CAAD Case 320/2018-T: IRC Cost Deductibility, Impairments & Withholding Tax Under Articles 23, 36 and 45 CIRC

ARBITRAL DECISION

The Arbitrators Carlos Alberto Fernandes Cadilha (Presiding Arbitrator), Luciano dos Santos Carvalho and Jorge Carita, designated by the Deontological Council of the Administrative Arbitration Centre to form an Arbitral Tribunal in the following manner

I – REPORT

On 9 July 2018, A..., Lda., NIPC..., with headquarters at Rua..., n.º..., ..., in Porto, hereinafter referred to as the "Claimant", requested the constitution of an arbitral tribunal and submitted a request for an arbitral ruling, under the terms of paragraph a) of Article 2, n.º 1 and paragraph a) of Article 10, n.º 1 of Decree-Law n.º 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter referred to only as RJAT), with a view to declaring the illegality of the assessment act resulting from Income Tax Withholding at Source n.º 2016..., of 21.11.2016, in the amount of € 115,609.81 (one hundred and fifteen thousand, six hundred and nine euros and eighty-one cents) and the assessment act of Corporate Income Tax (IRC) n.º 2016... of 21.11.2012, in the amount of € 6,681.34 (six thousand, six hundred and eighty-one euros and thirty-four cents), both relating to the financial year 2012 and respective compensatory interest, all in the total amount of € 122,368.56 (one hundred and twenty-two thousand, three hundred and sixty-eight euros and fifty-six cents), requested the annulment of the decision dismissing the administrative appeal presented, and finally requested the annulment of the contested assessments and the recognition of the right to indemnity interest.

The Claimant is represented in these proceedings by its representative, Dr. I..., and the Respondent, the Tax and Customs Authority (hereinafter referred to as AT) is represented by the jurists, Dr.ª B... and Dr.ª C....

Following verification of the formal regularity of the request presented, under the terms of paragraph a) of Article 6, n.º 2 of RJAT and since the Claimant did not proceed to appoint an arbitrator, the signatories were designated by the President of the Deontological Council of CAAD and accepted the position within the legally stipulated deadline.

The present tribunal was constituted on 19 September 2018, at the headquarters of CAAD, located at Av. Duque de Loulé, n.º 72 A, in Lisbon, as per the communication of the arbitral tribunal which is attached to these proceedings.

The Respondent, after being duly notified, submitted its reply on 25 October 2018.

On 7 November 2018, by order, the Tribunal scheduled 20 December 2018, at 11:30 for the holding of the meeting provided for in Article 18 of RJAT and examination of witnesses, which date was postponed to 17 January 2019, at the same time, due to the request submitted by the Claimant dated 20 November 2018, which was postponed again to 6 February 2019.

On 6 February 2019, the meeting provided for in Article 18 of RJAT took place, at which the examination of witnesses listed by the Claimant was conducted. At said meeting, the Tribunal notified the Claimant and Respondent to, in this order and successively, submit written submissions within 15 days, extended, in accordance with the provisions of Article 21, n.º 1 of RJAT, the deadline referred to in n.º 1 of that provision by two months, set 19 April 2019 for the purpose of rendering an arbitral decision, under the terms of Article 18, n.º 2 of RJAT, and finally warned the Claimant that it should proceed with the payment of the subsequent arbitration fee, under the terms of n.º 3 of Article 4 of the Regulation of Costs in Tax Arbitration Proceedings, and communicate such payment to CAAD.

Following this, on 22 February 2019, the Claimant submitted written submissions, with the Respondent submitting its submissions on 12 March 2019.

II. The Claimant submits its request, in summary, as follows:

The Claimant sustains its request for declaration of illegality of the assessment act by way of Income Tax Withholding at Source n.º 2016..., of 21.11.2016, in the amount of € 115,609.81 (one hundred and fifteen thousand, six hundred and nine euros and eighty-one cents) and the assessment act of Corporate Income Tax (IRC) n.º 2016..., of 21.11.2012, in the amount of € 6,681.34 (six thousand, six hundred and eighty-one euros and thirty-four cents), both relating to the financial year 2012 and respective compensatory interest, all in the total amount of € 122,368.56 (one hundred and twenty-two thousand, three hundred and sixty-eight euros and fifty-six cents), the annulment of the decision dismissing the administrative appeal presented, and finally requested the annulment of the contested assessments and the recognition of the right to indemnity interest, on the following grounds:

The Claimant invokes a breach of law, namely of Article 23 of the IRC Code regarding the deductibility of expenses associated with financial charges, on the grounds that "[t]he inspection reports that 'in determining the net and fiscal results of 2012, the Claimant deducted expenses with financial charges totalling € 230,419.22 which cannot be legally accepted, since the interest related to the loan obtained from D... (parent company), in the total amount of € 2,700,000.12 amounts to € 404,300.77, a value that corresponds to an average interest rate of loans obtained of approximately 14.88%. The inspection did not take into account the fact that the interest in question does not relate only to the loan but also to interest related to late payment of invoices'."

In effect, the Claimant clarifies that "[t]he amount recognized in the account '2661-Shareholders/Partners-D...' relates only to the loan provided by D... to the Claimant" being its "[...] main supplier [...], for which it issues invoices relating to various supplies." Furthermore stating that "[w]hen the Claimant was late in paying the invoices, D... charged the respective interest, hence the amount in account 22 also relates to amounts charged by D... for late payment of supplies of materials to the Claimant from unpaid invoices."

It refers, regarding this aspect that "[t]here are two types of interest charged by D... to the Claimant: - the value of interest on the mutual contract; and the amount of interest charged for late payment of invoices. Thus, in order to determine the average rate of financial charges borne by the Claimant, it is necessary to verify (i) which interest constitutes the remuneration of the mutual contracts supported, disregarding the value of commercial interest, and (ii) within those, what is the amount owed at the end of each month. Only in this way can the monthly interest rate paid by the Claimant to D... be determined, relating to the mutual contracts entered into, which cannot be mixed with late payment interest on invoices."

The Claimant continues clarifying that "[t]he value relating to the loan provided by D... to the Claimant during the entire financial year was the constant amount of $ 3,313,170.00, and during 2012, there was no amortization or increase in the loan provided. The Claimant obtained financing in the amount of € 2,700,000.12, as well as the amount recorded in the 251-'Financing obtained' of € 16,297.67. Thus, in the financial year 2012, the Claimant only obtained financing in the total amount of € 2,716.29.12. Now it is important to analyze the interest borne by the Claimant in 2012 and its source. [...] It is important to analyze the content of the interest recorded in account 69113111 – Interest on Financing obtained, since there was an error in the accounting record of this amount. In fact, in said account 69113111, are recorded the interest related to the loan provided by D... to the Claimant, as well as the interest related to the non-payment of invoices arising from commercial relations between the two entities."

The Claimant adds that "[t]he inspection, and only on the basis of invoices issued monthly by D... to the Claimant in the financial year 2012, concluded that the total amount of € 395,287.19 was paid. However, [...] D...'s monthly invoices were for the totality of interest (late invoices as well as interest related to the mutual). Thus, it is imperative to distinguish between the amounts recorded in said account[...]". Thus, the Claimant mentions that "[i]n the financial year 2012, the amounts paid by the Claimant to D... are broken down as follows:

Continuing, the Claimant states that "[t]hus, in the financial year 2012, the Claimant bore interest on the mutual entered into with D... in the amount of € 88,073.17, and not the amount of € 395,197.19." Being "[t]he rate of interest borne by the Claimant with the mutual entered into with D... in the financial year 3.50% and not 14.88%."

The Claimant further assesses that, as the holder of the entire share capital of company E..., Lda, it granted it a loan, in light of the lack of financial means to pay various expenses. A loan granted by the Claimant "[t]aking into account the interest that such investment entailed for E... and the potential for profit that the business presented", and in light of the intention of "appreciation of E..., since such appreciation would result in the increase in the value of its shares, and consequently its assets. [...] The loan to E... was to the extent necessary for it to invest in the business in question. That is, the Claimant's action in order to, on the one hand, allow the investment of E... and guarantee its assets, and on the other, increase the profits of E... that would benefit it."

Given this, the Claimant understands that "the costs recorded in the respective accounts were actually borne by the Claimant, being the same duly supported from an accounting perspective, [...] the first legal requirement [of Article 23 of CIRC] is verified for a given expense incurred to be considered as a fiscally deductible cost. The costs incurred by the Claimant were indispensable for the maintenance of its productive source", since without them "[...] the company [could not] carry out its activity, nor obtain the profits or gains it obtained." Further adding that, "[i]t is not necessary, to give fiscal relevance to expenses made, to demonstrate that they actually produced a direct positive result in the results of the Claimant. It is sufficient that they are acts that can be accepted as acts of management tending to obtain results, acts that a company undertakes with the objective of increasing profits and with potential capacity to provide such increase."

Concluding that "[t]he Claimant's decision to loan amounts to E... was based exclusively on a management decision regarding its investee, in order to meet treasury needs. In this case, we are dealing with a decision taken under the principles of management freedom which are not, and cannot be, subject to review by the Tax Authority", therefore "[t]he report, and as a consequence the assessment, and also the dismissal of the administrative appeal are affected by a violation of law, specifically Article 23 of CIRC, reason for which the fiscal correction to the taxable profit of the Claimant in the amount of € 230,419.22 should be annulled."

The Claimant invokes a breach of law, namely of Article 35 of the IRC Code regarding impairment of receivables, defending that "[i]n the context of the Tax Inspection carried out on the Claimant, corrections were also made to expenses relating to 'Losses on impairment of receivables', in the amount of € 2,040,628.09" motivated by the understanding upheld by the Tax Inspection Services in the sense that "(…) the taxpayer considered in determining the Net Result of the Financial Year, impairment losses in the amount of € 5,215,267.14, without having demonstrated the risk of uncollectibility thereof, (…)", with which the Claimant does not agree, because "[t]he value of impairment losses recorded by the Claimant in the financial year 2012 was due to the fact that the holder of the Claimant's share capital decided that in the financial year 2012, new internal rules would exist regarding credit granting and supply of products to customers with overdue invoices. This decision results from the implementation of commercial policies already applicable in Spain by the business group in which the Claimant is part of. These policies were the following – customers who had debts to the Claimant lost credit, having to pay immediately or even in advance."

The Claimant alleges that its management "[...] in light of the decision of the share capital holder, complied with the new credit granting policy", proceeded with the withdrawal of all defaulting customers, and contacted them by telephone, in order to claim immediate payment of invoices "[u]nder penalty of the Claimant being forced to stop supplying its goods. Furthermore, in addition to telephone contacts, there was personal contact through meetings with the various customers of the Claimant." In fact, "[t]he recording of impairment losses was based on telephone inquiries and meetings with all customers."

Thus, the Claimant defends that "such recording was carried out under the terms of n.º 2 of Article 36 of CIRC" and "[b]ased on this criterion, the value of impairment losses considered by the Claimant was € 2,041,591.27, a value resulting from compliance with legal criteria (…)".

The Claimant continues in the sense that "[a]s stated above, the formula for calculating the value of impairment losses was respected, under the terms of Article 36 of CIRC. Regarding the second requirement, that is, the fact that the receivables in question are evidenced as accounting impairments by the Claimant, it should be noted that it is satisfied, insofar as the inspection services themselves recognize it (…)."

The Claimant states that, "[...] the problem identified by the Inspection Services relates to compliance with the first requirement which concerns the 'Receivables can be considered as doubtful collection'", thus, the Claimant argues that "[l]et us then see the recording of fiscally deductible impairment losses by customer, in cases where there are legal proceedings, and in other cases, and as stated, various telephone contacts were made with customers in order to obtain the payment of the amounts in question. Being that, regarding the amount of € 2,041,591.27, the same is also justified, so the corrections proposed should be annulled, on the grounds of their illegality."

Regarding the invoked breach of law - Article 8 of the Portuguese Constitution and n.º 4 of Article 87 and 94 of the IRC Code - Withholding at Source on amounts paid or made available to D..., the Claimant manifests the understanding that "[t]he report considered that the Claimant paid or made available to D..., by way of interest, the amount of € 395,197.19, without having proceeded with the withholding and delivered to the State the IRC due, totalling the tax owed € 98,779.30". Further stating that, "[t]here is no doubt that the payments in question were made to D..., with headquarters in Switzerland." It happens that "[t]he Claimant presented, in the administrative appeal, Form 21 RFI relating to the year 2012, (...). In fact, such document is issued in 2017, but that does not eliminate the ability to be sufficient to eliminate the obligation to proceed with withholding at source. For that reason, the lack of withholding at source should be considered waived, under the terms of n.º 6 of Article 98 of CIRC", because "[h]aving the Claimant in its possession the 21-RFI form valid by the Swiss Tax Authority, the decision to dismiss the administrative appeal, as well as the additional assessment, should be annulled, for lack of legal grounds."

The Claimant further argues that "[i]t is not essential to present Form 21-RFI to eliminate the obligation for withholding at source. In fact, a Convention was entered into between Portugal and Switzerland to Avoid Double Taxation in matters of taxes on income and capital, approved by Decree-Law n.º 716/74, of 12 December, being subject to an Amending Protocol approved by Resolution of the Assembly of the Republic n.º 87/2013, of 27/06", under the terms of which and taking into account that "[t]he D... [is] a non-resident entity, with headquarters in Switzerland, cannot be imposed on it any ancillary obligations, in particular, the delivery of Form 21-RFI, as the Convention has greater force than internal rules by virtue of the provisions of Article 8, n.º 3 of the CRP."

Thus, it concludes that "[t]he interest paid by the Claimant to D... should not be subject to withholding at source. First, because the Convention does not require, indeed, states that the same will be taxed in Switzerland, on the other hand, due to the fact that the Claimant presented the respective Form 21-RFI which covered the year 2012. Hence, the dismissal of the administrative appeal and the additional assessment should be annulled."

Finally, it requests the payment of indemnity interest, under the terms of n.º 1 of Article 43 of the General Tax Law.

III. In its Reply, the Respondent invoked, in summary, the following:

The Respondent refutes the arguments of the Claimant regarding the alleged breach of law - Article 23 of CIRC - regarding the deductibility of expenses associated with financial charges, arguing that: "[...] notwithstanding the relevance assumed by the legal-economic reality underlying tax rules, the law requires the proof of the indispensability of the expense in obtaining income and not merely the proof of the possibility of obtaining such income." In effect, Article 23 of CIRC requires the fulfillment of "[t]hree essential requirements for financial charges borne to be valued and accepted as a fiscal expense: proof (justification), indispensability and the connection to gains subject to tax. The first requirement relates to the effectiveness of the realization of costs which consists of various forms of written support for accounting entries, that is, to their documentary proof. The second requirement makes the fiscal deductibility of the cost dependent on a justified relationship with the productive activity of the company and this indispensability is verified as long as these charges are connected with the obtaining of profit. The third requirement that makes up the general clause for deductibility of expenses, in the legal formulation introduced by the IRC Code, is the requirement of connection to 'gains subject to tax or the maintenance of the productive source'."

Furthermore, the Respondent assesses that "[i]t follows from the general principle of Article 23 of CIRC that expenses made by the taxpayer, in order to be fiscally deductible, must be limited to either the obtaining of gains subject to tax, or to the maintenance of the productive source." In effect, the Respondent notes that "[i]n the case at hand, it is verified that the taxpayer contracted loans, bearing charges with the same, and simultaneously 'grants' financing, unremunerated, to an entity that holds all of its capital. It results from this that said charges are not directly related to the activity of the taxpayer. By not being related to the activity of the taxpayer, the requirement of indispensability of the financial charges recorded by the taxpayer is not shown to be met, as established in Article 23 of CIRC."

Thus, the Respondent considers that: "[t]he arguments put forward by the Claimant, both in the inspection phase and in these proceedings, fail to displace the judgment made by the Respondent in the sense of removing from the regulatory scope of Article 23 of CIRC the financial charges now in dispute." because "[t]he indispensability referred to in Article 23 of CIRC, as a condition for a cost to be deductible, for purposes of determining taxable profit, does not refer to necessity (expenses as a sine qua non condition of profits), nor even to convenience (the expense as convenient for business organization), but requires, solely, a relationship of economic causality. Specifically, the indispensable cost is equivalent to every cost made in order to obtain income and that represents an economic decline for the company. Thus, the expenses provided for in that Article 23 must, in the first place, relate to the taxpayer company itself, that is, in order for a certain amount to be considered an expense thereof it is necessary that the respective activity be developed by it itself, not by other companies. [...] even where it comes to associated companies."

It contends that "[...] it is in relation to the entity whose costs are being considered, taking into account the business activity it develops, that the fiscal deductibility of financial charges must be assessed and not in the sphere of any other entity with which it is related, that is, the causal connection between the assumption of financial charges and the development of the activity of the debtor company", therefore "[c]onsequently, interest borne by a company relating to loans cannot be accepted as deductible in which it is manifestly proven that the funds obtained are diverted from its own exploitation to that of another entity with which it is related."

The Respondent adds that "[t]he financial costs incurred by the Claimant are not directly related to any activity listed in its corporate purpose, nor do they relate, even indirectly, to its activity." In effect, "[t]he law does not prohibit the Claimant from assuming the commitments depending on the group of companies, if it so wished, as a matter of business management, however, the usefulness to the group does not annihilate the interest of the respective parties. "

The Respondent refers that "[t]hus, it is in relation to the entity whose costs are being considered, taking into account the business activity it develops, that the fiscal deductibility of financial charges must be assessed and not in the sphere of any other entity with which it is related, that is, the causal connection between the assumption of financial charges and the development of the activity of the debtor company", as, in fact, "[e]xisting rules that determine the fiscal disregard of certain accounting costs, their non-inclusion therein, cannot be forced by increasingly complex forms of economic organization, and there is no question of any management options, but the verification of the requirements for deductibility of costs."

"Although it is understood that the existence of these structures is objectively aimed at minimizing the commercial or financial costs of the group, these cannot override the principles of the tax legal order, which in the present case lead to the fiscal disregard of financial charges relating to the financing of an entity with which the Claimant has a connection, because they were not used in its activity as an autonomous entity."

It further adds that "[a]nother limitation formulated in the IRC code, Article 45, n.º 1 is not deductible for purposes of determining taxable profit the following charges, even when recorded as expenses of the taxation period: J) Interest and other forms of remuneration of advances and loans made by shareholders to the company, to the extent that they exceed the amount corresponding to the 12-month Euribor reference rate on the day the debt was constituted...". Now, Regulation 184/2002 of 4 March came to define as the limit value of the remuneration of loans made by shareholders to the company, fixing at 1.5% of spread to be added to the 12-month Euribor rate on the day the debt was constituted. However, Law 55-A/2010 of 31-12-2010, came to amend that regulation, fixing 6% of spread to be added to the 12-month Euribor rate in the case of SMEs.", therefore consequently "[b]eing the remuneration rate of the loan of the Parent Company, amounts to 14.63%, a percentage much higher than the limitation imposed by Article 45 of CIRC, so the totality of the loan interest borne by the Claimant could not be fiscally accepted, but only those that are within the limit established in Article 45 of CIRC, combined with Regulation 184/2002."

Regarding the alleged breach of law – Article 35 of CIRC – Impairment of receivables invoked by the Claimant, the Respondent counter-argues by referring that "[g]iven the fact that there are impairments that affect the Net Result of the Financial Year, it is important to assess whether these costs were fiscally corrected, as provided for in Article 35 - losses on impairment fiscally deductible - of CIRC" defending that "[i]t will occur deduction for tax purposes as losses on impairment of receivables, if they meet the requirements of Article 36 of CIRC."

It clarifies that the Respondent "[r]egarding receivables in arrears, the risk of uncollectibility is only considered duly justified when the debt has been overdue for more than six months and there are proofs that diligence has been undertaken for its collection. [...] That is, objective proofs of impairment are required that demonstrate that the debtor had knowledge of the diligence undertaken for collection of the debt."

It adds that "[i]mpairment losses on receivables must, in obedience to the principle of prudence and the system of economic accrual, be recognized in the taxation period in which the risk of uncollectibility is found. Therefore, the Claimant should have demonstrated the diligence undertaken for the collection of these receivables, which manifestly was not done, as the tax legislator when made dependent as consideration of receivables of doubtful collection, the existence of proofs that diligence had been undertaken for their collection, did not have in mind that such proofs could be limited to verbal statements, (...)"

It further states that "[t]he risk of uncollectibility is the touchstone of fiscal acceptance of impairments, so much so that there are certain receivables that are not considered doubtful collection such as, receivables covered by insurance, receivables from the state."

Concluding that "(...) the Claimant did not demonstrate the execution of diligence with a view to collection, in obedience to the provisions of Articles 23, 35 and 36 of CIRC, [so] the non-deductibility of impairment losses from the financial year 2012 should be maintained."

Adding supplementarily, that "(...) as a negative component of taxable profit, impairment losses must be attributed to the financial year to which they relate and to which the law attributes the right to constitute them, the taxpayer not enjoying free will as to the financial year in which it wishes to record a provision. Now, legal proceedings related to their insolvency/bankruptcy were only instituted on a date after the period of 2012 and, on the other hand, insolvency/bankruptcy proceedings were not concluded in the period 2012, so the Claimant could not recognize the debt as uncollectible, under the terms of Article 41 of CIRC."

In response to the alleged breach of law - Article 8, n.º 3 of the CRP and Article 87, n.º 4 and Article 94 of CIRC - Withholding at Source on amounts paid or made available to D... the Respondent defends that "[u]nder Article 94 of CIRC, the income from application of capital obtained in Portuguese territory, by virtue of the provision of Article 4, n.º 3, paragraph c) 3) of CIRC, are subject to withholding at source at the rate of 25%, this obligation is permanent when the holder is a non-resident entity (D...), at the moment it is placed at its disposal, and the amounts withheld must be delivered to the State by the 20th of the following month. Now, amounts were placed at the disposal of D... as interest (€ 395,197.19) and the respective withholding at source missing for each month of the year 2012, totalling € 98,779.30."

In this way, the Respondent understands that "(...) Form 21-RFI was certified on 09 January 2017, five years after the occurrence of the facts, so the Tax Inspection Services acted correctly in requiring the delivery, by the Claimant, of withholding at source guides, plus compensatory interest, under the terms of Article 35 of the General Tax Law."

Concluding that "(...) the request should be judged unfounded, maintaining in the legal order the impugned acts."

IV. Clarification

The Tribunal is competent and regularly constituted, under the terms of paragraph a) of Article 2, n.º 1 and Articles 5 and 6, all of RJAT.

The parties have judicial personality and capacity, show themselves to be legitimate, are regularly represented, and the proceedings do not suffer from nullities.

V. Factual Matters

For the conviction of the Arbitral Tribunal, regarding the proven facts, the documents attached to the proceedings, the testimony of witnesses who presented direct knowledge of the facts in question and showed themselves to be totally credible and coherent, and the administrative file were relevant.

Facts taken as proven

With relevance to the decision, the following facts are taken as proven:

1. The Claimant has as its corporate purpose "[i]mportation, exportation and distribution, wholesale or retail, of sports and entertainment articles" – cfr. Agreement of the parties –;

2. The Claimant has been registered since 26/01/1994, for the main activity of "WHOLESALE TRADE IN TOYS, GAMES AND SPORTS ARTICLES", whose corresponding Economic Activity Code (CAE) is 46690, and secondary activity of Retail trade in sports, camping and leisure articles in specialized establishments, whose CAE 47640, and whose share capital is wholly held by D..., with NIF CH... – cfr. Agreement of the parties –;

3. In 2009, the Claimant resorted to financing with the purpose of meeting the operational needs of the company, which comes essentially from the parent company "D..., NIPC..., with headquarters in Switzerland – cfr. administrative file and agreement of the parties –;

4. In 2012, the Claimant, as holder of the entire share capital of the company "E..., Lda" NIPC... granted it a loan, free of charge, in the amount of € 365,731.55 (three hundred and sixty-five thousand, seven hundred and thirty-one euros and fifty-five cents) – cfr. administrative file and agreement of the parties –;

5. The Claimant was subject to an inspection that covered the financial year 2012, authorized by Service Order n.º OI2015..., carried out by the Tax Inspection Services of the Financial Directorate of Lisbon – cfr. administrative file –;

6. The Claimant was notified of the Inspection Report from which the following corrections arose in the context of IRC and withholding at source: – cfr. administrative file –

"In the context of IRC

In the context of withholding at source on IRC at the rate of 25% under n.º 4 of Article 94

1. The Inspection Report, which forms an integral part of the administrative file, contains the following:

"III.3.2. Compliance with declarative/fiscal obligations

Up to the date of drawing up the inspection report, it was verified that in terms of compliance with its declarative/fiscal obligations, it presented some shortcomings:

• Did not submit declaration form 30 approved by regulation 438/2004 of 30 April, as an ancillary obligation provided for in Article 128 of CIRC, for the payment of interest to a non-resident (year 2012);

• Did not effect withholding at source, nor delivered to the State the IRC that should have been withheld at the rate of 25%, under the terms of paragraph c) n.º 1 and n.º 4 of Article 94 of CIRC, relating to interest paid to D..., in the amount of € 395,197.19, and delivery, within the deadline of n.º 6 of the same article.

Regarding the Income Statements (form 22) referred to in paragraph b) of n.º 1 of Article 117 and Article 120 of the IRC Code, no declarative failures were detected.

Regarding the Simplified Business Information (IES)/Annual Statement, referred to in Article 117, n.º 1 c) and Article 121 of CIRC, no declarative failures were detected.

Regarding periodic VAT declarations (DPs) on which Article 41 of the VAT Code provides, no declarative failures were equally detected.

(…)

II. Analysis of Financial Charges/Impairments

In the context of the analysis carried out, it is verified that A..., Lda has resorted to financing with the purpose of meeting the operational needs of the company. This financing comes essentially from the parent company D..., NIPC..., with headquarters in Switzerland, and has the nature of a loan obtained.

As appears in Annex A of the IES, it is verified that this company has in the "current liabilities" in the account "shareholders/partners" an amount of € 2,700,000.12 since the financial year 2009, to support an operational activity, whose volume of business (sales and services rendered), in 2012, totals the amount of € 4,969,582.12.

The Net Result, in that same year, is -€ 6,678,861.76, as per information contained in the IES and Form 22. Notwithstanding certain variations, it is noted that in previous years the company's results have been positive (considering the time period 2009 to 2010 of € 334,942.43 and € 73,944.23 respectively) and negative in 2011 with the amount of -€ 762,840.60, and in 2012, -€ 6,678,681.76.

The non-current assets of the company amount to € 105,069.30. Of this amount, 86% corresponds to "Tangible Fixed Assets" shown in the financial statements in Tangible Fixed Assets (AFT) – account 43 in the amount of € 90,540.16.

In terms of non-current liabilities, there is the amount of € 8,093.00 in financing obtained. In this amount is inserted a Financial Lease contract.

In the IES comments, the Taxpayer did not present comments on the loans obtained or granted.

Through analysis in the AT computer system, the following facts are verified regarding loans obtained and granted in 2012:

Loans obtained

Regarding loans obtained, the taxpayer presented a list of the same, identifying as "Credits obtained" from D... NIF..., in the amount of € 2,700,000.12. This amount is reflected in accounts 2661 - Shareholders/Partners - D.... It is reflected in account 251 – "Financing obtained" – the amount of € 16,297.67, being € 8,039.00 in Non-Current Liabilities and € 8,258.67 in Current Liabilities (information contained in the Trial Balance and in the IES).

From this list, the amount of € 2,700,000.12 stands out, which relates to a loan from the parent company headquartered in Switzerland, without the existence of a contract according to information from the Taxpayer (ANNEX I).

The interest and similar charges supported amount to € 404,300.77, a value that corresponds to an average interest rate of loans obtained of approximately 15% (€ 404,300.72/€ 2,716,298.12= 14.88%)

Paying particular attention to the loan obtained from company D..., whose loan amount is the highest, in the value of € 2,700,000.12, it was determined by consultation of account 69113111-interest on Financing obtained – a total of € 395,197.19 in interest that corresponds to the application of an interest rate of 14.63%. (ANX II and ANX. V pg4).

Interest is also recorded in favor of F... in the amount of € 4,020.18, without any loan obtained from this entity being recorded, however, it appears as a supplier, recorded in account 2212000001-suppliers parent company – with a total credit of 270,256.23, being settled on 31-12-2012. Having analyzed the extract of account 69113112 F..., it is deduced that it is interest on late payment of invoices.

The Taxpayer clarified by email of 12 April 2016, that the debt to D... "is constituted by a loan granted in February 2010, and by the balance owed at each moment, regarding invoices to be settled related to the commercial activity, since D... is the supplier of goods sold by A..., and there was a high amount owed resulting from this commercial relationship, namely a balance owed at the beginning of 2012 of € 8,383,935.00".

Considering the above, it is considered that the loans obtained present significant relevance, taking into account the company's volume of business, as well as being relevant, taking into account the loan amount obtained, the interest rate practiced (14.88%), and the absence of a formal contract.

Loans granted

As in the previous point, the Taxpayer identified the loans granted, as "Credits Granted" to E..., Lda, NIF..., the total amount of which totals € 365,731.55, recorded in account 2662-Shareholders/Partners - E..., Lda (information contained in the Trial Balance and in the IES) (ANX II).

According to information provided by the Taxpayer in email of 13 July 2015, A..., Lda belongs to D... NIF... with headquarters in Switzerland, being controlled by F... NIF... with headquarters in the United States of America.

A..., Lda holds a holding of € 5,000.00 in company E..., Lda, NIF..., which represents the entire share capital (information corroborated in the 2012 IES). It is evident that in the group, loans are made in cascade with the objective of meeting treasury needs. From these loans interest is charged, but the loans are not formalized contractually, existing only the records in the respective accounting documents.

Impairment of receivables

The Taxpayer was notified on 16-08-2016 (point II.3.4) to present documentary evidence of impairment losses recorded in account 65, which total € 5,215,267.14, but failed to comply with the notification (ANX IV).

The information requested would allow assessment of whether impairment losses on receivables are related to receivables resulting from the normal activity of the Taxpayer, as well as whether the risk of uncollectibility is duly justified, including proof that diligence has been undertaken for their collection (Article 36 of CIRC).

From the detailed analysis of these situations, it is concluded that the deduction of the expenses in question, in the determination of the fiscal result of the financial year, is not fully in accordance with the tax provisions applicable to the case, so there is reason for corrections, as set out in the following point.

(…)

III. DESCRIPTION OF FACTS AND GROUNDS OF PURELY ARITHMETIC CORRECTIONS

III.1. Financial Charges

Given the fact that the taxpayer is bearing financial charges, namely interest, resulting from loans which it contracted and simultaneously is granting loans to an associated company, it is important to assess whether these charges are or are not accepted fiscally, in light of the provisions of Article 23 of CIRC.

(…)

In the case under analysis, it is verified that the taxpayer contracted loans through D..., bearing charges with the same, and simultaneously, 'grants' financing to the related company - E..., Lda.

It results from this that the totality of said charges are not directly related to the activity of the taxpayer, whose corporate purpose, as already previously mentioned, consists of carrying out importation, exportation and distribution, wholesale or retail, of sports and entertainment articles.

By not being related to the activity of the taxpayer, the requirement of indispensability of the totality of financial charges recorded by the taxpayer is not shown to be met, as established in Article 23 of CIRC, so it will proceed with the respective correction in the determination of the fiscal result as per point III.4 Corrections to the taxable matter of the tax.

Another limitation formulated in the IRC code, Article 45, n.º 1.

(...)" – cfr. Pages 7 et seq. of the Inspection Report - administrative file –;

1. The Claimant was notified of the Statement of Assessment of withholding at source on IR, n.º 2016..., of 31.11.2016, in the amount of € 115,609.81 (one hundred and fifteen thousand, six hundred and nine euros and eighty-one cents), relating to the financial year 2012; – cfr. Doc. n.º 1 attached with the request for constitution of the arbitral tribunal –;

2. The Claimant was notified of the statement of assessment of IRC n.º 2016..., of 21.11.2016, in the amount of € 6,681.34 (six thousand, six hundred and eighty-one euros and thirty-four cents), of the statement of assessment of interest n.º 2016..., of 23.11.2016, in the amount of € 77.41 (seventy-seven euros and forty-one cents) and of the respective statement of account settlement, all relating to the financial year 2012. – cfr. Doc. n.º 2 attached with the request for constitution of the arbitral tribunal –;

3. On 29.03.2017, the Claimant submitted an administrative appeal against the additional assessment act of IRC identified in E above – cfr. Doc. n.º 3 attached with the request for constitution of the arbitral tribunal –;

4. On 12.04.2018, the Claimant was notified that on 03.04.2018, the Deputy Director of the Financial Directorate of Lisbon, under delegated powers, had issued an order to the effect of dismissing the administrative appeal identified in F above. – cfr. Doc. n.º 3 attached with the request for constitution of the arbitral tribunal –;

5. On 9 July 2019, the Claimant submitted a request for constitution of the present Arbitral Tribunal.

Facts taken as not proven

With relevance to the proceedings, it was not proven, in particular, that:

• The interest that the Claimant made available to the parent company - D... contained in documents n.º 4 to 15 included interest relating to overdue invoices.

VI. The Law

In the present case, there are four (4) disputed legal questions:

1. whether the financial charges borne by the Claimant relating to interest paid to company D..., which include those resulting from financing obtained by the Claimant and with which it financed its associates, without allocating the totality of these expenses to the beneficiary entities, can be considered as a fiscal cost fitting within Articles 23 and 45, both of the IRC Code;

2. whether the impairment losses on receivables recorded by the Claimant in its accounting may be deducted for tax purposes as losses on impairment of receivables, under the terms of the provisions of Articles 35 and 36 of the IRC Code;

3. whether the Claimant should have made withholding at source regarding the interest it made available to company D..., under the terms of the provisions of Articles 87 and 94 of the IRC Code, and if so, whether it was obligated to possess Form 21 RFI at the moment of withholding;

4. whether the Claimant, if the previous questions are decided affirmatively, has the right to indemnity interest.

Let us examine them:

Financial Charges

Before proceeding to the assessment and weighing of the first question which is raised here, this Arbitral Tribunal makes a summary of the amount of interest which is involved in these proceedings, taken from the Inspection Report, as deductible or non-deductible financial charges and respective corrections carried out by the Respondent.

Thus, we have:

a) Total interest borne by the Claimant in the year 2012 – € 395,197.19;

b) Interest accepted by AT as deductible costs, in relation to that indicated in a) above, via Article 45 of the IRC Code – € 190,595.26;

c) Correction carried out by the Respondent regarding interest indicated in a) above – € 204,601.93;

d) Proportion of interest borne by the Claimant for the free financing which it made to its investee, not considered as a cost, via Articles 23 and 45 of the IRC Code – € 25,817.29;

e) Total and final interest borne by the Claimant accepted fiscally, via Articles 23 and 45 of the IRC Code – € 164,777.97.

Let us examine them:

First, as a matter of logical reasoning and given the way in which AT proceeded with the corrections in the context of its Inspection Report, we will address the issue of the financial charges (total) borne by the Claimant regarding interest which the same makes available to company D... (parent company), with headquarters in Switzerland, namely as to whether they can or cannot be considered as a fiscal cost fitting within Articles 23 and 45, both, of the IRC Code. Now,

In this regard, the Claimant states that "[t]he amount recognized in the account '2661-Shareholders/Partners-D...' relates only to the loan provided by D... to the Claimant" (...) "Thus, in the financial year 2012, the Claimant bore interest on the mutual entered into with D... in the amount of € 88,073.17, and not the amount of € 395,197.19." Being "[t]he rate of interest borne by the Claimant with the mutual entered into with D... in the financial year 3.50% and not 14.88%."

The Respondent referring, on the one hand, as to this matter that: "[t]hrough analysis of the documents made available by the Claimant as well as consultation of information contained in the AT computer system, it was verified, regarding loans obtained in 2012, that the same presented significant relevance, taking into account the company's volume of business, as well as being relevant, taking into account the loan amount obtained, the interest rate practiced (14.88%), and the absence of a formal contract."

Now, given the financing obtained by the Claimant from the parent company, in the amount of € 2,700,000.12 (paragraph c) of the proven facts), it was compelled to bear financial charges – interest - in the amount of € 395,197.19. Interest which corresponds to a rate of 14.67%.

It happens that this interest rate (14.67%) is not legally admissible, for purposes of deductible costs for determining taxable profit, via paragraph j) of n.º 1 of Article 45 of the IRC Code, which at the time of the facts provided, under the heading "Non-deductible charges for fiscal purposes" that:

"1 — The following charges are not deductible for purposes of determining taxable profit, even when recorded as expenses of the taxation period:

(…)

j) interest and other forms of remuneration of advances and loans made by shareholders to the company, to the extent that they exceed the value corresponding to the 12-month Euribor reference rate on the day the debt was constituted or another rate defined by a ministerial order which uses that rate as an indexing mechanism; (…)"

Regulation n.º 184/2002, of 4 March, defined "[a]s the limit value of the remuneration of advances and loans made by shareholders to the company to be accepted as a cost the amount corresponding to the 12-month EURIBOR rate on the day the debt was constituted plus a spread of 1.5%."

It happens that this Regulation was amended by Article 135 of Law n.º 55-A/2010 of 31-12-2010, now providing:

"1.º For the purposes provided for in paragraph j) of n.º 1 of Article 45 of the IRC Code, in the wording given to it by Law n.º 85/2001, of 4 August, is fixed at 1.5% the spread to be added to the 12-month EURIBOR rate on the day the debt was constituted, without prejudice to the provision of the following article.

2.º Whenever it comes to interest and other forms of remuneration of advances and loans made by shareholders to SMEs, as defined in the annex to Decree-Law n.º 372/2007, of 6 November, is fixed at 6% the spread to be added to the 12-month EURIBOR rate on the day the debt was constituted.

3.º (Previous 2.º)"

Now, the acceptance of interest for purposes of determining Taxable Profit, in the financial year here in question, was limited to the provision of Article 45 of the IRC Code, combined with Regulation n.º 182/2002, of 4 March, calculated at the 12-month Euribor rate plus 6% spread.

Thus, taking into account that the Claimant bore financial charges relating to interest paid and made available to company D..., in the total global amount of € 395,197.19 (three hundred and ninety-five thousand, one hundred and ninety-seven euros and nineteen cents) which, as the Respondent states, "[d]ecompose(...) as follows (as per Documents n.º 3 to 14) - cfr. Article 42 of the request for constitution of the Tribunal –:

... and that, for purposes of fiscally deductible charges, only those corresponding to the application of the Euribor rate and the spread provided for in the aforementioned Regulation can be accepted, combined with Article 45 of CIRC, we find that only the amount of € 190,595.26 could be accepted by the Respondent, as demonstrated in the Inspection Report, on page 14, and which is reproduced here:

"(b)= 2,700,000.12*(3+4)/100/12 (amount corresponding to the 12-month Euribor rate on the day the debt was constituted plus a 6% spread)."

Thus, and regarding the acceptance of the financial charges borne by the Claimant, by way of interest made available to the parent company, given the financing granted, only the amount of € 190,595.26 (one hundred and ninety thousand, five hundred and ninety-five euros and twenty-six cents) could be deducted from taxable profit, under the terms of the provision of Article 45 of the IRC Code combined with Regulation n.º 182/2002, of 4 March, as demonstrated by the Respondent in the Inspection Report.

However, it is necessary to understand whether the entirety of these financial charges can be considered costs for tax purposes, so we will have to examine the provision of Article 23 of the IRC Code for this purpose.

Thus, this legal rule, at the time of the facts, provided for the following:

"1 — Costs are considered those which are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the productive source, in particular:

(…)

c) Of a financial nature, such as interest on borrowed capital applied in the business, discounts, premiums, transfers, exchange differences, charges relating to credit operations, collection of receivables and issuance of bonds and other securities, repayment premiums and those resulting from the application of the effective interest method to financial instruments valued at amortized cost"

Said provision provides that, for a given cost of a legal entity to be deducted in the context of IRC, three requirements must be met:

a) Proof of that cost;

b) The indispensability thereof;

c) and that such indispensability of the cost has as its object the realization of income subject to tax or the maintenance of the productive source.

All of these requirements must be fulfilled, cumulatively, in order for costs to be fiscally deductible, under the terms of Article 23 of the IRC Code, being that,

... the proof of the cost, as the first requirement, refers, as the Respondent correctly mentions, "to the effectiveness of the realization of costs which consists of various forms of written support for accounting entries, that is, to their documentary proof."

The second requirement – indispensability of the cost – is clarified, in particular, by the decision of CAAD issued in process n.º 444/2015-T, in the following manner "[f]rom a general point of view, the essential features of the path established by national doctrine and case law on the matter of indispensability of costs can be summarized as follows":

• The judgment on the indispensability of costs incurred implies that their contribution to the obtaining of income or gains subject to tax or to the maintenance of the productive source is verified, whereby "[t]he legal notion of indispensability is therefore delimited, by a legal and economic perspective, by direct or indirect fulfillment of the ultimate motivation of contribution to the obtaining of profit" and "[t]he fiscal deductibility of the cost depends, only, on an economic causal relationship and justified with the company's activity." (Supreme Administrative Court Decision, issued on 30-11-2011, in process n.º 0107/11);

• "[c]osts (...) cannot fail to respect, from the outset, the taxpayer company itself. That is, for a given sum to be considered a cost thereof it is necessary that the respective activity be developed by it itself, not by other companies." (Supreme Administrative Court Decision, issued on 30-05-2012, in process n.º 0171/11);

• "[a] concept of indispensability which, definitively moving away from the idea of causality between costs and income, emphasizes the relationship of costs with the activity pursued by the taxpayer, that is, considering that the said concept of indispensability is verified whenever costs are incurred in the company's interest, in the pursuit of its respective activities." (Supreme Administrative Court Decision, issued on 04-09-2013, in process n.º 0164/12);

• The concept of indispensability is to be determined on a case-by-case basis, and the nexus of economic causality cannot be disconnected from the factuality of the specific case, being that "[t]he Tax Authority cannot evaluate the indispensability of costs in light of criteria relating to the opportunity and merit of the expense. A cost is indispensable when it relates to the company's activity, and costs foreign to the company's activity will be only those in which it is not possible to discern any causal nexus with the profits or gains (or with income, in the current expression of the code - cfr. Article 23, n.º 1 of C.I.R.C.), explained in terms of normality, necessity, congruence and economic rationality." (Administrative Court of Appeals - South, issued on 16-10-2014, process n.º 06754/13);

• "[t]he indispensability of the cost must result simply from its connection to business activity. If the cost is not foreign to the company's activity, that is, if it relates to the company's normal activity (regardless of whether the degree of intensity or proximity is greater or lesser), and if its existence is accepted (one is not faced with an apparent or simulated cost), the cost is indispensable." (Administrative Court of Appeals - North, issued on 20-12-2011, process n.º 01747/06.3BEVIS);

• "[f]rom the legal notion of cost provided by Article 23 of CIRC does not result that AT may call into question the principle of freedom of management, reviewing the soundness and opportunity of the company's management decisions and considering that only those costs can be assumed fiscally from which profits directly accrue to the company or which prove convenient for the company. The indispensability referred to in Article 23 of CIRC as a condition for a cost to be deductible does not refer to necessity (the expense as a sine qua non condition of profits), nor even to convenience (the expense as convenient for business organization), under penalty of intolerable interference by AT in the autonomy and freedom of management of the taxpayer, but requires, solely, an economic causal relationship, in the sense that it is sufficient that the cost be incurred in the company's interest, in order, directly or indirectly, to obtain profits.

The legal notion of indispensability is therefore delimited, by an economic-business perspective, by direct or indirect fulfillment of the ultimate motivation of contribution to the obtaining of profit. Indispensable costs are equivalent to expenses incurred in the company's interest or, in other words, in all acts abstractly subsumed in a profit-related profile. This aim deliberately brings economic and tax categories closer, through a primarily logical and economic interpretation of legal causality. The indispensable expense is equivalent to every cost incurred in order to obtain income and which represents an economic decline for the company. As a rule, therefore, the fiscal deductibility of the cost depends, only, on an economic causal relationship and justified with the company's activity. And outside the concept of indispensability will only fall acts inconsistent with the corporate purpose, those which do not fit within the company's interest, especially because they do not aim at profit." (Supreme Administrative Court Decision, issued on 30-11-2011, process n.º 0107/11);

• "[t]he rule is that correctly recorded expenses be tax costs; the criterion of indispensability was created by the legislator, not to allow the Administration to interfere in company management, dictating how it should apply its resources, but to prevent the fiscal consideration of expenses which, although recorded as costs, do not fall within the scope of the company's activity, were incurred not for its pursuit but for other foreign interests. Strictly speaking, these are not true company costs, but expenses which, given their object, were abusively recorded as such. Without the Administration being able to evaluate the indispensability of costs in light of criteria relating to their opportunity and merit.

The concept of indispensability not only cannot be equated to a strict judgment of imperative necessity, as has been said, but also cannot be based on a judgment concerning the convenience of the expense, made necessarily, after the fact. For example, expenses made with an advertising campaign which proved unsuccessful cannot, solely on the basis of that result, be stated to be dispensable.

The judgment regarding the opportunity and convenience of expenses is exclusive to the entrepreneur. If he decides to make expenses with a view to pursuing the company's purpose but is unsuccessful and those expenses prove, ultimately, fruitless, they nevertheless remain tax costs. But any expense which he records as a cost and which proves foreign to the company's purpose is not a tax cost, because not indispensable.

We therefore understand (...) that, under penalty of violation of the principle of tax capacity, the Administration can only exclude costs not directly excluded by law on the basis of a strong motivation which convinces that they were incurred beyond the corporate purpose, that is, in the pursuit of another interest which is not business, or, at least, with clear excess, deviant, in light of the objective needs and capacities of the company." (Supreme Administrative Court Decision, issued on 29-03-2006, process n.º 01236/05).

The third requirement relating to the indispensability of the cost for the purpose of realization of income subject to tax or the maintenance of the productive source, indeed comprises, as the Respondent alleges, "[t]he general clause for deductibility of expenses", providing in Article 23 of the IRC Code that the same must be immediately "subject to tax or to the maintenance of the productive source".

Having arrived here, it is necessary to subsume the proven facts to the provision of Article 23 of CIRC. Thus,

Now, on the one hand, we have what results unequivocally from the facts considered as proven, in particular, that the Claimant contracted loans from the parent company, bearing charges with the same,

... and, on the other, that part of that loan was granted to the Claimant's investee, free of charge.

In fact, whereas the first type of loan was granted for purposes of maintaining the Claimant's productive source, this Tribunal understands that the financial charges incurred meet the presuppositions of Article 23 of the IRC Code, to be considered deductible for tax