Process: 321/2014-T

Date: December 17, 2014

Tax Type: IRC

Source: Original CAAD Decision

Summary

In Process 321/2014-T, M...SA challenged an additional IRC assessment of €70,900.01 for the 2010 tax year before the CAAD arbitral tribunal. The dispute centered on €178,677 in expenses for specialized services invoiced by Belgian parent company A... and €69,962 in advertising expenses from another Belgian parent C..., both holding 49.982% stakes in the petitioner. The Tax Authority disallowed these costs, arguing the invoices lacked essential documentation to prove their necessity for business operations under Article 23(1) of the IRC Code. The invoices described services only in English using vague terms like 'General', 'EDP', 'Marketing', and 'Supply Chain' without specifying what services were actually provided, who performed them, or how charges were calculated. When requested to clarify during inspection, the company provided incomplete documentation including loose tables that referenced services not mentioned in the invoices and failed to establish the connection between charges and actual service delivery. The petitioner argued these expenses were necessary for maintaining its productive capacity and claimed the tax assessment lacked proper substantiation. The case highlights the strict documentary requirements Portuguese tax law imposes on companies claiming deductions for cross-border intra-group services. The arbitral tribunal, constituted under the RJAT (Legal Regime of Arbitration in Tax Matters), had to determine whether the expenses met the essentiality test and whether adequate documentation existed to support their deductibility, while also considering the petitioner's subsidiary claim regarding insufficient reasoning in the tax authority's decision.

Full Decision

ARBITRAL DECISION

The Arbitrators José Pedro Carvalho (Presiding Arbitrator), António Martins and João Sérgio Ribeiro, designated by the Deontological Council of the Administrative Arbitration Centre to form an Arbitral Tribunal, hereby agree on the following:

I – REPORT

On 4 April 2014, M…SA, NIPC …, with registered office at Rua …- …, … Alpiarça, filed a petition for constitution of an arbitral tribunal, pursuant to the combined provisions of Articles 2 and 10 of Decree-Law No. 10/2011, of 20 January, which approved the Legal Regime of Arbitration in Tax Matters, as amended by Article 228 of Law No. 66-B/2012, of 31 December (hereinafter abbreviated as RJAT), seeking declaration of illegality of the additional Corporate Income Tax (IRC) assessment relating to the year 2010, numbered …, in the amount of €70,900.01.

To substantiate its petition, the Petitioner alleges, in summary, that the expenses disallowed in that additional assessment were necessary for the maintenance of its productive source and are therefore deductible. It further alleges, incidentally, lack of substantiation of the tax act.

On 8 April, the petition for constitution of the arbitral tribunal was accepted and automatically notified to the Tax Authority.

The Petitioner did not appoint an arbitrator, so, pursuant to subsection a) of Article 6(2) and subsection a) of Article 11(1) of the RJAT, the President of the Deontological Council of CAAD appointed the undersigned as arbitrators of the collective arbitral tribunal, who communicated acceptance of the appointment within the applicable timeframe.

On 26 May 2014, the parties were notified of these appointments and manifested no intention to refuse any of them.

In accordance with the provisions of subsection c) of Article 11(1) of the RJAT, the collective Arbitral Tribunal was constituted on 9 April 2014.

On 15 July 2014, the Respondent, duly notified for such purpose, filed its reply defending itself solely by way of challenge.

On 25 September 2014, the hearing referred to in Article 18 of the RJAT was held, where witnesses presented by the Petitioner were examined.

Having been granted a period for presentation of written submissions, these were presented by the parties, addressing the evidence produced and reiterating and developing their respective legal positions.

A deadline of 30 days was set for pronouncement of the final decision, following presentation of submissions by the Tax Authority, which deadline was subsequently extended until 17 December.

The Arbitral Tribunal is materially competent and is regularly constituted, pursuant to Articles 2(1)(a), 5 and 6(1) of the RJAT.

The parties have legal personality and capacity, are legitimate and are legally represented, pursuant to Articles 4 and 10 of the RJAT and Article 1 of Ordinance No. 112-A/2011, of 22 March.

The proceedings are free from nullities.

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

Everything considered, it behoves us to pronounce

II. DECISION

A. FACTS

A.1. Facts deemed proven

  1. The Petitioner was subject to an inspection conducted by the Finance Department of Santarém, between 23.5.2013 and 23.09.2013, which covered IRC for 2010 and culminated in the additional assessment of Corporate Income Tax (IRC) No. …, relating to the financial year 2010, reflecting corrections to the taxable base, in the total amount of €70,900.01.

  2. These corrections were, among others, of the following amounts and related to the following grounds (insofar as relevant to the present appeal process):

a. Expenses (not accepted by the Tax Authority) relating to specialized work invoiced by A…, in the amount of €178,677.00;

b. Expenses (not accepted by the Tax Authority) relating to advertising invoiced by C…, in the amount of €69,962.00;

c. Deduction from income for fiscal benefit incentive for job creation for young people (Article 19 EBF), in the amount of €1,662.50.

  1. The Petitioner made payment, on 19.12.2013, of the additional IRC assessment mentioned above, in the amount of €8,325.01, without addition of compensatory interest, pursuant to Decree-Law No. 151-A/2013.

  2. The Petitioner is a company incorporated under Portuguese law whose capital belonged, at the date of the tax event in question in the proceedings, predominantly to two Belgian companies: company A… and company C…. Each of these companies holds a participation of 49.982% in the Petitioner, with the remaining 0.037% of the share capital held by the Petitioner itself.

  3. At the date of the tax event, there was no capital relationship between the aforementioned participating companies in the Petitioner.

  4. The value of the service provisions disallowed by the Tax Authority in the assessments subject to the present proceedings amounts to approximately 250 thousand euros, equivalent to just over 2% of the total billing of the Petitioner in the year in question.

  5. The expenses not accepted by the Tax Authority relating to specialized work invoiced by A… to the Petitioner, in the amount of €178,677.00, relate to a set of invoices issued by A… to the Petitioner, numbered 12049, of 31.3.2010; 12100, of 31.5.2010; 12134, of 30.6.2010; 12204, of 30.9.2010 and 12286 of 16.12.2010, invoices that are described on page 8 of the Inspection Report (RIT) which set out the services provided to which they relate, in English language, through the following expression "Settlement of quarterly charge for services rendered by A… on following areas:", followed by the indication of the following terms, also in English: "General; Purchasing; Production; Marketing; Supply Chain; EDP; Accounting, Investments; Human resources; Quality", and ending with the term, equally in English, "Period", followed by the indication of the letter "Q" together with a number between 1 and 4, thereby referring to the quarter of the year to which they relate, with invoice 12100 containing, in place of that reference, the expression, in English, "Correction Q1Q2".

  6. With respect to these invoices, the following was written in the RIT, inter alia:

"In the invoices, as can be verified from the table referred to above, there is no indication of:

  • What these service provisions consist of;
  • Agents who intervened in the provision of the services;
  • How the values charged to M… were determined in relation to each one of the service provisions;
  • The designations of the service provisions mentioned in the invoices are not intelligible, such as for example "EDP", "General";
  • It should also be noted that the contract presented by M… as relating to these service provisions is written in the English language, and is equally not intelligible, particularly due to the technical nature of some terms.

From what was described above, it was not possible to ascertain the indispensability of these expenses, for purposes of Article 23(1) of the IRC Code, for which reason the taxpayer was notified on 18/01/2013, during inspection activities for the periods 2005 to 2008, to "with respect to the invoices for service provisions issued, monthly, by entity A…, specify the service provisions set out therein and the determination of the respective value for each one of the provisions".

On 29/01/2013, the taxpayer with respect to the question raised, responded only with loose documents (cf. ANNEX 1), among which a table attached to the invoices and another table in which various entities are listed. In this latter table, in the column relating to M… only the numeral "3" appears in the row referring to the service provision "TECHNIEK". This service provision does not appear in the description of the invoices.

The same table contains names of persons and other service provisions not mentioned in the invoices, for example: "INTERCO PRICING", "LEGAL", "COST ACCOUNTING".

In the response to this question there were also presented printouts of an exchange of emails between M… and Mr … (Group Financial Director) in English language, where confidentiality is invoked for some expenses included in the service provisions in question and it is even stated "(…) It is impossible to link allocation from all points of contract (…)" and "I will not give you all the details of the calculation of the A… charge to M… since this calculation is partially including headcount expenses.(…)" (bold ours).

In the same notification (18/01/2013), a translation of the contract relating to the service provisions in question was requested. However, neither from the original contract in English, nor from the translation presented in response to the notification, is it possible to establish correspondence between the service provisions mentioned therein and those mentioned in the invoices, with the exception of those referring to: "Accounting" (designation that appears in the invoices) - "Accounting and administrative services" (designation that appears in the contract).

From the translation of the contract, relevant information is extracted, which is transcribed: "A… shall maintain precise records covering the discriminated expenses related to the services provided under this Contract and the same shall be accessible to the inspection conducted by M… LTDA and its duly authorized agents during the validity of this Agreement." (bold and underlined ours).

Considering the elements presented by the taxpayer to be insufficient and following the extract from the contract transcribed above, and also taking into account that these expenses were repeated in the following periods, the taxpayer was again notified on 08/02/2013, during inspection activities for the periods 2005 to 2008, of the following:

"(...)

a) Specify what the service provisions set out in the invoices consist of, since from your response to the notification made by these services on 18/01/2013 it is not clear what each one of them consists of, such as the example of the service provision designated "EDP";

b) Present the formula/calculation/determination of the value for each one of the service provisions, since from your response to the notification made by these services on 18/01/2013, it was not clarified how the distribution of the total expenses is made by each one of the service provisions, taking into account that the percentage of distribution differs according to the service provision in question;

c) Present the records referred to in paragraph 5 of point II of the service provision contract entered into with entity A… - "A… shall maintain precise records covering the discriminated expenses related to the services provided under this Contract and the same shall be accessible to the inspection conducted by M… LTDA. (...)". (bold and underlined ours).

When questioned, M… responded as follows:

"1 - The invoices for service provisions set out, by entity "A…"

a) Specification by Item of each service provided:

  • "General" Salary and expenses of Administration (CEO and Personal Assistant);
  • "Purchasing" - Salary and expenses of the Purchasing Management Department (Manager (I…) and Team);
  • "Production" - Salary and expenses of the Production Management Department (Manager (B…) and Team);
  • "Marketing" - Salary and expenses of Sales and Marketing Management Department (Manager (R…) and Team, International Fair Expenses, Development of Packaging Material);
  • "Supply Chain" - Salary and expenses of the Supply Chain Management Department (Manager (J…/I…) and Team);
  • "EDP" - Salary and expenses of the Information Technology Management Department (Manager and Team);
  • "Accounting" - Salary and expenses of the Finance Department (Manager and Team, Insurance, Group Administration, Coordination of Operations between Group Companies);
  • "Investments" - Salary and expenses of the Investment Project Management Department (Manager (G…) and Team (J…));
  • "Human Resources" - Salary and expenses of the Human Resources Management Department (Manager (A…) and Team);
  • "Quality" - Salary and expenses of the Quality Department (Manager (N…) and Team).

b) In general, it is distributed taking into account external sales of the previous year (50%) and the budgeted production volume of the year (50%) and in some specific cases it is directly allocated to the entity in question according to its needs (Example: If "M…" builds a New Cold Room, it will bear more expenses from the Investment Project Management Department).

In this way, its calculation is made taking into account the following:

  • "General" - Expense to be distributed - 10% CEO and 90% Personal Assistant;
  • "Purchasing" - Expense to be distributed - 100% I… and Team;
  • "Production" - Expense to be distributed - 70% B… and Team;
  • "Marketing" - Expense to be distributed 100% R…, 100% N…, 100% N…, 100% K…, 92% J…);
  • "Supply Chain" - Expense to be distributed - 100% J… and Team;
  • "EDP" - Expense to be distributed - 5% Manager and Team;
  • "Accounting" - Expense to be distributed - 40% G…, 20% Accounting, 80% Legal, 15% General);
  • "Investments" - Expense to be distributed - 53% G… and Team;
  • "Human Resources" - Expense to be distributed - 100% A… and Team;
  • "Quality" - Expense to be distributed - 100% N… and Team."

In response to subsections a) and b) of point 1 of the notification, M…, as can be verified from the above transcription, describes summarily and generically what the items of the service provisions mentioned in the invoices consist of and identifies the percentage of expenses to be distributed in each one of the service provisions to be distributed among the various entities of the group.

With respect to subsection c) of point 1 of the notification, M… gave no response, or presented nothing, to date. It did not even present the "(…) precise records covering the discriminated expenses related to the services provided under this Contract and the same shall be accessible to the inspection conducted by M… LTDA., (…)" (bold and underlined ours), as established, with mandatory character, by the service provision contract entered into between M… and A…, and which could clarify the indispensability of these service provisions.

In the present situation, it is further added that the entity that provided the services in question is non-resident, without a permanent establishment in the national territory, making it impossible for these Inspection Services to gather information from that entity relating to the said service provisions.

With respect to these service provisions invoiced by A…, M…, in the hearing of its right to be heard, within the framework of inspection procedures for the periods 2005 to 2008, made a generic description of each one of the service provisions identified in the invoices issued by A…, these being merely academic definitions, susceptible of being applicable to any company. In addition to these definitions, M… attached as an annex the international A… 2012 report and a presentation of C… products, also including a brief presentation of this company, very much in the manner of the presentation for A….

However, from the elements identified above, it continued not to be possible to demonstrate how the said service provisions were concretely carried out, thus preventing assessment of their indispensability.

In the 2010 period, as happened in the periods 2005 to 2009, M… has recorded in its accounts as expenses of the period, charges of the same nature debited by A…, through the invoices identified in the table above, in the total amount of €178,677.00, containing the same designations as those in the invoices that were issued in the years 2005 to 2008 by A…. In this way, the taxpayer was again notified, on 02/07/2013, during the present inspection procedure for the 2010 period, to inform whether the invoices for service provisions issued by A… derive from the same service provision contract presented during the inspection activities for the periods 2005 to 2008.

In response, M… states as follows, "The invoices for service provisions issued monthly, by entity "A…", derive from the same Service Provision Contract presented during the course of the previous inspection activities."

Thus, the same considerations already made and relating to the notifications made previously are maintained. Verification of the lack of documentation relating to these expenses makes it unfeasible to confirm the indispensability of the same pursuant to Article 23(1) of the IRC Code, despite the various measures taken to lead the taxpayer to present the necessary clarifications.

It should further be noted that M…, in the 2010 period, has recorded in its accounts expenses relating to service provisions of advertising, computing, accounting and audit, specialized commercial work, services for monitoring some agricultural crops, which are supported documentarily by invoices and other supporting documents where the service provisions are duly identified, such as for example:

a) Computing services (ex: internal record No. 04/100294, which includes the technicians involved, the hours they allocated, the type/reason for intervention, the cost/hour/technician);

b) Advertising services (ex: internal record No. 04/040038, of Marketing and own brand development services);

c) Administrative specialized services (ex: internal record No. 04/060129, which refers to the preparation of a study for PRODER application debited by entity "T… - … Lda");

d) Specialized audit services debited by company "D… SA" (ex: internal records No.(s) 04/100195 and 06/120020);

e) Specialized accounting services (ex: internal record No. 04/010030, of accounting services debited by company "M…");

f) Commercial services (ex: internal records No.(s) 04/020167 and 04/070304);

g) Research and development services (ex: internal record No. 04/110083);

h) Monthly fixed fee services for Intrastat preparation (ex: internal record No. 04/110031);

i) Services for validation of the Green Dot declaration (ex: internal record No. 04/070304).

Thus, in view of what is set out above, the lack of documentation relating to the expenses incurred with the service provisions invoiced by A…, in the 2010 period, in the amount of 178,677.00, makes it unfeasible to confirm the indispensability of the same, for which reason, pursuant to Article 23(1) of the IRC Code, the deduction of these expenses cannot be accepted fiscally."

  1. The expenses not accepted by the Tax Authority relating to specialized work invoiced by C… to the Petitioner, in the amount of €69,962.00, relate to invoice No. 03/109259 of 30/09/2010, issued by C… to the Petitioner.

  2. With respect to this invoice, the following was written in the RIT, inter alia:

"In the 2010 period, as happened in the periods 2005 to 2009, M…, has recorded in its accounts as an expense of the period, in the current account extract "6221321102 - Specialized Work - C… (Belgium)", by internal record 090399/04, expenses for advertising debited by C… - Tax ID: BE…, through invoice No. 03/109259 of 30/09/2010, in the amount of €69,962.00, referring to "INTERV PUBLICITAIRE - Invoice for advertising intervention and exhibition costs 2010".

Given that the designation in the invoice that documents this expense is very generic and does not specifically identify which advertising expenses it relates to, the taxpayer was requested, during inspection activities for the periods 2005 to 2008, to present the contract relating to these expenses, since the description of the invoices relating to the periods 2005 and 2006 mention the existence of a contract.

This contract was presented during the course of the previous inspection activities and it mentions some types of advertising expenses, as referred to in clause 1: "(…) insertion of announcements on regular dates in professional journals and this for its most important markets (United Kingdom, Belgium, France, Germany, Netherlands, Scandinavia). C… is present at international trade shows including S… - France, A… - Germany, S… - France, I… - Germany, P… - Netherlands, F… - Germany - United Kingdom, …".

In light of what is established in this contract, the taxpayer was requested, during inspection activities for the periods 2005 to 2008, to "Present documentary proof of advertising expenses invoiced by entity C… - Tax ID: BE…, (…) recorded in current account extract No. "6223632102", (…)".

In response to what was requested in the notification, M… presented the following elements:

§ Email printout from Mr. G… (Group Financial Director), of 18/01/2013, saying that "Concerning amounts invoiced by C…: it are the same amounts of the marketing expenses invoiced from A… to M… Lda. Logic behind this: both shareholders are making the same efforts to help M… to penetrate the community and external market."

§ Copy of the invoice issued by C… and relating to the advertising expenses, already identified above;

§ Map attached to invoices issued by A… - Tax ID: BE…, relating to expenses with specialized services – A…;

§ Email printout from Mr. G… (Group Financial Director), of 21/01/2013, saying that "(…) a. Joint-venture agreement: see point 17 for the service invoices. b. Manufacturing agreement: point 6 and 7 describe the pricing mechanism."; and

§ The contract "Joint-Venture Agreement between A… and C…, dated 8 November 2004", where they highlight point 17, whose translation presented by M…, states as follows: "(…) The parties agree that they will charge M… compensation for the expenses and services for the benefit of M…. A… will present annually a proposal for compensation to be charged by A… and C… for services to be provided to M… during that year. Compensation will be discussed and approved at the first meeting of the M… Board of Directors for each new financial period. Any compensation for services to be provided by A… or C… will be on an equitable and commercially reasonable basis."

With the response, no documentary proof was presented of the advertising carried out by C… for M…, namely evidence of participation in the fairs identified in the contract, of the advertisements published in specialized journals, of advertising brochures, or of other advertising activities, in accordance with what is established in the contract between the two entities. Thus, it is not possible to confirm the indispensability of the advertising expenses recorded in this period, pursuant to Article 23(1) of the IRC Code, despite the measures taken.

It further adds that the amount invoiced by C… to M…, relating to advertising coincides, in value, with what was invoiced by A… as referred to in the email of 18/01/2013 from Mr. G…, which he justifies as a result of the same efforts made by the two Belgian entities for integration of M… in the community and international market.

It should further be noted that, as the entity that provided the services in question is non-resident, without a permanent establishment in the national territory, it is not possible for these Inspection Services to gather information from that entity relating to the said service provisions.

In the hearing of its right to be heard, within the framework of inspection procedures for the periods 2005 to 2008, regarding these advertising service provisions debited by C…, nothing was said or presented by M….

Thus, considering that, in the period under analysis (2010), the company's procedure in terms of documentation of these expenses remains unchanged, we conclude that pursuant to Article 23(1) of the IRC Code, the deduction of expenses for advertising invoiced by C… to M…, in the amount of €69,962.00, cannot be accepted fiscally."

  1. To each invoice referred to in points 8 and 10 above, corresponds a financial flow duly recorded by M…'s accounts and which was paid by bank transfer.

  2. A…, in 2010, held the know-how at the level of industrial production, constituting all the operational support of its units spread throughout Europe, through a central structure, designated A… C… (…), which provided technical knowledge and assistance, training, merchandising and also assumed sales activities in international markets.

  3. At A… the managing directors of the various production units of the group met to define market strategies, prepare annual budgets and analyze the performance of the different production units.

  4. The Petitioner specialized in the production of certain types of foodstuffs, in particular peppers, which was, in 2010, predominantly marketed abroad through its Belgian shareholders.

  5. An agreement entitled "Joint venture agreement between A… and C…", dated 8.11.2004, was entered into, where in its number 17 it is stated that: "The parties agree that they will charge M… compensation for the costs and services provided for the benefit of M…. A… C… will present annually a proposal for compensation to be charged by A… C… and C… for services to be provided to M… during that year".

  6. A contract was also entered into between C… and M…, where C… undertook to incur advertising expenses in markets such as English, Belgian and French, and ensure presence in a set of trade fairs identified in the contract, as well as the publication of advertisements for products transacted by it.

  7. A… has decision-making power over the volume and specificity of the Petitioner's production and closely monitors its purchasing processes, production, quality control, commercial disclosure, market monitoring, supply chain, financial activities and human resources management.

  8. The description of the invoices from A…, above indicated, refers to services provided in the following areas: "General; Purchasing; Production; Marketing; Supply Chain; EDP; Accounting, Investments; Human resources; Quality":

i. "General": the Petitioner's participation in the salary and expenses of the Administration (CEO and Personal Assistant) of A…;

ii. "Purchasing": the Petitioner's participation in the salary and expenses of the Purchasing Management Department (Manager and Team) of A…;

iii. "Production": the Petitioner's participation in the salary and expenses of the Production Management Department (Manager and Team) of A…;

iv. "Marketing": the Petitioner's participation in the salary and expenses of the Sales and Marketing Management Department (Manager and Team, International Fair Expenses, Development of Packaging Material) of A…;

v. "Supply Chain": the Petitioner's participation in the salary and expenses of the Supply Chain Management Department (Manager and Team) of A…;

vi. "EDP": the Petitioner's participation in the salary and expenses of the Information Technology Management Department (Manager and Team) of A…;

vii. "Accounting": the Petitioner's participation in the salary and expenses of the Finance Department (Manager and Team, Insurance, Group Administration, Coordination of Operations between Group Companies) of A…;

viii. "Investments": the Petitioner's participation in the salary and expenses of the Investment Project Management Department (Manager and Team) of A…;

ix. "Human Resources": the Petitioner's participation in the salary and expenses of the Human Resources Management Department (Manager (…) and Team) of A…;

x. "Quality": the Petitioner's participation in the salary and expenses of the Quality Department (Manager and Team) of A….

  1. The Petitioner had at its disposal, in the year 2010, the services of A… described in the previous number, having benefited from the same both at the level of production, in Portugal, and at the level of sales abroad, and benefited from the disclosure of its products by C…, at the level of its foreign sales, and from the sales accounted for by the Petitioner, in the year 2010, 30% of the total went to A… and 28% of the total went to C…, and the billing of the Petitioner that was carried out in the national market amounted, in that year, to approximately 40% of the total.

  2. Among the deductions disallowed by the Tax Authority relating to the benefit contained in Article 19 of the EBF (job creation), there is one, in the amount of €1,662.50, relating to C…, spouse of a manager of the Petitioner.

  3. In this respect, it is stated in the RIT that:

"With respect to the number of permanent workers dismissed presented in the list of M…, (…) The remaining do not meet the requirements for the following reasons:

  1. C…, because they integrate the family unit of the employing entity, since they are the spouse of the manager of M…, G…;".

A.2. Facts deemed not proven

With relevance to the decision, there are no facts that should be considered as not proven.

A.3. Substantiation of proven and not proven facts

With respect to the facts, the Tribunal does not have to rule on everything that was alleged by the parties, and it is instead incumbent upon it to select the facts that matter for the decision and differentiate the proven from the unproven matter (cf. Article 123(2) of the Tax Procedure Code (CPPT) and Article 607(3) of the Civil Procedure Code (CPC), applicable by virtue of Article 29(1)(a) and (e) of the RJAT).

In this way, the pertinent facts for judgment of the case are chosen and delimited based on their legal relevance, which is established in light of the various plausible solutions of the legal question(s) (cf. former Article 511(1) of the CPC, corresponding to current Article 596, applicable by virtue of Article 29(1)(e) of the RJAT).

Thus, having regard to the positions assumed by the parties, in light of Article 110/7 of the CPPT, the documentary evidence and the procedural file joined to the case, the following facts were considered proven, with relevance to the decision, those listed above in points 1 to 10, 12, 13, 20 and 21.

The facts listed in points 11 to 14 and 17 to 19 also took into account the testimonial evidence which, in a manner consistent with all the documentation in the procedural file and other materials joined to the case, elucidated the Tribunal on the terms in which the relationship between the Petitioner and its shareholders was conducted, as well as, in a detailed manner, on the content of the services to which the invoices questioned in the case related.

The fact referred to in point 19 further took into account an assessment of normality, arising from the comprehensive nature of the situation presented to the Tribunal, which includes a Portuguese company held by two multinational companies (which, having no relationship between themselves, reconcile in the Petitioner convergent but opposing interests, in that the expense of the Petitioner to the benefit of one necessarily prejudices the other) and which directs its production for disposal predominantly through export, within which it has no structure of its own.

B. THE LAW

Essentially, the issue in the case is to determine whether, as the Petitioner alleges, the additional assessment act relating to the year 2010, subject to the present proceedings, is defective in its factual premises, and, without expressly distinguishing the formulation of such a question (incidentally, in Articles 31 and 94 of its initial petition), it further raises the lack of substantiation of such an act.

As no defects leading to nullity or non-existence of the challenged acts have been raised, and as no express request has been made that, in addressing the issues raised, the Tribunal follow a specific order, it shall proceed, pursuant to Article 124 of the CPPT, to examine the defect "whose finding determines, according to the prudent discretion of the adjudicator, more stable or effective protection of the injured interests", which in this case will be the alleged error in the premises of the challenged act.

There are two distinct situations at issue in the case, namely:

i. the disallowance, as a cost, of the invoices issued by A… to the Petitioner, numbered 12049, of 31.3.2010; 12100, of 31.5.2010; 12134, of 30.6.2010; 12204, of 30.9.2010 and 12286 of 16.12.2010, in the amount of €178,677.00, and No. 03/109259 of 30/09/2010, in the amount of €69,962.00, issued by C… to the Petitioner;

ii. The disallowance of the deduction, relating to the benefit contained in Article 19 of the EBF (job creation), in the amount of €1,662.50, relating to C…, spouse of a manager of the Petitioner.

Let us examine each one of them.

Essentially, the first of the issues listed is concerned with determining whether, with respect to the expenses documented by the invoices indicated, the requirements of Article 23(1) of the IRC Code are, or are not met, the content of which is transcribed hereunder:

"Expenses are those that are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the productive source, in particular:

a) Those relating to the production or acquisition of any goods or services, such as raw materials used, labor, energy and other general expenses for production, conservation and repair;

b) Those relating to distribution and sale, including those for transport, advertising and placement of goods and products;

c) Of a financial nature, such as interest on borrowed capital applied in business, discounts, premiums, transfers, exchange differences, expenses related to credit operations, debt collection 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;

d) Of an administrative nature, such as remuneration, including that attributed as profit-sharing, travel allowances, current consumption materials, transport and communications, rents, litigation, insurance, including life insurance and "Life" branch operations, contributions to pension savings funds, contributions to pension funds and to any supplementary social security schemes, as well as expenses for termination of employment benefits and other post-employment or long-term benefits of employees;

e) Those relating to analyses, rationalization, research and consultation;

f) Of a fiscal and parafiscal nature;

g) Depreciation and amortization;

h) Inventory adjustments, impairment losses and provisions;

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

j) Expenses resulting from the application of fair value to consumable biological assets that are not multi-year forest operations;

l) Realized losses;

m) Indemnities resulting from events whose risk is not insurable.".

With respect to the issue at hand, the Tax Authority alleges, in summary, that "It was not possible for the Tax Authority to ascertain demonstrably in what the service provisions referred to in the respective invoices consisted, for purposes of determining their fiscal deductibility.", given that "the clarifications obtained, (…) present themselves as vague and generic, not allowing identification of the service concretely provided, as to its origin, nature, destination and amount, for purposes of determining its fiscal deductibility."

The Tax Authority understands that it would be essential to "demonstrate in what the service provisions were concretely carried out" and "to assess their indispensability", to know "in particular:

• The agents who intervened in the provision of the services, (…);

• The determination of the values charged to M… with respect to each one of the service provisions (…);

• The third entities (clients, suppliers, financiers, business organizations, subcontracted entities, etc) involved in the said service provisions (…);

• The contracts, agreements, partnerships, documents in which group strategies, commercial and marketing actions, proofs of exhibitions and fairs, proofs of exhibitions and fairs, proofs of participation in audits and reports, the implementation of new projects and technologies, regular visits to the units, senior staff recruitment processes (…)."

The Tax Authority concludes, summarizing, that "In the case at hand, the Tax Authority questioned, it should be said in a well-founded manner, the fiscal relevance of certain amounts, accounted for as exercise costs.", and therefore "It was incumbent (…) on the Petitioner to prove this indispensability".

The Tax Authority also offers that "it is not in question that the invoiced services were provided", that "It is not (…) a matter of calling into question the veracity of the invoices".

Given this, the main problem that arises in the present case is to determine whether the charges documented by the invoices of A… and C… above identified have not existed, whose effectiveness, moreover, is not even put into question, as was seen, by the Respondent, but solely to determine whether the information provided by the Petitioner is sufficient to support the essentiality of these costs as required by Article 23 of the IRC Code.

The documents relating to the costs in question are deemed sufficient to show that the petitioner incurred the charges to which they relate, which, moreover, is not even contested by the Tax Authority.

Indeed, and for example, as was written in the Decision of the Supreme Administrative Court of 05-07-2012, rendered in case 0658/11, "In IRC matters, the documentary evidence and justification of costs for purposes of Articles 23(1) and 42(1)(g) of the IRC Code does not have to assume the essential formalities required for invoices under VAT, since the requirement for documentary evidence is not confused with nor exhausted by the requirement of an invoice, sufficient being only a written document, in principle external and with mention of the fundamental characteristics of the operation, since unlike what happens with VAT, in IRC matters, the justification of the cost constitutes a probative formality and, therefore, replaceable by any other type of evidence."

Thus, contrary to what happens in VAT (Article 36(5)), the concept of documentary evidence does not necessarily have to correspond to the invoice issued with the detail required under the VAT Code. In the IRC field, the requirements will be less stringent, it being sufficient that the documentary evidence explicitly sets out the main characteristics of the operation, namely, the parties, the price, the date and the subject matter of the transaction, and it is even admitted that the proof of the cost does not have to be made exclusively through a written document.

As was written in the Decision of the Supreme Administrative Court of 16-03-2005, rendered in case 00340/03:

"1. In properly documented expenses, there must be a presumption of truthfulness of the cost for purposes of determining taxable income in IRC matters, for which reason it is incumbent on the Tax Authority to allege the existence of elements capable of putting into question that truthfulness, in particular through the indication of objective, solid and consistent indications, which translate a high probability that these documents do not title actual operations.

  1. In undocumented or insufficiently documented expenses, the burden falls on the taxpayer to prove the respective cost, as Article 23 of the IRC Code requires of them, by demonstrating that the operations were actually carried out, and for this purpose it is possible for them to resort to other means of evidence (in particular to supplementary documentary evidence and testimonial evidence) to demonstrate it and convince of the propriety of the corresponding accounting entry and the illegality of the correction that the Tax Authority has carried out by virtue of this lack or insufficient documentation."

To the same effect, in the Decision of the Court of Appeal of the South, of 20-04-2010, rendered in case 03632/09, it can be read: "Thus, the evidentiary ineffectiveness of the accounting records does not prevent their supplementation by other means of evidence admitted in law and appropriate to substantiate the fairness of the assessment through proof of the underlying commercial operation to the defective record or documentary support of that accounting record."

It is not without relevance to note that in the recent IRC reform, the legislator has come to establish increased requirements in the documentary evidence, very similar to those of VAT (Article 23(4)), which allows one to infer, on the one hand, that these requirements did not previously exist and, on the other, that such requirements were not – as they are not – as stringent in IRC as they are in VAT.

Arriving here, it is believed that reason should not be given to the Tax Authority when it understands that it would be essential to "demonstrate in what the service provisions were concretely carried out" and "to assess their indispensability", to know "in particular:

• The agents who intervened in the provision of the services, (…);

• The determination of the values charged to M… with respect to each one of the service provisions (…);

• The third entities (clients, suppliers, financiers, business organizations, subcontracted entities, etc) involved in the said service provisions (…);

• The contracts, agreements, partnerships, documents in which group strategies, commercial and marketing actions, proofs of exhibitions and fairs, proofs of exhibitions and fairs, proofs of participation in audits and reports, the implementation of new projects and technologies, regular visits to the units, senior staff recruitment processes (…)."

since this lacks, from the outset, legal foundation.

On the other hand, it is also not subscribed to the understanding of the Tax Authority, according to which it "questioned, in a well-founded manner, (…) the fiscal relevance of certain amounts, accounted for as exercise costs.", relating to the invoices of A… and C….

Indeed, objectively, the Tax Authority has not gathered or presented any positive proof that raises any doubt about the usefulness or necessity of the expenses in which the Petitioner, admittedly, incurred. Rather, the Tax Authority merely casts a Cartesian doubt over these charges, demanding proof to the contrary, to accept their deductibility.

As was written in the Decision of the Court of Appeal of the South of 30-01-2007, rendered in case 01486/06:

"IV.- It is in the concept of indispensability inherent in Article 23 of the IRC Code that the essential question regarding the fiscal consideration of business costs is rooted and that the fundamental distinction between the cost effectively incurred in the collective interest of the company and what may result only from the individual interest of a partner, a group of partners or their entirety and which therefore cannot be considered a cost.

V.- This is an expense with a business purpose, which does not mean it has from the outset an immediate and directly lucrative purpose, but that it has, in its origin and in its cause, a business purpose, the law granting the Tax Authority sufficient powers to refuse acceptance as a fiscal cost of expenses that cannot be considered compatible with the purposes to be pursued by the company."

As can be seen there, the proof of the essentiality of an expense demonstrably incurred passes, not through a microscopic demonstration of the anatomy of the expense, but, rather, through the connection, from a point of view of reasonableness, to the "collective interest of the company", through the evidencing of a business cause and origin.

Thus, and moreover, Article 23(1) of the IRC Code, enumerates in its subsections a series of exemplary situations of the requirement established in its body, which should not be understood, in line with what Professor Teixeira Ribeiro understood in light of the old IRC Code, in any other way than that when costs or losses are specifically enumerated in Article 23, it is presumed that they are indispensable, correspondingly relieving the taxpayer of the burden of proof, and this is precisely the purpose of the enumeration (derived, moreover, from the use of the expression "in particular").

Now, as can be seen from the facts deemed proven, the expenses in question in the case fall within the various subsections of Article 23(1) of the IRC Code, being essentially reduced to expenses relating to production (subsection a)) and distribution and sale of products, including advertising (subsection b)), as well as expenses of an administrative nature (subsection d)) and analyses, rationalization, research and consultation (subsection (e)).

Furthermore, and independently, the fact is that it results from the evidence produced, consolidated in the facts deemed proven, that the Petitioner actually used the invoiced services, and that such services are not only, objectively and by their nature, potentially generators of gains, but the Petitioner derived concrete benefits from them, reflected in its production and sales.

Now, all of this is sufficient for the essentiality of the expenses in question to be considered demonstrated. And, once this is demonstrated, it will not be lawful for the reasoning to be that the non-proof of the form of calculation of the concrete amount of the expense – and its possible exaggeration – implies its disallowance as a whole.

As was written in case 91-2012-T of CAAD:

"Faced with the impossibility of determining which services were provided and their indispensability, the tax administration notified the Petitioner to, among other things, specify, date and quantify these services.

The Petitioner provided clarifications, but, after deep analysis could not determine which intra-group services were provided nor their quantification, nor their date.

Following this impossibility of determination, the tax administration understood that Article 23 of the IRC Code was breached, as the Petitioner did not prove the indispensability of the referred costs in the realization of profits nor in the maintenance of the productive source and concluded that it had to give a negative answer to the question of whether there was effectively an intra-group service provision.

(…)

In the case at hand, having the tax administration concluded that it could not be determined what services were carried out and their quantification, adopted an understanding that amounts to the fact that none of the services provided, which it did not know, was necessary for realization of profits or maintenance of the productive source.

This understanding does not correspond to reality, as some services were provided, as results from the facts deemed proven, and therefore the assessment acts relating to the years 2007 and 2008, insofar as they were based on corrections relating to "Management fees", are defective due to error in the factual premises.

Furthermore, having applied the regime of Article 23 of the IRC Code to a situation where it is not applicable, those acts suffer from the defect of violation of law due to error in the legal premises."

The Tax Authority's argumentation on this matter thus ends up demonstrating some contradiction, in that on the one hand it assumes not to challenge that the services were provided and, on the other, it declares not to know anything related to those ("origin, nature, destination and amount"), and it is a case for asking what services are these, then, that the Tax Authority admits have been provided…

Also the very reference, without drawing the due consequences – in particular at the level of autonomous taxation – to the possible occurrence of confidential expenses, made in the RIT and replicated in the Tax Authority's Reply already in arbitral proceedings, demonstrates this referred lack of understanding. Indeed, the refusal of a supplier to reveal the way it sets the price of a good, or service, effectively supplied is not capable of making the expense confidential. It was incurred for the good or service effectively provided, in the amount demonstrably paid to the identified recipient, and therefore all elements are known so that the same do not amount to confidential expenses.

A question distinct from that which has just been addressed, will be that of the reasonableness of its quantification. It would be a matter of determining whether, being the services demonstrably provided "indispensable for the realization of income subject to tax or for the maintenance of the productive source", as in this case they undoubtedly are, the value fixed and paid as consideration was adequate, or not.

This question – which would slide into the field of transfer pricing – was, however, not raised by the Tax Authority.

Suffering, in this manner and for all that has been said, the assessment subject to the present case, from the defect of violation of law due to error in the legal premises, it should be partially annulled, and in this part the arbitral petition proceeds, and therefore knowledge of the defect of form concurrently raised is prejudiced.

The Petitioner also challenges the disallowance of the deduction, relating to the benefit contained in Article 19 of the EBF (job creation), in the amount of €1,662.50, relating to C…, spouse of a manager of the Petitioner.

In this respect, it was written in the decision of case 74-2014T of CAAD, between the same parties and on the same question:

"In accordance with Article 19(4) of the EBF, "for purposes of net creation of jobs, workers who are part of the family unit of the respective employing entity are not considered".

The Respondent considered non-deductible the expenses incurred with employee D..., spouse of a manager of the Respondent. Now, the employing entity of this employee is, effectively, the Petitioner (which, being a legal person, does not have a family unit) and not its Board of Directors.

It should be noted, in this respect, that the argumentation of the Tax Authority explained in points 45 to 96 of its Reply may eventually be relevant from a de jure constituendo perspective but cannot be accepted de jure constituto.

The Tax Authority frontally violates the good rules of legal interpretation when it considers it to result from the text of the law, the interpretation it defends, namely, that in the expression "employing entity" in the text of Article 19(4) of the EBF, its bodies are included, in particular the members of the Board of Directors (because not also the members of the Audit Committee? And of the General Assembly Board?).

Thus, this Tribunal equally considers the non-consideration of the deduction for net job creation alleged by the Respondent to be without merit, understanding that, also on this point, the correction to the taxable base made does not have legal foundation, and therefore suffers from the defect of violation of law due to error in the legal premises."

Fully subscribing to the considerations transcribed, it is understood that the arbitral petition should, also in this part, proceed.

The Petitioner combines with its petition to annul the tax act subject to the present case, a petition for condemnation of the Tax Authority to payment of compensatory interest.

In the case at hand, it is manifest that the illegality of the assessment act, which amount the Petitioner paid, is attributable to the Tax Administration, which, on its own initiative, carried it out without legal support.

Consequently, the Petitioner is entitled to compensatory interest, pursuant to Article 43(1) of the General Tax Law (LGT) and Article 61 of the Tax Procedure Code (CPPT).

Compensatory interest is due from the date of payment made, and calculated based on the respective value, until its full reimbursement to the Petitioner, at the legal rate, pursuant to Articles 43(1) and (4) and Article 35(10) of the LGT, Article 61 of the CPPT and Article 559 of the Civil Code and Ordinance No. 291/2003, of 8 April (without prejudice to any subsequent changes in the legal rate).

C. DECISION

For these reasons, this Arbitral Tribunal decides to fully uphold the arbitral petition filed and, consequently,

a) partially annul the tax act subject to the present case, with all due and legal effects, in particular:

i. condemn the Tax Authority to reimburse the Petitioner the tax paid in the amount of €8,325.01, plus compensatory interest;

ii. determine the recalculation of the Petitioner's taxable income accepting the expenses not accepted from the invoices issued by its shareholders A… and C… as well as the tax benefit relating to employee C…, in the overall amount of €250,301.50;

b) Condemn the Tax Authority in the costs of the proceedings, in the amount of €2,448.00.

D. Value of the Proceedings

The value of the proceedings is set at €70,900.01, pursuant to Article 97-A(1)(a) of the Tax Procedure Code, applicable by virtue of subsections a) and b) of Article 29(1) of the RJAT and Article 3(2) of the Regulation on Costs in Tax Arbitration Proceedings.

E. Costs

The arbitration fee is set at €2,448.00, pursuant to Table I of the Regulation on Costs in Tax Arbitration Proceedings, to be paid by the Tax Authority, since the petition was entirely upheld, pursuant to Articles 12(2) and 22(4), both of the RJAT, and Article 4(4) of the said Regulation.

Notify accordingly.

Lisbon

17 December 2014

The Presiding Arbitrator

(José Pedro Carvalho – Reporter)

The Arbitrator Member

(António Martins)

The Arbitrator Member

(João Sérgio Ribeiro)

Frequently Asked Questions

Automatically Created

What conditions must business expenses meet to be deductible under Portuguese IRC rules?
Under Portuguese IRC rules, business expenses must meet several conditions to be deductible according to Article 23(1) of the IRC Code. First, expenses must be indispensable (essential) for the realization of income or maintenance of the productive source of the company. Second, they must be properly documented with invoices or equivalent documents that clearly identify the nature of services or goods provided, the parties involved, and how values were determined. Third, expenses must be recorded in the company's accounts. Fourth, they must not fall under the specific exclusions listed in Article 23-A of the IRC Code. For cross-border transactions, especially with related parties, tax authorities require enhanced documentation proving the actual provision of services and their business necessity, including detailed descriptions of services rendered, identification of service providers, and transparent pricing methodologies.
How does the essentiality principle apply to the deductibility of costs in corporate income tax (IRC)?
The essentiality principle (princípio da indispensabilidade) is fundamental to IRC cost deductibility under Article 23(1) of the IRC Code. An expense is considered essential when it is necessary for obtaining or maintaining the company's income-generating capacity. This means the cost must have a direct or indirect connection to the company's business activity and contribute to revenue generation or business sustainability. Tax authorities assess essentiality based on: (1) whether the expense relates to the company's actual business operations; (2) whether it serves a legitimate business purpose; (3) whether the amount charged is reasonable and market-based; and (4) whether adequate documentation proves the service or good was actually delivered. For management services from parent companies, taxpayers must demonstrate these services provided real added value beyond what the company could perform itself, were not duplicative, and were priced at arm's length.
Can a company challenge an additional IRC tax assessment through CAAD arbitration?
Yes, companies can challenge additional IRC tax assessments through CAAD (Centro de Arbitragem Administrativa) arbitration under the RJAT (Legal Regime of Arbitration in Tax Matters), approved by Decree-Law No. 10/2011 of January 20. This arbitration is an alternative to judicial courts for resolving tax disputes. To initiate arbitration, the taxpayer must file a petition within 90 days of notification of the tax assessment or, if a prior hierarchical appeal was filed, within 90 days of the decision on that appeal. The arbitration can address the legality of tax acts including additional assessments, tax liquidations, and enforcement procedures. The arbitral tribunal, composed of one or three arbitrators depending on the case value and parties' choice, has full jurisdiction to review both factual and legal issues, examine evidence, and declare tax acts illegal if they violate substantive or procedural tax law. The process is generally faster than judicial litigation and the decision is binding on both parties.
What are the grounds for contesting disallowed deductible expenses in an IRC additional assessment?
Companies can contest disallowed deductible expenses in IRC additional assessments on several grounds: (1) substantive grounds - arguing that expenses meet the essentiality test under Article 23(1) of the IRC Code and were necessary for business operations; (2) procedural grounds - claiming lack of proper substantiation (falta de fundamentação) in the tax authority's decision, meaning the tax authority failed to adequately explain why expenses were rejected; (3) evidentiary grounds - presenting additional documentation to prove services were actually rendered and had business purpose; (4) legal interpretation - arguing the tax authority misapplied legal criteria for deductibility; (5) proportionality - contesting that rejection of expenses was disproportionate given the evidence provided; and (6) violation of rights of defense - claiming the taxpayer was not given adequate opportunity during inspection to clarify or provide supporting documentation. Companies typically must demonstrate that expenses were properly documented, connected to business activity, and reasonable in amount.
How does CAAD evaluate claims of insufficient reasoning (falta de fundamentação) in IRC tax assessments?
CAAD evaluates claims of insufficient reasoning (falta de fundamentação) in IRC assessments by examining whether the tax authority's decision meets the requirements of Article 77 of the Tax Procedure Code (LGT) and Article 268(3) of the Portuguese Constitution. The tax authority must provide sufficient factual and legal grounds explaining why the taxpayer's position was rejected. The reasoning must be: (1) clear and intelligible, allowing the taxpayer to understand the basis for the decision; (2) complete, addressing the taxpayer's arguments and evidence; (3) congruent, meaning conclusions must logically follow from stated premises; and (4) adequate to enable effective judicial or arbitral review. However, CAAD tribunals distinguish between insufficient reasoning as a procedural defect versus substantive errors in applying tax law. Even if reasoning is technically present, it may be insufficient if it fails to explain critical factual or legal determinations. The burden is on the tax authority to demonstrate it properly considered evidence and explained its decision. If reasoning is found insufficient, the tax act may be annulled, though this does not automatically mean the taxpayer wins on substance - the matter may return to the tax authority for proper substantiation.