CAAD Ruling on IRC Deductibility of Financial Charges for Capital Acquisitions by SGPS under Article 32 EBF

ARBITRAL DECISION

The arbitrators Dr. Jorge Lopes de Sousa (arbitrator-president), Dr. A. Sérgio de Matos and Dr.ª Filomena Oliveira, designated by the Deontological Council of the Centre of Administrative Arbitration to form the Arbitral Tribunal, constituted on 10-08-2015, agree as follows:

1. Report

A… SGPS, SA (hereinafter referred to as A… or Claimant), a joint-stock company, holder of the Corporate Identification Number (NIPC)…, with registered office at Lugar de…. Apartado…, …---- São Mamede de Infesta, in its capacity as the dominant company of Group A…, came, pursuant to the provisions of article 10 of Decree-Law no. 10/2011, of 20 January ("Legal Regime for Arbitration in Tax Matters" - RJAT) and of articles 102 and 99 et seq. of the Code of Tax Procedure and Process ("CPPT"), of nos. 1 and 2 paragraph d) of art. 95 of the General Tax Law ("LGT"), to request the constitution of an Arbitral Tribunal, with a view to annulling the IRC additional assessment no. 2014…, dated 23-12-2014, relating to the fiscal year 2012.

The Respondent is the TAX AUTHORITY AND CUSTOMS AUTHORITY.

The request for constitution of the arbitral tribunal was accepted by the President of CAAD on 09-06-2015 and notified on that date to the Tax Authority and Customs Authority.

Pursuant to the provisions of paragraph a) of no. 2 of article 6 and of paragraph b) of no. 1 of article 11 of the RJAT, the Deontological Council designated as arbitrators of the collective arbitral tribunal the signatories, who communicated acceptance of the appointment within the applicable time limit.

On 24-07-2015 the parties were duly notified of this designation, and did not express any desire to refuse the designation of the arbitrators, pursuant to the combined provisions of article 11 no. 1, paragraphs a) and b) of the RJAT and of articles 6 and 7 of the Deontological Code.

In accordance with the provisions of paragraph c) of no. 1 of article 11 of the RJAT, the collective arbitral tribunal was constituted on 10-08-2015.

The Tax Authority and Customs Authority filed a defence, arguing against the merits of the present arbitral action and raising a preliminary issue in which it expresses its understanding that, in the event of annulment of the assessment, it shall be only partial, in the part corresponding to the correction of the taxable base of the Claimant in the amount of € 1,633,914.75.

By ruling of 01-10-2015, the meeting provided for in article 18 of the RJAT was dispensed with and it was decided that the proceedings would continue with written submissions.

The Parties filed submissions.

The parties possess legal personality and capacity, are legitimate and are duly represented (arts. 4 and 10, no. 2, of the same legislation and art. 1 of Ordinance no. 112-A/2011, of 22 March).

The proceedings are not affected by nullities and there is no obstacle to the examination of the merits of the case.

2. Factual Matters

2.1. Established Facts

The following facts are considered established:

a) The Claimant A…SGPS, SA is a holding company (SGPS);

b) The company is classified under the general system of taxation under Corporate Income Tax (IRC), being taxed under the Special Regime for Taxation of Groups of Companies (RETGS) provided for in article 69 of the Corporate Income Tax Code (CIRC), being itself the dominant company, the group being constituted by the following companies:

c) As at 31-12-2012, the Claimant held the following financial interests:

a) The direct participation in X… is 1 share with nominal value of 10 rupees

d) In the IRC income tax return for the period 2012, the Claimant, in determining Taxable Income, did not report, in field 779, any addition relating to financial charges borne with acquisitions of equity interests;

e) In compliance with service order no. … of 28-05-2014, the Tax Authority and Customs Authority conducted a general scope inspection of the Claimant relating to the fiscal year 2012;

f) Following that inspection, the Tax Authority and Customs Authority prepared the Tax Inspection Report contained in the administrative file, the content of which is reproduced herein, which states, among other things, the following:

III.1 - Corrections to Taxable Base - IRC

III.1.1 - Financial Charges Borne with the Acquisition of Equity Interests - € 1,633,914.75

a) Factual Matters

From the analysis of the IRC income tax return for the period 2012, we verified that the taxpayer, in determining Taxable Income, did not proceed, in field 779, to add the financial charges borne with the acquisitions of equity interests, as provided for in no. 2 of article 32 of the EBF.

Pursuant to the provisions of no. 2 of article 32 of the EBF, "the capital gains and losses realized by SGPS from equity interests of which they are holders, provided such are held for a period of not less than one year, and likewise the financial charges borne with their acquisition, do not contribute to the formation of the taxable income of such companies"

For the purposes of correctly determining the financial charges to be excluded, as set out below, supplementary contributions and ancillary contributions with the same regime should be considered as equity interests.

The taxpayer, in the period of 2012, presented in its trial balance, regarding equity interests, the following balances in the sub-accounts of Financial Investments (41), relating to equity interests and ancillary contributions:

Ancillary Contributions with characteristics of supplementary contributions (4161 and 4162), in the total amount of € 80,271,403.47, were made in favor of the following companies:

b) Concerning the rule of art. 32 of the EBF

The legal regime of SGPS, provided for in DL no. 495/88, of 30 December, defines that the typical object of such companies is "the management of equity interests as an indirect form of exercise of economic activity" (see no. 1 of art. 1 of such legislation). It further adds

that no. 2 of the same article, as amended by art. 1 of DL no. 318/94, of 24 December, that participation in a company is considered an indirect form of exercise of economic activity when it does not have an occasional character and reaches, at least, 10% of the capital with voting rights of the participated company, whether alone or together with participations of other companies in which the SGPS is dominant.

Thus, the legislation sought to limit the activity of SGPS to the management of stable equity interests, preventing them from serving as a means of stock market speculation or tax evasion on capital gains.

Law no. 32-B/2002, of 30 December (State Budget Law for 2003) introduced, in its article 38, a significant change to the tax regime applicable to the activity that constitutes the typical object of SGPS through the amendment it inserted in article 31 (now article 32) of the EBF.

This amendment consists in that both the income associated with holding equity interests, such as capital gains, and the expenses, such as the financial charges borne with financing obtained with a view to holding equity interests, do not contribute to the determination of taxable income. In summary, the activity typified in art. 1 of the regime of SGPS is, as a rule, excluded from taxation.

This is embodied in no. 2 of art. 32 of the EBF which establishes that "The capital gains and losses realized by SGPS from equity interests of which they are holders, provided such are held for a period of not less than one year, and likewise the financial charges borne with their acquisition do not contribute to the formation of the taxable income of such companies."

This regime is embodied in the grant of a benefit which, however, was offset by the non-contribution, for the purposes of determining taxable income, of the financial charges borne, creating an environment of neutrality between gains with certain financial assets and the liabilities necessary to acquisition and maintenance of such assets. Assets which in the future generate in their entirety, gains excluded from taxation.

Article 32 of the EBF thus establishes the existence of a link between the acquisition of equity interests held and maintained over a given minimum period, in line with the legal regime of SGPS, and the fiscal relevance of the financial charges borne with their acquisition.

The disregard as expenses of financial charges for the purposes of determining taxable income, enshrined in no. 2 of art. 32 of the EBF, constitutes a corollary of the general principle of the indispensability of expenses according to which fiscal deduction is conditioned on its connection with the obtaining of income subject to tax and from which it follows that if certain expenses are related to income not subject to tax they are not fiscally deductible, a principle established in no. 1 of art. 23 of the CIRC.

Accordingly, and having regard to the ratio legis of art. 32 of the EBF, it is important to demonstrate that the concept of equity interests for the purposes of this rule encompasses equity interests and supplementary contributions, as well as ancillary contributions under the same regime.

It should be noted, however, that this equalization to "equity interests" only encompasses supplementary contributions and ancillary contributions under the regime of supplementary contributions that are demonstrably subject to a regime identical to that enshrined in articles 210 et seq. of the CSC, of which it appears important to highlight as essential aspects:

I. not being remunerated;

II. their restitution cannot occur, if as a result thereof the net position of the company becomes less than the sum of capital and legal reserves;

III. their restitution depends on a decision of the shareholders;

IV. they cannot be restituted after bankruptcy has been declared of the company.

c) Equity interests and ancillary contributions subject to the regime of supplementary contributions

In the context of the issue at hand, that is, whether or not it is due, namely for the purposes of the application of no. 2 of art. 32 of the EBF, regarding supplementary contributions (or ancillary contributions with the regime of supplementary contributions) the treatment conferred to equity interests, it is necessary, as a first step, to invoke the rules of interpretation of tax rules, as provided for in art. 11 of the LGT, and in particular in its nos. 2 and 3.

Thus, in accordance with the said no. 2, "whenever, in tax rules, terms proper to other branches of law are used, they shall be interpreted in the same sense as they have there, unless

Given the absence of a rule in tax legislation which expressly proceeds to define the concept of "equity interests" (without prejudice to there being several rules of the CIRC which make reference to it, such as nos. 3 to 5 of art. 23 of the CIRC), and given that the tax rule under application - no. 2 of art. 32 of the EBF - employs a term ("equity interests") proper to the accounting legislation, it is in the sense that such concept has there that it should be interpreted, given that, pursuant to no. 2 of art. 11 of the LGT, nothing else follows "directly from law". Furthermore, corporate law only provides the concept of "capital".

Additionally, no. 3 of art. 11 of the LGT stipulates that "If doubt persists as to the meaning of the tax rules applicable, the economic substance of the tax facts should be considered", thereby establishing the tax legislator the "principle of substance over form".

Also Rui Nuno Marques, in "Revista de Doutrina Tributária", 3rd Quarter of 2002, argues that "in Tax Law one does not attend so much to the legal form used by the parties, but to the economic effects of the legal transaction. In this way neutral taxation is ensured which could not be influenced by the legal forms chosen by individuals, appealing to the old principle of Roman law «plus est in re quam in existimatione», thus prevailing, in Tax Law the economic substance over legal form (art. 11, no. 3 of the LGT)".

Portuguese tax law thus makes use of an interpretation method which, while not being pure economic interpretation, is also not literal interpretation, but rather teleological and systematic interpretation.

As Casalta Nabais points out, the principle enshrined in the aforementioned no. 3 of art. 11 of the LGT seems to meet a mitigated theory of economic interpretation of tax rules, according to which account should be taken of their purpose, as well as their economic meaning and the evolution of circumstances, albeit with limits.

Having regard to the interests proper to taxation, the sense and conceptual scope of the expression equity interests is broader than mere participation in capital.

I. In light of the role performed in the beneficiary company:

Supplementary contributions perform throughout their useful life a function of support to permanent capital, similar to capital, and, consequently, have, as a rule, a high permanence in the company, and thus, substantively, are covered by the concept of equity interests and subject to the regime of capital gains and losses for tax purposes.

Supplementary contributions, a paradigmatic example of financing through equity, consist of contributions made by shareholders, to reinforce such capital, at a given moment in the life of a company, assuming the form of additional capital. Thus, and even though supplementary contributions present distinctions from capital, they do not fail to have with this, in what concerns this matter, an analogous nature.

This is also the understanding sustained by Sofia Gouveia Pereira in "Supplementary Contributions in Portuguese Corporate Law", page 245, Principia Publisher, edition of January 2004, where she states that "...as to the legal nature we chose to consider supplementary contributions a premium (subsequent), or "overvalue of the quota" bringing them closer to capital and distancing them from shareholder loans, as to their function, this may be, as we saw, either reinforcement of capital, acting as an "innominate" capital or "second line" capital (...).

In the same sense, Gonçalves da Silva and Esteves Pereira consider that supplementary contributions are justified for two concurrent reasons:

1. Because it is not always possible to foresee what capital is necessary for the development of business activities, at least in certain periods;

2. Because, "although they do not constitute a capital increase, being equivalent to it, dispensing with the fulfillment of the respective legal formalities and the expenditure of inherent costs", further adding that "In reality, supplementary contributions constitute additional capital, distinct from nominal capital, occupying an intermediate place between this and reserves proper, and thus should be entered in a specific account of additional net position, additional, precisely with the following code and title: 53 - Supplementary Contributions (...)" .

And the jurisprudence itself that follows such guidance in the interpretation of tax rules, adopting the principle of substance over form. See, in this context, among others, the Judgment no. 523/05 of 3 May 2005 of the Central Administrative Court South (TCA South), stating that, "to tax law what matters above all is the real configuration of factual situations, «the economic reality, the reality of fact», «the economic relationship»".

Thus, given that supplementary contributions throughout their permanence in the company fulfill a function of strengthening permanent capital, and their reimbursement obeys certain conditions, for the purposes of application of the method contained in Circular 7/2004 they should have the treatment provided for "equity interests". In this sense, see Information no. …/10 of the DSIRC (points 13, 14, 31 and 32), which reaches the same conclusion.

(...)

II. In light of accounting classification

Pursuant to the provisions of no. 2 of article 11 of the General Tax Law (LGT) "Whenever, in tax rules, terms proper to other branches of law are used, they shall be interpreted in the same sense as they have there, unless another follows directly from law."

As Casalta Nabais considers, in "Tax Law", 5th edition, Almedina editions, page 165, "given the important and close relations it maintains with the various domains of commercial law, it is understandable that such a segment of tax law should have particular concerns for harmonization. This means, namely, that the CIRS and CIRC should duly take account of the discipline contained in the CSC, POC, CVM, etc., as well as the latter should not disregard the discipline contained in those codes".

Furthermore, the determination of taxable income, and consequently of IRC to be assessed, is based on the accounting result, so it is natural that historically the concepts advocated at the accounting level are considered in the framework of the subject for tax purposes.

Thus, it is important to assess whether in light of accounting legislation supplementary contributions are considered equity interests.

Under the Accounting Standardization System (SNC) supplementary contributions should be recorded, by the recipient, in account 53 - «Other Equity Instruments». The explanatory note states that; "This account shall be used to recognize supplementary contributions or any other financial instruments (or their components) that do not fit the definition of financial liability. In situations where financial instruments (or their components) are identified with financial liabilities, an appropriate item from accounts 25 - Obtained Financing or 26 - Shareholders/Partners" should be used.

From the perspective of the contributing entity, it was already found in the previous accounting regime, the Opinion of the Accounting Standardization Commission (CNC) no. 8/97, of 29 January 1997, which states that supplementary contributions should be classified "in a specific subdivision of the appropriate sub-account of account 411 - Equity Interests", such understanding being equally applicable to ancillary contributions that are subject to the same legal regime.

With the entry into force of the Accounting Standardization System (SNC), supplementary contributions granted continue to be included in account 41 - Financial Investments, similarly to what occurred under POC, taking into account their economic substance.

III. In light of coherence of the tax system

The issues relating to the tax regime applicable to supplementary contributions have already been analyzed by the AT (then DGCI) in Opinion no. …/2010, of 21 May, of the Tax Research Centre, "in which it is concluded, namely, that: i) supplementary contributions (...) which, by a decision of the shareholders, is agreed to apply a regime identical to that established in article 213 of the Commercial Companies Code should be qualified as contributions with the nature of equity, and, fundamentally (...) that ii) these ancillary contributions should, likewise, be considered for all purposes (...) as forming part of the concept of «equity interests»".

In fact, the regime of supplementary contributions regulated in articles 210 to 213 of the Commercial Companies Code points in the direction of "shareholders being bound to make supplementary contributions in the same way as they are obliged to make the capital contribution itself".

This understanding is confirmed by International Accounting Standard 32 - "Financial Instruments: Presentation", which defines as an equity instrument "any contract that evidences a residual interest in the assets of an entity after deduction of all its liabilities" (see § 11). Further adding that the differentiation between a financial liability and an equity instrument is based on "the existence of a contractual obligation of a participant in the financial instrument". From this it clearly follows that "supplementary contributions must be held legally and accounting-wise as forming part of equity."

Moreover: supplementary contributions, as well as ancillary contributions under the regime of supplementary contributions, as financial investments included in fixed assets, follow, on their disposal, the regime of capital gains and losses realized contained in articles 46 et seq. of the CIRC, and thus the losses suffered with the onerous transfer of ancillary contributions under the regime of supplementary contributions represent fiscally a loss, subject to the corresponding regime.

It is further verified that, in accordance with articles 21 and 24 of the CIRC, positive and negative changes in equity not reflected in the net result of the taxation period contribute to the formation of taxable income, excluding, in the first case "capital contributions, including share emission premiums, coverage of losses, in any manner made by capital holders" and in the second "outflows, in money or in kind, in favor of capital holders".

Now, as Pitta e Cunha emphasizes "to the concept of capital contributions, as accepted in paragraph a) of art. 21 of the CIRC, is not conferred the rigorous scope that in commercial legislation is given to the obligation of contribution, here configured as the principal contribution of shareholders as opposed to ancillary contributions, given that "the tax legislator understood by capital contributions not only the values corresponding to the formal contribution of shareholders to the company's capital, in the proper sense, but also other contributions from shareholders, for which there is no reason to exclude those made in the form of ancillary contributions".

On the other hand, it is important to highlight the reasons why, in substance, the financial charges borne with the financing of ancillary contributions should be excluded for the purposes of determining taxable income, under art. 32 of the EBF, embodying the principle contained in art. 23 of the CIRC.

See the following cases: Case 1:

The company A SGPS acquired in period n an equity interest corresponding to 100% of the capital of company B, constituted with a capital of € 50,000 and supplementary contributions of € 5,000,000, and for this purpose company A resorted to bank credit.

In period n+3, at the moment of disposal of company B, company A obtains a capital gain, excluded from taxation as the conditions of the rule in question are met. If supplementary contributions did not follow the same regime it would result that only the taxation of financial charges would be excluded, borne during the holding of the equity interest of € 50,000, when the economic capital gain and respective financial inflow resulted from all the investment made in the participated company (capital and supplementary contributions).

In this situation, the ratio underlying art. 32 of the EBF, which is based on the principle of the indispensability of costs, which embodies art. 23 of the CIRC, would never be fulfilled, in the sense that only expenses indispensable to the realization of taxable income would be accepted.

In the example, financial charges associated with the financing of ancillary contributions would have improperly contributed to the taxable income of the SGPS and there would have been no taxation of the capital gain, potentiated by those same ancillary contributions.

Case 2:

A SGPS company held an equity interest acquired for €100,000, having made supplementary contributions in the amount of € 50,000. In a given year, it disposed of, to a related entity, both the equity interest and the supplementary contributions for the value of € 20,000. Thus, it calculated an overall loss in the amount of € 130,000. Now if the loss calculated with the disposal of supplementary contributions were given a different treatment from that resulting from the loss with the disposal of equity interests (disregarded in the determination of taxable income pursuant to no. 5 of art. 23 of the CIRC), there would be evident a clear incoherence of the tax system, on the one hand, and on the other, it would mean that the legislator had intended to give more favorable tax treatment to financing by supplementary contributions, encouraging companies to have a low level of capital, that is to be endowed with capital with a lower character of permanence.

Thus, it is concluded that subsumption, to the concept of equity interests, set forth in art. 32 of the EBF, not only of equity interests (shares and quotas) but also of other components of equity that in substance perform the functions of capital, as is the case, herein, with supplementary contributions and ancillary contributions under the regime of supplementary contributions.

Concomitantly, financial charges associated with financing (i) the acquisition of equity interests as well as (ii) the grant of supplementary contributions shall be excluded for the purposes of determining taxable income, under art. 32 of the EBF.

Were it not so, not only the coherence of the tax system could be at issue, as well as an interpretation in breach of constitutional principles.

d) Conformity with constitutional principles

Let us then address the issue of conformity with constitutional principles.

The Constitution of the Portuguese Republic orders, in no. 2 of its article 104, that "the taxation of companies should be fundamentally based on their real income".

Now, "to tax real income means to target the taxable base actually realized by the taxpayer", as explained by Xavier de Basto, in his article "The Principle of Taxation of Real Income and the General Tax Law".

This concept of taxation of real income arose in opposition to that of taxation of normal income, whose objective was not "to tax the income actually received by the taxpayer", but "rather to tax the income that could have been obtained, under normal conditions of exploitation, independently, thus, of the actual conditions in which it developed its activity".

But when, in 1976, the Constituent Assembly enshrined the principle of taxation of real income, it became prohibited the possibility of determining the taxable base, in the case of business income, based on normal income, detached from the concrete reality of the taxpayer.

Also Sousa Franco (Public Finance and Financial Law, Vol. II, cited, pages 186-187), is categorical in the assertion that taxpaying capacity underlies tax constitution, considering that the system "indeed, takes into account the taxpaying faculties".

Casalta Nabais (Tax Law, 7th Edition, Coimbra, 2013, page 445 et seq.) states that the principle of taxpaying capacity is extracted from the principle of equality, established in article 13 of the Constitution. Also Sérgio Vasques (Manual of Tax Law, Coimbra, 2011, page 251), considers that the principle of taxpaying capacity represents «the material criterion of equality appropriate to taxes», and maintains that ("Taxpaying Capacity, Income and Assets", page 30) "for income to constitute a reliable indicator of taxpaying capacity it is necessary that (...) it comprises all the flow of wealth received by the taxpayer that is useful for payment of tax"). And adds that "if one intends to ascertain the taxpayer's payment capacity one must necessarily extend the tax to all increases in their economic possibilities".

Also Pamplona Corte-Real (Course in Tax Law, Vol. I, Lisbon 1982, pages 88-89), argues that "tax equality requires that identical taxpaying capacities (...), bear equalized tax burdens".

Let us see, then, in what way the interpretation we make of the rule provided for in article 32 of the EBF meets the principles stated:

By disregarding financial charges associated with financing through equity of the participated companies, what the legislator does is counterbalance the benefit granted to SGPS as against other IRC taxpayers (in this sense the Judgment no. 42/2014 of the Constitutional Court pronounced itself, in its point 14).

And that financing occurs both at the moment of acquisition of equity interests (the acquisition of equity interests, in a company at its inception, is nothing more than the grant of funds for the company to begin its activity) as when supplementary contributions are granted, which likewise aim to finance the activity of the company.

It is these financings at the moment of acquisition and maintenance of equity interests - generators of financial charges - that in developing and expanding corporate activity generate in the future the capital gains exempt from taxation.

As Luís Graça Moura explains "the legislator will have aimed at the grant of a benefit - total exclusion of taxation of capital gains - which, however, was «counterbalanced by the non-contribution of certain financial charges borne», creating an environment of «neutrality» between possible gains with certain assets (certain financial fixed assets) and the liability necessary to create the conditions for the obtaining of such gains, that is, the liability related to the acquisition of such interests (The "new" Taxation of Income of SGPS: Reflections on the Taxation of Capital Gains within the Framework of the Principle of Legal Certainty, in Legal Journal of Universidade Portucalense Infante D. Henrique, no. 10, March 2003, page 122)"

This means that if capital gains realized do not contribute to the formation of taxable income of SGPS, then, and having regard to the characteristic of neutrality to which the author refers - founded on the principles of equality and taxpaying capacity, - the financial charges borne with the acquisition and maintenance of equity interests which may, potentially, come to benefit from the regime of exclusion from taxation, also cannot influence the determination of taxable income of such companies. That is, if gains are not taxed, then, the expenses that are unequivocally underlying them also cannot be considered for the purposes of determining taxable income of SGPS.

It would be manifestly unjust, in light of the principles stated, faced with a company in which capital gains on equity interests are taxed to allow deduction of said charges to a SGPS which, as per law, does not subject those gains to taxation. The economic strength of both companies is different, the SGPS which removes from income the taxation of capital gains cannot have the same level of deduction of the respective charges. Real income taxation (income less related expenses) would not be applied but only the fiscal deduction of one of its components.

(...)

Further, having regard to constitutional principles of equality, taxpaying capacity and taxation of real income, stated in articles 13, no. 2, 103 and no. 2 of 104 of the Constitution, it is important to stress the following:

As point 20 of Judgment no. 42/2014, of 9 January, issued by the Constitutional Court, properly clarifies, "To this extent, the Constitution does not make it imperative that the taxation of company income always accompany, in timing and according to the accounting of positive and negative financial flows, gains, costs and losses realized or incurred in each taxation period. Being real income a normatively modeled concept, it does not violate the principle contained in no. 2 of article 104 of the Constitution the tax regime which, in favor of tax neutrality - the gain not being taxed, the cost associated with it should also not be - establishes the non-deductibility of a cost on the basis of the likelihood of realization of capital gains exempt from taxation, whose future realization is considered probable or foreseeable.", does so in obedience to the principle contained in no. 2 of article 104 of the Constitution, according to which "the taxation of companies is fundamentally based on their real income.

Now, as stated in Judgment no. 162/2004, of 29 April, and reaffirmed in Judgment no. 85/2010, of 3 March, both of the same Court, "the fiscally relevant real income" is "a normatively modeled concept". And, as António Carlos Santos affirms (From the Tax Issue to Tax Reform Reform, 1998, page 129), "the income effectively subject to taxation (...) is always a fact constructed according to the legislator's choices".

In fact, as neither dividends nor capital gains from the disposal of equity interests are taxed, such income will integrate the asset mass of SGPS, increasing their taxpaying capacity. If, in parallel, SGPS were permitted to deduct expenses - both financial charges borne with the acquisition of equity interests and those borne with the grant of supplementary contributions, which aim to obtain the expansion of the participated company's activity - associated with this income, the provisions of no. 2 of article 104 of the Constitution would be violated, as the available and relevant income would not in fact be considered for the purposes of determining the taxpaying capacity underlying its taxation.

It follows, then, that the financial charges incurred with the acquisition of equity interests or grant of supplementary contributions, which may potentially come to benefit from the regime of exclusion from taxation, cannot influence the determination of taxable income, that is, if gains are not taxed, the corresponding expenses which are linked to such income also cannot be considered for the purposes of determining taxable income.

In view of the foregoing, financial charges borne with the acquisition of equity interests or grant of supplementary contributions are excluded for the purposes of determining taxable income, pursuant to the provisions of art. 32 of the EBF.

e) Determination of financial charges

The Tax Administration, interpreting and applying the law, made public Circular no. 7/2004, of 30 March, of the DSIRC, which establishes the following understanding:

As regards the temporal application of the law, the said Circular states that: "it applies to financial charges borne in taxation periods commencing after 1 January 2003, even if they relate to financing obtained prior to such date", as moreover follows from no. 5 of art. 38 of Law 32-B/2002, of 30 December, which establishes that the (new) regime provided for in art. 31 of the EBF (now art. 32) applies to capital gains and losses realized in periods commencing after 1 January 2003.

In fact, the said provision does not establish any transitional regime applicable to financial expenses incurred after 1 January 2003, relating to financing obtained up to 31 December 2002. For this reason, all financial charges borne and recognized in the financial statements relating to the fiscal years 2003 onwards should be considered covered by article 32 of the EBF, regardless of the date on which the loans giving rise to them were contracted.

As to the period in which fiscal corrections of financial charges should be made, the Circular exposes the following: "regarding the fiscal year in which financial charges should be disregarded as costs, for tax purposes, the fiscal correction of those borne with the acquisition of interests that are susceptible to benefiting from the special regime established in no. 2 of art. 32 of the EBF should be proceeded with, in the fiscal year to which they relate, independently of whether all the conditions for the application of the special regime of taxation of capital gains have already been met. Should it be concluded, at the moment of disposal of the interests, that not all the requirements for application of that regime are met, the financial charges that were not considered as costs in previous fiscal years should be considered as fiscal costs in that fiscal year".

Now, given that a Company for Management of Equity Interests has for its contractual object the management of interests in other entities as an indirect form of exercise of economic activity, when the interest is held for a period exceeding one year and corresponds to at least 10% of the capital with voting rights, and further to the fact that SGPS companies are, as a general rule, prohibited from disposing or pledging equity interests held prior to one year from their acquisition, it seems appropriate to conclude that all interests held by SGPS should, at the moment of their disposal, meet the requirements necessary for the applicability of the special regime in question. Thus, adjustment should be made to the taxable income relating to financial charges borne with the acquisition of equity interests that are susceptible to benefiting from the special regime established in no. 2 of art. 32 of the EBF.

As regards the method for determining the charges in issue, the most appropriate solution consists in allocating the remunerated liabilities of SGPS, firstly to the loans granted at interest by the company to the participated companies and other interest-bearing investments, with the remainder being allocated to the remaining assets, namely equity interests, proportionally to their respective acquisition cost, and for this purpose, a calculation formula was proposed in Circular 7/2004, of 30 March.

This calculation option is thus associated with the fungibility that attends financial means and, concomitantly, the difficulty in establishing a direct relationship between the loans obtained and the financed assets, and the method recommended in the circular is not in conflict with the content of the rule under discussion.

Accordingly, if the ratio legis of the rule provided for in no. 2 of art. 32 of the EBF is to safeguard the validity of a regime of neutrality of income and expenses associated with capital gains excluded from taxation, ensuring that income not fiscally relevant should correspond, correspondingly, to a charge which is equally not fiscally relevant, then, thus being, to achieve such goal, any method (direct or indirect) is good, once the aforesaid ratio legis is safeguarded.

In fact, the said Circular merely establishes the methodology to be observed in the calculation of financial charges allocable to equity interests in order, by this means, to operationalize the application of the provisions of no. 2 of art. 32 of the EBF.

It should be said that the fact that the Inspection avails itself of the Circular to proceed with the quantification of the amount of financial charges allocable to equity interests does not translate into a diminution of the rights and guarantees of the taxpayer now inspected. Indeed, as Saldanha Sanches in Tax Law, 2nd edition, page 42 states:

"These administrative guidelines, in the form of circulars or other forms, are an interpretation of tax law and a unifying instrument for decisions, necessarily decentralized, of the administration and have their specific function in the mass process that constitutes the tax process, as an attempt to reconcile decentralized decisions and the finality of tax acts, even when practiced at the base of the administrative tax pyramid.

Continuing, "With the formal structure of the legal rule - since they are not the application of law to a concrete case but rather have a general and abstract character - the circulars are worth what the interpretation they make of the law is worth. As it was stated without ambiguities in a judgment of the STA in analyzing a particular administrative guidance. The value of the doctrine of that circular will be only that of its intrinsic worth. It contains a doctrine that will be good or bad, valid or invalid, as any other doctrine."

Finally, it concludes that "Administrative guidance - a circular of any DGCI service, a superior homologated opinion - may thus be considered, within these limits, as a source of law like any other form of doctrine".

In this way, in order to implement the provisions of no. 2 of art. 32 of the EBF, and in accordance with the methodology established by circular no. 7/2004, of 30 March, financial charges borne with liabilities destined to finance equity interests (equity interests, supplementary contributions and ancillary contributions with the regime of supplementary contributions) are excluded for the purposes of determining taxable income.

f) Method to be used and proposed corrections

The method to be used for the purposes of allocating financial charges to equity interests, in accordance with circular 7/2004, of 30 March is as follows: "(...) given the extreme difficulty of using, in this matter, a method of direct or specific allocation and the possibility of manipulation that it would allow, such allocation should be effected on the basis of a formula which takes account of the following:

1. Allocate the remunerated liabilities of SGPS to the interest-bearing loans granted by these to participated companies and to other interest-bearing investments;

2. Allocate the remainder to the remaining assets, namely equity interests, proportionally to their respective acquisition cost."

Using the said formula we prepared the calculations set out below in order to determine the value of financial charges borne by A… with the acquisition of equity interests:

1. Remunerated Assets

The taxpayer identified the balance sheet accounts where the loans granted by the company are recorded, as well as their respective values, which are shown in the table below:

II. Remunerated Liabilities

The taxpayer identified the balance sheet accounts where the loans obtained by the company are recorded, as well as their respective values, which are shown in the table below:

III. Financial Charges

In paragraph c) of no. 1 of art. 23 of the CIRC, we shall find typified, as expenses accepted for IRC purposes, financial charges "such as interest on foreign capital used in operations, discounts, premiums, transfers, exchange differences, expenses with credit operations, collection of debts and issuance of shares, bonds and other securities, redemption premiums and those resulting from the application of the effective interest method to financial instruments valued at amortized cost".

In these terms, the following charges shall be considered for the purpose of the application of art. 32 of the EBF:

Any financial interest, associated with loans, including interest resulting from hedging operations (swaps);

Exchange differences, given that the balance between accounts 68871 and 788713 should be considered, if negative, duly purged of potential exchange differences (which are, in any case, not fiscally accepted);

Charges debited by financial institutions for the grant of credit (e.g.: commissions).

IV. Allocation of financial charges to equity interests

Next we shall present the calculation of the determination of financial charges allocable to equity interests:

g) Concerning the rule of art. 23 of the CIRC

Even if supplementary contributions were not applicable to the special regime provided for in art. 32 of the EBF, the deductibility of these charges would always have to be assessed in light of no. 1 of art. 23 of the CIRC.

Financial charges borne, by an entity - whether or not a SGPS - with obtaining funds which are destined to be granted free of charge by that same entity to a participated company, are not considered tax expenses in light of the rule of art. 23 of the CIRC.

This article establishes the general principle concerning the fiscal deductibility of expenses borne by entities subject to IRC. It establishes, in its no. 1, paragraph c) (heading "expenses"), that "Expenses are those which can be proven to be indispensable for the realization of income subject to tax or for the maintenance of the source of income", and then provides a list of expenses which includes "Financial charges, such as interest on foreign capital used in operations, discounts, premiums, transfers, exchange differences, expenses with credit operations, collection of debts and issuance of bonds and other securities and redemption premiums and those resulting from the application of the effective interest method to financial instruments valued at amortized cost".

It is thus considered that the deduction of interest and other charges should obey the same rules as are generically applicable to other expenses borne by companies, and their deductibility is thus conditioned on compliance with the basic principle according to which they will only be fiscally deductible when they can be proven to be indispensable for the realization of gains or income subject to tax or for the maintenance of the source of income of the respective taxpayer.

In fact, the capital obtained, generating financial charges, by financing supplementary contributions (unremunerated contributions), and thus not connected with the taxable income of the company, are removed from the exploitation thereof, since they are instead used in the activity of the beneficiary.

On this matter jurisprudence has already been produced, namely by the Supreme Administrative Court, and we cite by way of example the Judgment of the STA, of 12 July 2006 - Proceeding no. 186/06, in which it was concluded that "the grant of such supplementary contributions was not indispensable for the obtaining of its gains or income or for maintaining its source of income. And, because of this, the interest borne on loans destined for them cannot be recorded as a cost of its activity.

Afterwards, because such interest was destined for the maintenance of the source of income of its participated companies and, for this reason, and because these are companies distinct from the Appellant with individual accounting, only in these could they be recorded as a cost. (...)".

More recently, and in the same sense, the STA pronounced itself, in the Judgment handed down in Proceeding no. 0107/11, on 30/11/2011, establishing that "in light of art. 23 of the CIRC, costs with interest and stamp duty on bank loans contracted by a company and applied in the free financing of its associated companies should not be considered fiscally relevant."

Finally, because even having the appellant as object the management of equity interests, such interest could not thus be qualified as an expense for "as results from DL 495/88, of 30/12, the object of such companies is essentially the management of participations in other companies, thus translating their activity into an indirect form of exercise of economic activity» [see Judgment of the STA, of 10 July 2002 - Proceeding no. 246]"

There also comes the Judgment of the Central Administrative Court of the South, of 24 April 2012 - Proceeding no. 5251/11, stating that "having the dominant company decided to make ancillary contributions of capital with the regime of supplementary contributions in its associated companies to (...) reinforce its capital, the charges relating to loans contracted for this purpose, because directly connected with the exercise of the activity of the associated companies, constitute a tax cost of these, not of the dominant company".

Finally, the Judgment of the Supreme Administrative Court, of 7 February 2007 - Proceeding no. 1046/05, decided that "(...) the costs provided for in that article 23 must respect from the outset the company taxpayer itself, that is, for a certain sum to be considered a cost thereof it is necessary that the respective activity be developed by it itself, not by other companies".

In the same sense of those Judgments, we also indicate a study published in Journals of Science and Tax Technique, no. 171, prepared by Dr. Maria dos Prazeres Lousa, which considers, on page 353, in point 3) that "when a company contracts a loan whose funds it ceded, in whole or in part, to third parties, without stipulating remuneration or fixing it but at a reduced rate, cannot as a principle deduct all the financial charges corresponding to such loans to the extent that it can be considered that the interest is neither borne to obtain gains or income subject to tax nor to maintain the source of income".

We conclude, thus, that, even if supplementary contributions were not considered equity interests for the purposes of application of art. 32 of the EBF, the financial charges borne with the financing obtained for the grant/maintenance of unremunerated supplementary contributions, are not accepted as an expense under no. 1 of art. 23 of the CIRC, in line with what jurisprudence, both of the STA and of the TCA of the South, has been.

In summary, financial charges borne with financing used for the grant of ancillary contributions to participated companies are not considered fiscally deductible, under art. 23 of the CIRC, because such capital is not used in the company's own activity nor is associated with remunerated assets.

It is important to note that in accordance with jurisprudence of our courts, an expense relating to a participated company is not accepted without more on the basis of a perspective of that company coming in the future to reimburse the participant.

(...)

h) Conclusion

In light of the foregoing, the taxpayer bore in the fiscal year in the form of financial charges with the acquisition of equity interests the amount of € 1,633,914.75, of which € 957,122.15 is allocable to financial charges with the acquisition of equity interests and € 676,792.60 to financial charges with the acquisition of ancillary contributions.

Now, analyzed the income tax return of the taxpayer, relating to the period of 2012, we verified that it did not proceed to any addition, in table 07 - field 779, regarding financial charges borne with acquisitions of equity interests, as provided for in no. 2 of art. 32 of the EBF.

In this way, the amount referred to above, in consonance with the provisions of no. 2 of art. 32 of the EBF, should be disregarded as an expense for tax purposes, whereby an addition to taxable income of € 1,633,914.75 is proposed.

IV – Reason and presentation of facts which imply recourse to indirect methods

Not applicable.

g) The Claimant was notified to exercise the right to a hearing regarding the draft Tax Inspection Report, but did not exercise it;

h) The Tax Authority and Customs Authority also issued Service Order OI2014…, dated 28-05-2014, intended to reflect in the taxable income of the group, under the terms of no. 1 of art. 70 and no. 1 of art. 91, both of the CIRC, the correction effected by the Tax Authority and Customs Authority, as a result of the inspection procedure determined by service order no. OI2014…, dated 28-05-2014, to the Claimant;

i) In that inspection conducted under Service Order no. O2014…, the Tax Authority and Customs Authority prepared the Tax Inspection Report contained in document no. 2 attached with the request for arbitration, the content of which is reproduced herein, which states, among other things, the following:

III - Description of facts and grounds of purely arithmetic corrections to taxable base

The present inspection action was based on the analysis of the income tax return of group A…, which presents a taxable income of € 41,364,275.04, having given rise to the assessment identified by no.: 2014..., dated 28-07-2014.

According to no. 1 of article 70 of the CIRC, " (...) the taxable income of the group is calculated by the dominant company, through the algebraic sum of the taxable incomes and tax losses determined in the periodic individual declarations of each of the companies belonging to the group".

Article 115 of the same legislation states that "when the provisions of article 69 are applicable, payment of IRC is the responsibility of the dominant company (...)".

The taxable income of the group, in the amount of € 41,364,275.04, corresponds to the sum of the fiscal results presented by the companies that constitute group A…, as shown in the following table:

In this way, corrections to the fiscal result effected in the individual sphere of the companies belonging to a group taxed according to the special regime for taxation of groups should be reflected in the income tax return of the group, as indicated in the following paragraphs.

III.1 - Corrections to the taxable base of the group

The total value of corrections to the taxable income of the group determined under no. 1 of article 70 of the CIRC, reaches, in fiscal year 2012, € 1,633,914.75, as follows discriminated:

Resulting from corrections effected to the fiscal result of the individual company of the dominant company A… SGPS, SA - NIPC …

As a result of the external inspection action directed to company A…SGPS, SA, carried out by the Large Taxpayers Unit, under Service Order no. OI2014…, corrections to the level of the fiscal result declared individually by this company were determined, in the total amount of € 1,633,914.75, with the grounds contained in the tax inspection report then prepared, a copy of which is attached (Annex 1).

In order to reflect in the sphere of the group the correction effected in determining the individual taxable income of company A…, under the terms of no. 1 of article 70 of the CIRC, the amount of € 1,633,914.75 should be added to the taxable income declared by the group, increasing from € 41,364,275.04 to € 42,998,189.79, as shown in the following table:

(...)

VIII - Other relevant elements

The value of the Municipal Surtax, as well as that of the State Surtax shall be adjusted, in accordance with art. 14 of Law no. 2/2007 of 15/01 and art. 87-A of the CIRC respectively, as a result of the correction contained in point III.1 of this report.

Under the terms of art. 35 of the General Tax Law, compensatory interest is due on the additional assessments which are made, as a consequence of the corrections mentioned in point III.1 of this report, as per the demonstrative note of calculation the content of which shall be opportunely notified to the taxpayer.

j) Following the inspections referred to, the Tax Authority and Customs Authority issued an additional IRC assessment no. 2014…, dated 23-12-2014, with a compensation date of 29-12-2014, which incorporates the correction to the taxable base of the group in the amount of € 1,633,914.75, resulting from the correction effected regarding the financial charges which the Tax Authority and Customs Authority considered non-deductible (document no. 3 attached with the request for arbitration, the content of which is reproduced herein);

k) G…, S.A. was incorporated, by A…, by public deed executed on 18-11-1997, under the name of II…, S.A, holder of corporate number …, with capital of 5,000,000$00 (five million Escudos, corresponding to € 24,939.89), fully subscribed and paid in cash (Document no. 5 attached with the request for arbitration, the content of which is reproduced herein);

l) Subsequently, by deed executed on 06-01-1998, a capital increase of 5,995,000,000$00 (Five million, nine hundred and ninety-five thousand Escudos, corresponding to € 29,902,933.93) was effected, fully subscribed by A… and effected in kind through the transfer of an industrial establishment held by A… (see Document no. 5 attached with the request for arbitration, the content of which is reproduced herein);

m) Until 2009, A…held a participation in JJ…, S.A., whose shares had been received by A… in exchange for the contribution in kind for the realization of capital, at the time of constitution of that company – JJ…S.A.;

n) In 2010, JJ…, S.A., was subject to merger by incorporation into KK…., S.A., now called B…, S.A., with the participation of JJ…, S.A., being included in the acquisition cost of the incorporating company – B…, S.A. (document no. 6 attached with the request for arbitration, the content of which is reproduced herein);

o) The Tax Administration issued Circular no. 7/2004, dated 30 March, the content of which is reproduced herein, available at http://info.portaldasfinancas.gov.pt/NR/rdonlyres/25504FA8-CD27-4EA3-A238-E67E6A99ED75/0/circular_7-2004_de_30_de_marco_da_dsirc.pdf;

p) On 22-05-2015, the Claimant filed the request for constitution of the arbitral tribunal which gave rise to the present proceedings.

2.2. Unestablished Facts

It was not established that the Claimant used the financing which generated the financial charges referred to in the Tax Inspection Report to acquire equity interests or effect ancillary contributions with the regime of supplementary contributions, as defined by the Tax Authority and Customs Authority.

2.3. Justification for the determination of factual matters

The determination of factual matters is based on the administrative file and on the documents attached with the request for arbitration, with no controversy over the established facts.

3. Legal Matters

3.1. Preliminary Issue

The Tax Authority and Customs Authority raises a preliminary issue relating to the value at issue in the present proceedings, saying, in sum, that the taxable base which is the subject of taxation through the act now impugned goes far beyond that resulting from the correction at issue here, and thus in the event recognition is given to the Claimant, the annulment of the assessment could never be total, but only partial, in the part in which it reflects such correction.

The Claimant replied saying that it requested the "annulment of the additional assessment act resulting from the correction to the taxable base of the Group, for fiscal year 2012 in the amount of Euro 1,633,914.75", whereby it sees no reason to alter the request.

The Claimant discusses the legality only of a correction to the taxable base of the Group of which it is the dominant company in the amount of € 1,633,914.75, and thus what is at issue, in the event of merit to its request for arbitration, shall be the annulment of the assessment in the part corresponding to such correction.

The request formulated by the Claimant is that of "annulment of the additional IRC assessment act no. 2014…, dated 29 December 2014, which incorporates the correction to the taxable base of the Group, in the amount of Euro 1,633,914.75 (One million, six hundred and thirty-three thousand, nine hundred and fourteen Euros, seventy-five Cents), resulting from the correction effected in the individual sphere of A… for supposed non-deductible financial charges, under the terms of no. 2 of article 32 of the EBF".

It appears that this request expresses the intention of the Claimant to, in the event of merit, have the assessment annulled in the part resulting from the correction effected for non-deductible financial charges.

In any event, it is unambiguous that both Parties understand that the request has this scope, and thus it shall be understood in this manner, without it being necessary to correct it.

3.2. Positions of the Parties on the substantive issues of the request for arbitration

The Tax Authority and Customs Authority effected a correction to the individual taxable income of the Claimant and, correspondingly, to the taxable income of the Group of which the Claimant is the dominant company in the amount of € 1,633,914.75.

The ground for the said correction is that the Tax Authority and Customs Authority understands that the financial charges in the amount of € 1,633,914.75 borne with financing obtained for the acquisition of equity interests (in the amount of € 957,122.15) and ancillary contributions with the regime of supplementary contributions (in the amount of € 676,792.60) are not to be considered as expenses of the Claimant, as an individual company, because they should not contribute to the formation of taxable income, under the terms of article 32, no. 2, of the Tax Benefits Statute (EBF).

As the method for determining the non-deductible financial charges, the Tax Authority and Customs Authority adopted the regime provided for in Circular no. 7/2004, dated 30 March, which establishes, in its point 7, the following:

1. As to the method to be used for the purposes of allocating financial charges borne with the acquisition of equity interests, given the extreme difficulty of using, in this matter, a method of direct or specific allocation and the possibility of manipulation that it would allow, such allocation should be effected on the basis of a formula which takes account of the following: the remunerated liabilities of SGPS and SCR should be allocated, firstly, to the interest-bearing loans granted by these to participated companies and to other interest-bearing investments, allocating the remainder to the remaining assets, namely equity interests, proportionally to their respective acquisition cost.

As a subsidiary ground for the correction effected, the Tax Authority and Customs Authority invokes article 23, no. 1, of the CIRC, understanding that "financial charges borne, by an entity - whether or not a SGPS - with obtaining funds which are destined to be granted free of charge by that same entity to a participated company, are not considered tax expenses in light of the rule of art. 23 of the CIRC".

The Claimant states, in sum, the following:

– that, as a general rule, financial charges are deductible and, only at the moment of verification of the suspensive condition and if such suspensive condition is verified (passage of the applicable period provided for in article 32, nos. 2 and 3) proceed to make the necessary adjustments for the purposes of determining taxable income;

– that it is illegal to determine financial charges through the method provided for in point 7 of Circular no. 7/2004, with only a criterion of direct and actual allocation of financial charges borne with the acquisition of equity interests being applicable;

– that the burden of proof of the allocation of certain financial charges to the respective acquisitions of equity interests falls on the Tax Authority and Customs Authority, when it diverges from what was declared by the taxpayer and that, in the case at hand, the Tax Authority and Customs Authority failed to prove that, in 2012, financial charges resulting from financing obtained for the acquisition of equity interests that would subsequently be disposed of were borne;

– that equity interests held by a SGPS in a company, when such interest consists of shares received in exchange for contribution in kind for the realization of capital at the time of constitution of such companies, cannot be considered as acquired equity interests for the purposes of applying the regime provided for in article 32 of the EBF and that some of the interests held by A… resulted from asset contributions, consisting of shares received by A… in exchange for contribution in kind for the realization of capital at the time of constitution of such companies, namely the interest held by A… in G… and part of the interest held in B…, SA. (formerly called KK…, SA) company which incorporated, by merger in 2010, JJ…, S.A.; the Claimant invokes in support of its position the content of the Doctrinal Note of the Tax Authority and Customs Authority concerning proceeding 2799/2009;

– that the financial charges borne with the realization of supplementary contributions (ancillary contributions subject to the regime of supplementary contributions) should not be considered for the purposes of applying the regime provided for in no. 2 of article 32 of the EBF, because, in sum, they do not fit within the concept of «equity interests», which does not encompass supplementary contributions;

– that expenses with financial charges borne by a SGPS to effect ancillary contributions to its participated companies are deductible, in light of article 23, no. 1, of the CIRC, and the concept of indispensability therein contained and that, if this is not the case, there is a situation of unconstitutionality through breach of the principle of taxation of real income;

The Tax Authority and Customs Authority defends in the present proceedings the following, in sum:

– as to the period in which fiscal corrections of financial charges should be made, it is applicable what is provided for in no. 6 of Circular no. 7/2004: "Regarding the fiscal year in which financial charges should be disregarded as costs, for tax purposes, the fiscal correction of those borne with the acquisition of interests that are susceptible to benefiting from the special regime established in no. 2 of art. 32 of the EBF should be proceeded with, in the fiscal year to which they relate, independently of whether all the conditions for the application of the special regime of taxation of capital gains have already been met. Should it be concluded, at the moment of disposal of the interests, that not all the requirements for application of that regime are met, the financial charges that were not considered as costs in previous fiscal years should be considered as tax costs in that fiscal year"; but, in the case at hand, all interests had been held for more than one year;

– it is not unconstitutional article 32, no. 2, of the EBF, in the part in which it imposes the non-deductibility for tax purposes of financial charges borne with the acquisition of equity interests as soon as these are incurred, independently of the realization of capital gains exempt from taxation with the disposal of such equity interests;

– the Tax Authority and Customs Authority did not presume any disposal, nor would such be sensible or necessary for the correction effected;

– in art. 32 of the EBF a link was created between the acquisition of equity interests held and maintained over a given minimum period, in line with the legal regime of SGPS, and the fiscal relevance of the financial charges borne with their acquisition, an environment of neutrality between gains with certain financial assets and expenses associated with the liability necessary for the acquisition and maintenance of such assets, which constitutes a mere corollary of the general principle of the indispensability of expenses, that is, of the principle according to which fiscal deduction is conditioned on its connection with the obtaining of income subject to tax and from which it follows that if certain expenses are related to income not subject to tax they are not fiscally deductible;

– no. 2 of article 32 of the EBF does not require that the method to be applied for allocation of financial charges be the direct method, whereby any appropriate method may be used;

– the Claimant did not proceed with a specific allocation of its financial charges, whereby it would be difficult to apply the direct method and no elements were brought to the attention of the inspection which would allow application of the direct method;

– the non-specific allocation is, in that situation, the only one which allows respect for the ratio legis of the regime in question, that is, neutrality between income and costs;

– acceptance of the normative interpretation of no. 2 of article 32 of the EBF defended by the Claimant would also result in an unacceptable violation of the principle of equality and also of the principle of taxpaying capacity which expresses and embodies the principle of tax equality, for only taxpayers who did not effect direct allocation could fiscally deduct financial charges;

– also as to the imputed unconstitutionality of Circular no. 7/2004 the request for arbitration is unmeritorious;

– the Binding Information to which the claimant refers applies to a specific case: the case in which equity interests have been acquired from entities with which special relationships exist, and not to all entities generally;

– acquisitions in exchange for contributions in kind do not lose their nature of acquisitions for not having a monetary payment associated, there being no legal justification which would allow concluding that the form of payment alters the translative nature of the act;

– supplementary contributions are part of the concept of «equity interests»;

– they are non-deductible, in light of article 23, no. 1, of the CIRC, the financial charges with loans borne by SGPS for the grant of ancillary contributions to its participated companies;

– expenses which do not have a connection - even if potential - to income are never accepted;

– the understanding of the Tax Authority and Customs Authority is not incompatible with the principle of taxation fundamentally based on real income;

– the interpretation presented by the Claimant is, also itself, a violation of the principle of taxpaying capacity.

3.3. Powers of cognition of arbitral tribunals in annulment contentious proceedings and order of knowledge of defects

The tax arbitral proceedings, as an alternative means to judicial challenge proceedings (no. 2 of article 124 of Law no. 3-B/2010, of 28 April), is, like this, a procedural means of mere legality, in which one aims to declare the illegality of acts of the types indicated in article 2 of the RJAT and eliminate the legal effects produced by them, by annulling them or declaring their nullity or non-existence [articles 99 and 124 of the CPPT, applicable by force of the provisions of article 29, no. 1, paragraph a), thereof].

For this reason, being the act practiced by the Tax Administration the object of the proceedings, its legality must be assessed in light of its precise terms, as it occurred, with the reasoning used in it, with other possible justifications that could serve as support for other acts, of decisional content totally or partially coinciding with the act practiced, being not relevant. Thus, justifications invoked a posteriori, after the end of the tax procedure in which the act whose declaration of illegality is requested was practiced, are irrelevant, including those advanced in the jurisdictional proceedings.

As regards the order of knowledge of defects, account must be taken of the provisions of article 124 of the Code of Tax Procedure and Process (CPPT), subsidiarily applicable by force of the provisions of article 29, no. 1, paragraph c), of the RJAT, whereby, without defects being imputed to the assessments impugned which lead to the declaration of non-existence or nullity, nor an order of subsidiarity being indicated, the order of appreciation of defects should be that which determines, according to the prudent criterion of the judge, more stable or effective protection of the interests offended.

As is a corollary of the establishment by the said article 124 of the CPPT of an order of knowledge of defects, if a defect is judged meritorious which ensures effective protection of the rights of those impugning, it will not be necessary to know of the others, for, if it were always necessary to appreciate all the defects imputed to the act impugned, it would be immaterial the order of their knowledge.

In the case at hand, the Claimant does not impute formal defects, whereby the effects which the merit of defects may have at the level of stability and effectiveness of protection of the interests of the Claimant are similar, whereby the order indicated by the Claimant shall be followed, as is provided for in the initial part of paragraph b) of article 124 of the CPPT.

3.4. Issue of non-deductibility of financial charges as soon as they are incurred

The Tax Authority and Customs Authority interprets the request for arbitration as raising the issue as to the period in which fiscal corrections of financial charges should be made.

However, examining the request for arbitration and the submissions of the Claimant, there is not found in the approach that the Claimant makes of that issue the imputation of any defect to the act, namely any statement that, should corrections be made, they should be made in another fiscal year.

In truth, the Claimant merely makes an allusion to the difficulties of application of the regime of article 31, no. 2, of the EBF, "as regards the concept of financial charges and the moment of definition of the regime, as regards the necessity of allocation of financial charges", and affirms that "it has always conducted itself by the adoption ab initio of a principle of deductibility" which "consists in considering, as a general rule, that financial charges are deductible and, only at the moment of verification of the suspensive condition and if such suspensive condition is verified, proceed to make the necessary adjustments for the purposes of determining taxable income in the terms of the provisions of nos. 2 and 3 of article 32 of the EBF. (articles 19 to 22 of the request for arbitration).

But, at no point in the request for arbitration does the Claimant impute error to the Tax Authority and Customs Authority as to the issue of the fiscal year in which deduction should be effected, namely not making any reference to violation of the legal rules which regulate the allocation of expenses to fiscal years.

In truth, the suspensive condition to which the Claimant alludes, making a citation at article 20 of the request for arbitration, is that of more than one year having elapsed since the acquisition of the equity interests, the Claimant not stating that such condition has not been met.

The conclusions of the submissions confirm this interpretation of the request for arbitration, as no allusion is made to this issue.

Therefore, as to this point there is nothing to decide.

3.5. Issue of the illegality of the determination of financial charges through the method provided for in point 7 of Circular no. 7/2004

Article 32, no. 2, of the EBF establishes that "the capital gains and losses realized by SGPS from equity interests of which they are holders, provided such are held for a period of not less than one year, and likewise the financial charges borne with their acquisition do not contribute to the formation of the taxable income of such companies".

As was mentioned, the Tax Authority and Customs Authority determined the financial charges which it understood to have been borne by the Claimant to acquire the equity interests and effect ancillary contributions with regime of supplementary contributions through the method provided for in point 7 of Circular no. 7/2014, which establishes that "as to the method to be used for the purposes of allocating financial charges borne with the acquisition of equity interests, given the extreme difficulty of using, in this matter, a method of direct or specific allocation and the possibility of manipulation that it would allow, such allocation should be effected on the basis of a formula which takes account of the following: the remunerated liabilities of SGPS and SCR should be allocated, firstly, to the interest-bearing loans granted by these to participated companies and to other interest-bearing investments, allocating the remainder to the remaining assets, namely equity interests, proportionally to their respective acquisition cost".

The Claimant argues that neither the CIRC nor the EBF define a rule for the determination of "presumed" financial charges borne by SGPS with financing obtained for the acquisition of interests, which are to be considered fiscally non-deductible and that article 32, no. 2, referred to presupposes direct allocation and that it is not admissible to resort to criteria for allocation of non-deductible financial charges, created outside the law, being, in the case, formal law or authorized decree-law required, by force of the principle of legality.

In truth, no. 2 of article 32 of the EBF establishes that "financial charges borne with their acquisition" do not contribute to the formation of taxable income, referring to equity interests, whereby it is manifest that it presupposes that the allocation of financial charges to the acquisition of certain equity interests be determined that (in the interpretation assumed by both parties) will have to be held for more than one year.

On the other hand, there is not the least legal support for, instead of determining case-by-case whether or not such allocation of financial resources generating the charges to the acquisition of certain equity interests exists, allocate the charges, "firstly, to the interest-bearing loans granted by these to participated companies and to other interest-bearing investments, allocating the remainder to the remaining assets, namely equity interests, proportionally to their respective acquisition cost".

This method would only correspond to that legally required to determine the non-deductible charges, if it could be proven that, in fact, the financing to which the financial charges refer had been allocated in the manner provided for therein and, namely, as regards equity interests, had been used proportionally to acquire them. But, beyond this lack of proof of the correspondence between reality and the allocation criterion used by the Tax Authority and Customs Authority, no explanation is even advanced in the said Circular for the formula indicated being used rather than another.

On the other hand, as the Claimant argues, the definition of the assumptions of taxation is a matter subject to the principle of legality, above all by force of the provisions of article 103, no. 2, of the CRP, which states that "taxation shall be imposed according to the principles of the constitutional law, in particular, the principles of equality and fairness, and shall respect the rights, freedoms and guarantees of citizens".

The principle of legality in tax matters imposes that rules imposing tax obligations, and in particular rules defining the tax base, must be established by law and with sufficient specificity and certainty. The method for determining financial charges to be considered non-deductible, which had substantial consequences for the determination of the tax base, should have been defined in a law and with appropriate clarity, given that it has essentially significant effects on the taxation of taxpayers.

The regulation of such method through an administrative circular, even if given consideration as an interpretation of existing law, is not sufficient in face of the exigency of definitional specificity and certainty required by the principle of legality for matters concerning the definition of the tax base.

There is, therefore, a violation of the principle of legality in the application of the method of allocation of financial charges through the formula established in Circular no. 7/2004, in the terms in which it was applied, for the determination of non-deductible financial charges.

Accordingly, the determination through the formula of the non-deductible financial charges should be annulled, and the Claimant should have recourse, in the proceedings for determination of its tax obligations, to direct methods of allocation or, in the absence thereof, the burden of proof of the connection between the financings and the acquisitions of equity interests should rest on the Tax Authority and Customs Authority.

Moreover, the absence of proof that the financial charges were indeed borne with financing obtained for the acquisition of equity interests that would subsequently be disposed of also supports the annulment of the correction.

The non-establishment of the facts upon which the correction was based, namely the fact that the financial charges were borne with financing obtained for the acquisition of equity interests, further supports its annulment.

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