Process: 322/2014-T

Date: December 2, 2014

Tax Type: IRC

Source: Original CAAD Decision

Summary

This CAAD arbitral case (Process 322/2014-T) addresses the critical issue of expense deductibility under Portuguese Corporate Income Tax (IRC) when special relationships exist between entities. Company A challenged an additional IRC assessment for 2009 (€10,489.74 including default interest) after the Tax Authority disallowed financial expenses related to credit extended to related company B. The central legal question concerns whether Article 63 of the CIRC (transfer pricing rules) permits disallowing deductible expenses solely based on special relationships. The claimant argued that (1) special relationships alone cannot justify expense disallowance, (2) transfer pricing rules should result in income adjustments rather than expense rejection, (3) the Tax Authority engaged in abusive interference with management decisions, and (4) properly documented financial costs incurred within operational activities must be deductible. The Tax Authority countered that the financial expenses arose from pledged accounts used to release resources for financing B through extended payment terms exceeding normal commercial practices, that these costs did not contribute to the claimant's productive source, and that the burden of proof rested on the taxpayer to demonstrate the necessity of such expenses. The case highlights fundamental principles of IRC expense deductibility: expenses must be necessary for generating or maintaining taxable income, special relationships trigger enhanced scrutiny under transfer pricing rules, and taxpayers bear the burden of proving business purpose when the Tax Authority challenges expense deductibility. The arbitral tribunal's jurisdiction under the RJAT (Legal Framework for Arbitration in Tax Matters) provides an alternative dispute resolution mechanism for challenging additional IRC assessments and associated default interest, with decisions binding on both parties and subject to limited judicial review.

Full Decision

Case No. 322/2014-T

I – Report

1.1. A, taxpayer no. ..., with registered office at ..., no. ..., ... (hereinafter designated as "claimant"), having been notified of the dismissal of the administrative review claim filed against the additional corporate income tax (IRC) assessment and respective default interest, relating to the year 2009, submitted, on 5/4/2014, a request for constitution of an arbitral tribunal and for arbitral decision, in accordance with the provisions of article 10 of Decree-Law no. 10/2011, of 20/1 (Legal Framework for Arbitration in Tax Matters, hereinafter designated only as "RJAT"), and of articles 1 and 2 of Ministerial Order no. 112-A/2011, of 22/3, in which the Tax and Customs Authority (AT) is requested, with a view to "the annulment of the tax act that is the subject of the present tax arbitral proceeding [additional IRC assessment and respective default interest for the year 2009, no. ...69, in the amount of €10,489.74]" and the condemnation of the respondent to the return of the "tax unduly paid, plus indemnificatory interest to be computed between the date of payment of the amount referred to and the issuance of the corresponding credit note in favour of the Claimant, as provided for in article 43 of the General Tax Law".

1.2. On 11/6/2014, the present Sole Arbitral Tribunal was constituted.

1.3. In accordance with article 17, paragraph 1, of the RJAT, the AT was cited, as respondent party, to submit a reply, in accordance with the said article, on 1/7/2014. The AT submitted its reply on 12/9/2014, arguing for the total dismissal of the claimant's request.

1.4. By order of 11/11/2014, the Tribunal considered, in accordance with article 16, subparagraph c), of the RJAT, that the meeting provided for in article 18 of the RJAT was unnecessary, and that the case was ready for decision. The date of 2/12/2014 was also fixed for the delivery of the arbitral decision.

1.5. The Arbitral Tribunal was properly constituted, is materially competent, the case is not affected by defects that would invalidate it, and the Parties have legal standing and capacity, being duly legitimated.

II – Legal Grounds: The Facts

2.1. The claimant submits, in its initial petition, that: a) "it is incomprehensible how the existence of special relationships (no. 4 of article 63 of the CIRC) determines, in itself alone, the disallowance as a deductible expense of costs incurred"; b) "acting on the basis of the existence of special relationships and consequent application of the transfer pricing rules should never determine the non-recognition as deductible expenses of costs actually incurred, but rather the recognition of income determined in accordance with the provisions of paragraph 2 of article 63 of the CIRC, and it is certain that the corresponding positive adjustment in A should provoke the corresponding adjustments (negative correction) in B..."; c) "the consideration as a deductible expense of part of the financial costs objectively incurred and properly documented to a certain adoption of a credit granting policy to customers, albeit in a situation of special relationships, amounts to an abusive interference in the management of the company, through judgments of opportunity and convenience of said costs"; d) "the financial costs incurred and properly documented with bank financing were incurred within the specific scope of the company's operational activity, and the decision to grant a longer or shorter period for the receipt of credits from customers should not be a reason for the disallowance, even in part, of demonstrably incurred costs, as deductible expenses for tax purposes."

2.2. The claimant concludes that it should be: a) "judged that the request submitted in the present tax arbitral proceeding is well-founded and proven"; b) "annulled the tax act that is the subject of the present tax arbitral proceeding"; c) "condemn[ed] the Respondent to return to the Claimant the tax unduly paid, plus indemnificatory interest to be computed between the date of payment of the amount referred to and the issuance of the corresponding credit note in favour of the Claimant, as provided for in article 43 of the General Tax Law".

2.3. For its part, the AT submits, in its reply: a) that, "in the situation sub judice, the costs corresponding to financial expenses arising from the use of pledged accounts, with the purpose of releasing financial resources that would allow financing B..., as a result of late performance and without place for payment of interest, [...] such costs are directly related to the activity of the Claimant"; b) that "it results from the analysis undertaken, in particular from the assessment of the accounting elements analysed, that the financial flows resulting from the loans obtained were not applied within what would correspond to the corporate purpose of the Claimant, in particular in what is commonly understood as "operation", as was evident, since they had the purpose of releasing financial resources to finance B..."; c) that "the AT verified that the costs resulting from the use of pledged accounts did not contribute to the maintenance of the productive source of the Claimant and, in the absence of proof to the contrary, removed their tax relevance."; d) that "the claimant merely argues, without proving, neither in procedural terms, nor within the scope of the present arbitral request, that the financing obtained was obtained within the specific scope of the company's operational activity"; e) that "the AT called into question [...] the tax relevance of certain amounts, recorded as exercise costs [thus placing] the burden on the Claimant to prove this indispensability. Proof that the claimant did not provide"; f) that "the fact that [the claimant], for years, did not demand the credits in the current account of B... constitutes financing of the company with which it has a direct interest and, the latter resorting to credits for its treasury needs, is undeniably financing its customer B..., on the one hand, and recording expenses with financing charges, which do not contribute in any way to the realization of its income, on the other. It is clear that the non-payment of the supplies made by the Claimant to B... assumes a nature equivalent to that of financing, since the Claimant had to use its pledged accounts in order to release financial resources to finance B..., and therefore incurred costs."

In summary, the AT maintains that "the present arbitral request [should] be judged as unfounded, not proven, and consequently the Respondent absolved of all requests, all with the due legal consequences."

2.4. The following facts are considered proven:

i) Following the inspection action, under Service Order no. OI..., carried out by the SIT of DF of …, a correction was made to the taxable amount, in the context of IRC, relating to the exercise of 2009, in the amount of €35,815.94.

ii) The claimant has brought the present arbitral action for assessment of the legality of the additional IRC assessment, relating to the exercise of 2009, embodied in the Assessment Statement no. 2013 ..., with tax to be refunded in the amount of €130,719.96 - which, after the compensation movements, resulted in the Collection Notice no. ..., in the total amount, now at issue, of €10,489.74 (of which €998.52 in default interest).

iii) The claimant and B, S.A. (hereinafter called "B") "have common members of the administration and capital holders"; despite this fact, the claimant does not have a transfer pricing file to which it refers in article 63, paragraph 6, of the CIRC (see fl. 10 of the RIT contained in the PAT attached).

iv) The claimant's financing to B, by way of credit granted in commercial relations, exceeded the period normally set for other customers (see fl. 14 of the RIT contained in the PAT attached).

v) The costs corresponding to financial expenses arising from the use of pledged accounts, with the purpose of releasing financial resources that would allow financing B (as a result of late performance and without place for payment of interest), are not directly related to the claimant's activity. And it was for that reason that such costs were not considered as indispensable for the realization of income, in accordance with the provisions of article 23 of the CIRC (see fls. 14-16 of the RIT). The demonstration of the indispensability of the said costs was not made in this proceeding by the claimant.

vi) The claimant filed an administrative review claim, which was dismissed by order dated 15/1/2014 (which was notified to the claimant on 20/1/2014).

2.5. There are no unproven facts relevant to the decision of the case.

III – Legal Grounds: The Law

In the case now under analysis, there are three disputed questions of law: 1) to know whether "the existence of special relationships [...] determin[ed], in itself alone, the disallowance as a deductible expense of costs incurred", to know whether "the costs corresponding to financial expenses arising from the use of pledged accounts, with the purpose of releasing financial resources that would allow financing B", could be considered as directly related to the claimant's activity and, finally, to know whether the AT's assessment resulted in an "abusive interference in the management of the company"; 2) to know whether it is the responsibility of the taxpayer, following reasoned action by the AT, to bear the burden of proof of the indispensability of the costs in question; 3) to know whether indemnificatory interest is due.

Let us proceed.

1 and 2) The claimant argues that the existence of special relationships should not determine, in itself alone, "the disallowance as a deductible expense of costs incurred". Instead, and according to the claimant, "acting on the basis of the existence of special relationships and consequent application of the transfer pricing rules [...] should determine [...] the recognition of income determined in accordance with the provisions of paragraph 2 of article 63 of the CIRC".

It becomes clear, first of all, and as the claimant itself recognizes, that the existence of special relationships is, in this case, indisputable. It remains, then, to know whether it was, as it also alleges, the "justification for the correction made (disallowance of financial costs)" or whether such correction is connected with other reasons.

Now, as can be seen from reading the present files and, in particular, from the report of the SIT, nothing permits assuming that the finding of the existence of special relationships was "the" reason underlying the AT's thesis that "the financial flows resulting from the loans obtained were not applied within what would correspond to the corporate purpose of the Claimant [...], as [...] they had the purpose of releasing financial resources to finance B...".

It is found, rather, that the AT made the correction under review in respect of the provisions of article 23 of the CIRC, i.e., keeping in mind that, notwithstanding such special relationships, the amount now in question could only be accepted as a cost of the claimant if the underlying financial expenses related to its activity and had been applied in it.

To confirm this reasoning, read the following excerpt from the SIT's report, in the part here considered relevant: "the non-payment of the supplies made by A to B assumes a nature equivalent to that of financing, thus inducing A to increase its financial costs, to the extent that A had to use its pledged accounts in order to release financial resources to finance B.... Obviously, the financial costs arising from the use of pledged accounts did not, in their entirety, contribute to the maintenance of the productive source of A, to the realization of its income subject to tax and did not generate any direct, measurable and evident inflow in the exercise of its activity."

Indeed, it is not apparent how costs relating to financial expenses arising from the use of pledged accounts – with the purpose of releasing financial resources that would allow financing B (given the late performance and without place for payment of interest) – could be considered as directly related to the claimant's activity.

And neither is it seen how the assessment carried out by the AT constitutes "an abusive interference in the management of the company". For, as rightly noted in the following ruling, "fiscally deductible costs are all expenses that are directly related to the productive process [...]. [...] [U]nder penalty of violation of the principle of taxable capacity, the Administration can only exclude costs not directly excluded by law under strong motivation that [convinces] it that they were incurred beyond the corporate purpose, that is, in the pursuit of another interest than the business interest, or, at least, with clear excess, deviant, in view of the objective needs and capacities of the company." (Judgment of the STA of 30/11/2011, case 107/11).

Now, it was precisely this that occurred in the case under analysis. The AT presented sufficient reasons to conclude that the disallowed costs were incurred in the pursuit of another interest than the business interest of the claimant, i.e., of an interest that lay outside the scope of its operational activity; and, with such grounds, the correction was justified, so it was now incumbent on the claimant, in turn, to demonstrate the indispensability of the mentioned costs. It is found, however, that such demonstration was not made in this proceeding.

In this regard, observe, for example, the following ruling: "It provides [article 23 of the CIRC] that costs or losses are considered those that are demonstrably indispensable for the realization of income or gains subject to tax or for the maintenance of the productive source. Thus, the costs provided for in that article 23 must relate from the outset to the company taxpayer itself, that is, in order for a certain amount to be considered a cost thereof, it is necessary that the respective activity be carried out by it itself, not by other companies. Otherwise, how could the exercise of the activity of another company, with which it had some relationship, be attributed to a company. [The amounts in question] are not, therefore, directly related to any activity of the taxpayer inscribed in its corporate purpose [...]. On the other hand, this is not about interest on foreign capital applied in the operation itself, those that are indeed provided for as costs in subparagraph c) of paragraph 1 of article 23 of the CIRC. The mere possibility of being able to have in the future gains resulting from the application of such capital in its associate does not determine in itself that such investments can be framed within the concept of tax costs because for that it would be necessary that such expenses were indispensable for the realization of income or gains subject to tax or for the maintenance of the productive source. And such indispensability is far, in this case, from having been demonstrated." (Judgment of the STA of 7/2/2007, case 1046/05).

Observe, furthermore, now regarding the burden of proof that undeniably fell on the claimant, the following judgment: "Only costs are not indispensable «those that do not have a causal and justified relationship with the productive activity of the company», that is, the indispensability of tax expenses must be understood «as referred to the connection of costs to the activity carried out by the taxpayer». It is certain to affirm that the burden of proof of the indispensability of its costs does not rest with the taxpayer. However, if the tax administration/AT, acting subject to the principle of legality, reasonably, triggers doubt about the justified relationship of a particular expense with the activity of the subject obligated to pay, necessarily and logically, because it is better positioned to do so, it is incumbent upon the latter to provide an explanation about the «economic congruence» of the operation, which is not fulfilled with the abstract and conclusory allegation that the expense falls within the corporate interest and/or the existence of a justified relationship with the activity carried out, instead requiring that the taxpayer allege and prove concrete facts, susceptible to review, capable of demonstrating the reality, truthfulness, of the business actions giving rise to the recorded costs, in order that, among other things, the supervisory function of the AT is not made impossible." (Judgment of the TCAS of 27/3/2012, case 5312/12).

It is concluded, from the above, that the claimant is not right, either as to the allegation that the identification of special relationships would have determined the disallowance of the costs in question (because the same were instead disallowed in light of what is provided for in article 23 of the CIRC), or as to the burden of proof of their indispensability (because, after reasoned decision by the AT, the claimant did not make a reasoned demonstration, supported by concrete facts, that such costs were part of its operational activity).

  1. In accordance with article 43, paragraph 1, of the LGT, indemnificatory interest is due when it is determined, in administrative review or judicial contestation, that there was error attributable to the services from which results payment of the tax debt in an amount higher than legally due.

It is, therefore, a necessary condition for the attribution of such interest the demonstration of the existence of error attributable to the services. In that sense, see, for example, the following judgments: "The right to indemnificatory interest provided for in paragraph 1 of article 43 of the LGT [...] depends on it having been demonstrated in the case that this act is affected by error regarding the factual or legal assumptions attributable to the AT." (Judgment of the STA of 30/5/2012, case 410/12); "The right to indemnificatory interest provided for in paragraph 1 of article 43 of the General Tax Law presupposes that it is determined in the case that in the assessment «there was error attributable to the services», understood as the «error regarding the factual or legal assumptions attributable to the Tax Administration»" (Judgment of the STA of 10/4/2013, case 1215/12).

Now, there having been no, as is noted from the reading of 1) and 2), any error attributable to the services, it is concluded, also, that the said request for payment of indemnificatory interest in favour of the claimant is unfounded.

IV – Decision

In view of the above, it is decided:

  • To judge as unfounded the present arbitral request, maintaining in the legal order the tax assessment act contested, and accordingly absolving the respondent entity of the request.

  • To judge as unfounded the present request insofar as it relates to the recognition of the right to indemnificatory interest in favour of the claimant.

The value of the case is set at €10,489.74 (ten thousand four hundred eighty-nine euros and seventy-four cents), in accordance with article 32 of the CPTA and article 97-A of the CPPT, applicable by force of the provisions of article 29, paragraph 1, subparagraphs a) and b), of the RJAT, and article 3, paragraph 2, of the Regulation on Costs in Tax Arbitration Proceedings (RCPAT).

Costs to be borne by the claimant, in the amount of €918.00 (nine hundred eighteen euros), in accordance with Table I of the RCPAT, given that the present request was judged unfounded, and in compliance with the provisions of articles 12, paragraph 2, and 22, paragraph 4, both of the RJAT, and the provisions of article 4, paragraph 4, of the cited Regulation.

Notify.

Lisbon, 2 December 2014.

The Arbitrator

(Miguel Patrício)

Text prepared by computer, in accordance with the provisions of article 138, paragraph 5, of the CPC, applicable by referral of article 29, paragraph 1, subparagraph e), of the RJAT.

The drafting of the present decision is governed by the spelling prior to the Orthographic Agreement of 1990.

Frequently Asked Questions

Automatically Created

What are the conditions for deducting expenses between related parties under Portuguese IRC?
Under Portuguese IRC law, expenses between related parties are deductible when they meet general deductibility requirements (Article 23 of CIRC): they must be documented, necessary for generating or maintaining taxable income, and not excluded by law. When special relationships exist under Article 63(4) of CIRC (common shareholders, management, or control), transfer pricing rules apply requiring arm's length conditions. The Tax Authority may challenge expenses that deviate from market conditions or lack business purpose. While special relationships trigger enhanced scrutiny, they do not automatically disallow expenses. Taxpayers must maintain transfer pricing documentation under Article 63(6) demonstrating that transactions reflect market conditions. The burden of proof shifts to taxpayers when the Tax Authority questions whether expenses contributed to the productive source, requiring demonstration that costs were incurred for legitimate business purposes rather than merely financing related entities.
How do transfer pricing rules under Article 63 of the CIRC affect expense deductibility?
Article 63 of the CIRC establishes transfer pricing rules affecting expense deductibility in related party transactions. Under Article 63(2), when special relationships exist and transactions deviate from arm's length conditions, the Tax Authority may adjust taxable income to reflect market terms. Crucially, these rules should result in income adjustments (positive corrections for the payer, corresponding negative adjustments for the recipient) rather than outright expense disallowance. However, Article 63 must be read with Article 23 of CIRC on general deductibility requirements. If expenses lack business purpose or don't contribute to generating taxable income, they become non-deductible regardless of transfer pricing adjustments. The absence of mandatory transfer pricing documentation (Article 63(6)) strengthens the Tax Authority's position when challenging expense deductibility. In practice, transfer pricing rules create a two-tier analysis: first, whether expenses meet general deductibility criteria; second, whether pricing reflects arm's length conditions requiring income adjustments.
Can the Portuguese Tax Authority disallow deductible costs solely based on special relations between entities?
No, the Portuguese Tax Authority cannot disallow deductible costs solely based on special relations between entities. As the claimant correctly argues in this case, the existence of special relationships under Article 63(4) of CIRC does not automatically render expenses non-deductible. Transfer pricing rules aim to adjust income to reflect market conditions, not to deny deductibility of legitimately incurred business expenses. However, special relationships justify heightened scrutiny of the business purpose and necessity of expenses. The Tax Authority must demonstrate that expenses fail to meet Article 23 of CIRC requirements—lacking documentation, business purpose, or connection to income generation. In this case, the Tax Authority argued that financial costs were incurred to finance the related company through extended credit terms rather than for the claimant's operational needs, thus failing the necessity requirement. The key distinction is that disallowance must be based on failure to meet general deductibility criteria, with special relationships serving as an evidentiary factor rather than an independent disqualification ground.
What is the role of CAAD arbitration in resolving disputes over IRC additional tax assessments?
CAAD (Centro de Arbitragem Administrativa) arbitration provides an alternative dispute resolution mechanism for IRC additional tax assessments under the RJAT (Decree-Law 10/2011). Taxpayers may request arbitration after exhausting administrative review procedures, as occurred in this case. The arbitral tribunal has jurisdiction to review the legality of tax assessments, including substantive tax law application and procedural compliance. In IRC expense deductibility disputes, tribunals evaluate whether the Tax Authority correctly applied Articles 23 and 63 of CIRC, assess evidence of business purpose, and determine whether the burden of proof was satisfied. Arbitral decisions are binding on both parties and have the same effect as court judgments. The process offers advantages over judicial litigation: specialized tax expertise, faster resolution (decisions typically within months), and reduced formality. Tribunals may annul illegal assessments and order refunds with compensatory interest under Article 43 of the LGT. The CAAD process has become increasingly important for resolving complex IRC issues like transfer pricing and related party transactions.
Are compensatory interest charges applied on additional IRC tax assessments subject to arbitral review?
Yes, compensatory interest charges (juros de mora) applied on additional IRC tax assessments are subject to arbitral review in CAAD proceedings. As demonstrated in this case, the claimant challenged both the principal tax amount and the default interest (€998.52 of the total €10,489.74). Default interest is an accessory obligation that follows the principal tax debt under Article 35 of the LGT (General Tax Law). If the arbitral tribunal determines the additional assessment is illegal and annuls it, the corresponding default interest is also eliminated as it lacks legal basis. Conversely, if the tribunal upholds the assessment but with a different amount, default interest is recalculated accordingly. Additionally, taxpayers who prevail in arbitration may claim compensatory interest (juros indemnizatórios) under Article 43 of the LGT for amounts unduly paid, calculated from payment date until refund. This creates a complete review mechanism: arbitral tribunals assess both whether tax and default interest were legally due, and whether the State owes compensatory interest for unjustified collection, ensuring full remediation of illegal tax assessments.