Deductibility of Loan Charges Between Group Companies Under IRC - CAAD Case 313/2017-T

ARBITRAL DECISION

REPORT

A.., LDA., legal entity no…, with registered office in … (hereinafter referred to as A… or Claimant), came forward on 04/05/2017, pursuant to articles 2 no. 1, paragraph a) and 10 et seq. of the Legal Regime of Tax Arbitration, provided for in Decree-Law no. 10/2011, of 20 January, as amended by article 228 of Law no. 66-B/2012, of 31 December (hereinafter abbreviated as LRTA) and articles 1 and 2 of Ordinance no. 112-A/2011, of 22 March, to file a petition for arbitral pronouncement on the legality of acts of additional assessment of Corporate Income Tax (CIT) nos. 2016…, 2016… (compensatory interest) and 2016… (settlement), relating to the financial year 2012, in a total amount of € 167,444.33.

The PORTUGUESE TAX AND CUSTOMS AUTHORITY (hereinafter, PTA) is the Respondent.

The petition for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the PTA on 04/05/2017.

The Claimant did not proceed with the appointment of an arbitrator, whereby, pursuant to article 6 no. 2, paragraph a) and article 11 no. 1, paragraph b) of the LRTA, the President of the Deontological Council of CAAD appointed the undersigned as arbitrators of the collective arbitral tribunal, and they communicated acceptance of the office within the applicable period.

The parties were duly notified of this appointment and did not express any intention to refuse it, pursuant to the combined provisions of articles 11 no. 1, paragraphs a) and b) of the LRTA and articles 6 and 7 of the Deontological Code, whereby, in accordance with article 11 no. 1, paragraph c) of the LRTA, the arbitral tribunal was constituted on 14/07/2017.

Duly notified, the PTA submitted, within the legal timeframe, a response defending non-acceptance of the petition, defending itself solely by contesting and attaching a copy of the administrative file.

As the meeting referred to in article 18 of the LRTA was dispensed with, on the grounds that it would be futile in this case, the tribunal invited the parties to submit written submissions, which they did, reiterating and developing their respective legal positions.

The deadline for the decision was extended by two months, pursuant to article 21 no. 2 of the LRTA, with 12/03/2018 set as the date for its delivery.

The Claimant requests that the illegality of the above-identified assessments, which include compensatory interest, in a total amount of € 167,444.33, be declared and, consequently, that they be annulled and the amount already paid be refunded, plus indemnificatory interest.

The assessments are tainted by defects consisting of violations of articles 104 no. 2 of the Constitution of the Portuguese Republic (CRP), 75 no. 1 of the General Tax Law (GTL) and articles 15, 17 and 23 of the Corporate Income Tax Code (CITC), and the assessment of compensatory interest is not substantiated, thereby also violating article 35 no. 9 of the GTL.

PRELIMINARY RULINGS

The arbitral tribunal is substantively competent and was duly constituted.

The parties have legal standing and capacity, are legitimate and are legally represented.

The proceedings do not suffer from any nullities and there are no objections or preliminary matters to decide.

Accordingly, there is no obstacle to the examination of the merits of the case.

FACTUAL FINDINGS

With relevance to the decision of the case, the following facts have been established, resulting from a critical examination of the documentary evidence attached to the file, in particular the inspection reports conducted by the PTA:

a) The Claimant's principal activity is waste management, with the main Classification of Economic Activities (CEA) code 38220 – Treatment and disposal of hazardous waste, secondary CEA code 1: 010920 – Manufacture of pet food, secondary CEA code 2: 032996 – Other diverse manufacturing industries, NE; secondary CEA code 3: 082990 – Other business support services, NE.

b) It has been classified, since 01.01.2006, for CIT purposes, under the special taxation regime for groups of companies (STRGC).

c) In 2012, this regime was applied to A…, Lda., and to companies B…, Lda. and C.., Lda..

d) Pursuant to service order no. OI2015… of 19.06.2015, the PTA's inspection services carried out an internal inspection of the Claimant, of limited scope, for the tax period 2012, focused on CIT.

e) On 19.10.2016, it was notified of the Draft Tax Inspection Report in which the PTA proposed to effect an increase to taxable profit of € 554,188.00.

f) The Claimant did not exercise its prior hearing right, and was therefore notified on 17.11.2016, by office no. … of 16.11.2016, of the Tax Inspection Report, in which the correction proposed in the Draft Report was maintained.

g) Pursuant to service order no. OI2016…, of 24.10.2016, a second internal tax inspection was carried out on the Claimant, of limited scope, for CIT purposes and relating to the tax period 2012, here in the context of the STRGC, and was notified on 15.11.2016 of the Draft Inspection Report, within the scope of which the PTA proposed to effect an increase to the taxable amount of the STRGC of € 554,188.00, bringing it to € 3,217,285.20.

h) The Claimant also chose not to exercise its prior hearing right, and was notified by office no. … of 30.11.2016, of the Tax Inspection Report, in which the correction initially proposed was confirmed.

i) Subsequently, the Claimant was notified of the CIT assessments nos. 2016…, compensatory interest assessments no. 2016… and settlement no. 2016…, which incorporated the corrections made in the inspection, resulting in a total tax liability of € 167,444.33.

j) The Claimant paid these tax assessments and interest (cf. Doc. 16 attached to the Petition for Constitution of Arbitral Tribunal).

k) The Claimant acquired, at different points in time, companies operating in its sector of activity, namely, B… and D…, Unipessoal, Lda. (entity which was subsequently merged with B… on 16.05.2012).

l) The Claimant agreed, in 2010 and 2011, with its majority shareholder, the Luxembourg capital company E… S.A.R.L., to the provision of supplies which totaled the amount of € 18,205,000.00.

m) It is provided in the respective contracts that their purpose is the repayment of existing loans, the financing of acquisitions and general operating expenses.

n) According to the same contracts, the financings granted by E… to the now Claimant in the form of supplies bore interest at the Libor rate plus a spread of 2 ½% on the amount outstanding (cf. document no. 2).

o) With respect to the tax period 2012, the Claimant accounted for and deducted for tax purposes as interest owed to E…, by virtue of the contracted supplies, the amount of € 554,188.24.

p) Throughout the tax periods 2011 and 2012, the Claimant granted to B… loans, in the form of supplies, in the amount of € 2,724,000, of which € 459,023.23 were reimbursed.

q) In 2011, the Claimant granted loans to D…, in the form of supplies, which totaled the amount of € 1,231,000.00, and the reimbursement to the Claimant of € 270,000.00 also occurred.

r) It was also established in those contracts that the financings granted by the Claimant to B… and D… in the form of supplies bore interest at the Euribor rate plus a spread of 1.5% on the amount outstanding.

s) In the tax period 2012, the Claimant accounted for as interest received from its subsidiaries, related to the contracted supplies, € 64,452.24.

t) From the above-referenced inspection reports, here given as fully reproduced, it appears that:

"Given that the taxpayer is bearing financial charges, namely interest, resulting from loans it has contracted and, at the same time, is granting loans, it is important to assess whether these charges are or are not accepted for tax purposes, in light of the provisions of article 23 of the CITC" "In the case under analysis, it is verified that the taxpayer contracted loans, bearing charges therewith, and, simultaneously, grants financing to company B…"

"From this it results that the entirety of said charges are not directly related to the taxpayer's activity" and therefore "not [being the Claimant] a capital participation management company (…) the requirement of the indispensability of financial charges accounted for by the taxpayer is not shown to be met, as established in article 23 of the CITC".

Concluding by "not accepting for tax purposes the entirety of the interest from borrowed loans accounted for by the taxpayer".

No relevant facts have gone unproven for the examination of the merits of the case.

LEGAL MATTERS

Let us now examine the reasons that led the PTA to effect corrections to the taxpayer's and the group's taxable amount, and to issue an act of additional CIT assessment, for the tax period 2012.

POSITION OF THE PTA

It should be noted from the outset that in its Response to the petition for constitution of arbitral tribunal submitted by the PTA, it merely refers to the Conclusions of the above-mentioned Inspection Reports.

4.1.1. Charges incurred with loans contracted

In the analysis carried out on the accounting elements of the 2012 financial year, the PTA verified that the taxpayer had resorted to financing from the economic group to which it belongs, which were accounted for in the sub-accounts of SNC accounts 25 (Financings Obtained) and 26 (Shareholders/Partners) in the total of € 18,205,000.00.

These loans, obtained on 28.12.2010 and 03.04.2011, pursuant to contracts submitted by the taxpayer (Doc. 2 of the Petition for Constitution of Arbitral Tribunal – "Petition"), had as their purpose "repay existing loans, fund aquisitions by F…, Lda [current A…, Lda] and for general operating cash purposes", that is, repayment of existing loans, fund acquisitions and support for treasury in general.

On the other hand, the taxpayer indicated as costs of loans obtained the value of € 554,208.24, in the balance of the "691-Interest Borne" account.

In accordance with the extracts from accounts 272239 (Interest to Charge A…) and 69119 (Intercompany), the entirety of expenses recorded as financial charges relating to loans obtained, namely interest from financing obtained, amounting to € 554,188.00, is recorded as a counterpart of account 272239 (Interest to Charge A…).

The PTA emphasizes, on the one hand, that in response to the additional request for documents made via email of 16.05.2016, in the context of which it requested the submission of "a copy of all supporting documents issued by external entities relating to the movements recorded in account 69119 – "Intercompany" debit balance of € 554,188.00", the taxpayer sent the extract from this account, a copy of emails reflecting the calculations of the expenses recorded, and accounting documents – all of which are internal documents.

A 2nd additional request for documents was made via email of 01.08.2016, again relating to the interest recorded in account 69119 – "Intercompany", debit balance € 554,188.00, requesting (a) the submission of copies of all supporting documents issued by external entities relating to the movements recorded in the Account Extract; (b) if the documents to be sent were the same as those previously sent, an indication of whether invoices had been issued, and if so, the submission of copies thereof; and also (c) an indication of the date of payment of the interest in question.

The taxpayer did not respond to this request.

4.1.2. Loans granted to third parties

On the other hand, the PTA emphasizes that the taxpayer presents in the 2012 financial year a debit balance in account 266015 - "B… Lda" -, with respect to loans granted in the years 2010 and 2011 to entity B…, Lda and to entity D…, Unipessoal, Lda, which was merged with the former on 16.05.2012.

Legal framework of financial charges

Having reached this point, given the fact that the taxpayer is bearing financial charges, namely interest, resulting from loans it contracted and, at the same time, is granting loans to entities of the group, the PTA considered it relevant to assess whether these charges were or were not accepted for tax purposes, in light of the provisions of article 23 of the Corporate Income Tax Code.

Drawing on no. 1 of article 23 and paragraph g) of no. 1 of article 45 of the Corporate Income Tax Code, as worded during the tax period 2012, the PTA listed three essential requirements in order for the financial charges borne to be valued and accepted as a tax deduction:

Proof (justification) – effectiveness of the realization of costs, which consists of "various forms of written support for accounting entries, that is, their documentary evidence";

Indispensability – justified connection of the cost with the company's productive activity, this requirement is verified "provided that those charges are connected with the obtaining of profit"; and

Connection to income subject to tax – comprises the general clause of deductibility in matters of expenses, stemming from the general principle of article 23 of the Corporate Income Tax Code "that expenses incurred by the taxpayer, in order to be tax-deductible, must be restricted to the obtaining of income subject to tax, or to the maintenance of the income-producing source."

Now, in this case, the PTA – starting from the assumption that the taxpayer contracted loans, bearing charges therewith, and, simultaneously, granted financings to company B… Lda. – considered that the entirety of the charges was not directly related to the taxpayer's activity, which is not a capital participation management company (CPMC). For this reason, it considered that the requirement of the indispensability of the financial charges accounted for by the taxpayer was not shown to be met.

On the other hand, the PTA understood that the taxpayer did not present the supporting documentation inherent to the financial charges (referring to point III.1.1 of the Report), and that the failure to present these documents prevented the Tax Administration from determining "either the correct accounting of the financial charges, or their justification, or their connection to income subject to tax", whereby it understood that the requirement of "expense", as established in no. 1 of article 23 and no. 2 of article 123 of the Corporate Income Tax Code, was not shown to be met.

Not finding the requirements for the deductibility of expenses to be fulfilled, the PTA concluded that it would not be appropriate to accept for tax purposes the entirety of the interest from loans obtained accounted for by the taxpayer, resulting in a total amount of financial charges not accepted of € 554,188.00.

POSITION OF THE CLAIMANT

According to the Claimant, the tax acts, arising from the inspection actions, are tainted by a defect consisting of violation of law, with the PTA basing itself on an incorrect interpretation of the applicable legal norms.

In the first place, the Claimant alleges that the PTA committed "several and very serious logical errors" when substantiating the correction to the Claimant's taxable profit.

The first would have been the fact of having considered that the entirety of the taxpayer's charges was not directly related to its activity. In this sense, the Claimant emphasizes the existence of a mathematical impossibility of considering that all of the supplies obtained from E… (allegedly in the amount of € 18,205,000.00) were used to grant supplies to its related entities (allegedly in the amount of € 3,225,976.77).

Indeed, the Claimant emphasizes that the financing granted to third parties is much less than the financing it obtained (approximately 82.3%).

Thus, it argues that the correction to taxable profit in the amount of € 456,096.72 (€ 554,188.00 * 82.3%) should be considered excessive and illegal, as it runs counter to rules of logic and mathematics that a significant portion of the loans granted by E… to the Claimant do not have a connection with the loans granted by the latter to B….

Consequently, subsidiarily, it requests that the contested CIT and compensatory interest assessments be annulled in the corresponding part - € 137,806.68 (€ 167,444.33 * 82.3%), concluding that the PTA's understanding is illegal and unconstitutional due to violation of the principle of taxation on actual income.

The second logical defect of the PTA stems, according to the Claimant, from the fact that it had "declared itself 'prevented' from establishing a 'connection' between: (i) the financial charges (which the PTA confirms were accounted for) with the passive financings contracted by the Claimant with E…, and (ii) the interest (which the PTA confirms were earned and given to be taxed) which it obtained through the financings granted to B…".

To promote and substantiate this impediment, the Claimant understood that the PTA resorted to two arguments: on the one hand, the fact that it is not a CPMC, therefore the supplies granted are outside the scope of its activity, and on the other, the fact that the Claimant did not effect payment of the financial charges in question here or did not present documentation proving that payment.

The Claimant defends in this point the indispensability of the financial charges deducted. Thus, it states that, according to the formulation of article 23 of the Corporate Income Tax Code in force at the time of the facts, the rule was that, for financial charges to be considered as tax expenses, it was sufficient that they were, in the abstract, suitable or indispensable for the realization of income or a means to ensure the maintenance of its income-producing source, article 23(1)(c) moreover establishing that "financial charges, such as interest" were deductible.

For this reason, the Claimant argues that it fell to the PTA to bear an increased burden of demonstrating why it considered that the incurred interest did not meet the criterion of indispensability.

Furthermore, the Claimant emphasizes the understanding – confirmed by the doctrine and case law invoked – that "in a legal order that recognizes the freedom of economic initiative and the right to private property, the wisdom of business choices cannot be scrutinized by the PTA, unless there is a suspicion that they are illegal or that they pursue objectives foreign to the company (e.g., those of shareholders, members of statutory bodies or third parties)."

In this way, the Claimant alleges that the PTA merely found that it had granted a small amount of supplies to its subsidiaries and (based on the case law understanding that the provision made, free of charge, by companies which do not constitute a CPMC, and which are not covered by the STRGC, to associated companies, cannot be considered as tax expenses) decided to disregard for tax purposes the entirety of the interest incurred by the Claimant.

However, the Claimant emphasizes that, in this case, there are no free supplies at issue, the Claimant and B… are covered by the STRGC, and the financial charges borne by the Claimant cannot be considered as arising from the supplies made to its subsidiaries.

Even if the financial charges were borne to grant these supplies, these would, in its opinion, be deductible. In this sense, the Claimant resorts to doctrine and case law to defend a broad interpretation of article 23 of the Corporate Income Tax Code, "to include in it all operations resulting from the use of the assets of taxpayers for a business purpose, in particular of its assets and management of its liabilities, which, taken as a whole, allow the entity in question to fulfill its economic purpose: the pursuit (immediate or in the long term) of an economic surplus (profit)."

Fundamentally, the Claimant argues that productive activity should not be understood in a restrictive sense, directly related to the company's corporate purpose, but rather in a broad manner, encompassing any activity related to an income-producing source of the entity bearing expenses.

Thus, it considers it evident that, in the case at hand, the holding of participations and their management of other entities, as well as the contracting of loans to finance such activity through supplies, even if free of charge, should not cease to be considered as included in the Claimant's economic interest and activity. Consequently, the interest incurred could not cease to be considered as deductible and accepted as tax expenses.

The last logical defect of the PTA concerns the lack of proof of the incurred financial charges, in particular, the fact that it invoked that the Claimant had only presented it with internal documents and that "it had not made available to it, nor documented it, a series of elements and information necessary for the correct determination of the accounting of such expenses, their respective justification and connection to income subject to tax".

Here the Claimant understands that it made available all documents and information associated with the contracts for loans obtained and granted to related parties and that, contrary to what the PTA alleged, it presented information and documents that allowed the PTA and any person in good faith to understand (i) the rationale underlying the contractualization of loans to related parties, (ii) the terms and conditions negotiated, (iii) the amounts of financial charges borne by the Claimant, the manner in which the charges were recorded in the accounting and disclosed in tax returns, (iv) the connection that those charges had, taking into account the economic activity carried out by the Claimant, and (v) the tax framework that the Claimant attributed to said financial charges.

On the other hand, starting from the assumption that the PTA seems to understand that the interest from supplies properly accounted for is only deductible if the payer has an invoice issued by the shareholder, the Claimant argues for the non-existence of any legal requirement for a document of this type in the case of interest, referring to the new wording of no. 4 of article 23 of the Corporate Income Tax Code and arguing that "if in 2017 the Corporate Income Tax Code does not require any 'invoice' to prove charges with interest...much less was such requirement imposed in 2012!".

Thus, it considers that also by this path the PTA is not correct, insofar as the Claimant has proved all the facts alleged by it and presented all documents necessary to prove the incurred financial charges.

Violation of the inquisitorial principle

The Claimant further alleges that the PTA did not present a single element, indication, document or proof of the fact that would support the correction to its taxable amount, that is, that the financing obtained from E… was used to finance B… and gave rise to the remunerated liability that appears in its financial statements.

On the contrary, what the evidence "indelibly dictates is that at least a significant portion (more than 80%) of the supplies provided by E… to the Claimant were not used to finance B…", emphasizing the Claimant the purposes expressly listed in the supply contracts entered into with E….

On the other hand, the Claimant refers that the Inspection Report makes no reference to any action taken by the PTA with the purpose of obtaining information about the hypothetical use or non-use of the funds from the loans granted to the Claimant in the granting of remunerated loans to B…, nor does it contain any explanation of the reasons why, in light of the Claimant's accounting records, the PTA reached this conclusion.

Therefore, the Claimant argues that the PTA did not adequately respect the principles of the inquisitorial investigation and discovery of material truth and did not fulfill the burden of proof necessary to affect or destroy the presumption of veracity that the Claimant's tax and accounting information enjoys.

Consequently, given the constitutional obligation of companies to be fundamentally taxed according to their actual income (and not presumed), it understands that the CIT assessments and compensatory interest assessments at issue here are unconstitutional and illegal, and should therefore be annulled.

Lack of notification of the substantiation of the compensatory interest assessment

The Claimant alleges that it was never notified of the substantiation of the compensatory interest assessment, making reference to the case law understanding that the minimum substantiation required in matters of these assessment acts must include the indication of the amount on which the interest is calculated, the period of time considered for the assessment and the rate applied, as well as the legal norms on which the assessment is based.

The Claimant therefore considers that it was not notified of the substantiation of this assessment and that the same is illegal, due to violation of no. 9 of article 35 of the GTL, requesting, moreover, its annulment.

Finally, the Claimant requests the payment of indemnificatory interest calculated at the rate of 4% from the date of the undue payment of tax until the date of processing of the credit note, due to error attributable to the services.

GROUNDS FOR THE DECISION

With respect to the violation of the inquisitorial principle, we consider that the PTA adequately respected the principles of the inquisitorial investigation and discovery of material truth, having fulfilled the burden of proof necessary to affect or destroy the presumption of veracity that the Claimant's tax and accounting information enjoys.

In fact, the PTA analyzed the Claimant's accounting documentation, having requested that it submit analytical trial balances as of 31-12-2012, before and after determination of results; a list of the holders of capital in the said financial year and as of the date of the financings; a list of the capital stakes in the financial year under analysis; presentation of the list of all credits obtained and granted appearing in the balance sheet; among other documents.

Based on these elements, the PTA set aside the presumption of veracity of the Claimant's accounting and tax declarations provided for in no. 1 of article 75 of the GTL, pursuant to no. 2 of that provision, insofar as there were founded indications that those did not reflect or prevented knowledge of the taxpayer's taxable amount. In the case at hand, the PTA highlighted the failure to comply with the requirements for deductibility of the financial charges incurred by the taxpayer.

Furthermore, it made two additional requests for documents relating to the movements recorded in account 69119 – Intercompany – with a debit balance of € 554,188.00, a value which was subject to correction and added to the Claimant's taxable profit.

In cases where the presumption of veracity of the Claimant's accounting and tax declarations, provided for in no. 1 of article 75 of the GTL, is set aside, the rules of burden of proof provided for in article 74 of the GTL shall apply, it falling to the PTA to prove the facts constitutive of its right to tax and to the Claimant the facts relevant for purposes of determining the taxable amount.

However, this burden of proof is not to be confused with the respect by the PTA for the inquisitorial principle enshrined in article 58 of the GTL. In fact, we consider, independent of the presumption, that the Administration carried out all necessary actions to satisfy the public interest and to discover the material truth, since it analyzed the Claimant's accounting documentation and even made additional requests for documents relating to account 69119.

On the other hand, by alleging that the financial charges deducted by the Claimant from its taxable amount as tax expenses under article 23 of the Corporate Income Tax Code did not meet the requirements of that provision regarding indispensability and proof, it set aside the presumption of veracity provided for in no. 1 of article 75 of the GTL. In fact, paragraph a) of no. 2 of that article only requires the verification of founded indications that the taxpayer's declarations do not reflect its actual taxable amount and not conclusive proof that, in fact, the declarations do not reflect the actual taxable profit.

Therefore, contrary to what the Claimant alleges, we do not consider that the PTA violated the provisions of no. 1 of article 75 of the GTL, nor do we consider that it violated the provisions of articles 15, 17 and 23 of the Corporate Income Tax Code. Consequently, we also do not consider that the constitutional principle of taxation of actual income, enshrined in no. 2 of article 104 of the Constitution of the Portuguese Republic, was put in question here by the PTA.

We further add that, in accordance with the rules of burden of proof provided for in no. 1 of article 74 of the GTL, it fell to the Claimant to demonstrate the facts relevant for purposes of determining the taxable amount, and those preventing the right of the PTA to tax, which, as will be seen, it did, presenting documentary evidence of the meeting of the requirements required by article 23 of the Corporate Income Tax Code for the deduction of financial charges from its taxable profit.

With respect to the acceptance of the financial charges incurred by the taxpayer as tax expenses, deductible for purposes of determining the taxable amount, these should be accepted insofar as it is considered that all the requirements legally required, provided for in article 23 of the Corporate Income Tax Code, are met.

In fact, with respect to the criterion of indispensability, we agree with the broad interpretation of article 23 of the Corporate Income Tax Code, defended by the Claimant and which has been adopted by the case law of CAAD and the courts.

We therefore follow the understanding reflected, for example, in the decision of the Supreme Administrative Court of 24-09-2014, delivered in the context of case no. 0779/12, in the course of which it was understood that:

"In the understanding that doctrine and case law have been adopting for the purpose of determining the indispensability of a cost (cf. art. 23 of the CITC in the version in force in 2001), the PTA cannot scrutinize the wisdom and appropriateness of management decisions of the company, on penalty of intruding on the freedom and autonomy of management of the company.

II - Thus, a cost will be accepted for tax purposes if, in a judgment made at the moment it was incurred, it is appropriate to the company's productive structure and the obtaining of profits, even if it turns out to be an unfruitful or economically ruinous economic operation, and the PTA can only disregard as tax costs those that do not fall within the scope of the taxpayer's activity and were incurred, not in the taxpayer's interest, but for the pursuit of foreign objectives (when it can be concluded, in light of the rules of common experience, that it had no potential to generate benefits)."

No absolute causal nexus is required between the costs incurred and the development of the taxpayer's activity understood as the pursuit of its corporate purpose. It is sufficient that the cost is appropriate to the company's productive structure and the obtaining of profits and that it is not intended for the pursuit of foreign objectives (that is, of the shareholders or third parties).

With respect, in particular, to costs arising from the obtaining of loans (interest) by a company which aims at granting loans to companies it participates in, integral to the same fiscal group (subject to the STRGC), see the decision of the arbitral tribunal delivered in case no. 587/2014-T, in the context of which it was held that:

"Thus, in the question which at this point is discussed, the deductibility of interest borne by the participant will depend on the fact that such financings contributed to, according to normal rules of management, increase the expectation of future benefits or to maintain the income-producing source (financial asset) of ALFA (which grants the supplies to the subsidiary).

This means that the expenses resulting from the financing obtained by ALFA and which was subsequently applied in the financing of BETA must satisfy one (or both) of the following conditions:

a) Be associated with the expectation of increased benefits of the participant;

b) Permit the maintenance of the income-producing source of revenues (that is, contribute to the continuity of the activity of the subsidiaries and the consequent continued recognition of the financial asset in the sphere of the participant)."

We furthermore emphasize that acceptance should be global and not merely partial, since it is necessary to separate cash flows from economic flows. In fact, the cash flows of a company are those relating to accounts related either to assets and liabilities (Balance Sheet) or to the statement of income. Only for purposes of analysis are they usually divided into cash flows relating to operational, investment and financing activities. In this particular case, we are faced with cash flows of inflows from a financing activity (the loans granted to the Claimant by the economic group it belongs to in the amount of € 18,205,000) and cash flows of outflows from investment activities (the supplies granted by the Claimant of € 3,225,967.77). In either case, those flows occurred mainly in years prior to 2012 (2010 and 2011). And even to be able to assert (which we consider to be fiscally irrelevant given the reasons previously set forth) that the supplies of € 18,205,000 made to the Claimant had served for it to finance the supplies of € 3,225,967.77 to the entity in group relation with it, one would have to undertake an exhaustive analysis of all actual cash flows (divided among the three types of flows referred to above) in each of those two years, and it is not guaranteed that such analysis would be conclusive. But even if it could prove in arithmetically unquestionable terms that those inflows (€ 18,205,000) had been partially applied in granting supplies made by the Claimant in the amount of € 3,225,967.77, it is not the PTA's role to verify whether this portion (and never the total amount) was fully applied in the "repayment of existing loans, acquisitions of funds and support for treasury in general" - this would possibly be a matter between two companies of the economic group given the contract signed between those two parties. The PTA must, yes, verify revenues, expenses and patrimonial changes in accordance with the rules relating to the calculation of the taxable amount of CIT, being, consequently, lawful to inquire about the indispensability of expenses (economic perspective and not treasury perspective), among other tax-relevant aspects, but in a global assessment of the Claimant, which involves all activities: those relating to its purpose but also non-operational activities related to extra-operating assets, such as is the case of a supply granted to a subsidiary.

One cannot dissociate the asset as a whole from its financing as a whole (by own capital or by liabilities, and within this by remunerated or non-remunerated liabilities). And financial charges are thus indirectly related to all assets and not merely to one type of asset. Therefore, the central question will be whether the financial costs presented are or are not appropriate to the financing of the activity developed by the Claimant, there including the granting of loans (in this particular case even remunerated) to support subsidiaries.

For which reason we consider that this requirement, in this case, is met.

With respect to the requirement of proof of the expense, it should be noted, in the first place, that paragraph c) of no. 1 of article 23 of the Corporate Income Tax Code provided at the time of the facts that "expenses are deemed to be those that are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the income-producing source, in particular: (...) c) Of a financial nature, such as interest on borrowed capital applied in the business, discounts, premiums, transfers, exchange differences, charges with credit operations, collection of debts and issuance of bonds and other securities, redemption premiums and those resulting from the application of the effective interest method to financial instruments valued at amortized cost;" (emphasis ours). Paragraph g) of no. 1 of article 45 of this statute, in turn, determined that the following charges were not "deductible for purposes of determining taxable profit, even when accounted for as expenses of the tax period: (...)g) Charges not duly documented".

However, it was only with the wording of article 23 resulting from Law no. 2/2014, of 16 January, that its no. 3 came to determine that "deductible expenses under the above numbers must be documented, regardless of the nature or support of the documents used for that purpose".

This means that that provision, at the time of the facts, only required – as a requirement for acceptance of costs as tax expenses – that they be proved, without, however, restricting the form of proof or the type of document required.

However, the case law of the superior courts, as well as doctrine, began to argue that this wording of article 23 of the Corporate Income Tax Code required that tax expenses be proved by external documents, that is, those which emanate from or are intended for the exterior, such as invoices, receipts and credit notes, with mention of the fundamental characteristics of the operation (cf. Decision of the Supreme Administrative Court of 27-04-2016, delivered in case no. 01541/14 and of 05-07-2012, delivered in case no. 0658/11, as well as Freitas Pereira in Opinion of the Center for Tax Studies of the Ministry of Finance with no. 3/92, of 6 January 1992, published in Tax Science and Technique no. 365, pages 343 to 352, cited in the first decision)

Consequently, taxpayers' costs without external documentary support were understood as undocumented costs. However, case law understood that the fact that they were not supported by external justifying documents did not, by itself, determine their non-deductibility as tax costs under article 23 of the Corporate Income Tax Code.

On the contrary, when costs were undocumented, in order for them to be considered as deductible tax costs, it would fall to the taxpayer to prove their existence by any means (including by witness testimony), provided it was adequate to demonstrate the main characteristics of the transaction.

The Supreme Administrative Court thus pronounced itself in its decision of 27-04-2016, delivered in the context of case no. 0154/14, the understanding of which we adopt in its entirety:

"In the case at hand what the Treasury questions is the absence of external documents proving the trips and distances traveled.

The requirement of external documents is based on the principle that thereby there is a guarantee of authenticity.

(…)

In the case of insufficiently documented cost, this does not mean that it cannot be deductible for CIT purposes, since proof of its existence can be made by any means, including witness testimony, with the burden falling on the party contesting it given the reversal of the burden of proof as previously referred to.

It is thus incumbent on him to clearly and conclusively demonstrate the existence of operations relating to the cost recorded and its indispensability for the realization of profits or maintenance of the income-producing source."

We further follow the understanding of Tomás Castro Tavares ("On the relation of partial dependence between accounting and tax law in determining the taxable income of legal persons: some reflections at the level of costs", Tax Science and Technique, 396, pp. 123 et seq"), cited in the decision of the Supreme Administrative Court of 05-07-2012, that, in these cases, where a given transaction or cost is not supported by an external document, or if this document is incomplete, "it is not sufficient that [the taxpayer] evidence an internal document (made by itself). Alongside that support will have to demonstrate, by any other means, the existence and main characteristics of the transaction. In that task it may bring any means of proof (witnesses, auxiliary documents, explanation of its accounting), with the judge to assess the completion of the proof. In this way, an undocumented cost has tax effects if the taxpayer proves, by whatever means at its disposal, the effectiveness of the operation and the amount of the expense" (underlined and bold ours).

Now, in the case at hand, the PTA considered that the taxpayer did not present supporting documentation inherent to the financial charges deducted as tax expenses, and that the failure to present the same had prevented the PTA from determining "either the correct accounting of the financial charges, or their justification, or their connection to income subject to tax".

As results from the analysis of the Final Tax Inspection Report (Office no.…), in response to the additional request for documents made by the PTA, relating to the movements recorded in account 69119 – "Intercompany" – with a debit balance of € 554,118.00, the taxpayer sent only internal documents: the extract from this account, a copy of emails reflecting the calculations of the expenses recorded and accounting documents. Furthermore, the PTA made a second additional request for documents, again relating to the interest recorded in account 69119, requesting the submission of copies of all supporting documents issued by external entities, relating to the movements recorded in this account, with the taxpayer not responding to this request.

If it is true that the taxpayer, in response to the request for documents made by the PTA, only presented internal documents, we cannot agree with the Administration's understanding that the failure to present external documents prevented it from determining the correct accounting of the financial charges. In fact, the accounting of these charges is possible on the basis of the email attached to the Petition for Constitution of Tribunal as Doc. 10 and made available to the Administration.

Furthermore, it must be stated that emails, as electronic documents, are integrated into the concept of documentary evidence (cf. Decision of the Court of Appeal of Coimbra of 14-11-2017, delivered in case no. 2840/12.9TBFIG.C2).

On the other hand, in the case of undocumented costs, only proved by internal documents, it is not, as has been seen, possible to exclude tout court the deductibility of the same for CIT purposes. On the contrary, it fell to the taxpayer to prove, by whatever means at its disposal, the effectiveness of the operation and the amount of the expense, which it did.

Thus we understand this insofar as, in addition to the internal documents referred to above, the PTA had access to (and the taxpayer attached to its Petition for Constitution of Arbitral Tribunal as Doc. 2) the two supply contracts entered into between the Claimant and E…, in the context of which the applicable interest rate was indicated[1].

We therefore consider that the internal documents proving the financial charges and the supply contracts entered into between the Claimant and E… constitute sufficient evidence of the existence and the principal characteristics of the costs, with the requirement of proof of tax expenses, provided for in no. 1 of article 23 of the Corporate Income Tax Code, being met.

In this way, with the requirements provided for in article 23 of the Corporate Income Tax Code for the deductibility of financial charges – proof and indispensability – met, the same should be accepted as tax expenses for CIT purposes. In consequence, the acts of CIT assessment and the respective compensatory interest assessments, resulting from the correction of € 554,188.00 to the Claimant's taxable amount, should be annulled.

5. DECISION

In accordance with the above, this Arbitral Tribunal decides:

1. To hold the petition for arbitral pronouncement to be well-founded and, in consequence, to declare illegal the contested CIT assessments, annulling them, with the legally applicable tax-legal consequences.

2. To hold the petition for indemnificatory interest to be well-founded, calculated on the amount of the sum assessed, from its payment until reimbursement.

6. VALUE OF THE CASE

The value of the case is fixed at € 167,444.33, pursuant to article 305, no. 2 of the Code of Civil Procedure and 97-A, no. 1, a), of the Code of Tax Procedure and Process, applicable by virtue of paragraphs a) and b) of no. 1 of article 29 of the LRTA and no. 2 of article 3 of the Regulation of Costs in Tax Arbitration Proceedings.

7. COSTS

The amount of the arbitration fee, to be borne by the Respondent, is fixed at € 3,672.00, pursuant to articles 12, no. 2, and 22, no. 4, both of the LRTA, and article 4, no. 4, of the Regulation of Costs of Tax Arbitration Proceedings and the attached Table I thereto.

Notify.

Lisbon, 12 March 2018

The Arbitrators

(José Baeta de Queiroz)

(Diogo Feio)

(Luís Janeiro)

[1] From these contracts also results the justification of the expenses and their connection to income subject to tax.