IRC Corporate Tax on Company Mergers and Bond Loans – CAAD Arbitration 337/2016-T

CAAD Arbitration Award

The arbitrators Counsellor José Baeta de Queiroz (arbitrator-president), Dr. Luís M. S. Oliveira and Dr. Luís Pereira da Silva (arbitrators-rapporteurs), appointed by the Deontological Board of the Administrative Arbitration Center to form the Arbitral Tribunal, agree on the following:

REPORT

A…, LDA., legal entity no.…, with registered office at…, …, …, …-… … hereby, pursuant to Articles 10 and 2, no. 1, paragraph a), both of Decree-Law no. 10/2011, of January 20 (hereinafter "RJAT"), and Ordinance no. 112-A/2011, of March 22, submits a petition for constitution of a collective arbitral tribunal, in which the Tax and Customs Authority (AT) is the Respondent, seeking the declaration of illegality of the Corporate Income Tax (IRC) assessment no. 2013…, as well as the interest assessment no. 2013… and the statement of account reconciliation no. 2013…, from which resulted an amount due of € 3,051,237.78, relating to the tax year 2010.

It further seeks to obtain the declaration of illegality of the decisions of rejection of the administrative complaint no. …2014… and the hierarchical appeal no. …2014….

Additionally, it seeks to obtain the condemnation of the AT to payment of indemnity interest from the date of the undue payment of the tax liability by the Petitioner, with the other legal consequences.

The petition for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority on 27-06-2016.

Pursuant to the provisions of paragraph a) of no. 2 of Article 6 and paragraph b) of no. 1 of Article 11 of RJAT, as amended by Article 228 of Law no. 66-B/2012, of December 31, the Deontological Board appointed as arbitrators of the collective arbitral tribunal the undersigned, who communicated acceptance of the appointment within the applicable time limit.

On 25-08-2016 the parties were duly notified of such appointment, and did not manifest the intention to refuse the appointment of the arbitrators, in accordance with the combined terms of Article 11, no. 1, paragraphs a) and b) of RJAT and Articles 6 and 7 of the Deontological Code.

Thus, in conformity with the provisions of paragraph c) of no. 1 of Article 11 of RJAT, as amended by Article 228 of Law no. 66-B/2012, of December 31, the collective arbitral tribunal was constituted on 09-09-2016.

The Tax and Customs Authority responded, contending that the petition should be judged unfounded.

Dispensing with the meeting referred to in Article 18 of RJAT, the parties were invited to submit written arguments, which they did, reiterating their respective positions.

PRELIMINARY EXAMINATION

The arbitral tribunal was regularly constituted and is materially competent in light of the provisions of Articles 2, no. 1, paragraph a), and 30, no. 1, of RJAT.

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

The proceedings do not suffer from nullities and no exceptions were raised.

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

FACTUAL MATTERS

3.1. Proven Facts

The following facts are considered proven:

a) A tax inspection action was conducted on the Petitioner, covering the tax years 2009, 2010 and 2011, which originated from a declaratory control action, through which the need for control of interest recorded in the company's accounts was proposed and officially sanctioned, relating for the most part to charges for its own acquisition;

b) The tax inspection action was carried out through Service Orders issued by the Lisbon Finance Directorate with nos. OI2013…/…/…, which determined the relevant facts and corrected the declared tax result, in the amount of € 9,564,020.43, relating to the tax year 2010 at issue here, with respect to considerable financial charges, considered by the AT as not essential to the obtaining of income or the maintenance of the income-producing source, pursuant to Article 23 of the Code of Personal Income Tax (CIRC);

c) Within the scope of the tax inspection, the AT determined that in the years 2009, 2010 and 2011, the Petitioner bore and recorded in its accounts costs (interest) with bond loans and shareholder loans, costs which the AT understood were not related to its business activity, nor served to maintain its income-producing source, therefore understood that such costs should not be accepted for purposes of calculating the tax result, pursuant to paragraph c) of no. 1 of Article 23 of CIRC;

d) The Petitioner made representations regarding the Draft Tax Inspection Report, but the AT maintained its previously assumed position, issuing the IRC assessment no. 2013…, as well as the interest assessment no. 2013… and the statement of account reconciliation no. 2013…, from which resulted an amount due of € 3,051,237.78, relating to the tax year 2010, the Petitioner having made, on 19.12.2013, payment under the exceptional regime for regularization of tax debts approved by Decree-Law no. 151-A/2013, of October 31 (RERD), in the amount of € 2,772,609.52 - see document 4 attached with the petition;

e) The Petitioner, in the tax year 2010 at issue here, was engaged in the activity of "Accounting and audit activities; tax consultancy", CAE… (until 27.01.2010) and from 28.01.2010 is registered for the activity of "Specialized clinical medical practice activities, on an outpatient basis" – CAE…, having as a secondary purpose "Accounting and audit activities; tax consultancy" – CAE…;

f) The "B…" group of companies, which is at the origin of the group with the current designation A…, began its activity in Portugal on 19.10.1990 with the designation C… SGPS Ltd., having as its purpose the management of equity interests in other companies as an indirect means of exercising economic activities;

g) C… SGPS, Ltd. (TIN…) began its activity with share capital of € 1,047,475.58;

h) On 22.12.2005, C… SGPS, Ltd. (TIN…) carried out a capital increase of € 100.00, with its share capital changing to € 1,047,575.56;

i) On 10.01.2006, C… SGPS, Ltd. (TIN…) changed its designation to D…, Ltd., having on 26.12.2006 been subject to a division from which resulted the separation of company E…- SGPS Ltd., with NIPC…;

j) On 01.08.2007, D…, Ltd., (NIPC…) is acquired by F…, Ltd. (hereinafter F…), with NIPC…, for the amount of € 122,611,711.00, changing its designation to A…, Ltd. (and maintaining NIPC…) on 04.12.2007;

k) All information relating to this company is contained in the registration with the Commercial Registry Office (annex 5 to the Tax Inspection Report);

l) D… Ltd. (TIN…), at the date of acquisition by F…, held the ownership of the following companies:

- G…, S.A.;
- H…, Ltd.;
- I…, Ltd.;
- J…, Ltd.;
- K…, S.A.;
- L…, S.A.;
- M…, S.A.;
- N…, S.A.;
- O…, Ltd.;
- P…, Ltd.;
- Q…, S.A.;
- R…, S.A.;
- S…, S.A.;
- T…, S.A.; and,
- Still partially, company U…, Ltd.;

m) To realize these acquisitions, the B… Group (originating in Sweden) had to lend substantial amounts to D… Ltd., as well as to the companies identified in the previous article, which totaled, at the date of acquisition by F…, € 50,513,599.84;

n) In 2007, company V…, wishing to enter this line of business, agreed with Group B… (Sweden), the acquisition of W… (international), including the acquisition of D… Ltd. (NIPC…) in Portugal (but not E…– SGPS, Ltd. NIPC…);

o) To realize such acquisition, V… established a company in Luxembourg, designated X….;

p) In Portugal, X… acquired F…, Ltd. (NIPC…), which, in turn, came to acquire, on 01.08.2007, as already noted, D…, Ltd. (NIPC…);

q) Once holding the totality of the share capital of F… (at that time, of € 5,000.00), X… provided it with the necessary funds to realize the acquisition of the Portuguese companies that made up the division of W… in Portugal, identified above in l).

r) Such acquisition included the purchase by F… of the totality of the quotas of D… Ltd. (TIN:…) and the acquisition by X… of the credits/loans (of € 50,513,599.84) that had been granted by Y… and Z…, both resident in Sweden, in the capacity of partners, to D… Ltd., and to the other companies in which it had equity interests (identified above in l)).

s) For this purpose, on 27.06.2007, X… decided to increase the share capital of F… by € 40,896,711.00 (from € 5,000.00 to € 40,901,711.00);

t) Also on 27.06.2007, F… proceeded to issue bonds, in the amount of € 81,700,000.00, which were fully subscribed by its partner X…, within the scope of a subscription agreement entered into between both companies;

u) On 29.06.2007, the bonds which were the object of the contract referred to in the previous point were issued by F…, with the first interest payment due on December 29, 2007;

v) On 02.07.2007, F… (in its capacity as buyer) entered into with companies Y… and Z… (in their capacity as sellers), a contract for transfer of quotas of the Portuguese company D…, Ltd. (NIPC…), for the overall value of € 122,612,071.00;

w) At the moment of such acquisition, X… proceeded to full payment of the price due to group B…(Sweden), on behalf of its subsidiary F…;

x) None of the aforementioned operations (capital increase and bond loan) gave rise to actual transfer of funds between X… and its subsidiary F…;

y) After the acquisition of the quotas by F…, X… decided to provide it with the financial means necessary for the reimbursement of the credits/loans it had acquired from the aforementioned sellers Y… and Z…, shareholder loans which these held over D… Ltd. (TIN…) and its subsidiary companies, noted above in l);

z) These credits reached the overall amount of € 50,513,599.84 (cf. detailed description in Table 1 of Document no. 5), which corresponded to the sum of principal outstanding (€ 49,702,046.20) and accrued interest as of 02.12.2007 (€ 811,553.64);

aa) On 30.11.2007, X… decided to increase the share capital of the Petitioner from € 40,901,711.00 to € 57,773,878.00, the increase corresponding to the amount of € 16,872,167.00;

bb) On 03.12.2007, X… and its subsidiary F… entered into an Inter-Company Proceeds Loan Agreement, in which the first entity granted a loan (shareholder advance) to the second for the amount of € 33,641,432.84;

cc) With these two decisions, totaling € 50,513,599.84, X… provided F… with sufficient capital for F… to acquire the credits in the value of € 50,513,599.84 that X… (by acquisition from Y…) held over D… Ltd. (TIN:…) and its subsidiaries;

dd) None of the two operations referred to in the previous paragraphs implied the actual transfer of funds, that is X… retained the amounts from the realization of the capital increase and the shareholder advance for itself to reimburse itself from the cession to F… of the credits of € 50,513,599.84 previously acquired by X… from Y… and Z…;

ee) F… (NIPC…) became itself a creditor of D… Ltd. (NIPC:…) and of the companies in which it had equity interests, as per the breakdown contained in Table 1 of Document no. 5, with the amount corresponding to D… Ltd. itself (TIN:…) being the overall amount of € 37,359,426.00;

ff) For each credit, F… entered into appropriate contracts, and in the case of D… Ltd. (TIN…) this contract was signed on 03.12.2007 –… between itself (lender) and D…, Ltd. (borrower) for the value of € 37,359,426.00;

gg) F… was a debtor, on 03.12.2017, to X…, its partner, of € 81,700,000.00 relating to the bonds issued on 29.06.2007, and of shareholder advances of € 33,641,432.84 contracted on this date;

hh) The companies in which D… Ltd. had equity interests, identified in paragraph l) became debtors to F…, together, of € 13,154,173.84, as of December 3, 2007;

ii) On 07.07.2008, F… changed its designation, ceasing to be designated F… Ltd. (NIPC…) and coming to be designated AA… Ltd. (maintaining the same NIPC);

jj) Shortly before, on 04.12.2007, D… Ltd. had also already changed its designation, coming to be designated A…, Investments and Services Ltd. (maintaining TIN:…);

kk) In parallel, on 07.04.2008, X… also changed its designation, coming to be designated BB…, maintaining its registered office in Luxembourg;

ll) On 25.11.2008, AA… (ex- F…, NIPC…) and A…, Ltd. (NIPC:…) jointly prepared, in accordance with Article 98 of the Commercial Corporations Code, a merger plan – in the form of a merger by incorporation, through the transfer of the totality of the assets of company A…, Ltd. (incorporated, NIPC:…) to AA… (NIPC:..);

mm) This merger by incorporation was completed on 31.12.2008 (with effects on the following day, 01.01.2019) and was covered by the tax neutrality regime contained in Articles 73 et seq. of the IRC Code, with AA… changing its designation to A… Ltd. (maintaining its NIPC…), that is, adopting the designation that had previously been that of the incorporated company (TIN:…), which ceased to exist as a result of the merger;

nn) Subsequently, on 30.10.2009, all the companies in which A…, Ltd. had equity interests, which were held prior to the first merger referred to in the previous paragraphs, were aggregated, all of them directly or indirectly, exclusively held by it;

oo) A second merger plan was completed on 10.12.2009 between A… Ltd. (TIN…) and the following entities:

- G…, S.A.;
- H…, Ltd.;
- I…, Ltd.;
- J…, Ltd.;
- K…, S.A.;
- L…, S.A.;
- M…, S.A.;
- N…, S.A.;
- O…, Ltd.;
- P…, Ltd.;
- Q…, S.A.;
- R…, S.A.;
- S…, S.A.;
- T…, S.A.;

with the effects of this retroacting to 01.01.2009;

pp) Said merger was also covered by the tax neutrality regime provided for in Articles 73 et seq. of CIRC;

qq) The merger operation "aimed at pursuing, among others, the following objectives:

- To consolidate the Group's presence in the medical dialysis services sector;
- To increase transparency of the Group vis-à-vis stakeholders;
- To increase efficiency of the administrative process;
- To increase efficiency in treasury management;
- To increase operational efficiency;
- To boost training policy at A…;
- To improve financing conditions for A… (in Portugal) with "V…".

rr) Until the first merger (its incorporation in the Petitioner), A… Ltd. (NIPC…) had as its activity consultancy and provision of business services in the areas of administrative, financial and personnel management, accounting, information technology, scientific research, professional training and commercial sale of devices, utensils and products intended for the health care provision sector, functioning as a purchasing center and manager of a series of other companies, whose main purpose was the treatment of kidney patients;

ss) With this operation all the assets of the incorporated A… Ltd. (NIPC…) were transferred to its incorporating company, AA… (NIPC:…);

tt) With said incorporation, all assets and liabilities became encompassed in a single entity, the entity resulting from the two mergers coming to bear the charges established between X… and the former F… (now AA…, later designated A…Ltd.), resulting from the bond loan;

uu) The second merger (of the remaining companies held in A… Ltd.) obtained consent from the respective Regional Health Administrations;

vv) The amount of interest relating to the bond loan, recorded in accounts and paid to company X…, is approximately 8.1 to 8.5 M€, in all the tax years analyzed by the Tax and Customs Authority;

ww) On 10.10.2013, the Petitioner was notified by the Tax and Customs Authority to prove the necessity of the costs and/or expenses incurred with interest borne with the bond loan for the obtaining of income (annex 13 to the Tax Inspection Report);

xx) The Petitioner responded to the notification on 18.10.2013;

yy) The financial charges were incurred in pursuit of the activity of the former F… / AA…/A… and for its sole and exclusive benefit;

zz) Without such bond financing, the issuer would not have been in a position to complete the acquisition of D… (and indirectly of the companies in which it had equity interests);

aaa) Such acquisition, as well as the subsequent management of the respective equity interests, constituted an important part of the Petitioner's activity at the time prior to the mergers;

bbb) Regarding the period after 01.01.2009, the financial expenses are directly related to the activity of the petitioner, as well as to its corporate purpose, and contribute to the generation of income subject to tax;

ccc) After the second merger, the corporate purpose of the Petitioner became as follows: "1 — Consultancy and provision of business services in the areas of administrative, financial and personnel management, accounting, information technology, scientific research, professional training, the commercialization of devices, utensils and products intended for the health care provision sector and the preparation of studies and provision of medical care in all specialties, as well as the provision of related or similar services. 2 - The activities contained in the corporate purpose may be developed, in whole or in part, indirectly, through the holding of shares or equity interests in and of companies with identical or analogous purpose", which is maintained;

ddd) This change of activity was aimed at accommodating the activities developed by the incorporated companies, the Petitioner coming to develop, through the merger, all the activities developed by the incorporated companies;

eee) The first merger (of A… in AA…) did not result in the disappearance of any asset in the sphere of the latter (namely equity interests) which were at the origin of the bond loan that generated financial charges in the sphere of AA…, but rather in the conversion of such asset into the set of assets and liabilities which those securities already represented;

fff) The financial charges borne fit into the activity of the Petitioner also after the second merger, insofar as they were intended to finance the acquisition of assets sufficient and necessary for the development, in its sphere, of the dialysis care provision activity previously developed by the subsidiaries, on an individual basis;

ggg) The mergers that occurred do not constitute an alteration to the consolidated economic reality of the incorporating company and the incorporated companies, which is maintained;

hhh) There did not occur, at any moment, any confusion between the financial charges borne by the Petitioner and the activity of third parties;

iii) With the second merger, all assets and liabilities became encompassed in a single entity, therefore the cash flows freed by the activity and assets of the resulting entity support the charges resulting from the bond loan that came to allow the acquisition of the companies subsequently incorporated;

jjj) With the mergers, the amounts of debts between the Portuguese companies were offset, maintaining only the registration of the debt to the Luxembourg company X…, in the amount of € 47,399,162.66 relating to loan/shareholder advance contracts;

kkk) The totality of financial charges with shareholder advances, relating to the year 2010, amounted to € 4,522,041.00, of which the AT considered that € 1,112,836.26 should not be tax-deductible, in the proportion of the balance of the shareholder advances that would have been influenced by the payment referred to in the following paragraphs;

lll) Regarding the interest of the bond loan due in relation to the years 2007 and 2008, the same was paid by D… Ltd. (NIPC…), on behalf and by agreement with the former F…/AA…;

mmm) The AT considered that the sum of € 11,664,656.99, paid by B… on behalf of the debt it had with the Petitioner, influenced the debt of the Petitioner to its partner (which amounted at the end of 2009 to € 47,399,162.66);

nnn) However, at the date of the mergers, the debt, in the value of € 47,399,163.86, was composed of the following items:

- € 33,641,432.84, which correspond to the value of the shareholder advances which the Petitioner received from its partner on 30.11.2007 to be able to pay for the acquisition of the shareholder advances which B… (Sweden) held over D… Ltd. in Portugal and which was part of the acquisition business;
- € 4,000,000, which correspond to treasury support which the Petitioner received from its partner on 01.08.2008 (cf. document no. 23 attached with the arbitration petition);
- € 7,100,000, which correspond to an additional loan which the Petitioner received from its partner on 29.09.2008 (cf. Document no. 24 attached with the arbitration petition) and which allowed it to acquire a clinic in Figueira da Foz; and
- € 2,628,218.23, which correspond to accrued interest in the period from 2.12.2007 (date of acquisition) to 31.12.2008 (cf. Document no. 5 attached with the arbitration petition);
- € 29,512.19, referring to a withholding which the Petitioner considered should be a cost borne by D…, Ltd.

ooo) The amount of bond loan interest paid by B… to X… in 2007 and 2008, totaling € 11,664,656.99, gave rise to a credit of D…, Ltd. over F…(since this is the issuer), but these credits were offset when the merger took place, with others of opposite sign, leaving the amount of € 47,399,162.66 due to X… (now BB…);

ppp) The shareholder advance interest paid to entity X… was not subject to tax in Portugal in accordance with Decree-Law no. 193/2005, of November 7;

2.2. Basis for Determining the Factual Matters

The proven facts are based on the Tax Inspection Report and documents attached with the initial petition, all herein reproduced, with no controversy about them.

Among those alleged, relevant to the decision, there are no unproven facts.

3. Matters of Law

3.1. Position of the Parties

3.1.1. Position of the Tax and Customs Authority (AT)

For the AT, the inspection action on the Petitioner resulted from the need to control high-value financial charges with very significant weight relative to the income recorded, which would originate from debt contracted for the acquisition of equity interests in companies subsequently incorporated by merger.

The use of the F… vehicle allowed the financing cost that would be borne by the Luxembourg company X…, current BB…., in a direct acquisition, to be borne by the assets of the operating company (A…), being fully deducted from the result of this company, after the incorporation of its assets into the vehicle company, with the respective impact at the tax level.

Now, the tax deductibility of interest borne depends on a judgment as to its necessity for the realization of income or gains subject to tax or for the maintenance of the income-producing source – body of no. 1 of Article 23 of CIRC, with paragraph c) clarifying that such interest on borrowed capital is "applied in operations". This requirement of necessity of costs/expenses for the realization of income/gains subject to tax or for the maintenance of the income-producing source, established by Article 23 of CIRC, has been duly addressed by case law. The Supreme Administrative Court has stated, regarding the sense and functioning of the requirement of necessity of costs for tax purposes, that: "the requirement of necessity of a cost must be interpreted as an indeterminate concept requiring case-by-case determination, as a result of an analysis from a business economic perspective, in the perception of a relationship of economic causality between the assumption of a cost and its realization in the interest of the company, having regard to the corporate purpose of the commercial entity in question" (cf., for example, the decisions of the STA of 15.6.2011, case no. 049/11, no. III and of 29.3.2006, case no. 01236/05, no. 3.4).

The Supreme Administrative Court has further clarified, in the decision of 10.7.2002, case no. 0246/02, that "the costs provided for in Article 23 must respect the taxpayer company itself, as such", therefore "for a certain sum to be considered a cost of that company it is necessary that the respective activity be developed by it itself, not by other companies even if in a relationship of control", reiterating in its subsequent decisions of 7.2.2007, case no. 01046/05, no. III, of 20.5.2009, case 01077/08, of 30.11.2011, case no. 0107/11 and of 30.05.2012, case no. 171/11, that: "the costs must respect the taxpayer company itself, that is, for a certain sum to be considered a cost of that company it is necessary that the respective activity be developed by it itself, not by other companies", because, "otherwise, how could the exercise of the activity of another company with which it had some relationship be attributed to a company".

In another aspect, it is equally clearly stated that it is a prerequisite in the application of Article 23 of CIRC "the individual consideration of each company or institution, therefore reasoning based on criteria for management of the "group" or even financing – even if gratuitous – from its partners or even the will of these which on this matter is irrelevant, since it is a legal criterion, being only relevant the legal entity whose costs are under consideration" (decision of the Central Administrative Court South of 16.10.2007, case no. 01276/06).

Thus, it is strictly in relation to the entity whose costs are under consideration, having regard to the business activity it develops, that it is important to examine the tax deductibility of financial charges. Such tax deductibility presupposes that the costs incurred with financial charges have a relationship of causality with the business activity developed, especially serve the development of the activity of the company owing them.

In the case of A…, the costs borne with the bond loan are not related to its business activity, nor served to maintain the income-producing source. Such costs, although recorded in its accounts, do not benefit its activity nor its respective business interest, but rather benefit a third party (BB..., former X...), not being accepted for purposes of calculating the tax result, pursuant to paragraph c) of no. 1 of Article 23 of the IRC Code.

In sum, regarding costs with the bond loan, with the incorporation of A…, Ltd. (NIPC…), into its parent company AA…, Ltd. (NIPC…), the income generated by the activity and assets of the incorporated company came to bear the charges resulting from the bond loan entered into between X… and F…, for acquisition of company D…, therefore, with the merger, the income generated by the activity of the incorporated company came to bear the costs of its own acquisition, the funds not being used in operations. In accordance with this, they are not deductible under Article 23 of CIRC.

Likewise, regarding charges with shareholder advances: the interest was paid through CC…, S.A., by company D…, the acquired company through such loan, because F… never had operational activity, as evidenced by the operations recorded in the accounts of the entity and reflected in the analytical trial balances of the 2007 and 2008 of F… (cf. annex 16, of 9 pages), which contain merely records in financial cost and income accounts. Now, in those same years (2007 and 2008), X…, in addition to the bond loan, proceeded to loans through shareholder advances to various group companies, with D… being the largest recipient of such shareholder advances, in the amount of € 37,359,426 (annex 17, of 6 pages). Thus, D… received shareholder advances from X…, via F…, directing part of such received shareholder advances to the payment of interest on the bond loan of the parent company (F…), since it had no operational activity that generated financial inflows. This interest paid by D… to X… was recorded in F… as debt to third parties (D…), that is, D… paid interest on a bond loan whose parties were X… (creditor) and F… (debtor), these interest amounts constituting a credit of D… over F…. This credit over F… generated no income, regardless of the fact that by virtue of this D… was bearing a charge with shareholder advance interest to meet the payment of interest which should be an actual charge of the parent company F….

The amount of interest which D… paid to X… (responsibility of the parent F…) in the years 2007 and 2008 amounted to the sum of € 11,664,656.99 (annex 12), divided between € 3,874,826.75 relating to 2007 and € 7,789,830.24 relating to 2008. This amount constituted a credit of F… over D… (shareholder advances), in that the latter had no financial means to settle the interest on the bond loan.

With the merger, the amounts of debts between the Portuguese companies were offset, maintaining only the registration of debt to the Luxembourg company in the amount of € 47,399,162.66 relating to shareholder advances, this amount being influenced by the aforementioned sum (€ 11,664,656.99) relating to the payment of bond loan interest in the years 2007 and 2008 by D…. Thus, and pursuant to paragraph c) of no. 1 of Article 23 of the IRC Code, the AT proceeded to the correction of interest borne relating to shareholder advances in the proportion of € 11,664,656.99 relative to the value of shareholder advance debt (€ 47,399,656.99). That is, the specific correction made regarding this point respects the interest of shareholder advances corresponding to the part of the shareholder advances necessary to the financing of costs with the bond loan, which would not benefit the Petitioner, as no evidence has been found that unequivocally demonstrates that the value of € 11,664,656.99 is not included in the value of shareholder advances. Thus, and for the AT, in the absence of such demonstration, the basis for the correction comes down to that of the correction relating to the bond loan.

In the AT's view, for financial charges borne to be accepted as a tax deduction, it is necessary that they meet three requirements: proof (justification), necessity and, further, the link to income or gains subject to tax. Now, to accept the deductibility of financial charges associated with financing the acquisition of equity interests in companies whose activities generate the income and gains that make possible the deduction of such expenses would be to deny the principle of balancing between expenses and income that is inherent in no. 1 of Article 23 of the IRC Code.

Thus, the non-deductibility of financial charges borne with the bond loan subscribed by BB… (former X...), intended to finance acquisitions in the tax periods 2009, 2010 and 2011, has as its legal basis the non-verification of the conditions of a substantive nature on which no. 1 of Article 23 of the IRC Code makes the deductibility of expenses and losses depend, as they have been interpreted by legal scholars and case law.

3.1.2. Position of the Petitioner

For the Petitioner, from a management perspective, it made no sense for the operations of the DD… group in Portugal to be dispersed across 16 different companies. Thus, the merger between the Petitioner (then AA…, former F…) and A…, Ltd. (whose designation the Petitioner came to adopt) and, then, with the operating companies that made up the former division of W… had precise economic objectives.

It further contends that the acquisition of assets underlying the business could not be done, by virtue of regulatory reasons in force in the health sector, in a direct manner.

Regarding expenses borne with the bond loan, the Petitioner refutes the AT's thesis, its understanding being that such charges relate, clearly, to the activity or interest of the Petitioner. It argues that such financing was even more intensive in equity, compared to similar operations, since for every two euros of debt it achieved one euro of equity.

In the Petitioner's view, without the mergers and the financing that occurred, it could not exist today, within its sphere of operation, a financial result identical to that which it has generated. Without the charges it bears, the Petitioner states it could not have acquired the former division of W… and would not have achieved the dimension and economic structure it presently has.

It also contends that it was the one that contracted the bond loan and that the charges resulting from it were constituted in its sphere. And that, with the merger, this reality was not modified. With the merger, in the Petitioner's view, there was a true acquisition of assets and liabilities, distinct from equity interests, and generating operational results. Thus, the interest paid results from operations which, after their completion, brought into the sphere of the Petitioner the assets (means of obtaining income) and the debts (financial support for such means), all of this with clear economic rationality. That is, the assets and the capital (in this case, the debt) that finances them came together in the same entity, not making, according to the Petitioner, sense the AT's thesis of separating such operations or economic effects. It cites, in support of its thesis, arbitration decisions that would go in the direction it advocates.

Regarding the question of shareholder advance interest, the Petitioner contends that its debt to X… was in no way influenced by the € 11,664,656.99 that the AT raises in the RI. In the Petition an explanation is made of the origin of such amount, the Petitioner concluding that: "in the composition of the amount owed by the Petitioner to X…, at the basis of which are the charges with shareholder advances, in no way interferes the amount of € 11,664,656.99 remitted by D…, Ltd. (TIN…) to CC… (paying agent of the bond loan), since this remittance of € 11,664,656.99 represented only a partial reduction of the debt of D…, Ltd. (TIN:…) to the Petitioner. (…) contrary to what the AT states, this amount did not inflate, nor influence, the amount of the Petitioner's debt to its shareholder, nor had any impact on its calculation, therefore the charges corresponding to it in no way distinguish themselves from the charges - which the AT did not question, neither in this year nor in previous years - with the other X… shareholder advances to the Petitioner" (articles 332 to 335).

4. Analysis and Decision

4.1. Legal Foundations: on the Interpretation of Article 23 of CIRC and the Question of "Necessity" of Expenses

The tribunal concurs with the understanding reached by the arbitral tribunal in Case no. 42/2015-T, the deciding part of which is hereby endorsed:

In a relationship of dependence, even if partial, between tax result and result determined by accounting, CIRC establishes as the basis for determining the taxable result the profit or loss determined by accounting. However, and aiming to safeguard the public interest underlying taxation, it imposes certain requirements on the tax consideration of income and costs. On the costs side, such requirements appear more developed, with Article 23 being the provision that establishes the general principle of their acceptance. As it existed at the date of the facts, Article 23 of CIRC provided, in the relevant part:

Article 23 Costs or Losses

1 — Costs or losses are those that are proven to be necessary for the realization of income or gains subject to tax or for the maintenance of the income-producing source, particularly the following:

(...)

c) Financial charges, such as interest on borrowed capital applied in operations, discounts, premiums, transfers, exchange differences, credit operation expenses, debt collection and issuance of shares, bonds and other securities, redemption premiums;

Thus emerges a core requirement in the admissibility of costs or expenses for tax purposes: necessity. Case law has a well-established analysis on how such concept should be understood, from which stands out the treatment given in the Decision of the TCAS rendered in case 03022/09 – of October 6, 2009:

"But how should the concept of necessity be assessed? Accepting that we are dealing with a vague concept requiring completion and accepting that we are not, regarding such completion, facing any discretionary power (in terms of technical discretion) on the part of the Tax Authority, it is important, then, to pay attention to the terms in which the law frames such concept. (...)

Appealing to the study of TOMÁS TAVARES (...) we will say, as the author points out, it seems evident that from the legal notion of cost provided by Article 23 of CIRC it does not follow that the Tax Authority can call into question the principle of freedom of management, scrutinizing the propriety and opportunity of the economic decisions of the company's management and considering that only those can be fiscally assumed from which income directly derives for the company or which prove convenient for the company.

The necessity referred to in Article 23 (...) requires, solely, a relationship of economic causality, in the sense that it is sufficient that the cost is realized in the interest of the company, in order, direct or indirectly, to obtain profits. (...) And outside the concept of necessity will fall only acts that do not conform to the social purpose, those that do not fit within the interest of the company, especially because they do not aim at profit".

Also the decision of the TCA North - case 00624/05.0BEPRT, Decision of January 12, 2012:

"In the consideration and completion of this indeterminate concept – necessity - it is required that the analysis of a concrete cost be done in light of the company activity, that is, in light of its objective within the framework of the company's activity; necessary costs are equivalent to expenses incurred in the interest of the company. The criterion of necessity was created by the legislator precisely to prevent the fiscal consideration of expenses which, despite being recorded as costs, do not fall within the scope of the company's activity, which were incurred not for its pursuit, but for other interests"

The Decision of 29-03-2006 - Case no. 1236/05 – of the STA:

"The concept of necessity, being indeterminate, has been filled by case law on a case-by-case basis (...). The rule is that properly recorded expenses be tax costs; the criterion of necessity was created by the legislator, not to allow the Administration to meddle in company management, dictating how it should apply its resources, but to prevent the fiscal consideration of expenses which, even if recorded as costs, do not fall within the scope of the company's activity, were incurred not for its pursuit but for other extraneous interests. Strictly speaking, these are not true costs of the company, but expenses which, having regard to their object, were abusively recorded as such. Without the Administration being able to assess the necessity of costs in light of criteria bearing on their opportunity and merit [...] under penalty of violation of the principle of tax capacity, the Administration can only exclude expenses not directly ruled out by law under strong motivation that convinces that they were incurred beyond the corporate objective, or, at least, with clear excess, deviant, faced with the objective needs and capacities of the company".

In legal scholarship, Rui Morais: [1]

"The invocation of the rule of necessity of costs can never be made to substitute the judgment of convenience and opportunity of charges assumed, as they resulted from the decision of the corporate organs, by another judgment, also of a business nature made by the tax administration or courts [...] We cannot consider good the direction of certain case law which refuses tax accreditation of certain costs because it is not possible to establish a direct correlation with the obtaining of concrete income. Taken to the extreme such understanding, we would have that charges with research would only be fiscally deductible when such research had success, when, as a result, the company came to sell new goods and services [...] We contend that the question of whether a cost should be deemed necessary should be resolved based on the objective intent of the transaction, that is, the business purpose test... We think it is fairly clear the scope of the rule: to refuse tax participation in some of the charges borne by the taxpayer... If the assumption of the charge was preceded by genuine business motivation... the cost is necessary. When it should be concluded that the charge was determined by other motivations (personal interest of partners, administrators, creditors, other companies in the same group, commercial partners, etc) then such cost should not be deemed necessary."

J.L. Saldanha Sanches: [2]

"...knowing whether a certain cost corresponds or not to the most effective defense of the company's interests is a question that cannot be resolved by the attribution of a power of state intervention... so as to make a judgment of merit on a certain option of business management, just as it cannot validate the qualification of the expense as a cost by subjecting it to the condition of the subsequent verification of the actual generation of income".

The interpretation of the concept of "necessity" has been equated to costs incurred in the interest of the company, to expenses borne within the activities resulting from its corporate scope. Only when the expenses result from decisions that do not meet such requirements should they then be disregarded.

Now, having legal entities a corporate scope or objective defined in their bylaws, having regard to the realization of the purpose for which they are formed – the obtaining of a surplus to be distributed among the partners – the management acts that contribute to such purpose must constitute the activity of the companies. Activity must be understood in a broad sense, meaning activity related to an income-producing source of the entity bearing the expenses. The concept of company activity cannot be restricted to mere or simple operations of production of goods or services. To say that a cost must have a relationship with the activity can only mean to have a relationship with the overall economic operations, of operations, or with the operations or management acts that fit within the pursuit of the entity's own interest that assumes such costs. In that sense, the activity of a company consists of the operations resulting from the use of its assets, its assets and the management of its liabilities. That is, the way management uses business assets – the assets – within the scope of the various operations (productive, commercial, investment and disinvestment, general financing, acquisition of financial interests and others) which, together, allow the entity in question to fulfill its economic purpose. Such assets are, by virtue of their normative-accounting classification, divided into different types, tangible fixed assets, immobilized or non-current, intangible, financial, non-current assets held for sale, current, such as inventories/stock, etc.. This range of assets is the set of material (alongside human, organizational, etc.) resources which management has available to generate income and surplus. Thus, the purchase of physical assets for investment and their eventual sale, the purchase and sale of equity interests, with their respective financing, the application of liquidity, all forms part of what are considered normal management acts of a company. The meaning and economic scope of such operations depend on the economic-financial characteristics of the entities but, in a general sense, all of them fall within objectives and instruments of business management. Thus, the business activity that generates deductible costs is that which translates into operations with a purpose, an intent (and not an obligatory nexus of immediate causality) of obtaining income or the purpose of maintaining the potential of an income-producing source.

4.2. Application of the Concept of Necessity to the Case at Hand

As results from the record, the Petitioner resulted from the merger of, essentially, three types of entities.

At a first level, there were operating companies, which dedicated themselves to the provision of health services, especially to the diagnosis and treatment of kidney diseases. At a second level, these companies were held by D… Ltd., which held, in Portugal, the entities integrated in the Swedish Group B…, which operated globally in this area of health service provision.

At a certain moment, the entity then designated by F… acquired the business of Group B… in Portugal. For such, F… was provided with financial means (equity and debt) by X…, with registered office in Luxembourg.

F… (under the designation AA…) then became indebted to its owner, and therefore paid it financial charges resulting from the debt with which it had been financed to acquire assets related to the business which group B… operated in Portugal.

After various corporate reorganization operations, AA… merged with D… Ltd., which had also already changed its designation, coming to be designated A… Ltd., and, finally, the various operating companies were also merged. In sum, at the end, the Petitioner incorporated both the former D… Ltd. and the operating companies which it held.

The essential question to be decided is, therefore, whether Article 23 of CIRC implies, as the AT alleges, that the financial charges paid by the Petitioner to BB… (former X…) are not deductible, as they do not meet the requirement of necessity as stated in that legal provision.

For the AT, the interest paid by the Petitioner would not respect its activity, but rather the activity or interest of its partner, and could not contribute to the taxable result of the Petitioner, as they departed from its social interest or its own activity.

As the AT refers, at point 44 of its Arguments: "to accept the deductibility of financial charges associated with financing the acquisition of equity interests in companies whose activities generate the income and gains that make possible the deduction of such expenses, would be to deny the principle of balancing between expenses and income that is inherent in no. 1 of Article 23 of the IRC Code".

Now the STA, in Case 0779/12, in a Decision of 24-09-2014, rejects the interpretation of Article 23 of CIRC as necessarily implying a mandatory connection, a balancing or a relationship between costs and income:

"I - In the understanding that legal scholarship and case law have come to adopt for the purpose of examining the necessity of a cost (cf. Article 23 of CIRC in the wording in force in 2001), the AT cannot scrutinize the propriety and opportunity of the economic decisions of company management, under penalty of meddling in the freedom and autonomy of company management.

II - Thus, a cost will be accepted fiscally if, in a judgment made at the time it was incurred, it is adequate to the productive structure of the company and to the obtaining of profits, even if it comes to prove an unprofitable or economically ruinous economic operation, and the AT can only disregard as tax costs those that do not fall within the scope of the taxpayer's activity and were incurred, not in its interest, but for the pursuit of extraneous objectives (when it is to be concluded, in light of the rules of common experience, that it had no potential to generate income).

III - Being the taxpayer a company that is engaged in building construction, the AT cannot disregard the costs relating to the acquisition of two properties on the ground of lack of demonstration of necessity, even if such business comes to prove economically non-profitable by reason of its sale at a price six times lower than that at which they were acquired having generated a loss."

It does not follow, therefore, that the fiscal acceptance of an expense must respect a principle of balancing (or connection) with income.

Further, the AT sustains that (point 51 of its Arguments): "With respect to financial charges, that provision requires, just as for the generality of expenses, that the expenses and losses, deductible for the determination of taxable profit, be necessary for the obtaining of income and gains subject to tax and for the maintenance of the income-producing source and specifies, in its paragraph c) of no. 1, the expenses of "financial nature, such as interest on borrowed capital applied in operations".

Regarding the question of the application of capital in operations: the AT's thesis has no support in law. The terms "namely" and "such as", used in the preamble of no. 1 of Article 23 and in the respective paragraph c), emphasize that financial charges on capital applied in operations are deductible but do not exhaust the universe of deductible financial charges. These will be, even if not applied in said operations; provided they pass the general test of necessity, are proven and are not ruled out by another legal-tax provision. The concept of necessity is consensually interpreted as implying that the expenses concern the activity or interest of the company. Financial charges that fit within this, even if not applied in activities considered operational or of operations, can meet the conditions of necessity.

And the financial charges here at issue are related to the activity of the Petitioner, as they result from the financing of assets held by it and which even generate income of an operational nature.

The AT further advances, regarding the exclusion of financial charges, as not being inherent to the Petitioner's own interest (articles 53, 56 and 73 of its Arguments):

"the costs borne with the loan are not related to its business activity, nor served to maintain the income-producing source. Such costs, although recorded in its accounts, do not benefit its activity nor its respective business interest, but rather benefit a third party (BB…, former X…) not being accepted for purposes of calculating the tax result, pursuant to paragraph c) of no. 1 of Article 23 of the IRC Code."

"The mergers within which the company AA…, Ltd. (former F…, Ltd.) incorporated company A…, Ltd. (former D…, Ltd.) and its subsidiary companies, even though they were upstream mergers implied, in fact, a complete transmutation of the incorporating company which legally remained but whose activity came to correspond entirely to the activities that were already being exercised by the incorporated companies."

"What occurred with the merger operations was that, as a consequence of the extinction of the equity interests held by company AA…, Ltd. (ex. F…), the activity previously developed to which the bond loan was associated did not have continuity, what remained was only operational activity developed by the companies that had belonged to Group B…, in the operation of which the funds obtained with such financing were not applied and, therefore, the financial charges borne did not contribute to the generation of income or revenue from kidney treatment activities."

The AT is not correct when it calls into question the deductibility of financial charges, in the context of the Petitioner, on the ground that these are disconnected from its activity, from its own interest, and that the funds obtained were not applied in operations. As a result of the merger operations, the same company (the Petitioner) came to hold, as patrimonial elements recorded or recognized in its balance sheet, the assets and liabilities of the operating companies and continued to record, also in its balance sheet, the equity and financial liabilities that supported the equity interests that previously represented this set of patrimonial elements. There is a clear economic link between the debt that bears interest and the assets and liabilities which such debt supports.

When the AT refers to "what remained was only operational activity developed by the companies that belonged to Group B… in the operation of which the funds obtained with such financing were not applied", it does not take into account that the ownership of the operational activity was only made possible by paying the group B… an acquisition price that involved the financing of bond loans and shareholder advances that generated the interest paid. Even from a strict perspective of economic nexus between income and expenses, it exists. The income derived from the business is related to the interest paid for its acquisition. In a patrimonial perspective, there is even greater approximation between assets and the capital that finances them, now recorded in the same entity. Without the AT calling into question the economic purpose of the corporate reorganization operations carried out, the disregard of interest paid has no support in Article 23 of CIRC.

Regarding the topic of shareholder advances, and the amount of € 11,664,656.99, the AT refers (article 30 of its Arguments) that: "As results from the RIT, no evidence was found that unequivocally demonstrates that the amount of € 11,664,656.99 is not included in the value of shareholder advances, all the more so since company D… paid directly such interest on behalf of company F…, Ltd., by virtue of this company not having financial means to proceed to the settlement of interest".

Now, the request for arbitration submitted by the Petitioner calls into question the AT's thesis, without the latter, in its response or arguments, having rebutted in a convincing manner the Petitioner's positions and explanations on the said € 11,664,656.99.

The Tribunal understands that there is no reason to disregard the interest on the bond loan and this conclusion also affects the correction made by the AT regarding shareholder advances, therefore the correction is illegal and, consequently, the assessment must be annulled, due to a defect of violation of law, specifically Article 23, no. 1, of CIRC, in the part on which it is based.

4.3. Indemnity Interest

The Petitioner requests that indemnity interest be paid from the date of undue payment of the tax liability.

In accordance with the provisions of paragraph b) of Article 24 of RJAT, the arbitration decision on the merits of the claim that is not subject to appeal or challenge binds the tax administration from the expiration of the time limit for appeal or challenge, this body being required, in the exact terms of the success of the arbitration decision in favor of the taxpayer and until the expiration of the time limit for spontaneous execution of decisions of tax judicial courts, to "restore the situation that would exist if the tax act which is the object of the arbitration decision had not been carried out, adopting the necessary acts and operations for this purpose", which is in line with what is provided in Article 100 of the General Tax Law, applicable by virtue of the provisions of paragraph a) of no. 1 of Article 29 of RJAT: "the tax administration is obliged, in case of total or partial success of an administrative complaint, judicial challenge or appeal in favor of the taxpayer, to immediately and fully restore the legality of the act or situation subject to dispute, comprising the payment of indemnity interest, if applicable, from the expiration of the time limit for execution of the decision".

Even though Article 2, no. 1, paragraphs a) and b), of RJAT, uses the expression "declaration of illegality" to define the jurisdiction of arbitral tribunals operating at CAAD, not making reference to convicting decisions, it should be understood that it comprehends in its jurisdiction the powers attributed to tax courts in challenge proceedings.

The judicial challenge process, despite being essentially a process of annulment of tax acts, admits the condemnation of the Tax Administration to payment of indemnity interest, as can be inferred from Article 43, no. 1, of the GTL, which establishes that "indemnity interest is owed when it is determined, in an administrative complaint or judicial challenge, that there was error attributable to the services from which resulted payment of the tax liability in an amount superior to that legally owed" and Article 61, no. 4 of the TCPC (as amended by Law no. 55-A/2010, of December 31, which corresponds to no. 2 in the original wording), which "if the decision recognizing the right to indemnity interest is judicial, the time limit for payment is counted from the beginning of the time limit for its spontaneous execution".

Thus, no. 5 of Article 24 of RJAT, when it says that "interest is owed, regardless of its nature, in accordance with the terms provided for in the general tax law and in the Tax Procedure and Process Code" should be understood as permitting the recognition of the right to indemnity interest in the arbitration process.

As results from the factual matters established, on 19-12-2013, the Petitioner made, pursuant to the exceptional regime for regularization of tax debts approved by Decree-Law no. 151-A/2013, of October 31, the payment of the sum of € 2,772,609.52, relating to the assessment at issue, with waiver of payment of compensatory interest.

In accordance with Article 43 of the GTL, in the part here applicable, "indemnity interest is owed when it is determined, in an administrative complaint or judicial challenge, that there was error attributable to the services from which resulted payment of the tax liability in an amount superior to that legally owed".

In the case at hand, it is manifest that, as a consequence of the illegality of the IRC assessment act, reimbursement of the tax is due, by virtue of the aforementioned Articles 24, no. 1, paragraph b), of RJAT and 100 of the GTL, as this is essential to "restore the situation that would exist if the tax act which is the object of the arbitration decision had not been carried out", since the corrections made were illegal.

As concerns indemnity interest: the illegality of the IRC assessment acts is attributable to the AT, which, on its own initiative, carried it out without legal support. We are dealing with a defect of violation of substantive law, embodied in error in legal assumptions, attributable to the AT.

Consequently, the Petitioner is entitled to indemnity interest, in accordance with Article 43, no. 1, of the GTL and Article 61 of the TCPC, calculated on the amount which it paid unduly.

Thus, the AT must execute this decision, in accordance with Article 24, no. 1, of RJAT, paying to the Petitioner indemnity interest on the amount of € 2,772,609.52, at the legal default rate for civil debts, in accordance with Articles 35, no. 10, and 43, nos. 1 and 5, of the GTL, 61 of the TCPC, 559 of the Civil Code and Ordinance no. 291/2003, of April 8 (or the enactment or enactments that succeeded it).

The indemnity interest is owed from the date of payment (19-12-2013), until the processing of the credit note, in which it is included (Article 61, no. 5, of the TCPC).

4.5. Decision

Therefore, this Arbitral Tribunal agrees to:

a) judge the request for arbitration well-founded;

b) annul the additional IRC assessment no. 2013… and the compensatory interest assessment no. 2013…, from which resulted an amount due by the Petitioner of € 3,051,237.78, relating to the tax year 2010, revoking, consequently, the rejection decisions rendered in the administrative complaint proceeding and hierarchical appeal;

c) condemn the Respondent to pay to the Petitioner indemnity interest, at the legal default rate for civil debts, in accordance with no. 10 of Article 35 and nos. 1 and 5 of Article 43 of the GTL, Article 559 of the Civil Code and Ordinance no. 291/2003, of April 8 (or the enactment or enactments that succeeded it), and no. 2 of Article 61 of the TCPC, calculated on the amount of € 2,772,609.52, from 19.12.2013 until the date on which the corresponding credit note is processed.

5. Case Value

In accordance with the provisions of Article 306, no. 2, of the CPC and 97-A, no. 1, paragraph a), of the TCPC and 3, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the case value is fixed at € 2,772,609.52.

6. Costs

In accordance with Article 22, no. 4, of RJAT, the amount of costs is fixed at € 35,496.00, in accordance with Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, to be borne by the Tax and Customs Authority.

Notify.

Lisbon, January 27, 2017

The Arbitrators

(José Baeta de Queiroz)

(Luís M. S Oliveira)

(Luís Manuel Pereira da Silva)

[1] Notes to the IRC, Almedina, Coimbra, 2007. pp. 86 and 87.

[2] The limits of tax planning, Coimbra Publisher, 2006, p. 215.