CAAD 380/2017-T: Deductibility of Financial Charges for SGPS under Article 32(2) EBF and Circular 7/2004

ARBITRAL DECISION

I – REPORT

A…, SGPS, S.A., legal entity no. …, with registered address at …, no. …, …, …-… Lisbon ("Claimant"), notified of the dispatch of the Honorable Assistant Director of Finance of the Finance Department of Lisbon dated 21 March 2017, by way of substitution, which rejected the administrative review filed against the assessment of Corporate Income Tax ("CIT") no. 2016 … and the corresponding statement of reconciliation of accounts no. 2016 … (compensation no. 2016 …), relating to the fiscal year 2012, from which resulted a tax loss in the amount of € 313,381.21 (cf. Docs. 1 and 2, which are hereby considered fully reproduced for all legal purposes), under the terms and for the purposes provided in section a) of number 1 of article 2 and articles 10 et seq., all of the Legal Framework for Tax Arbitration ("RJAT"), in conjunction with no. 1 of article 102 of the Code of Tax Procedure and Process ("CPPT"), applicable by virtue of the provision in section a) of number 1 of article 10 of the RJAT,

submitted a request for arbitral decision against the CIT assessment no. 2016…, relating to the fiscal year 2012, and respective statement of reconciliation of accounts no. 2016 … (compensation no. 2016 …) and, as well, against the dispatch of 21 March 2017, of the Honorable Assistant Director of Finance of the Finance Department of Lisbon.

The Claimant alleged, substantially and in summary:

• It is subject to the general CIT regime;

• Within the context of Tax Inspection Order 2015…, it was subject to tax inspection of limited scope relating to the period of 2012 and CIT;

• It was notified of the Report of that inspection, with the determination by the Tax Authority of two corrections: (i) Correction pursuant to article 45-1/j) of the CIT Code, to the amount of interest on shareholder loans in the amount of €708,068.72 and (ii) correction of financial expenses not accepted for tax purposes under article 32-2 of the Tax Benefits Statute;

• Such corrections resulted in an alteration to the tax loss determined by the Claimant in the cited taxation period (2012), in such a way that from an initial amount of €2,023,926.00, it changed to the amount of €313,381.21;

• An administrative review was filed, with the Claimant arguing, in summary: (i) Illegality of the correction determined under article 45-1/j) of the CIT Code regarding interest on shareholder loans; (ii) Illegality, by violation of the provision in article 32-2 of the Tax Benefits Statute, insofar as financial expenses could not be attributed to a non-existent operation of acquisition of capital shares using financing; (iii) illegality of the integration of supplementary contributions into the concept of capital shares for the purposes of applying the provision in article 32-2 of the Tax Benefits Statute; (iv) Illegality of the correction determined by the Tax Authority insofar as it should have resorted to a direct method of allocation that would allow the effective determination of financial expenses inasmuch as this latter method prevails over the exemplary method provided in Circular no. 7/2004 (which is less precise) and (v) invalidity of the reasoning both as to the manner in which the amount of €34,500.00 was determined, relating to the cost of acquisition of the capital shares acquired by the Claimant, and the determination of "other assets" that were considered in the calculation of non-deductible financial expenses.

• Such administrative review was rejected by dispatch of 21 March 2017.

The request for constitution of the arbitral tribunal was accepted by the President of the Tax Arbitration Council and automatically notified to the Tax and Customs Authority in accordance with regulatory requirements.

Pursuant to the provision in section a) of number 2 of article 6 and section b) of number 1 of article 11 of the RJAT, as amended by article 228 of Law no. 66-B/2012 of 31 December, the Ethics Council designated the undersigned as arbitrators of the collective arbitral tribunal, who communicated acceptance of the assignment within the applicable period.

The parties were duly and timely notified of such designation and did not manifest the intention to refuse it, in accordance with the combined provisions of article 11 no. 1 sections a) and b) of the RJAT and articles 6 and 7 of the Ethics Code.

Thus, in accordance with the provision in section c) of number 1 of article 11 of the RJAT, as amended by article 228 of Law no. 66-B/2012 of 31 December, the collective arbitral tribunal was constituted on 29-8-2017.

The Tax and Customs Authority responded to the initial petition filed, arguing that the claim of the Claimant should be dismissed on the basis that it had already done so in essence within the context of the administrative review, having, in addition, raised the incidental matter of the value of the case on the grounds that, being the tax loss in the amount of €313,381.21, this should be (and not the amount indicated by the Claimant) the value of the case for the purposes of the provision in articles 97-A/1/a) of the CPPT, applicable by virtue of article 3 of the Regulation of Costs in Tax Arbitration Processes.

Given that in this case none of the purposes legally assigned to it are present, the meeting provided for in article 18 of the RJAT was dispensed with, considering its futility.

The parties submitted final written submissions.

The arbitral tribunal was duly constituted and is materially competent under the provisions of articles 2 number 1, section a), and 30 number 1 of Decree-Law no. 10/2011 of 20 January.

The parties possess legal personality and capacity, are legitimate parties and are represented (articles 4 and 10 no. 2 of the same diploma and article 1 of Regulation no. 112-A/2011 of 22 March).

The process is not affected by nullities and no exceptions were raised.

Regarding the aforementioned incidental matter of the value of the case:

12.1 In the present process, the correction carried out by the Tax Authority to the tax losses in the context of CIT relating to the fiscal year 2012 is at issue;

12.2 The Claimant declared tax losses in the amount of €2,023,926.00 and the Tax Authority corrected this amount, reducing it to €313,381.21.

12.3 Now the value of the economic utility of the claim is that resulting from the annulment sought, that is, the value corresponding to the difference between €2,023,916.00 and €313,381.21, or €1,710,544.79.

12.4 Considering that this was the amount indicated by the Claimant, there is nothing to correct, and therefore the request to alter the value of the case is dismissed, maintaining the amount initially indicated by the Claimant.

All considered, it is necessary to render a final decision.

II. REASONING

A. FACTUAL MATTER

A.1. Facts Established

According to the principle of free assessment of evidence, the Tribunal bases its decision, in relation to the evidence produced, on its intimate conviction, formed from the examination and evaluation it makes of the means of proof brought to the process and in accordance with its experience of life and knowledge of persons (cf. article 607, no. 5, of the Civil Procedure Code, as amended by Law no. 41/2013 of 26/6). Only when the probative force of certain means is pre-established in law (e.g., full probative force of authentic documents - cf. article 371 of the Civil Code) does the principle of free assessment of evidence not dominate the evaluation of evidence produced.

Based on the elements contained in the proceedings (administrative proceedings, facts agreed upon by the parties and documents incorporated in the record and not contested), the following facts relevant to the decision are established as proven:

• The Claimant was incorporated on 21 July 2008, with the legal form of a joint-stock company (it later assumed the type of company managing social participations), with the objective of carrying out the acquisition of a direct participation of 100% in company B… by Fund C… (as per Point II.3.1 of the Tax Inspection Report which refers to the Management Report of the Claimant relating to 2012).

• On 19 September 2008 the shareholders of the Claimant were as follows (as per Point II.3.1 of the Tax Inspection Report and article 40 of the Company Bylaws):

Fund C…: 83.122%

D… (AG): 0.626%

E… (PS): 0.626%

F… (JG): 0.626%

G… (MCG): 15%

• Between July and September 2008 the Claimant received the following funds, under different titles:

• Share capital: € 50,000 (as per Joint-Stock Company Contract – Document 3 attached to the Administrative Review)

• Supplementary contributions: € 4,750,000 (Minutes no. 2 of the Claimant – Document 4);

• Shareholder loans: € 19,200,000 plus € 97,175.96 (Minutes no. 2 of the Claimant – Document 4 and Contract – Document 7);

• Financing of B…: € 10,500,000 (Contract – Document 6)

• The total funds obtained between July and September 2008 by the Claimant were thus € 34,597,175.96.

• In September 2008, the Claimant incorporated company H…, to which it transferred the following funds, under different titles:

• Fully subscribed share capital: € 50,000 (Joint-Stock Company Contract – Document 12);

• Supplementary contributions: € 4,750,000 (Minutes no. 1 of H… – Document 15);

• Shareholder loans: € 19,200,000 (Shareholder Loan Contract – Document 14);

• Financing: € 10,500,000 (Contract – Document 13).

• The total funds applied by the Claimant in H… in 2008 was thus € 34,500,000.

• Also in the same taxation period, H… acquired company B…, S.A. for € 34,500,000 [as per sections d) and e) of Point II.3.2 of the Tax Inspection Report].

• In December 2009, the Claimant began to directly hold B… after an operation of reverse merger incorporating H… into B… (Point III.2.3.2.3 of the Tax Inspection Report, article 63 of the Company Bylaws and Justice Portal – Online Publication of corporate acts).

• In December 2009, the financing of the Claimant to B…, and the claim of the former against H…, both in the amount of € 10,500,000, are extinguished by confusion of debt (Agreement for Extinction of Credits – Document 9 attached to the Management Report).

• Between December 2010 and July 2011, the Claimant applied to B… the amount of € 17,787,500 under the title of supplementary contributions (Minutes 34 and 37 of B… – Documents 16 and 17).

• In September 2011, B… reimbursed € 10,000,000 relating to the shareholder loan of € 19,200,000 granted in 2008 by the Claimant to H… (Amendment to Shareholder Loan Contract – Document 11 attached to the Management Report).

• In the fiscal year 2012, H… incurred a total of € 2,958,636.57 (III.2.3.2.1 Tax Inspection Report which refers to the Trial Balance of the Claimant) in financing expenses, distributed as follows (Point II.2.1 of the Tax Authority's Response to the Administrative Review):

• From shareholder loans contracted between July and September 2008

• Shareholder loans of € 16,056,600 from F. C…: € 2,448,631.43

• Shareholder loans of € 2,880,000 from shareholder I…: € 439,200

• Shareholder loans of € 120,192 from shareholder J…: € 18,329.28

• Shareholder loans of € 120,192 from shareholder K…: € 18,329.28

• Shareholder loans of € 120,192 from shareholder L…: € 18,329.28

• From shareholder loans contracted after September 2008

• Shareholder loans from Fund C… of € 103,720: € 15,817.3

• Also in 2012, the Claimant earned interest in the amount of € 1,403,000 (point III.2.3.2.1 of the Tax Inspection Report) relating to shareholder loans of € 9,200,000 made to H… in 2008 (in the total initial amount of € 19,200,000), and in which 2012, given the merger that had meanwhile occurred, constituted financings to B….

• With regard to the fiscal year 2012 the Tax Authority considered not accepted for tax purposes, by application of section j) of number 1 of article 45 of the CIT Code, financing expenses in the amount of € 708,068.72 (As per point III.2.2.3.1 of the Tax Inspection Report).

• Of the amount of € 708,068.72 disregarded by the Tax Authority, it is decomposed as follows (as per points III.2.2.3 and III.2.2.3.1 of the Tax Inspection Report and article 23 of the Company Bylaws):

• Amount relating to financing expenses from shareholder loans made by shareholders Fund C… and M…: € 582,492.38 + € 3,546.74 + € 3,753.97 + € 105,115.20 (in a total of € 694,908.29)

• Amount relating to financing expenses from shareholder loans made by the remaining shareholders: 3 x € 4,386.81 (in a total of € 13,160.43)

• With regard to the same fiscal year, of the remaining financing expenses in the amount of € 2,250,567.85 (corresponding to the total expenses of € 2,958,636.57 minus non-accepted expenses of € 708,068.72), the Tax Authority further considered not accepted for tax purposes the amount of € 1,002,476.07 by application of no. 2 of article 32 of the Tax Benefits Statute (Point III.2.4 of the Tax Inspection Report).

• For the calculation of financing expenses not accepted for tax purposes by application of no. 2 of article 32 of the Tax Benefits Statute, the Tax Authority made use of the application of the provision in Circular no. 7/2004 of 30 March, Point 2.2 of the Tax Authority's Response to the Administrative Review).

• Within the scope of the Tax Inspection Order [OI 2015…] the Claimant was subject to internal tax inspection of limited scope in relation to the taxation period of 2012 and CIT [As per administrative proceedings file, page 6 of the Tax Inspection Report].

• The Claimant was notified of the Report of that Tax Inspection through official letter no. 027412 of 21 June, in which two corrections were determined:

• Correction, pursuant to article 45-1/j) of the CIT Code, to the amount of interest on shareholder loans in the amount of €708,068.72 and

• Correction of financial expenses not accepted for tax purposes under article 32-2 of the Tax Benefits Statute, in the amount of €1,002,476.07

• Such corrections resulted in an alteration to the tax loss determined by the Claimant in the taxation period of 2012: from an initial amount of €2,023,926.00 to the amount of €313,381.21 [Cf. pages 34/37 of the Tax Inspection Report in the attached administrative proceedings]

• The Claimant filed an Administrative Review against the assessment resulting from the aforementioned corrections, arguing the illegality of the corrections determined;

• This Administrative Review was rejected by dispatch of 21 March 2017 of the Assistant Director of Finance of the Finance Department of Lisbon (cf. Doc 1, attached with the Petition for Arbitral Decision and Administrative Proceedings File)

A.2.2 Facts Not Established

There are no other essential facts, either established or not established, that are essential for the decision of the dispute.

II REASONING (cont.)

B. THE LAW

• The subject matter of the present arbitral process is the challenge to the additional CIT assessment no. 2016…, relating to the fiscal year 2012 and respective statement of reconciliation of accounts no. 2016… (compensation no. 2016…), as well as the dispatch of 21 March 2017 of the Assistant Director of Finance of the Finance Department of Lisbon.

• The Tribunal does not have the duty to rule on all the matters alleged, but rather has the duty to select only those that are relevant to the decision, taking into account the cause (or causes) of action that supports the claim filed by the claimant (cf. articles 596 no. 1 and 607 nos. 2 to 4 of the Civil Procedure Code, as amended by Law 41/2013 of 26/6) and to state whether it considers them proved or not proved (cf. article 123 no. 2 of the Tax Procedure and Process Code).

• According to the principle of free assessment of evidence, the Tribunal bases its decision, in relation to the evidence produced, on its intimate conviction, formed from the examination and evaluation it makes of the means of proof brought to the process and in accordance with its experience of life and knowledge of persons (cf. article 607, no. 5 of the Civil Procedure Code, as amended by Law 41/2013 of 26/6). Only when the probative force of certain means is pre-established in law (e.g., full probative force of authentic documents - cf. article 371 of the Civil Code) does the principle of free assessment of evidence not dominate the evaluation of evidence produced.

I - The correction by application of section j) of number 1 of article 45 of the CIT Code:

• General Framework:

The Claimant alleges in the initial petition that the Tax Inspection Services applied blindly and arbitrarily article 45, number 1, section j) of the CIT Code (in accordance with the wording in force at the time of the facts) to the interest expenses incurred with the shareholder loans obtained from all shareholders of the Claimant, ignoring the provision in Regulation no. 184/2002 of 4 March.

Let us examine this:

• Regulation no. 184/2002 of 4 March provides that "to situations to which the regime established in article 58 of the CIT Code and Regulation no. 1446-C/2001 of 21 December apply (…) the provision in section j) of no. 1 of article 42 of the CIT Code does not apply" [article 45-1/j), CIT Code/2012: "(…) The following are not deductible for the purpose of determining taxable profit (…) interest and other forms of remuneration of shareholder loans and borrowings made by shareholders to the company, insofar as they exceed the value corresponding to the 12-month Euribor reference rate on the date the debt was incurred or another rate defined by regulation of the Minister of Finance using that rate as the index]

• Number 1 of article 58 of the CIT Code, subsequently renumbered to 63, provides that "in commercial transactions, including in particular transactions or series of transactions relating to goods, rights or services, as well as in financial transactions, carried out between a taxpayer and any other entity, whether subject to CIT or not, with which it is in a situation of special relations, terms or conditions substantially identical to those which would normally be agreed, accepted and practiced between independent entities in comparable transactions must be agreed, accepted and practiced."

• And the same article, in its number 4, considers that there are special relations between two entities in situations in which one has the power to exercise, directly or indirectly, significant influence on the management decisions of the other, which is considered to be verified, in particular, between: (a) an entity and the holders of its respective capital, or the spouses, ascendants or descendants of these, who hold, directly or indirectly, a participation of not less than 10% of the capital or voting rights (…).

• Thus, all transactions that the Claimant will carry out with its shareholders whose holding percentage is above 10% must be agreed, accepted and practiced under conditions substantially identical to those that would be agreed, accepted and practiced between independent entities.

• The fact that there is no transfer pricing file does not eliminate the obligation to practice terms substantially identical to those practiced between independent entities.

• In fact, Regulation 1446-C/2001 of 21 December provides that the maintenance in an organized manner of information and documentation relating to the policy adopted in the determination of transfer prices is an ancillary obligation of the taxpayer, from which it can even be exempt if, in the previous fiscal year, it has achieved an annual value of net sales and other revenues less than € 3,000,000. From this exemption (which does not exclude the possibility of the Claimant being within it) does not result the inapplicability of the transfer pricing regime, but only the obligation to maintain a set of information of complex and expensive processing.

• To the contrary of what the Tax Authority concluded, the Claimant concluded by the existence of an amount of non-deductible interest of €708,068.72, a value that includes interest relating to shareholders D…, E… and F… with which there were no special relations in the aforementioned terms.

• Thus, as regards shareholders Fund C… and G…, the Tax Authority should have followed the path of investigating whether or not there was compliance with the provision in number 1 of article 58 of the CIT Code (subsequently renumbered to 63, as already mentioned) for the purposes of correction to the amount of financing expenses relating to shareholder loans. Indeed, consisting as these are of transactions carried out between related parties, the provision in article j) of no. 1 of article 42 of the CIT Code does not apply to them, as per Regulation no. 184/2002 of 4 March.

• In summary: the Claimant contests the correction based on the combined interpretation of article 63 of the CIT Code and Regulation no. 184/2002 insofar as situations to which the regime of article 58 of the CIT Code applies in conjunction with Regulation no. 1446-C/2001 as well as those conventional situations relating to transfer prices, the provision in article 42-1/j) of the CIT Code does not apply.

• The Transfer Pricing Regime:

• The "transfer pricing" regime constitutes an anti-abuse clause, through which it is intended to prevent "related entities" - entities between which there are special relations as provided in number 4 of article 63 (corresponding to the previous article 58) of the CIT Code (CIT Code) - in the relations they develop between themselves, establish, agree to, or practice transactions, as described in article 9 of the OECD Model Tax Convention and in number 1 of article 63 (ex-58) of the CIT Code, that are substantially different from those that would be agreed between independent entities.[1]

• It is intended, with the transfer pricing regime, that the taxation of transactions between entities that maintain special relations be made on the basis of the values that would be agreed in normal market situations, giving the tax administration the possibility of making the corrections it deems necessary to the taxable income of a taxpayer so that this result, for exclusively tax purposes, is what it should be under normal market conditions, thereby purging it of the fiscal effects attributable to the specialness of the relations between the parties (thus, v. decision rendered in process no. 300/2013-T).

• It has been settled understanding that the legal prerequisites for the Tax Authority to be able to correct the taxable matter under the previous article 58 and current article 63 of the CIT Code are as follows (thus, cf., among others, the Court of Appeal of the South Administrative Court, case no. 01573/98 of 9.4.2002 and, in identical sense, the decision rendered in process no. 300/2013-T):

a) The existence of special relations between the taxpayer and another person;

b) That between them terms different from those normally agreed between independent persons have been established;

c) That such special relations are an adequate cause of such terms;

d) That they have led to a profit determined different from that which would be determined in their absence.

• The legislator intends, in this way, to limit the possible abuses that transactions between entities with close relations – "special relations" – could imply in the face of (eventual) concertation of the terms and conditions under which they contract.

• In other words, the regime consists of the pricing policy that prevails in the internal relations of interdependent companies, which due to special relations can generate the fixing of artificial prices, different from market prices.

• The transfer pricing regime intends, therefore, to determine the correction of the price practiced intra-group, if appropriate.[2]

• Whenever there are special relations (e.g., due to the fact that the participating entity holds a percentage equal to or greater than 10 percent of the capital of the participated company), compliance with the provision in number 1 of article 58 of the CIT Code (current article 63) must consequently be ensured, that is, in commercial transactions, including in particular transactions or series of transactions relating to goods, rights or services, as well as in financial transactions, terms or conditions substantially identical to those that would normally be agreed, accepted or practiced between independent entities in comparable transactions must be agreed, accepted and practiced.

• This means that, functioning as article 58 of the CIT Code (current article 63) as an anti-abuse clause, typically at the disposal of the Tax Administration, verifying special relations as provided in number 4 of article 58 (current no. 4 of article 63), and if the parties do not observe the conditions that would be agreed between independent persons, corrections are necessary to restore taxation in accordance with market values or at arm's length (thus, cf. decision rendered in process no. 239/2015-T of the Tax Arbitration Council, paragraphs 59 and 60 and, in identical sense, decision rendered in process no. 733/2015-T).

• The arm's length principle emerges here as the paradigm of the transfer pricing regime, around which a broad international consensus has been established, as it is understood that its adoption allows not only to establish parity in the tax treatment of companies integrated in international groups and independent companies but also to neutralize certain tax evasion practices and ensure the consequent protection of the internal tax base (cf. preamble of Regulation no. 1446-C/2001 of 21 December).[3]

• The arm's length principle thus ensures that all economic operators are treated in the same manner with regard to the determination of the tax base for income tax purposes, regardless of whether they are part of a group or are independent entities in the market.

• The Assumption of Special Relations for Application of the Transfer Pricing Regime:

• The existence of special relations between the parties constitutes a fundamental and essential prerequisite for application of the transfer pricing regime, which, once verified, will be qualified as "related parties."

• Once the existence of a transaction between parties linked by special relations is confirmed, as defined in law, the arm's length principle must be observed, without the need for demonstration of additional elements, such as an abusive intent of the participants (cf. no. 1 of art. 63 of the CIT Code, no. 1 of art. 1 of Regulation no. 1446-C/2001, as well as no. 3 of art. 77 of the General Tax Law) (in this sense, cf. decision rendered in process no. 733/2015-T).

• The concept of special relations is, therefore, fundamental for framing the application of the transfer pricing regime and is essential to verify whether or not special relations exist when analyzing the prices practiced between two companies.

• This concept is provided for in article 9 of the OECD Model Tax Convention on Income and Wealth and in number 4 of article 63 of the CIT Code (and, as well, in number 4 of article 58 of the previous CIT Code).

• It is true that Regulation no. 1446-C/2001 of 21 December confers on entities that are in a situation of special relations the responsibility of having a set of information and documentation relating to their practices and methodologies adopted in terms of transfer prices.[4]

• But this constitutes an ancillary obligation of those entities.

• Within the framework of tax obligations regarding Transfer Prices, CIT taxpayers who practice transactions with related entities must be in a position to demonstrate, before the Tax Authority, that the terms and conditions practiced in those linked transactions, in each taxation period, observe the arm's length principle, and should do so, under normal conditions, in the Transfer Pricing Tax File.

• It is intended, in this way, that, upon the verification of the existence of special relations between two entities, the Tax Authority demonstrates that the conditions practiced are different from those that would exist between unrelated parties, as a result of a factually analyzed and neutral analysis of the situation that allows it to conclude whether or not there is the establishment of conditions different from the conditions that would normally be agreed (in this sense, although in a different context, cf. decision rendered in Process no. 609/2015-T).

• Pursuant to number 6 of article 63 of the CIT Code, the entity must prepare and make available information and documentation relating to the policy adopted in determining transfer prices, with article 117 of the General Regime of Tax Infractions providing that the failure to present within the period that the tax administration sets documentation regarding the policy adopted on transfer pricing matters is punishable with a fine, for each taxation period in which there is a lack of Transfer Pricing documentation, in cases in which it must exist.

• This ancillary obligation does not apply when the entity, in the previous fiscal year, has a turnover of less than 3 million euros, notwithstanding that it must ensure the verification of the arm's length principle.

• Therefore, and given that the transfer pricing regime is based on two foundational principles - that of arm's length and that of comparability – it is incumbent upon the Tax Authority to demonstrate that the transfer pricing regime was not correctly applied, pursuant to no. 1 of article 74 of the General Tax Law, and the provision in article 77, no. 3 of the CIT Code must also be followed.

• In other words, and as resulted from number 1 of article 58 (current article 63) of the CIT Code and from no. 1 of art. 1 of Regulation no. 1446-C/2001, which refer to the "duty" to agree, accept and practice "terms or conditions substantially identical to those that would normally be agreed, accepted and practiced between independent entities in comparable transactions," the rules on transfer pricing establish, for the purpose of determining the taxable matter, the obligation, for entities in a situation of special relations, to adopt, in the transactions between themselves carried out, criteria for value determination identical to those used by independent entities in equivalent transactions.

• It is the violation of this legal obligation – not the prior detection of any abusive objective – that determines the need for corrections to the taxable matter by the Tax Authority, as concluded from no. 3 of art. 77 of the General Tax Law when it refers to "determining the taxable matter corrected of the effects of special relations" "whenever there is non-compliance with any obligation established in law" for the situation of special relations.

• The Application of the Transfer Pricing Regime in the Specific Case:

• In the case at hand, the applicable regime was clearly that of transfer pricing.

• Indeed, it was established that there were special relations between the Claimant and shareholders Fund C… and G…, since these held a social participation greater than 10% (cf. article 58, no. 4, section a) of the CIT Code) in the capital of the former, which is why in the commercial transactions carried out between them terms substantially identical to those that would be agreed, accepted and practiced between independent entities must be agreed, accepted and practiced.

• One might speculate whether the amount of financing expenses relating to shareholder loans, in this case, and relating to these two shareholders, respected or did not respect conditions substantially identical to those that would be agreed, accepted and practiced between independent entities.

• What is certain is that, being at issue transactions carried out between related parties, the provision in (then in force) article j) of no. 1 of article 42 of the CIT Code did not apply to them, as results from the provision in no. 2 of Regulation no. 184/2002 of 4 March.

• This is because the Claimant was, with respect to those two shareholders, within the scope of application of the transfer pricing regime, given the circumstance that "related entities" were at issue.

• In summary, given the facts established as proved, the relation between the Claimant and shareholders Fund C… and G… was referable to the concept of special relations provided in no. 4 of article 63 of the CIT Code, whereby the shareholder loans granted by shareholders to the Claimant company constituted linked transactions being carried out between related entities, pursuant to section a) of no. 4 of article 63 (former article 58) of the CIT Code and sections b) and d) of no. 3 of article 1 of Regulation no. 1446-C/2001 of 21 December, and were thus subject to compliance with the arm's length principle.

• The Tax Authority should therefore have followed the path of investigating whether or not there was compliance with the provision in number 1 of article 58 of the CIT Code (subsequently renumbered to 63, as already mentioned) for the purposes of correction to the amount of financing expenses relating to shareholder loans.

• For this, it was incumbent upon the Tax Authority to bear the burden of proof, pursuant to articles 74 no. 1 and 77 no. 3 of the General Tax Law.

• In proceeding with any eventual correction, the Tax Authority could require from the taxpayer the information that would allow it to verify compliance with the legal requirements of elements relating to transfer pricing, in particular compliance by the linked transaction with the arm's length principle, knowing that the non-existence or non-provision of that information by the Claimant could lead to the application by the Tax Authority of fines, by virtue of non-compliance with ancillary obligations, as well as to the subsequent correction of the observed values.

• However, the Tax Authority did not do so in the case sub judice, because it completely disregarded the application of the transfer pricing regime, despite the fact that, with regard to two of the shareholders - Fund C… and G… - there were related entities at issue, which determined the application of the provision in no. 2 of Regulation no. 184/2002 of 4 March.

• Given all of the above, the Claimant is upheld as regards the tax correction determined by the Tax Authority in the amount of 694,908.29€ relating to the interest on shareholder loans of shareholders Fund C… and G….

• The Claimant's claim is dismissed as regards the tax correction determined by the Tax Authority in the amount of 13,160.43€ relating to the interest on shareholder loans of shareholders D…, E… and F…, because there are no special relations with these shareholders and there is therefore no place for the application of the transfer pricing regime for the purposes of the provision in no. 2 of Regulation no. 184/2002 of 4 March.

II Correction to Financial Expenses Under Article 32-2 of the Tax Benefits Statute.

1. The respondent Tax Authority considers that H…, S.A., a company participated in by the Claimant, acquired company B…, S.A. and this later came to be directly controlled by the Claimant, which leads it to conclude that it was an onerous acquisition, via H…, S.A., which is why the respondent Tax Authority concluded that an acquisition of a capital share is at issue, determining consequently the application of article 32, number 2 of the Tax Benefits Statute to the situation sub judice.

2. In a different sense, the Claimant understands that, after its incorporation in 2008, the participated company H…, S.A. was created, which in that same taxation period acquired company B…, S.A. and that the Claimant in the period of 2011, following a corporate reorganization operation that took place in the taxation period of 2009, began to directly hold only company B….

3. The Claimant proved that, in its capacity as sole shareholder and in order to provide the participated company H… with funds for the execution of its corporate purpose, it carried out a series of transactions in the total amount of 34,500,000 €.

4. There is a divergence in the qualification of this amount of 34,500,000 €.

5. The Tax Inspection Services and the respondent Tax Authority consider it as the value of acquisition of capital shares.

6. The Claimant considers that it corresponds to the amounts expended in the constitution and provision of funds to the participated company H…, namely through the granting of shareholder loans, financing and supplementary contributions.

7. Consequently, the Claimant understands that the financing expenses incurred by the Claimant cannot be attributed to a transaction for the acquisition of capital shares using financing, since said acquisition never existed.

8. The Claimant understands that, given that said amount of 34,500,000€ was not used for the acquisition of capital shares – a prerequisite on which application of article 32, number 2 of the Tax Benefits Statute depends – there is an error as to the factual and legal assumptions with regard to the correction carried out by the Tax Inspection Services, which must determine the annulment of the CIT assessment.

9. The question that arises is therefore whether the concept of "capital shares" integrates only social participations or also integrates supplementary contributions.

Having set forth this introduction and raised the issue sub judice, the concept of "capital shares" contained in article 32, number 2 of the Tax Benefits Statute must be analyzed for subsequent subsumption to the specific case.

1. In seeking the scope of application of number 2 of article 32 of the Tax Benefits Statute we can make use of the vast jurisprudence existing on this matter.

• In process 258/2013-T of the Tax Arbitration Council the question (and the doctrinal and jurisprudential divisions) were centered in the following manner:

"Insofar as article 32, number 2 of the Tax Benefits Statute did not define what it meant by "financial expenses," part of the doctrinal and jurisprudential discussion focused on the definition of what could be understood by "capital share," since from that definition – largely sought independently of what already resulted from Circular 7/2004 – there would result an object more broad or more restricted in scope of application of the regime of no. 2 of art. 32 of the Tax Benefits Statute. From the search for the concept of "capital shares" two understandings emerged:

• "Minimalist" understanding: if it were understood that the reference was to the notion of "share capital" (social participations, shares or quotas), privileging the "commercial" view from which the figure of "supplementary contribution" is excluded, the scope of no. 2 of art. 32 of the Tax Benefits Statute would be restricted – and concomitantly increased the possibilities of consideration of financial expenses as costs fiscally deductible;

• "Maximalist" understanding: if it were understood that the reference was to "equity capital," privileging the "accounting" sense and integrating in it the figure of "supplementary contribution," the scope of no. 2 of art. 32 of the Tax Benefits Statute would be enlarged – and concomitantly reduced the possibilities of consideration of financial expenses as costs fiscally deductible.

This difference in consequences profoundly conditioned the discussion, even doctrinal, prevailing the opinion that the reference to "capital share" in art. 32, number 2 of the Tax Benefits Statute refers to shares of share capital, thus excluding from the incidence of that norm "supplementary contributions" (which, being "components" of "equity capital," would not be "capital shares") – thus subscribing to a "minimalist" understanding as to the incidence of art. 32, number 2 of the Tax Benefits Statute.

In concrete terms, the "minimalist" understanding materialized in the following regime: only interest linked to the acquisition of capital shares (specifically: shares or quotas) would be disregarded for tax purposes; those connected with (third-party) capital used in supplementary contributions, or in ancillary contributions that followed the regime of supplementary contributions (including the coverage of losses), by not being included, or being able to be included, in the concept of "share capital," would be of the nature of costs fiscally deductible.

• It would therefore be a matter of harmonizing art. 32, number 2 of the Tax Benefits Statute with art. 45, number 3 of the CIT Code regarding the understanding of what "capital shares" are for tax purposes, and of subtracting those supplementary contributions (and their equivalents) from the regime of art. 32, number 2 of the Tax Benefits Statute, submitting them exclusively to the requirements of indispensability of art. 23 of the CIT Code (except for the special cases of nos. 3 to 5 of art. 23 of the CIT Code in the version then in force)."

• In seeking an interpretation on the concept of supplementary contributions for the specific case, consideration must be given (and accepted) to the interpretation carried out in the decisions of the Tax Arbitration Council no. 9/2012-T, 69/2012-T, 12/2013-T, 24/2013, 39/2013-T and 113/2013-T.

• This last decision is resumed – 113/2013-T – by transcribing the understanding adopted therein on "capital shares" and "supplementary contributions" for the purposes of application of article 32, number 2 of the Tax Benefits Statute:

"The Tax Benefits Statute (approved by Decree-Law no. 215/89 of 1 July) as well as the remaining tax legislation does not contain the definition of "capital shares" for tax purposes. Thus, the need for application of the provision in art. 11 of the General Tax Law arises, which establishes the rules for interpretation of tax norms.

Notwithstanding the non-existence of the aforementioned definition, in systematic terms the legislator clearly separates the concept of capital shares from the concept of equity capital in no. 3 of article 45, in the wording given to it by Law no. 60-A/2005 of 30 December:

The negative difference between gains and losses realized through the onerous transfer of capital shares, including their redemption and amortization with capital reduction, as well as other losses or negative patrimonial variations relating to capital shares or other components of equity capital, in particular supplementary contributions, shall contribute to the formation of taxable profit at only half of their value.

That is, the legislator uses the concept of equity capital in the exact commercial and accounting sense, which allows concluding that, having regard to the literal and systematic elements, the concept of "capital" in the expression "capital shares" is not synonymous with "equity capital," with supplementary contributions and loss coverage being expressly included in the latter.

On the other hand, the non-existence of a tax definition of "capital shares" leads the interpreter – in observance of the aforementioned art. 11 of the General Tax Law – to seek that definition in commercial law and in accounting law, having regard, in the latter case, to the model of partial dependence that is established between accounting and tax law in the determination of taxable profit.

Supplementary contributions "are cash inputs that can be made by shareholders of a limited liability company for strengthening its assets, beyond share capital, not earning interest and that can be returned to them, which are not included in the share capital of the company" (Luís Brito Correia, Commercial Law, 2nd vol., 1989, p. 297). In the specific case of joint-stock companies, the shareholders conferred on supplementary contributions the nature of supplementary contributions and, consequently, the rules provided in articles 210 to 213 apply to them.

Pursuant to number 1 of article 210, supplementary contributions can only be required of shareholders if they are provided for in the bylaws which must establish: (i) the overall amount of supplementary contributions; (ii) the shareholders who are obliged to make supplementary contributions among the shareholders obliged to make them and (iii) the criteria for the distribution of supplementary contributions among the shareholders obliged to make them.

The limitations on the return of supplementary contributions provided for in article 213 are one of the most important characteristics – if not the most important – of this institution: supplementary contributions can only be returned to shareholders when the following conditions are met: (i) provided that the net equity does not fall below the sum of capital and legal reserve; (ii) the shareholder has already paid their quota and (iii) insolvency of the company has not been declared.

This regime is clearly distinct from the obligation of contributions to share capital (articles 25 to 30 of the Commercial Companies Code and special rules for general partnerships – 176 no. 1, al. a), 178 and 179; for limited liability companies – 202 to 208 and for joint-stock companies – 277 and 285 and 286).

In the same sense, entries made for loss coverage aim to strengthen equity capital and the financial position of the company through the cancellation of negative carried forward results.

In accounting terms, supplementary contributions and entries for loss coverage integrate, together with other items – namely share capital – the so-called equity capital of the entity – residual interest in the company's assets after deducting all of its liabilities (Cf. paragraph 49 of the Conceptual Framework, Notice no. 15652/2009 in Official Gazette no. 173 – II Series of 7 September).

However, the aggregation in equity capital of the item of share capital, supplementary contributions and loss coverage does not mean the uniformization of its nature. In any case, equity capital and share capital are not synonymous, particularly because only share capital is transferable.

From all of the above, it is concluded that the application of the regime of article 32 no. 2 of the Tax Benefits Statute to financing expenses incurred with ancillary contributions in the form of supplementary contributions and loss coverage has no legal basis, since such credits do not meet the concept of capital shares."

• In summary, it is understood that no. 2 of article 32 of the Tax Benefits Statute does not equate supplementary contributions with capital shares, since this does not result from either the letter or the spirit of the law.

• It accordingly follows the conclusions set forth in the decisions of the Tax Arbitration Council contained in processes 12/2013-T; 24/2013-T; 39/2013-T; 80/2013-T and 113/2013-T.

• Without prejudice to the various arguments presented in those arbitral decisions, it is commonly stated that "the concept of capital shares used in art. 32, number 2 of the Tax Benefits Statute has the same meaning as in article 45, number 3 of the CIT Code: it is limited to the notion of capital shares as capital participations (shares or quotas), without extending to the figure of supplementary or ancillary contributions" (cf. arbitral decisions no. 80/2013-T and 113/2013-T of the Tax Arbitration Council).

• As such, neither could the Tax Inspection Services nor can the respondent Tax Authority consider that the provision of funds carried out by the Claimant, in its capacity as sole shareholder, in favor of the participated company H…, for the execution of its corporate purpose, in the total amount of 34,500,000 €, was equivalent to the value of acquisition of capital shares for the purposes of no. 2 of article 32 of the Tax Benefits Statute.

• Additionally, examining the question from another perspective

From the facts established as proved nos. 3 to 6 it follows that:

• between July and September 2008, the Claimant received funds under different titles totaling approximately 34.6 million euros;

• in September of that same year, the Claimant incorporated H…, transferring funds to it in the amount of 34.5 million euros;

• also in that year, H… acquires B… for a value corresponding to also 34.5 million euros;

• in December 2009, the Claimant begins to directly hold B… after reverse merger of H… into B….

• The proximity, and even coincidence, of values so elevated, of dates of occurrence of incorporation of companies and subsequent merger so close and of origins of funds so synchronized with their application with determined intent is unambiguous, and it is legitimate to argue that there existed in substantial terms a manifest acquisition of B… by the Claimant, although in an initial phase intermediated by a third company.

• Indeed, it is legitimate to argue that in 2008 the Claimant was incorporated, providing it with the necessary funds to be transferred to H…, with the objective of the latter acquiring, with those same funds, B…. Slightly more than one year later, H…, the instrumental company for the acquisition, is liquidated, resorting to a reverse merger operation, concretizing the sole objective of direct holding of B….

• Following this line of argument, and concluding by the acquisition of B… by the Claimant for the value of 34.5 million euros, the question follows as to the origin of the funds that financed such acquisition.

• As per fact established no. 3, the Claimant resorted in 2008 to remunerated financing that it used for the incorporation of H… (with a view, as was seen, to the acquisition of B…) in the amount of € 19,200,000 and € 97,175.96 while shareholder loans, and € 10,500,00 while financing.

• Part of the funds referred to above subsist in 2012, the year to which the tax corrections relate, from which it is inferred that the Claimant resorted to external remunerated funds to finance the acquisition of B…, although not in the full amount of the value of acquisition of B…, which, as was inferred, would be 34.5 million euros.

• Having said this, that is, knowing that the Claimant financed itself externally to acquire B…, it is of interest to analyze whether or not it would be estimable in a direct manner the amount of interest incurred in 2012 relating to financing used by the Claimant for such acquisition.

• Now, part of the funds that in 2008 were transferred by the Claimant to H… subsist in 2012 as remunerated loans that yield interest, loans which, as already inferred, are unequivocally related to the acquisition of B….

• That is, it does not seem unfeasible to directly determine the funds obtained by the Claimant that were necessary for the acquisition of B….

• But, in truth, the respondent Tax Authority so considered when it resorted to the application of Circular 7/2004, opting to make an unjustified extensive interpretation, insofar as, on the one hand, it considered the existence of an acquisition of financial participation for € 34,500,000, independently of the value and description by which it appears in the Assets of the Claimant on 31 December 2012, and on the other hand used values actually contained in the Assets to determine proportions of financing of asset elements by liability elements.

• That is, what the Tax Authority did was a determination of the acquisition value by observation of the economic substance of corporate incorporation and reorganization, and the calculation of interest associated with financing necessary for such acquisition, not by the same method of observation of economic substance of transactions, but by indirect application of calculations resulting from observable and non-observable elements in the Balance Sheet of the Claimant as of 31 December 2012.

• Thus, and in line with the provision in the Arbitral Decision relating to process 379/2017, if the Tax Authority considers there to have been an acquisition stating that "the funds obtained between 2008 and 2012 were intended for the acquisition of capital shares in B…," then the same Tax Authority could have directly determined the funds necessary for the acquisition of B….

• Being possible the direct determination of those funds, and consequently of the financing expenses associated, it is considered, once again in line with Arbitral Decision 379/2017, that the Tax Authority misinterpreted no. 2 of article 32 of the Tax Benefits Statute by inadvertently using the presumptions of Circular 7/2004.

• It is thus concluded by the existence of an error as to factual and legal assumptions with regard to the correction carried out by the Tax Inspection Services, which must determine the annulment of the CIT assessment of the Claimant in the part relating to the correction to financing expenses not accepted for tax purposes under article 32, number 2 of the Tax Benefits Statute, in the amount of 1,002,476.07€.

C. DECISION

It is decided in this Arbitral Tribunal to declare the arbitral claim partially upheld and, in consequence:

• To consider the arbitral claim upheld with respect to the examination of the legality of the act of assessment of Corporate Income Tax and augmented with no. 2016…, relating to the fiscal year 2012 and respective statement of reconciliation of accounts no. 2016… (compensation no. 2016…) and of the decision to dismiss the administrative review, in the part relating to the correction, pursuant to article 45, number 1, section j) of the CIT Code to the amount of interest on shareholder loans, in the value of 694,908.29€ relating to the interest on shareholder loans of shareholders Fund C… and G…;

• To consider the arbitral claim dismissed as regards the examination of the legality of the act of assessment of Corporate Income Tax and augmented with no. 2016…, relating to the fiscal year 2012 and respective statement of reconciliation of accounts no. 2016… (compensation no. 2016…) and of the decision to dismiss the administrative review, in the part relating to the correction, pursuant to article 45, number 1, section j) of the CIT Code to the amount of interest on shareholder loans, in the value of 13,160.43€ relating to the interest on shareholder loans of shareholders D…, E… and F…;

• To consider the arbitral claim upheld as regards the examination of the legality of the act of assessment of Corporate Income Tax and augmented with no. 2016…, relating to the fiscal year 2012 and respective statement of reconciliation of accounts no. 2016… (compensation no. 2016…) and of the decision to dismiss the administrative review, in the part relating to the correction to financing expenses not accepted for tax purposes under article 32, number 2 of the Tax Benefits Statute, in the value of 1,002,476.07€

• To condemn the Claimant and Respondent in the costs of the process in the proportion fixed below.

D. VALUE OF THE PROCESS

The value of the process is fixed at 1,710,544.79€ (one million seven hundred and ten thousand five hundred and forty-four euros and seventy-nine cents), pursuant to article 97-A, number 1, a) of the Code of Tax Procedure and Process, applicable by virtue of sections a) and b) of number 1 of article 29 of the RJAT and of number 2 of article 3 of the Regulation of Costs in Tax Arbitration Processes.

E. COSTS

Under article 22, number 4 of the RJAT, and in accordance with Table I attached to the Regulation of Costs in Tax Arbitration Processes, the amount of costs is fixed at € 22,644.00 (twenty-two thousand six hundred and forty-four euros), in the proportion of the respective losses, with 0.77% (174.36€) to be borne by the Claimant and 99.23% (22,469.64€) to be borne by the Tax and Customs Authority.

• Notice of this decision be given.

Lisbon, 26 January 2018

The Collective Arbitral Tribunal

José Poças Falcão
(President Arbitrator)

Nuno Cunha Rodrigues
(Arbitrator Vogal)

Luísa Anacoreta
(Arbitrator Vogal)

[1] The OECD understands that transfer prices are prices through which a company transfers tangible goods, intangible assets or provides services to associated companies which result in an indirect transfer of profits, in which the price established differs from the fair price.

V. OECD - "Principles applicable to transfer pricing for multinational enterprises and tax administrations," Notebook of Science and Tax Technique no. 189, Ministry of Finance, Lisbon, 2002, Paragraph 11 of the Foreword of the OECD Report on transfer pricing.

[2] Thus, cf. FRANCISCO DE SOUSA DA CÂMARA and BRUNO SANTIAGO, "Analysis of some aspects of the Domestic Transfer Pricing Regime and its Relationship with Tax Law," Studies in Honor of Professor Doctor Paulo Pitta, Vol. II – Economy, Public Finance and Tax Law, Almedina, 2010, p.165.

[3] In identical sense, v. § 1.2 of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations: "a tax adjustment under the arm's length principle would not affect the underlying contractual obligations for non-tax purposes between the associated enterprises, and may be appropriate even where there is no intent to minimize or avoid tax. The consideration of transfer pricing should not be confused with the consideration of problems of tax fraud or tax avoidance, even though transfer pricing policies may be used for such purposes".

[4] This is the Regulation referred to in no. 13 of article 63 of the CIT Code, which provides as follows: "The application of transfer pricing determination methods, whether to individualized transactions or to series of transactions, the type, nature and content of the documentation referred to in no. 6 and the procedures applicable to correlative adjustments are governed by regulation of the Minister of Finance".