Code);

m) Even in the absence of transfer of shares and any financial receipt, with the accumulated accounting result being zero by application of any of the methods, it would be definitively taxed on an income it did not obtain, which contravenes the most elementary principles by which business taxation should be governed;

n) If by mere hypothesis the financial holding represented more than 5% of the capital of the investee company, the effects of the fair value method would not be tax-relevant, which further emphasizes the lack of any basis for the Tax Authority's understanding;

o) The arbitral decision in proc 108/2013-T confirms the interpretation defended here that the scope of application of n.º 3 of Article 45.º of the CIRC is limited to losses realized resulting from onerous transfers, excluding from its scope of application potential losses such as losses resulting from adjustments to fair value;

p) Having demonstrated that n.º 3 of Article 45º of the CIRC does not apply to adjustments resulting from the use of the fair value method, which, annually, during the period of holding of financial instruments, are recognized in the accounts, it follows that it also does not apply to the result obtained by the transfer of the financial instrument because, although at that moment the definitive gain or loss attributable to the financial instrument is consolidated, this result has been recognized in the accounts throughout its holding period and, consequently, the result recognized in the tax year of its sale may be entirely different from that final result;

q) Thus, as the gain or loss recorded in the tax year of alienation of the financial instrument results from a final adjustment of a security recognized at fair value, it also does not fall within the provision of n.º 3 of Article 45.º of the CIRC;

r) In summary, no amount of the negative component of transition adjustments and subsequent adjustments should be added to the taxable base of the tax years 2011 and 2012, since the provision of n.º 3 of Article 45.º of the IRC Code does not apply to their tax treatment, rather the provision of paragraph i) of n.º 1 of Article 23.º of the same Code, with the wording at that time and, should the question be raised regarding the qualification of negative patrimonial variations attributed to transition adjustments, the regime of n.º 1 of Article 24.º also of the IRC Code."

1. The Tax and Customs Authority presented a response and submitted the administrative file, invoking, in summary, the following:

5.1. By way of objection

a) In the tax year 2010, at the time of transition to the Accounting Normalization System (SNC), the Claimant had, with respect to the social shares held in other companies, a latent positive patrimonial variation of €23,769,764.82 and a negative patrimonial variation of €37,092,751.12, corresponding to the difference between acquisition values and their official quotations, both variations having been reflected in the equity capital accounts;

b) In applying the transitional regime of adjustments provided for in n.ºs 1 and 5 of art. 5º of Decree-Law No. 159/2009, of 13/7, the Tax Authority understood that, given the limitation set out at the end of n.º 3 of Article 45º of the CIRC, both in tax year 2010 and in the tax years 2011 and 2012, only half of 1/5 of the negative patrimonial variation should contribute to the formation of taxable profit, that is, (1/5 x €37,092,751.12) x 50% = €3,709,275.11), while positive patrimonial variations would contribute at the full value;

c) As for the tax effects arising from the variation that occurred during the tax years 2011 and 2012, by application of the fair value method, the application to the case of art. 18º, n.º 9 of the CIRC (the Claimant held a percentage of participation not exceeding 5% of the capital stock of its investees, which had a price formed in a regulated market), the Tax Authority proceeded to make corrections in the determination of the balance (negative) between positive and negative variations resulting from the recognition of financial instruments by application of fair value through profit or loss, understanding that only half - 50% - of the negative variation resulting from the effect of using the fair value method in the valuation of its holdings be accepted fiscally;

d) The same understanding was followed by the Tax Authority in the corrections relating to losses resulting from the alienation, in the tax years 2011 and 2012, of shares in the different companies, in which the Claimant held holdings;

e) It is manifestly in error to invoke illegality of the three types of corrections made by the Tax Authority and the consideration that the provision of Article 45º, n.º 3 of the CIRC does not include adjustments resulting from the application of fair value to financial instruments that are relevant to the formation of taxable profit nor losses resulting from the onerous transfer of financial instruments recognized at fair value, that are relevant to the formation of taxable profit, all in accordance with the provision of Article 18º, n.º 9, paragraph a) of the CIRC;

f) In order not to burden a single tax year with the accounting adjustments of transition, positive and negative, resulting from the adoption of the SNC (DL No. 158/2009, of 13 July), Article 5º of the aforementioned decree-law established, for the first year of implementation, a transitional regime, with distribution of effects in equal parts, over 5 years, from the start of the new system;

g) The application of Article 5.º of Decree-Law 159/2009 should be done in conjunction with Article 45.º, n.º 3 of the CIRC, so the deductible value in each of the five years corresponds to half of 1/5 of the total loss value, in 2010 and each of the four following tax years;

h) The Claimant, in the Model 22 declarations submitted, considered that positive transition adjustments should be balanced against negative transition adjustments and, from the value thus determined, gain or loss, half of 1/5 of the value of that sum should contribute to the formation of taxable profit;

i) The Claimant argues for the non-applicability of Article 45º, n.º 3 of the CIRC to adjustments resulting from the use of the fair value method, and in its view, a negative patrimonial variation should be determined in the amount of €7,418,550.22 for the years 2011 and 2012, considering that 1/5 of the positive transition adjustments and 1/5 of the negative transition adjustments verified should be accepted without any other limitation;

j) However, from a reading of that Article 45.º, n.º 3 of the CIRC, two distinct segments emerge: (1) one relating to the treatment to be given to the negative difference between gains and losses realized through the onerous transfer of capital shares; (2) and another relating to other losses or negative patrimonial variations relating to capital shares;

k) The case at hand is not a situation that falls within the first part of the rule, subject to the tax treatment of gains and losses, but a negative patrimonial variation relating to capital shares, resulting from the accounting adjustments made due to the transition from the POC to the SNC;

l) What contributes to the formation of taxable profit in only half its value will be exactly the losses or negative patrimonial variations in question and not the negative difference between positive patrimonial variations and negative patrimonial variations, as the Claimant intended;

m) In defending an interpretation and application that is global or unitary of the provision, in contrast to the segmented interpretation of it, it is the Claimant that applies the 1st part of Article 45º, n.º 3 of the CIRC, by analogy, that is, the calculation of the difference between gains and losses resulting from the transfer of capital shares to other losses or negative patrimonial variations relating to capital shares;

n) It is not possible to derive from the letter of the law the tax treatment advocated by the Claimant, since the regime provided for in the first part of the legal rule in question applies exclusively to gains and losses resulting from the transfer of capital shares, and is not at all applicable in the determination of the balance between positive and negative patrimonial variations (transition adjustments), nor in the determination of the balance between the differences of the positive and negative variation in quotation relating to social participations held by the taxpayer and recorded at fair value (potential or latent gains);

o) It should be noted that in the 2.ª part of the wording of the rule in question, one does not read "as well as the negative difference between other gains and other losses or between positive patrimonial variations and negative patrimonial variations relating to capital shares (…) contribute to the formation of taxable profit in only half its value" but rather «as well as other losses or negative patrimonial variations relating to capital shares or other components of equity, namely supplementary contributions, contribute to the formation of taxable profit in only half its value.»;

p) What corroborates the interpretation that, as to the concurrence of losses resulting from the variation in fair value of capital shares for the determination of taxable profit, the difference between gains and losses of the year under scrutiny is not relevant, but rather and only the "other losses", so the services of the Respondent acted correctly in promoting the correction for 2011 in the amount of €1,015,221.23 (€2,030,442.46 * 50%) and for 2012 in the amount of €1,039,092.24 (€2,078,184.48 * 50%);

q) The argument that the loss in question is merely potential, and therefore the principle of realization underlying the legal rule under analysis cannot be concretized does not hold, because, although potential or latent gains and losses are, in fact, excluded from taxation, even if expressed in the accounts, adjustments resulting from the application of fair value are tax-relevant when they meet the requirements prescribed in Article 18.º, n.º 9, al. a), by virtue of the provision of Articles 20.º, n.º1, paragraph f), 23.º, n.º1, i) and 45.º, n.º3, all of the CIRC, and cannot, for the reason that potential losses are excluded from taxation, the same occurring with "other losses", since the same have effectively tax relevance and the tax regime applied to them configures an exception to the aforementioned principle forming the system of taxation of corporate income;

r) This interpretation is in accordance with the doctrine sheet issued within the scope of Process No. 39/2011 (order of 24/02/2011, of the General Directorate of Taxes), in the doctrine, André A. Vasconcelos In "Fair value and the IRC Code", Journal of Public Finance and Tax Law, Year 3, Number 4, Winter, page 202;

s) Paragraph a), n.º 9, Article 18.º of the CIRC contains an option to give tax relevance to losses verified in capital shares, regardless of their actual realization, in a clear departure from the principle of realization;

t) This understanding is corroborated by the fact that in successive legislative amendments made to the CIRC, the legislator did not establish in Article 45.º, n.º 3 of the CIRC any exception relating both to losses determined by transition adjustments resulting from the change in the accounting rules, as to losses accepted fiscally resulting from the reduction in fair value through profit or loss, with the rule continuing to apply to all losses, with tax relevance, verified in capital shares, namely potential losses, such as will be the case of variations in fair value;

u) And if the legislator's intention had been the maintenance of the principle of realization, it would not have made the distinction made in n.º 9 of Article 18.º, and in Articles 23.º and 20.º, all of the CIRC, and would not have accepted the possibility of taxation regardless of actual transfer;

v) Given the successive legislative amendments made to Article 45º (formerly 42º), n.º 3 of the CIRC, and the reasons for combating fraud and tax evasion that explain it, it should be understood that the objective pursued was not limited to situations resulting from the onerous transfer of capital shares, for which reason it extended the application of the provision («as well as») to «other losses or negative patrimonial variations relating to capital shares or other components of equity, namely supplementary contributions» - if the legislator intended only with the amendment made by Law No. 60-A/2005, of 30/12, the clarification of the concept of "capital shares", it would have sufficed to add to the rule the proposition "or other components of equity, namely supplementary contributions");

x) Rather, the law intended to apply the limitation on fiscal deductibility to a broader universe of losses, aiming for example at those determined with social shares and supplementary contributions as a result of spin-off, merger and liquidation operations of companies, determining the new wording of the law that then also these should be deductible in only half their value;

y) And if it were the legislator's intention to exclude the losses in question in the case at hand from the scope of application of art. 45.º, n.º3 of the CIRC, it would certainly have made this clear in the law, promoting, for that purpose, the appropriate amendment to the provision in question;

z) The defense of the non-applicability of n.º 3 of Article 45.º would, indeed, and in accordance with an interpretation a contrario sensu, result in a more unfavorable treatment to situations in which the cost method were applied, since that the loss verified with the actual alienation would only be taken into account in half, while the loss verified in the social shares measured at fair value would not suffer any limitation, being fully considered for purposes of determining the taxable base;

aa) Being in question only financial instruments with the requirements defined in art. 18.º, n.º 9, paragraph a) of the CIRC, measured at fair value through profit or loss (i.e., with the changes in its value reflected in net income), the respective owner, taxpayer of IRC, will know that, in each reporting period (at the end of each tax year), the gain reflected in the accounts, will also be fully considered for tax purposes and the loss reflected in the accounts, will only be considered for tax purposes in half its value, in accordance with art. 45.º, n.º 3 of the CIRC, but this exceptional regime, implemented in the consideration of variations in fair value of capital shares, in a given tax year, does not suffer from any contradiction, since the successive fluctuations verified will be taxed in a "continuum" perspective;

bb) The applicability of art. 45.º, n.º 3 of the CIRC does not depend on the circumstance of whether losses have been, or have not been, actually realized but on the circumstance that such losses constitute expenses of the period - in the case of losses with capital shares admitted as negative components of taxable profit in accordance with art. 23.º and art. 18.º, n.º 9, paragraph a), are eligible for purposes of application of the provision of art. 45.º, n.º 3 of the CIRC (thus, Luísa Anacoreta Correia, SGPS: Taxation of the alienation of capital shares" in "Auditors and Reviewers", No. 53 (April/June 2011);

cc) The argument (84.º initial petition) according to which the regime provided for in Article 45.º, n.º 3 of the CIRC would constitute a counterpart to the regime of partial exclusion of taxation of the positive difference between gains and losses, prescribed in Article 48.º of the same decree-law, and should not, therefore, be the aforementioned reductions subject to the tax treatment provided for in the first rule, does not hold;

dd) The exceptional regime provided for in Article 48.º of the CIRC does not operate "automatically", rather it applies only upon the verification of certain requirements, being necessary that for that purpose there is reinvestment, otherwise there is taxation of the gain in full;

ee) Also losses resulting from transfer of financial instruments recognized at fair value are covered by Article 45.º, n.º 3 of the CIRC insofar as it applies to «other losses», being therefore considered in 50% the losses (expenses) generated with the alienation of some of the social shares measured at fair value;

ff) This interpretation does not contravene the constitutional principles of taxation on actual profit, of tax capacity, of reservation of law, of equality and of proportionality;

gg) It is a matter of application of rules approved by the legislator in the use of competencies constitutionally attributed, with the services having made no analogical integration, violating the constitutional principle of reservation of law for rules of objective incidence, in accordance with the terms advocated by the Claimant;

hh) Nor does the inclusion of fair value reductions in the provision of n.º 3 of Article 45.º of the CIRC constitute a violation of taxation on actual income, thus violating the principles of tax capacity, reservation of law, equality and proportionality (having regard to Judgment No. 85/2010 of the Constitutional Court and Judgment of the STA of 15-02-2007, proc.0959/06);

ii) There is no violation of the principle of equality because there are grounds for unequal treatment and Article 13.º of the CRP enshrines the observance of material equality (not merely formal) and should treat "equal what is equal and unequally what is unequal";

jj) The interpretation sustained by the claimant promotes negative discrimination of the accounting adjustments of transition resulting from the introduction of the SNC, of losses resulting from the variation in fair value of capital shares and of losses resulting from transfer of financial instruments recognized at fair value, in view of the applicability of Article 45.º, n.º 3 of the CIRC to the negative difference between gains and losses realized through onerous transfer of capital shares, which is consensually accepted;

kk) Thus, even if the dilatory exceptions are not judged as well-founded, with the discharge of the Respondent from the proceedings, the claim should be considered as lacking merit.

5.2. By way of exception

In addition to these allegations, relating to the merits of the case, the Respondent, in its Response, defended itself preliminarily by exception, having invoked:

a) Exception of lack of competence of the Arbitral Tribunal, on the basis of value, in accordance with n.º 1 of Article 3.º of Regulation No. 112-A/2011, insofar as the value of the proceedings would exceed the value of €10,000,000;

b) Exception of lack of competence of the Arbitral Tribunal, on the basis of subject matter, given the provision of Articles 2.º, n.º 1, and 4º of the RJAT and in Regulation No. 112-A/2011, of 22 March, insofar as the Claimant petitions the correction for 2011 of taxable profit of €6,763,215.70 and, for 2012, of a tax loss of €4,219,144.15.

1. On 19-6-2015 the meeting provided for in Article 18.º of the RJAT took place, in accordance with the content set out in the respective minutes.

In response to the invitation directed by the Tribunal for the Claimant to clarify the request, it dictated for the minutes the following petition:

"In compliance with paragraph a) of the notification now made of the present hearing, the Claimant hereby perfects the initial petition, substituting the request contained in the "conclusion", which it does in the following terms: In these terms and in any other respects that the Arbitral Tribunal may deem appropriate, the present request for arbitral pronouncement should be judged as well-founded and proven, whereby the assessments which are its subject should be declared illegal, based on violation of law, namely the provision of n.º 3 of Article 45.º of the IRC Code and, by error in the legal assumptions, being consequently annulled the said assessments, which is reflected in the following manner, in the fields of table 7 of the corrected Model 22 declarations:

a) As to the tax year 2011:

1. In field 705, where the amount of €2,376,976.48 was entered, the value of €7,418,550.22 should have been entered;

2. In field 737, where the amount of €1,068,325.26 was entered, the value of €0.00 should have been entered.

b) As to the tax year 2012:

1. In field 705, where the amount of €3,709,275.11 was entered, the value of €7,418,550.22 should have been entered;

2. In field 737, where the amount of €1,104,460.77 was entered, the value of €0.00 should have been entered."

To this Petition the Respondent replied, reinforcing the position assumed in the response to the request for arbitral pronouncement, regarding the well-foundedness of the exception of material incompetence of the Tribunal.

The parties also pronounced themselves on the exception of lack of competence of the arbitral tribunal on the basis of value, raised by the Respondent.

As neither of the parties requested that the exceptions invoked be immediately known and decided, it was decided not to immediately rule on them or on the petition for improvement.

Moreover, it was decided, with the agreement of the Parties, that they could present successive written submissions, within a period of 15 days, with 15-10-2015 being set as the date for the issuance of the arbitral decision. This deadline was later extended by the Tribunal to 17 December.

1. The Claimant and the Respondent presented written submissions, maintaining, in essence, the arguments set out in the initial pleadings. It should be noted that the Claimant further specified that the assessments subject to the request should be declared illegal, based on violation of law, namely the provision of Article 45.º, n.º 3, of the CIRC and, on error in the legal assumptions.

II. SANITATION

8.1. Competence of the Tribunal

The respondent raises, in its response, the absolute incompetence of the arbitral tribunal on the basis of value and on the basis of subject matter.

It is necessary to analyze and decide.

8.1.a. Exception of lack of competence of the tribunal on the basis of value

The Respondent invokes the incompetence of the Tribunal on the basis of the value underlying the request, alleging, in summary, that the proceedings exceed the scope of the value to which the Tax Administration is bound, within the scope of disputes submitted to the jurisdiction of arbitral tribunals, contained in Article 3.º, n.º1, of Regulation No. 112-A/2011, of 22 March, which sets a limit of €10,000,000.

In response to the exception, the Claimant invokes, in turn, "to the present request for arbitral pronouncement was assigned the value of €1,564,629.32, which was not contested by the ATA, whereby it has full and manifest competence of this Tribunal, in accordance with the provision of Article 97.º-A, n.º 1, paragraph a) of the CPPT, by reference to n.º 2 of Article 3.º of the Regulation of Costs in Tax Arbitration Proceedings" (see Minutes of the meeting to which this refers).

It appears that reason is on the side of the Claimant.

In proceedings in which the assessment of taxes is challenged, the Code of Procedure and Tax Process (CPPT) expressly provides that the value of the cause be the value of the importance whose annulment is sought, as provided for in Article 97.º-A, n.º1, paragraph a) of the CPPT.

Now, in the case at hand, what is challenged is the illegality of two additional IRC assessments, relating to the tax year 2011, which resulted in the IRC amount payable of €1,392,593.45, and relating to the tax year 2012, which resulted in the total amount payable of €172,035.87, whose annulment is requested from this Tribunal.

Thus, this is the value of the cause for all legal purposes, a value, incidentally, indicated by the Claimant and which was not put in question by the Respondent.

It is therefore held that the invoked exception of lack of competence of the Arbitral Tribunal, on the basis of value, is lacking in merit.

8.1.b. Exception of lack of competence of the tribunal on the basis of subject matter

The Respondent invokes the lack of competence of the Arbitral Tribunal, on the basis of subject matter, given the provision of Articles 2.º, n.º 1, and 4.º of the RJAT and in Regulation No. 112-A/2011, of 22 March, insofar as the Claimant petitions the correction, for 2011, of taxable profit of €6,763,215.70 and, for 2012, of a tax loss of €4,219,144.15.

In the initial petition, the Claimant had formulated the following request:

"In these terms, the present request for arbitral pronouncement should be judged as well-founded and proven with all the consequences of the law, by improper application of n.º 3 of art. 45.º of the IRC Code, it being necessary to determine for the period of 2011 taxable profit of €6,763,215.70 and, for 2012, a tax loss of €-4,147,786.81, promoting, in accordance, the correction of the corresponding IRC assessments".

Upon notification of the scheduling of the hearing, provided for in art. 18.º of the RJAT, the tribunal included, in the order of business, under al. a), the invitation to correct pleading and, under al. b), the hearing of the parties for pronouncement on the subject matter of exception and exercise of the right to be heard.

In the said hearing, the tribunal communicated, to the parties, in compliance with the mentioned al. a) of the order of business, the existence of an irregularity, which could be remedied, in the request formulated by the Claimant, inviting it to reformulate, if it so wished, such request, so as to make it more clear and coherent with the tenor of the initial petition as a whole, to which the Respondent did not object.

Before such invitation, the Claimant reformulated the request initially made, dictating, for the minutes, the following petition:

"In compliance with paragraph a) of the notification now made of the present hearing, the Claimant hereby perfects the initial petition, substituting the request contained in the "conclusion", which it does in the following terms: In these terms and in any other respects that the Arbitral Tribunal may deem appropriate, the present request for arbitral pronouncement should be judged as well-founded and proven, whereby the assessments which are its subject should be declared illegal, based on violation of law, namely the provision of n.º 3 of Article 45.º of the IRC Code and, by error in the legal assumptions, being consequently annulled the said assessments, which is reflected in the following manner, in the fields of table 7 of the corrected Model 22 declarations:

c) As to the tax year 2011:

1. In field 705, where the amount of €2,376,976.48 was entered, the value of €7,418,550.22 should have been entered;

2. In field 737, where the amount of €1,068,325.26 was entered, the value of €0.00 should have been entered.

d) As to the tax year 2012:

1. In field 705, where the amount of €3,709,275.11 was entered, the value of €7,418,550.22 should have been entered;

2. In field 737, where the amount of €1,104,460.77 was entered, the value of €0.00 should have been entered."

In exercise of the right to be heard, the Respondent argued for the maintenance of the petition for well-foundedness of the dilatory exception, on the basis of subject matter, raised by it in the response, dictating, for the minutes, the following:

"Following the improvement of the initial arbitral petition regarding the previously called "conclusion", in view of its new formulation, the Respondent understands that requests have been petitioned that exceed the competence of the present Arbitral Tribunal, for the reasons already presented in the exception raised in its Response (as per Section II.I, articles 61.º to 68.º) which in compliance with the principle of celerity are given here as fully reproduced. In these terms, it asks that the present Tribunal judge the dilatory exception invoked as well-founded, accordingly discharging the Respondent from the proceedings."

Being, in compliance with the provision of al. b) of the order of business of the hearing, granted the floor to the Claimant, to pronounce on the exception of lack of competence raised by the respondent, it dictated, for the minutes, the following petition, in which are highlighted, in italics, the segments with relevance for knowledge of the exception of lack of competence of the tribunal on the basis of subject matter that is now analyzed:

"The Tax and Customs Authority (ATA) raised in its response an exception of competence of the Arbitral Tribunal in two respects:

1. Lack of competence of the Tribunal on the basis of the request formulated by the Claimant;

2. Lack of competence of the Tribunal on the basis of the value attributed by the Claimant to its request for arbitral pronouncement.

"With regard to the question enumerated in 2 by the Claimant, it is necessary to say that the ATA is not correct in any respect, since, as it itself recognizes, "the binding of the services and bodies referred to in Article 1.º of Regulation No. 112-A/2011, of 22 March, is limited to disputes of value not exceeding €10,000,000.00". It happens that, to the present request for arbitral pronouncement was assigned the value of €1,564,629.32, which was not contested by the ATA, whereby it has full and manifest competence of this Tribunal, in accordance with the provision of Article 97.º-A, n.º 1, paragraph a) of the CPPT, by reference to n.º 2 of Article 3.º of the Regulation of Costs in Tax Arbitration Proceedings.

"With regard to the question stated in 1 by the Claimant, it is necessary to say the following: the present request for arbitral pronouncement is based on a request for declaration of illegality of assessment acts under IRC, namely of the tax years 2011 and 2012, which falls within the competence of this Tribunal. This is the request for arbitral pronouncement presented by the Claimant. Everything else is in fact a consequence of the request for declaration of illegality. For this reason, the Respondent is not correct, since what is requested is made under the provision of n.º 1 of Article 2.º of the RJAT, by which this Tribunal is governed." (italics ours)

Requested the floor, the Respondent pronounced itself, dictating, for the minutes, the following petition, from which is highlighted, in italics, the extract with relevance in the present context:

"In accordance with the petition already dictated in the present minutes by the Respondent and without prejudice to that now invoked by the Claimant in response to the exception relating to the value underlying the arbitral request, given all the requests formulated by it in its request for arbitral pronouncement, following the invitation for improvement from this Tribunal, it understands being of maintaining the exception raised by it in the response it presented (especially in articles 74.º to 78.º of the same which are given here as fully reproduced) in these terms, given everything that was petitioned concludes that the Arbitral Tribunal constituted is materially incompetent to assess the sub judice which constitutes a dilatory exception in the terms already petitioned in the Response, articles 77.º and 78.º of the same." (italics ours)

The tribunal granted the Claimant's petition for reformulation of the request, reserving for final decision the question of the exception.

Before the petition, thus reformulated, and the reasons adduced by Claimant and Respondent, regarding the exception of lack of competence of the arbitral tribunal on the basis of subject matter, it is necessary to decide.

In accordance with the provision of Article 2.º, n.º 1, of the RJAT, arbitral tribunals are, in tax matters, competent to know: "a) The declaration of illegality of assessment acts of taxes, of self-assessment, of withholding at source and of payment on account; b) The declaration of illegality of acts of determination of taxable matter when it does not give rise to the assessment of any tax, of acts of determination of taxable base and of acts of fixing of patrimonial values".

Which means that the competence of the arbitral tribunals functioning in CAAD is limited to the declaration of illegality of acts of the types referred to in Article 2.º of the RJAT, so one is dealing with a mere contentious annulment, structured in accordance with the procedural model prior to the administrative litigation reform of 2002-2004, which continues to apply in tax litigation.

Comparing the aforementioned legal regime, applicable in terms of competence on the basis of subject matter, with the request formulated by the claimant, it is found that the first part thereof contained (corresponding to the following segment: "In these terms and in any other respects that the Arbitral Tribunal may deem appropriate, the present request for arbitral pronouncement should be judged as well-founded and proven, whereby the assessments which are its subject should be declared illegal, based on violation of law, namely the provision of n.º 3 of Article 45.º of the IRC Code and, by error in the legal assumptions, being consequently annulled the said assessments"), fits within paragraph a) of the rule above transcribed, so the tribunal is competent to know of it.

This will not be the case, however, with regard to the second part of the same request (corresponding to the following segment: "which is reflected in the following manner, in the fields of table 7 of the corrected Model 22 declarations: a) as to the tax year 2011: 1. In field 705, where the amount of €2,376,976.48 was entered, the value of €7,418,550.22 should have been entered; 2. In field 737, where the amount of €1,068,325.26 was entered, the value of €0.00 should have been entered. b) as to the tax year 2012: 1. In field 705, where the amount of €3,709,275.11 was entered, the value of €7,418,550.22 should have been entered; 2. In field 737, where the amount of €1,104,460.77 was entered, the value of €0.00 should have been entered").

If it is to be understood, as seems to be the sense of the Tax and Customs Authority, that the Claimant requests the condemnation of the Respondent in the corrections mentioned, such request does not fit within any of the paragraphs of the aforementioned art. 2.º of the RJAT, as it goes beyond mere annulment litigation.

It is therefore held that the dilatory exception of lack of competence of the tribunal, on the basis of subject matter, raised by the respondent is partially well-founded, declaring, in consequence, the tribunal absolutely incompetent to know of the second part (transcribed in the paragraph above) of the request formulated by the Claimant.

8.1.c. It is concluded, before the above, that the arbitral tribunal was regularly constituted and has, moreover, competence, in the face of the provision of arts. 2.º, n.º 1, paragraph a) and 30.º, n.º 1 of D.L. No. 10/2011, of 20 January.

8.2. The parties enjoy legal personality and capacity, are legitimate and are regularly represented (arts. 4.º and 10.º, n.º 2 of D.L. No. 10/2011, of 22 March).

8.3. The proceedings do not suffer from any defects.

8.4. There is thus no obstacle to the assessment of the merits of the case.

III. MERITS

III-A. Matters of Fact

9.1. Proven Facts

Based on the elements contained in the present proceedings and in the administrative file submitted by the Respondent, the following facts are considered proven:

1. The disputed case in the proceedings concerns the IRC assessments Nos. 2014… and 2014…, respectively relating to the tax years 2011 and 2012, arising from corrections made in the scope of inspection procedures (Service Orders - OI 2013… and 2013…) (RIT, II, 1 and art. 1º of the Response);

2. The inspection procedures relating to the tax years 2011 and 2012 followed from the inspection procedure also conducted on the claimant with respect to the tax year 2010 (Service Order No. OI2012…) and which was notified to the Claimant on 18 June 2013 (RIT, pp. 8 and 19 and Response, art. 4º);

3. On 31 December 2009 the Claimant held, within the scope of its legal activity as a Management Company of Social Shares (SGPS), financial participations in several companies (table p. 17 RIT and art. 6º of the response);

4. On that date (31/12/2009), the participations were measured in the claimant's financial statements at acquisition cost, in a total of €204,679,646.16, under the POC (RIT, p. 15 and Response arts 6, table I, and 7º);

5. In the tax year 2010, in the transition to the National System of Accounting (SNC), the Claimant, in its financial statements, began to measure the social shares held in accordance with Accounting and Financial Reporting Standard 27 (NCRF 27), with a positive patrimonial variation of €23,769,764.82 occurring (corresponding to the difference between the acquisition value of one of the companies and its official quotation, which was reflected in the equity capital accounts) and a negative patrimonial variation of €37,092,751.12, corresponding to the difference between the acquisition value of two other companies and its official quotation, which was also reflected in the equity capital accounts. (RIT, pp. 16 and 17, Response art. 14º);

6. The following accounting entry was made of the variations referred to in the previous number:

[accounting table in original]

(RIT, p. 17, Response, art. 14º);

1. For the tax year 2010, the Claimant submitted two periodic income declarations of IRC (Model 22), having in the first declaration entered in field 703 (positive patrimonial variations, transitional regime art 5º DL No. 159/2009, of 13/7) the amount of €4,753,952.96, corresponding to 1/5 of the value of the adjustment resulting from the retrospective application of the fair value method and in field 705 (negative patrimonial variations - transitional regime Article 5º DL No. 159/2009) the amount of €7,418,550.22 (1/5 of the value of the adjustment resulting from the retrospective application of the fair value method). (RIT, p. 17 and 18, and Response arts 17º and 18º);

2. Subsequently, in a replacement declaration, the Claimant entered in field 705 (negative patrimonial variations) the amount of €1,332,298.63, according to the following calculations:

[accounting table in original]

(RIT, p. 18 and Response art. 19º);

1. In the determination of taxable profit relating to the tax year 2010 was indicated the negative difference between the positive patrimonial variation and the negative patrimonial variation of the adjustments, that is, of €2,664,597.26, and then considered in half of that value (€1,332,298.63), in accordance with the provision of Article 45.º, n.º 3 of the CIRC (RIT, p. 18; Response, art. 20º);

2. Following the position assumed by the Tax Administration in the binding information relating to Process No. 39/2011, the Respondent made corrections regarding the transition adjustments occurring in the change of the tax year 2009 to 2010 of the cost acquisition method to the fair value method, in the following sense: in the entry in field 703 (positive patrimonial variations) of the amount of €4,753,952.96, relating to 1/5 of the value of the positive patrimonial variation (€23,769,764.82) verified in the social share in E…, S.A., and, in field 705 (negative patrimonial variations), the value of €3,709,275.11, relating to 50% of 1/5 of the negative patrimonial variation (€37,092,751.12) registered in the social shares in companies B…, C…and D… (RIT, pp. 19 and 20; Response, arts 22º to 25º);

3. On 31 May 2012, the Claimant submitted the periodic income declaration model 22 for the tax year 2011, where it determined taxable profit of €8,554,476.68 (RIT, p. 20; Response, art. 26º);

4. In that declaration the Claimant entered in field 705 – negative patrimonial variations – of model 22, the amount of €1,332,298.63, as it had done in the replacement declaration submitted for the tax year 2010, and referred to in point 5 (RIT, p. 21; Response, art. 27º);

5. The Tax Authority promoted, according to the same criterion followed for 2010, corrections:

• As to the negative patrimonial variation (field 705), of €7,418,550.22, that only the value of €3,709,275.11 should contribute to the determination of taxable profit;

• As to the positive patrimonial variation of €4,753,952.96, that it should contribute to the determination of taxable profit in full (Response, art. 28º RIT, pp. 21 and 22);

1. In the tax year 2011: there was a negative variation in the quotation of the shares in companies E.., S.A. and C…, S.A., recorded in account snc - 66 (Losses on reductions in fair value), in a total of €2,030,142.46 (€1,752,050.64 + €278,391.82) and a positive variation in the quotation of the share in company B…, of €1,112,517.77, recorded in account SNC - 77 (Gains on increases in fair value), with the Claimant having alienated the social shares in company D… (RIT, pp. 22 and 23, Response, 31º to 36º);

2. In the determination of taxable profit determined in the model 22 declaration presented, the Claimant entered in field 737 the value of €458,952.35 which is equivalent to 50% of the balance (negative) between positive and negative variations resulting from the recognition of financial instruments by application of fair value through profit or loss, according to the table:

[accounting table in original]

(RIT p. 23 and Response, arts. 37º and 38º);

1. The Tax Authority promoted the respective correction of the taxable matter, proposing that the amount of €1,015,221.23 contribute to the determination of taxable profit, that is, half (50%) of the negative variation in the effect of using the fair value method in the valuation of its holdings be accepted fiscally:

[accounting table in original]

(RIT, p. 24 and Response, art. 39º);

1. In the tax year 2011, shares of C…and B…) were alienated at a selling price below that at which they were accounting recorded, with total loss of €104,328.06, a value which was recorded by the Claimant in account SNC 635 (Gains and losses on remaining financial investments) (RIT pp. 25 and 26, Response, arts 40º to 42º);

2. With respect to the entry referred to in the previous number, the Tax Authority promoted correction of the taxable matter proposing that only half - 50% - of the negative variation in the effect of using the fair value method in the valuation of its holdings be accepted fiscally, entering the amount of €52,164.03 in the aforementioned field 737 of Q07 of model 22 (RIT pp. 25 and 26, Response, arts. 42º and 43º);

3. On 31 May 2012, the Claimant submitted the periodic income declaration model 22 for the tax year 2011, where it determined a tax loss of €1,888,858.65 (RIT, p. 26; Response, art. 45º);

4. In that declaration the Claimant entered in field 705 – negative patrimonial variations – of model 22, the amount of €1,332,298.63, as it had done in the model 22 declarations for 2010 (replacement) and 2011, as referred to in points 5 and 8) (RIT, p. 26; Response, art. 46º);

5. The Tax Authority promoted, in accordance with the same criterion followed in the corrections made in the tax years 2010 and 2011, the following corrections to the tax year 2012:

• As to the negative patrimonial variation (field 705), of €7,418,550.22, that only the value of €3,709,275.11 should contribute to the determination of taxable profit;

• As to the positive patrimonial variation of €4,753,952.96, that it should contribute to the determination of taxable profit in full (RIT, p. 27; Response, art. 47º);

1. In the tax year 2012 there was a negative variation in the quotation of the share in B… recorded in account snc - 66 (Losses on reductions in fair value), in a total of €2,078,184.48 and a positive variation in the quotation of the share in company E…, S.A. of €224,925.42, recorded in account SNC - 77 (Gains on increases in fair value) (RIT, pp. 28, Response, 48º to 54º);

2. In the determination of taxable profit determined in the model 22 declaration presented, the Claimant entered in field 737 the value of €926,629.53 which is equivalent to 50% of the balance (negative) between positive and negative variations resulting from the recognition of financial instruments by application of fair value through profit or loss, according to the table:

[accounting table in original]

(RIT p. 28 and 29 and Response, arts. 56º and 57º);

1. The Tax Authority promoted the respective correction of the taxable matter, proposing that the amount of €1,039,092.24 contribute to the determination of taxable profit, that is, half (50%) of the negative variation in the effect of using the fair value method in the valuation of its holdings be accepted fiscally:

[accounting tables in original]

(RIT, p. 29 and Response, art. 58º);

1. In the tax year 2012 shares of C…and B…were alienated at a selling price below that at which they were accounting recorded, with total loss of €131,029.26, a value which was recorded by the Claimant in account SNC 635 (Gains and losses on remaining financial investments) in full. (RIT, p. 29; Response, arts 55º, 59º and 60º);

2. With respect to the entry referred to in the previous number, the Tax Authority promoted correction of the taxable matter proposing that only half - 50% - of the negative variation in the effect of using the fair value method in the valuation of its holdings be accepted fiscally, entering the amount of €65,514.53 in the aforementioned field 737 of Q07 of model 22. (RIT pp. 29 and 30, Response, art. 63º);

3. The table of corrections to the taxable profit of the periods of taxation of 2011 and 2012 resulting from the inspection actions and contained in the Tax Inspection Report were, in summary:

1. Upon notification of the Tax Inspection Report project to the Claimant, it exercised the right to a hearing on 22 July 2014, in a document addressed to the Director of Finances of … (2014…) – Annex 1 to the final RIT;

2. On 13 August, the final version of the Tax Inspection Report was prepared which, rejecting the arguments presented by the Claimant in prior hearing, maintained the corrections proposed in the RIT Project and merited an agreement memorandum from the Deputy Director of Finances, where it states: "it was concluded, as a result of the application of the rules relating to the introduction of fair value in the valuation of financial instruments, in accordance with the cited legislation, that adjustments should be made in the determination of taxable profit for the tax years 2011 and 2012, respectively, in the amount of €2,985,399.39 and €2,544,953.72, which, as mentioned, leads to the increase of the taxable profit of 2011 to €11,593,876.07 and the change of a tax loss in 2012 to a taxable profit of €666,095.75" (RIT, PA);

3. Having obtained the agreement memorandum of the Director of Finances of …, on 28 August 2014, the final Report was notified to the Claimant on 2 September 2014, accompanied by official letter No. … which clarified that it was a notification of corrections to the taxable matter and tax, and that shortly after the Tax Authority would send notification of the respective assessment containing the means of defense and payment deadline, if applicable, and that no claim or challenge was available from this notification (P.A. Attached to the proceedings);

4. The Claimant was notified of the assessments relating to the IRC for 2011 and 2012, made on the basis of corrections to the taxable base, with the values determined being €1,392,593.45 (tax year 2011) and €172,035.87 (tax year 2012), for payment by 10/11/2014 and 12/11/2014, respectively (see collection documents attached to the proceedings with the Request for arbitral pronouncement, numbers 2014… and 2014…);

5. The present request for arbitral pronouncement presented on 19 January 2015, indicates as value €1,564,629.32, an amount corresponding to the sum of the values determined in the assessments referred to in the previous number.

9.2. Unproven Facts

There are no other facts with relevance for the assessment of the merits of the case that have not been proven.

III-B. Matters of Law

With regard to the substantive issue, once the exceptions invoked have been judged as lacking in merit, it is important to verify the tax consequences of measuring at fair value, in 2011 and 2012, of financial holdings of the Claimant constituted by shares representing the capital stock of E…, SA, of C…, SA, of D…, SA and of B..., SA, all of them corresponding to less than 5% of the capital stock of those companies and admitted to trading on a regulated market.

This is a question that has already been the subject of various judgments from the Administrative Arbitration Center, notably, the one rendered in process 108/2013-T, which we will follow very closely.

As is peaceably accepted by both Claimant and Respondent, the question that arises in the present proceedings concerns knowing what tax treatment is to be given to losses resulting from the application of the fair value model to financial instruments, whose counterpart is recognized through profit or loss.

Specifically, it is verified that the Claimant, in the tax year 2010, was the holder of social shares in several companies, which, by application of the fair value accounting criterion, suffered depreciation corresponding to the difference between the acquisition value of the said shares and their official quotation as of 1 January 2010, on the one hand, and the variation that occurred in the tax years 2010, 2011 and 2012, on the other. It is therefore necessary to determine to what extent and in what terms such depreciations should contribute to the determination of the taxable profit of the Claimant.

The Claimant understands that for the determination of its taxable profit, 1/5 of the depreciation recorded on 1 January and the entire depreciation recorded on 31 December should be relevant and not only 50% of the same.

Thus, in the proceedings only the consideration of only 50% of the accounting loss is questioned, both that resulting from the depreciation in the quotation of the shares verified in the tax years 2011 and 2012 and that resulting from the retrospective application of the fair value method and not the deduction of only 1/5 of that value, which is accepted by the Claimant.

Accepted by both procedural participants is also that the financial participation in question should be accounted for according to the fair value criterion and that it was recognized through profit or loss.

In this way, the question to be resolved in the proceedings is properly delimited, which is therefore to know whether the accounting loss resulting from the retrospective application of the fair value method and the accounting loss verified in the tax years 2011 and 2012, resulting from the depreciation in the quotation of the shares of which it was the holder, properly accounted for in accordance with the applicable fair value criterion, and recognized in profit or loss, should be considered in full or only in 50%.

Normatively, the epicenter of the dispute embodied in the proceedings is located in the provision of Article 45.º/3 of the applicable CIRC, whose text states that:

"The negative difference between gains and losses realized through the onerous transfer of capital shares, including their redemption and amortization with capital reduction, as well as other losses or negative patrimonial variations relating to capital shares or other components of equity, namely supplementary contributions, contribute to the formation of taxable profit in only half their value."

In the proceedings, it will therefore be necessary to determine whether this rule applies to the case at hand, as the Tax Authority defends in its response, or whether, on the contrary, the situation sub judice does not fall within such provision.

Let us therefore see.

The Tax Authority sustains that the aforementioned rule, when specifically referring to "other losses or negative patrimonial variations relating to capital shares or other components of equity (…), contribute to the formation of taxable profit in only half their value", will be encompassing situations such as those in the proceedings, requiring that the negative patrimonial variation in question contribute to the formation of taxable profit in only half its value. The Tax Authority relies on the opinion of André A. Vasconcelos, which is justified by the extensive scope of the same.

The Tax Authority also notes, noting the maintenance of the wording of the provision that concerns us, in light of amendments to the CIRC caused by the beginning of implementation of the SNC, that the absence of amendments verified in the rule in question reveals that it was not intended that the regime in question undergo any change, as a function of the amendments introduced to the accounting system.

Finally, the Tax Authority also invokes the Judgment of the Constitutional Court 85/2010, which judged the provision in question as constitutional.

The specific question at issue in the proceedings is rooted in the generic question of determining the taxable profit of corporate taxpayers.

In this regard, Article 17.º/1 of the applicable CIRC provides that:

"The taxable profit of legal entities and other entities mentioned in paragraph a) of n.º 1 of Article 3.º is constituted by the algebraic sum of the net result of the fiscal year and the positive and negative patrimonial variations verified in the same period and not reflected in that result, determined on the basis of the accounts and possibly corrected in accordance with this Code."

N.º 9 of Article 18.º of the same Code provides that:

"Adjustments resulting from the application of fair value do not contribute to the formation of taxable profit, being accounted for as income or expenses in the period of taxation in which the elements or rights that gave rise to them are alienated, exercised, extinguished or liquidated, except when:

a) They relate to financial instruments recognized at fair value through profit or loss, provided that, if they are equity instruments, they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a participation in capital exceeding 5% of the respective capital stock; or

b) This is expressly provided for in this Code."

Article 20.º/1 of the CIRC provides that:

"Income is considered as resulting from operations of any nature, as a result of normal or occasional action, basic or merely accessory action, namely: (...)

f) Income resulting from the application of fair value to financial instruments; (...) h) Gains realized;"

Likewise, Article 23.º/1 of the same Code provides that:

"Expenses are considered those that are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the productive source, namely: (...)

i) Expenses resulting from the application of fair value to financial instruments; (...)

l) Losses realized;"

With respect to positive patrimonial variations, Article 21.º/1 of the CIRC provides that:

"The following also contribute to the formation of taxable profit positive patrimonial variations not reflected in the net result of the period of taxation, except: (...)

b) Potential or latent gains, even if expressed in the accounts, including revaluation reserves under tax legislation;"

As for negative patrimonial variations, Article 24.º/1, also of the same decree-law, states that:

"Under the same conditions referred to for expenses, the following also contribute to the formation of taxable profit negative patrimonial variations not reflected in the net result of the period of taxation, except: (...)

b) Potential or latent losses, even if expressed in the accounts;"

With regard to gains and losses, Article 46.º/1 of the same Code provides that:

"Gains or losses realized are considered as gains obtained or losses suffered through onerous transfer, by whatever title it operates and, as well as those arising from claims or resulting from permanent assignment to purposes unrelated to the activity exercised, relating to: (...)

b) Financial instruments, with the exception of those recognized at fair value in accordance with paragraphs a) and b) of n.º 9 of Article 18.º"

The regulatory framework relevant to the assessment of the question sub judice closes with the provision of Article 45.º/3, also of the applicable CIRC, already transcribed.

Having established the relevant regulatory framework, it is necessary to proceed to the analysis and combination of the various rules that comprise it.

It should be emphasized that such analysis must take into due account the necessary systematic perspective of its integration, also considering the historical context of the genesis of the provisions involved. Indeed, each of the rules considered relevant for the assessment of the question to be decided should be understood in the corresponding concrete framework, from which its significant content can be drawn.

Thus, first of all, it should be noted that the current Article 45.º/3 of the CIRC results from the renumbering of the previous Article 42.º/3, made by Decree-Law No. 159/2009. That n.º of Article 42.º in question, in turn, was introduced by Law 32B/2002, of 30 December, with the following wording:

"The negative difference between gains and losses realized through the onerous transfer of capital shares, including their redemption and amortization with capital reduction, contributes to the formation of taxable profit in only half its value."

In accordance with the Report of the Ministry of Finance for the State Budget of 2003 (p. 33), the legislative intervention in the area in question (IRC) was guided by two priorities, namely: the fight against tax fraud and evasion and the broadening of the tax base, the amendment that is of interest here fitting within the scope of "Broadening of the tax base and measures of moralization and neutrality" (p. 51).

The current wording of the rule under analysis resulted from the amendment implemented by Law 60-A/2005 of 30 December, and in accordance with the corresponding Report of the Ministry of Finance (p.31), the measure in question fit within the scope of "FIGHTING TAX EVASION AND FRAUD AND OTHER MEASURES DIRECTED AT BUDGET CONSOLIDATION."

For its part, n.º 9 of Article 18.º of the applicable CIRC obtains directly its justification in the preamble of DL 159/2009, of 13 July, which introduced it into the aforementioned Code, where it can be read:

"Still in the field of approximation between accounting and taxation, the application of the fair value model to financial instruments, whose counterpart is recognized through profit or loss, is accepted, but only in cases where the reliability of the determination of fair value is in principle assured. Thus, equity instruments that do not have a price formed in a regulated market are excluded. Furthermore, the application of the principle of realization was maintained with respect to financial instruments measured at fair value whose counterpart is recognized in equity, as well as capital shares corresponding to more than 5% of capital stock, even if recognized at fair value through profit or loss. (...)

In the same sense, assets covered by the regime of fiscal gains and losses are identified as tangible fixed assets, intangible assets, investment properties, financial instruments, with the exception of those in which adjustments resulting from the application of fair value contribute to the formation of taxable profit in the period of taxation."

These expressed intentions have correspondence in that rule of n.º 9 of Article 18.º, as well as in the introduction, by the same legal decree, of paragraphs f) and i) of n.º 1 of Articles 20.º and 24.º of the CIRC, as well as of paragraph b) of n.º 1 of Article 46.º.

Within the set of amendments introduced by the aforementioned Decree-Law No. 159/2009, of 13 July, it should also be noted that where previously one spoke of "income" and "gains" (Article 20.º), one now speaks of "income", and where previously the expression "costs" or "losses" (Article 23.º) was used, this was replaced by "expenses".

The application of fair value as an accounting valuation criterion with tax relevance represents a Copernican change in the regime of taxation of income or expenses resulting from the acquisition of financial instruments.

Indeed, prior to the adoption of fair value, patrimonial variations relating to financial instruments were irrelevant from the point of view of the formation of taxable profit of each period, as a result of the provision of Article 21.º/1/b) of the CIRC. Only at the time of realization of the gain or loss did the patrimonial variation verified assume tax relevance.

This fiscal framework had (and has, in the part in which it is maintained) three well-marked characteristics, namely:

1. It was single taxation, that is, that occurred only once throughout the entire period of holding of the financial instruments;

2. It was dependent on a voluntary act of the taxpayer, in that the transaction of the instruments generating the patrimonial variation, condition of the tax relevance thereof, would only occur if and when the taxpayer so wished;

3. The value of the patrimonial variation was fixed based on the specific transaction that triggered its tax relevance.

The combination of these three characteristics that have been pointed out provided fertile ground for accounting and tax manipulations, since the taxpayer could choose to trigger the tax relevance of the patrimonial variation at the moment and in the terms that would be most fiscally beneficial to it.

On the other hand, and given the relevance of the taxpayer's will in the mechanism of tax relevance of the patrimonial variation, the system established was suited to the adoption of mechanisms of conditioning such will, to conform it to economically more desirable behaviors, in which case these are the preference for realization of gains, to the detriment of the realization of losses.

It is in this framework that the emergence of the rule of the previous Article 42.º/3 of the CIRC is explained, which precedes the current Article 45.º/3 of the same.

Such a rule, whether in its original wording, resulting from Law 32-B/2002, of 30 December, or in that given to it by Law 60-A/2005 of 30 December, is explained objectively and subjectively (that is, in light of the motivation expressed by the legislator) by needs linked to the fight against fraud and tax evasion and the broadening of the tax base, directed at the desired consolidation of the public accounts.

The acceptance of the application of the fair value model to financial instruments, operated by Decree-Law No. 159/2009, of 13 July, introduced, in the part covered, a radically different model, both in terms of valuation and of tax relevance of patrimonial variations relating to the holding of such instruments.

Indeed, the legislator's intention in the reception of the fair value model, properly evidenced, assumed and expressly stated, was to maintain "the application of the principle of realization with respect to financial instruments measured at fair value whose counterpart is recognized in equity, as well as capital shares corresponding to more than 5% of capital stock, even if recognized at fair value through profit or loss".

As for "financial instruments" corresponding to less "than 5% of capital stock", "whose counterpart is recognized through profit or loss, (…) in cases in which the reliability of the determination of fair value is in principle assured", the legislative intention was to accept "the application of the fair value model", excluding the principle of realization.

In consonance, Article 18.º/9 of the applicable CIRC came to provide that, as a rule, "Adjustments resulting from the application of fair value do not contribute to the formation of taxable profit, being accounted for as income or expenses in the period of taxation in which the elements or rights that gave rise to them are alienated, exercised, extinguished or liquidated." This is a clear and deliberate manifestation of the assumed principle of realization.

However, the same rule, in its paragraph a), establishes the exception to this regime, in the following terms: "except when: a) They relate to financial instruments recognized at fair value through profit or loss, provided that, if they are equity instruments, they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a participation in capital exceeding 5% of the respective capital stock;"

That is, and equally as assumed by the legislative entity, when "income or expenses (…) Relate to financial instruments recognized at fair value" "contribute to the formation of taxable profit" "provided that":

a. They are recognized "through profit or loss";

b. They are "equity instruments";

c. "Have a price formed in a regulated market" and

d. "The taxpayer does not hold, directly or indirectly, a participation in capital exceeding 5% of the respective capital stock."

Once these conditions are met:

a. income resulting from the application of fair value to financial instruments is considered (Article 20.º/1/f) of the CIRC); and

b. expenses resulting from the application of fair value to financial instruments is considered (Article 23.º/1/i).

In this way, where before we had a single tax relevance (one-off), when the transaction of such instruments occurred, we now have continuous tax relevance. That is, in light of the new rules comprising the regime of tax relevance of accounting at fair value of financial instruments, income or expenses resulting from the application of fair value to them now become directly relevant to the formation of taxable profit (Articles 20.º/1/f) and 23.º/1/i) of the CIRC) of the very year in which they occur, provided that certain conditions are met (Article 18.º/9 of the CIRC), which include the formation of the price in a regulated market, with patrimonial variations being recorded as gains or losses not being taxed (Article 46.º/1/b) of the CIRC). In this framework, there cease to be, manifestly, any needs relating to the fight against fraud and tax evasion, not only because the tax relevance of patrimonial variations ceases to be conditioned by a voluntary act of the taxpayer, but also because the valuation is objectively fixed.

Against the foregoing, let it not be argued, among other things, that the regulated market is always manipulable, as are the prices fixed therein, and that the 5% limit permits, in any situation, to have significant influence on the taxes to be paid.

While it is true that it cannot be asserted, in general theory, that no market is free from manipulation, from this it also cannot be inferred that, in the abstract, a holder of 5% of shares is susceptible to influencing the market on its own. This is a misplaced conclusion, because it is based on the assumption of an inactive market, with poor liquidity, where few "players" act and, therefore, susceptible of being influenced by individual actors. On the contrary, each agent, considered in isolation, has, as a rule, marginal influence, if the reference for fair value is the price practiced in an active market, with significant levels of liquidity, characterized by a plurality of agents, both on the demand side and the supply side, and with regularly disclosed prices. Furthermore, the power of significant or relevant influence on the market price depends on the convergence of several actors and multiple factors, such as the specific asset in question and the capital structure of the associated company.

In light of the foregoing, it seems to lack sense any measure of conditioning the will of the taxpayer, so as to favor economically more "desirable" behaviors and, as such, consistent with the interests of broadening the tax base and budget consolidation.

Notwithstanding all the amendments introduced by Decree-Law No. 159/2009, of 13 July, the previous Article 42.º/3 of the CIRC, renumbered to Article 45.º/3, maintained its applicability, with its unchanged wording.

Hence the question, as occurs in the proceedings, whether such a rule will apply, or not, to depreciation relating to financial instruments, which contribute to the formation of taxable profit, in accordance with Article 18.º/9/a) of the CIRC.

Prima facie, the answer to such a question would be affirmative, as the Tax Authority defends, given the extensive scope of the provision in question, already pointed out by the Author cited by it in its response.

A careful and coordinated reading of the normative provisions relevant to the analysis of the case, which have already been indicated, will, however, allow for a different conclusion.

Let us see.

Article 45.º/3 of the CIRC, already transcribed, states that:

"The negative difference between gains and losses realized through the onerous transfer of capital shares, including their redemption and amortization with capital reduction, as well as other losses or negative patrimonial variations relating to capital shares or other components of equity, namely supplementary contributions, contribute to the formation of taxable profit in only half their value."

The analysis of the normative text reveals with clarity that the legislator chose, for inclusion therein, three types of situations that should be considered, based on the presumption of good legislative technique, as distinct, namely:

a. "The negative difference between gains and losses realized through the onerous transfer of capital shares";

b. "other losses (…) relating to capital shares or other components of equity";

c. "other (…) negative patrimonial variations relating to capital shares or other components of equity".

Let us then verify whether the situation in the proceedings is reducible to one of the enumerated situations.

The situation referred to under letter a) above is not applicable to the specific case at hand, since Article 46.º/1/b) of the CIRC excludes the situations described in Article 18.º/9/a) from the concept of realized gains, that is, it expressly excludes from the concept of gains the alienation of financial instruments recognized at fair value through profit or loss, provided that they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a participation in capital exceeding 5% of the respective capital stock.

On the other hand, the apparent indiscriminate breadth of the provisions in question may, however, be reasonably mitigated if it is noted that "losses" and "other negative patrimonial variations", will be concepts that are not redundant, but endowed with their own and distinct meaning.

To understand this fact, it will be necessary to go back to Articles 23.º and 24.º of the same Code, noting the terminological evolution operated by Decree-Law No. 159/2009, of 13 December.

Indeed, prior to the entry into force of the latter decree-law, the Articles referred to of the CIRC provided, respectively, that:

"Costs or losses are considered those that are demonstrably indispensable for the realization of income or gains subject to tax or for the maintenance of the productive source, namely the following: (...)";

"Under the same conditions referred to for costs or losses, the following also contribute to the formation of taxable profit negative patrimonial variations not reflected in the net result of the fiscal year, except: (...)".

It is thus verified that at the time of the establishment of the current wording of Article 45.º/3 of the CIRC, this Code expressly distinguished, for what is relevant here, three types of situations, namely:

a) Costs;

b) Losses;

c) Negative patrimonial variations not reflected in the net result of the fiscal year.

The provision of Article 42.º/3, predecessor of the current 45.º/3, should thus be considered as reported to these concepts, defined in Articles 23.º and 24.º. Thus, and for obvious reasons, the previous provisions of Article 42.º/3 should be understood as referring to these concepts, defined in Articles 23.º and 24.º. Thus, and for obvious reasons,

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