IRC Cost Deductibility Under Article 23 CIRC: CAAD Arbitration Case 381/2018-T Analysis

ARBITRAL DECISION

I – REPORT

On 10 August 2018, A..., Lda., Tax Identification Number..., with registered office at Rua ..., no...., Lisbon, hereinafter referred to as the "Claimant", requested the constitution of an Arbitral Tribunal and submitted a request for arbitral pronouncement, pursuant to paragraph a) of article 2(1) and paragraph a) of article 10(1) of Decree-Law no. 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter referred to only as RJAT), with a view to obtaining a declaration of illegality of the Corporate Income Tax (IRC) assessment acts no. 2018... and no. 2018..., and respective compensatory interest, relating to the fiscal years 2014 and 2015, in the amount of €10,386.40 and €10,262.66, respectively, totalling €20,841.83 (twenty thousand, eight hundred and forty-one euros and eighty-three cents), and consequently, the annulment of the disputed assessments.

The Claimant is represented, in the scope of these proceedings, by its representative, Dr. B..., and the Respondent, the Tax and Customs Authority (hereinafter referred to as AT), is represented by legal counsels, Dr. C... and Dr. D....

Following verification of the formal regularity of the request, pursuant to paragraph a) of article 6(2) of the RJAT, the undersigned was designated by the President of the Deontological Council of CAAD as arbitrator.

The Arbitrator accepted the designation made, with the Arbitral Tribunal being constituted on 19 October 2018, at the registered office of CAAD, located at Avenida Duque de Loulé, no. 72-A, in Lisbon, as confirmed by the communication of constitution of the Arbitral Tribunal which is attached to these proceedings.

After being duly notified, the Respondent submitted its reply on 23 November 2018, having presented its defence by way of exception, which the Tribunal decided to rule upon only at the time of final judgment, and by way of substantive challenge.

On 10 December 2018, the Claimant submitted a request exercising the right of contradiction regarding the exception raised by the Respondent.

As there was no need for production of additional evidence beyond that which was already incorporated in the proceedings in documentary form, and as there was no apparent need for the parties to correct their respective procedural documents, with the proceedings containing all necessary elements for rendering the decision, on grounds of procedural economy and expedition, and the prohibition of performance of unnecessary acts, the Tribunal decided to dispense with holding the hearing referred to in article 18 of the RJAT, by means of an order issued on 14 December 2018, granting successive ten-day periods to the Claimant and Respondent, in that order, to submit their respective written submissions.

In that same order, the Tribunal, in compliance with article 18(2) of the RJAT, set 19 April 2019 for pronouncement of the arbitral decision, having warned the Claimant that it should proceed with payment of the subsequent arbitral fee, pursuant to article 4(3) of the Regulation of Costs in Tax Arbitration Proceedings, and communicate such payment to CAAD.

On 4 January 2019, the Claimant submitted a request whereby it attached to the proceedings documentary evidence contained in a CD-Rom; such attachment was granted by means of an order of 8 January 2019.

The Claimant and Respondent submitted their submissions on 9 January 2019 and 18 January 2019, respectively.

On 12 March 2019, the Respondent submitted a request to the proceedings, whereby, and in the sequence of the exception raised, it attached the arbitral decision rendered in case no. 379/2018-T, of 11.03.2019, an attachment that was admitted by means of an order of 19 March 2019, granting a ten-day period for the Claimant to pronounce itself under the principle of contradiction.

On 29 March 2019, the Claimant submitted a request in response to the order indicated above in item 11, in compliance with the principle of contradiction which the Arbitral Tribunal admitted.

II. The Claimant Sustains Its Request, In Summary, As Follows:

The Claimant sustains the request for a declaration of illegality of the Corporate Income Tax assessment acts no. 2018... and no. 2018..., and respective compensatory interest, relating to fiscal years 2014 and 2015, in the amount of €10,386.40 and €10,262.66, respectively, totalling €20,841.83 (twenty thousand, eight hundred and forty-one euros and eighty-three cents), and its consequent annulment, as follows:

The Claimant invokes error regarding the factual and legal premises, considering that "the Tax Inspection Services equally highlighted the fact that, during the course of the inspection procedure, they notified the Claimant for justification and identification of services supported in documents issued by E... (...) with the Claimant providing the clarifications which constitute Annex 4 to the respective Tax Inspection Report Project (...) joining to the procedure hundreds of documents evidencing the services provided by company E..., Lda, during fiscal years 2014 and 2015. (...) More specifically, the Claimant reiterated, in the exercise of the right to a hearing, that company E..., Lda, provided continuous support to the Claimant in the said fiscal years 2014 and 2015, both in advisory services and specialized administrative support in diverse areas, resorting to specialized technical work of its own, or to external collaborators hired for such purpose, according to the requests and needs of the Claimant. The Claimant equally emphasized that the services provided by company E..., Lda, enabled the simultaneous development of various activities generating taxable income in VAT and IRC contexts, activities which otherwise would have been impossible to carry out due to lack of human resources for their implementation."

Indeed, the Claimant further states that "evidencing the services concretely provided by company E..., Lda, the Claimant attached to the inspection procedure various documents extracted from the electronic mail account that was created as a work platform for the execution of the referred activities of administrative support, technical assistance and project management (...)".

The Claimant clarifies that "it intends, through the present request for arbitral pronouncement, to challenge the tax acts above identified in the part in which they are consequent to the correction made to IRC for fiscal years 2014 and 2015, that is, in the part in which such acts translate the disregard of "(...) expenses incurred in invoices issued by E..., Lda (...) which, in fiscal years 2014 and 2015, total €43,500.00 and €42,500.00, respectively", since "(...) the mentioned correction to IRC for fiscal years 2014 and 2015 of the Claimant was based on the fact that the invoices embodying such expenses had generic descriptions, that is, because 'the services actually performed, nor the quantities or dates of their completion were not specified(...), which led the Tax Inspection Services to conclude that there was non-compliance with 'the legal requirements provided in article 36(5) of the VAT Code, leading the Tax Authority not to accept the deduction of the corresponding VAT by virtue of article 19(2)(a) of the VAT Code and non-acceptance of the associated expenses by virtue of article 23 of the IRC Code.'"

In fact, the Claimant considers that "the correction performed was based on error regarding its legal premises, insofar as it attributed to article 36 of the VAT Code a scope which, in the concrete case, not only proves to be contrary to Union Law (as it has been interpreted and established by the Court of Justice of the European Union "CJEU") but also conflicts with the jurisprudence that has been established by this arbitral instance."

The Claimant states "In summary, it is possible to conclude that both community and national jurisprudence has admitted that non-compliance with the formal requirements prescribed for invoice issuance (namely, the lack of identification of the 'quantity and usual denomination of goods transmitted or services provided'), is not capable of preliminarily prejudicing the exercise of the right to tax deduction by the respective purchaser, and that it should be allowed to the latter (unrelated to the invoice issuance act), the subsequent proof of the requirements upon which the exercise of such right to deduction depends through the evidentiary means at its disposal." The Claimant continues in the sense that "Now, the pointed conclusion, although established in the VAT domain, can be directly transposed to the IRC context, insofar as article 23(4) and (6) of the IRC Code make the deductibility of expenses in IRC dependent upon the possession of an invoice issued in accordance with the terms prescribed by the VAT Code (and, therefore, referring to the weighing of interests performed by the legislator regarding the essentiality of the formal requirements demanded therein)."

The Claimant further argues in support of its thesis that "(...) without prejudice to the generic nature of the descriptions contained in the two invoices issued by company E..., Lda, it is verified that the Claimant attached to the tax inspection procedure a detailed description of the services provided by that entity (and implicit in the invoices issued by it), as well as hundreds of documents evidencing their performance and content (...). Such elements would have allowed the Tax Inspection Services – as it is reasonable to admit – to verify compliance with the material premises upon which the admissibility of such invoices depended since they enabled a detailed analysis of the content of the services concretely provided and their relevance in the context of the Claimant (especially their relevance for obtaining income subject to IRC, as required by article 23 of the IRC Code. In fact, the Claimant proved the content of the services provided by company E..., Lda in the most objective and detailed manner that could be required of any taxpayer, that is by attaching to the inspection procedure not only the details of the services acquired, but equally, the material result of their concrete performance (...) for which reason it is imperative to conclude that, the invoices under consideration being admissible and suitable for purposes of deduction of the respective VAT, they should equally be considered admissible and suitable for proof of the corresponding expenses deductible in IRC, in the terms prescribed by article 23(4) and (6) of the IRC Code."

The Claimant concludes in the sense that "(...) as the Tax Inspection Services disregarded the elements presented by the Claimant during the inspection in a preliminary manner, considering the corresponding expenses non-deductible, they committed error regarding their legal premises, tarnishing the correction made to IRC for fiscal years 2014 and 2015 of the Claimant (and, in that measure, the acts performed under its authority, here contested) with the defect of illegality."

III. In Its Reply the Respondent Invoked, In Summary, The Following:

The Respondent begins its reply by raising a question of prejudiciality, arguing for such purpose that "(...) in the sequence of the corrections undertaken by the Respondent in VAT, and taking into account that the invoices issued by company E... did not contain the legal requirements in article 36(5) of the VAT Code, the fiscal cost was correspondingly not accepted in IRC, in accordance with article 23(4)(c) of the IRC Code. Now, the Claimant, as far as VAT assessments are concerned, (...) initiated a request for arbitral pronouncement, which is pending in this Arbitration Center under no. 379/2018-T (...) and in which the also Respondent herein submitted reply on 2018-11-19."

Now, in fact, the Respondent continues in the sense that: "the tax acts here reviewed are nothing more than a consequence of the premises established in VAT, with article 23(4)(c) of the IRC Code establishing that expenses are not deductible for purposes of determining taxable profit when their documentation does not comply with articles 23(3) and (4) of the IRC Code, that is, expenses must be documented, and when incurred or incurred in the acquisition of goods or services, the supporting document must contain, at least, the following elements (...). This means, therefore, that non-acceptance of the expense in IRC, in accordance with article 23(4)(c) of the IRC Code, is nothing more than a consequence of non-compliance with the legal requirements of the invoices as well as lack of proof that such service provisions occurred. Therefore, the present proceedings are in a relationship of prejudiciality relative to Case no. 379/2018-T."

Indeed, the Respondent understands that "(...) it suffices for such purpose to compare the requests for arbitral pronouncement relating to the present proceedings with that of Case no. 379/2018-T, to easily ascertain that the arguments are identical, as well as the factual and legal grounds. (...) It is thus noted that the issue raised in the present proceedings is in a relationship of prejudiciality relative to Case no. 379/2018-T, and could lead to two diametrically opposed and divergent questions on the same matter. Therefore, the issue raised in the present proceedings constitutes a true prejudicial question with framing in article 15 of the Code of Administrative Court Procedure ("CPTA"), pursuant to article 29(1)(b) of the RJAT. In this endeavor, it is incumbent upon this Single Arbitral Tribunal to suspend the present instance, until the question in discussion regarding the legality of invoice requirements and material proof of the alleged service provisions is resolved in Case no. 379/2018-T and consolidated in the legal order."

Concluding in the sense that "[we] request that the present arbitral instance be suspended, with all legal effects, pending decision until it is decided and consolidated in the legal order within the scope of case no. 379/2018-T."

By way of substantive challenge and in response to the alleged error regarding the factual and legal premises, the Respondent defends that: "[w]ithin the scope of the present arbitral proceedings, the Claimant petitions for a declaration of illegality of the IRC tax acts above better identified, basing its claim on error under the factual and legal premises, by attributing to article 36 of the VAT Code a scope that is contrary to Community Law and the jurisprudence emanating from the CJEU."

The Respondent further states that: "[i]t results from the tax inspection report that several invoices of considerable amounts were detected in the Claimant's accounting, issued by company E..., Lda (hereinafter E...) which have dates comprised between 2003 and 2016 and generic descriptions such as "Logistical support", "other works" and "Accounting and management". In fiscal years 2014 and 2015, expenses were recorded in the account "62211-Specialized Works" supported by invoices issued by E... in the amount of €43,500.00 and €42,500.00". Indeed, "[t]aking into account the descriptions of service provision with the mention "Other works" and "Logistical Support", these are manifestly generic in light of what is established in article 36(5)(b) of the VAT Code and do not allow verification of indispensability for obtaining income, in manifest violation of article 23(4)(c) of the IRC Code."

The Respondent further adds that "[i]n the scope of the request for arbitral pronouncement, the Claimant reiterates all the arguments, as well as the evidence produced in the exercise of the right to a hearing regarding the materiality of the operations, reiterating that, in light of the evidence presented, it was demonstrated that company E... provided repeated support in advisory services and specialized administrative support in diverse areas, resorting to specialized technical work or with external collaborators, according to requests and needs of the Claimant", however, the Respondent considers that it is concluded "(...) clearly and evidently from the insufficiency of discrimination of the services actually provided in the invoices issued by company E... in accordance with article 36 of the VAT Code, which prevents control of the substantive premises of the right to tax deduction, provided in articles 19 and 20 of the same legal instrument.", basing its position on CJEU jurisprudence and the VAT Directive.

In fact, the Respondent considers that "it was incumbent upon the Claimant to have proved the substantive conditions required for deductibility of the expense in IRC (the burden of proof of substantive conditions of the right to deduction falls upon the taxpayer, pursuant to article 74(1) of the General Tax Law), which did not occur, insofar as the evidence carried by the Claimant is not apt to demonstrate or complement the performance of the alleged services provided."

The Respondent further states that "[t]he evidence produced by the Claimant with a view to determining the indispensability of the expense for obtaining income does not allow corroboration of the conclusions that it draws from those documents, nor does it allow demonstration of the services provided. This is because the invoices issued by E... do not contain the elements provided in the referred legal rules, not allowing validation and justification of the services that were listed by the Claimant, namely if they were invoiced, for what values, unit quantities and their respective unit values."

Further adding that "[s]uch elements possessed crucial importance with a view to determining whether the total values evidenced in the invoices correspond to the services that the Claimant alleges were provided."

The Respondent further adds that "[f]rom the clarifications provided, it was further ascertained that payments made to E... were made throughout the year, or paid in a phased manner and depending on client payments, agreed credit and the availability of payment by the Claimant, and were secured by the cash fund which were managed by accounting, with account settlements in continuity or at year-end."

The Respondent mentions that the invoices issued by company E... do not identify and quantify either the engagement of the Claimant's certified accountant or expenses incurred with the academic qualification of "Master" – which are transversal to the exempt activity and the activity subject to VAT -. Further adding that "[a]s concerns the emails enumerated in the exercise of the right to a hearing and mentioned in the request for arbitral pronouncement, these are associated, according to what is described therein, with tasks or works that have names such as for example "Project...", "Training", "Telenovelas/TV...", "I.../Group...", "Master's Thesis", among others. However, the rigor that appears to exist in the emails is not extensible to the invoices, as these have generic descriptions such as "other works" and "logistical support" and in none of them is there reference to names as those indicated in the prior right to a hearing and in the request for arbitral pronouncement or to services."

It further argues that "the invoices of materially relevant values (which in 2014 amount to €43,500.00 and in 2015 total €42,500.00) are, according to accounting records, paid in cash, contradicting article 63-C(3) of the General Tax Law which states that payments of value exceeding €1,000.00 must be made through a means of payment that allows identification of the recipient." Indeed, "[d]ocuments from E...'s accounting were consulted, namely current account statements (...), having been ascertained that invoices relating to 2014 and 2015 were recorded in the accounting as having been paid all at once in cash (cash credit). Such financial flows are reduced to mere accounting records, since it is not possible to identify the actual recipient of such amounts."

The Respondent concludes by mentioning that "as the invoices issued by E... do not contain a description of the services provided, as well as the respective price, quantity and date of their performance, and as the Claimant does not have a bank account recorded in the accounting and payments in cash of materially relevant values do not allow the Respondent to control the invoices, namely at the level of VAT deduction as well as correct allocation of expenses to each fiscal year. Therefore, the issuance of invoices by E... with the mention of "Logistical support" or "Other Works" without compliance with the legal requirements provided in article 36(5) of the VAT Code, not allowing verification of whether these are indispensable for obtaining income, in accordance with article 23(4)(c) of the IRC Code, (...)"

Terminating the Respondent in the sense that "(...) the Claimant has not demonstrated with the wealth of attached documentation proof of the effectiveness of the services provided in light of the inconsistencies detected during the inspection procedure. The documents attached during the right to a hearing and reiterated within the request for arbitral pronouncement do not contain information complementary to the invoices, with the Respondent not possessing the additional elements necessary to verify whether the substantive requirements relating to the exercise of the right to deduction were met." for which reason, "[t]he Claimant's arguments are liminary devoid of merit."

IV. Curative Proceedings

The Tribunal is competent and properly constituted, pursuant to paragraph a) of article 2(1) and articles 5 and 6, all of the RJAT.

The parties possess legal standing and capacity, appear to be legitimately represented, find themselves properly represented, and the proceedings do not suffer from any nullities.

V. Factual Matters

For the conviction of the Arbitral Tribunal, relative to the facts proved, the documents attached to the proceedings and the administrative file were relevant.

Facts Established As Proved

With interest for the decision, the following facts are established as proved:

1. The Claimant is a limited liability company whose corporate purpose is "provision of information services for health, colloquia, conferences and publications, occupational medicine, activity of safety, health and safety at work" – cf. administrative file -;

2. The Claimant engages in the activity of "other human health activities", integrated in CAE 086906 and is classified, for IRC purposes, under the general taxation regime as of 01.01.2009. – cf. administrative file - ;

3. The Claimant was subject to a tax inspection action, carried out under Service Orders nos. OI 2017... and OI 2017..., of 28.06.2017 and 07.07.2018 for fiscal years 2014 and 2015, respectively, of partial scope, in Value Added Tax (VAT) and Corporate Income Tax (IRC); - cf. Doc. no. 1 attached with the request for constitution of the Arbitral Tribunal -;

4. In the course of February 2018, the Claimant was notified, through office no. DFLISBOA ..., of 12.02.2018 from the Tax Inspection Services of the Finance Department of Lisbon, of the Tax Inspection Report Project resulting from the inspection action referred to in B. above, and, if it so wished, to exercise the right to prior hearing provided in article 60 of the General Tax Law – cf. Doc. no. 5 attached with the request for constitution of the Arbitral Tribunal and administrative file - ;

5. The Claimant exercised the right to prior hearing that was due to it, through a request submitted on 13.03.2018, following a request for extension of the deadline admitted by the Finance Department of Lisbon – cf. Doc. no. 1 attached with the request for constitution of the Arbitral Tribunal and administrative file - ;

6. The Claimant was notified, at the end of March 2018, through office no. ..., of 20.03.2018, from the Tax Inspection Services of the Finance Department of Lisbon, of the Tax Inspection Report, from which the corrections already proposed in the Tax Inspection Report Project result, namely:

1. The Tax Inspection Report contains, regarding IRC corrections, the following:

"III.2. Proposed Corrections in IRC

III.2.1 Expenses Declared for Purposes of IRC Taxation

Following analysis of the income statements for the periods under review, the following summary map was prepared:

Values in euros

Among the more relevant values identified in the above table, the supplies and external services line is highlighted, sub-account 62211 – "specialized works", where expenses supported by invoices issued by E... were recorded. Thus, on the basis of the invoices hereinafter identified, expenses were recorded in that sub-account which, in fiscal years 2014 and 2015, total €43,500.00 and €42,500.00, respectively.

(a) Expense attributed to fiscal year 2014; (b) Expense attributed to fiscal year 2015.

As can be seen, the service descriptions are generic, not allowing verification of whether they are indispensable for obtaining income, whereby article 1 and article 23(4)(c) of the IRC Code were violated in IRC.

Similarly, as mentioned in section II.3.3.1.1.1., A... does not reveal the bank account in its accounting records, and in the accounting entries, the referred invoices were recorded as having been paid in cash, all at once, debiting the account 111-"Cash" and crediting accounts 243222-"VAT Deducted" and 281-"Expenses to be Recognized" (see Annex 2). For these facts, article 63-C, paragraphs 1 and 3, in the wording in force at the date of the facts, was violated.

From analysis of the contents of the income statements (Model 22 form) submitted in the Finance Portal, with reference to fiscal years 2014 and 2015, we verified that they present the following values in their Schedule 07:

Values in euros

III.2.2. Quantification of Proposed Corrections in IRC – Fiscal Years 2014 and 2015

In light of the foregoing section III.2.1 of this report, purely arithmetic corrections are proposed in IRC in the values indicated in item 2 of the following table whereby the declared fiscal result will be altered to the values indicated in item 3 of the same table.

Articles 23(4) of the IRC Code and 63-C, paragraphs 1 and 2 of the General Tax Law were violated."

1. The Claimant was notified of the Corporate Income Tax Assessment Statements, interest assessments and account settlement relating to compensation no. 2018..., in the amount of €10,463.34, relating to fiscal year 2014 - cf. Docs. nos. 2, 3 and 4 attached with the request for constitution of the Arbitral Tribunal -;

2. The Claimant was notified of the Corporate Income Tax Assessment Statements, interest assessments and account settlement relating to compensation no. 2018..., in the amount of €10,378.49, relating to fiscal year 2015 - cf. Docs. nos. 2, 3 and 4 attached with the request for constitution of the Arbitral Tribunal -;

3. On 10 August 2018, the Claimant submitted the request for constitution of the present arbitral tribunal.

4. The Claimant attached, both in the scope of the inspection procedure and in the course of the present arbitral proceedings, a CD-Rom from which various information/complementary documentation results regarding the actions developed by E... throughout fiscal years 2014 and 2015 – cf. Agreement of the parties, as the factual matter was not contested by the Respondent - .

5. The Claimant, on 12 March 2019, attached to the proceedings the decision of CAAD rendered in Case no. 379-2018-T.

Facts Established As Not Proved

There are no facts relevant for the decision of the case which have not been proved.

VI - On The Law

Prior Question:

The Respondent, in the Reply it submitted, raised, as an exception, a question of prejudiciality stating that "(...) in the sequence of the corrections undertaken by the Respondent in VAT, and taking into account that the invoices issued by company E... did not contain the legal requirements in article 36(5) of the VAT Code, the fiscal cost was correspondingly not accepted in IRC, in accordance with article 23(4)(c) of the IRC Code. Now, the Claimant, as far as VAT assessments are concerned, (...) initiated a request for arbitral pronouncement, which is pending in this Arbitration Center under no. 379/2018-T (...) and in which the also Respondent herein submitted reply on 2018-11-19."

Defending, for such purpose that "the tax acts here reviewed are nothing more than a consequence of the premises established in VAT, with article 23(4)(c) of the IRC Code establishing that expenses are not deductible for purposes of determining taxable profit when their documentation does not comply with articles 23(3) and (4) of the IRC Code, that is, expenses must be documented, and when incurred or incurred in the acquisition of goods or services, the supporting document must contain, at least, the following elements (...). This means, therefore, that non-acceptance of the expense in IRC, in accordance with article 23(4)(c) of the IRC Code, is nothing more than a consequence of non-compliance with the legal requirements of the invoices as well as lack of proof that such service provisions occurred. Therefore, the present proceedings are in a relationship of prejudiciality relative to Case no. 379/2018-T."

Indeed, the Respondent understands that "(...) it suffices for such purpose to compare the requests for arbitral pronouncement relating to the present proceedings with that of Case no. 379/2018-T, to easily ascertain that the arguments are identical, as well as the factual and legal grounds. (...) It is thus noted that the issue raised in the present proceedings is in a relationship of prejudiciality relative to Case no. 379/2018-T, and could lead to two diametrically opposed and divergent questions on the same matter. Therefore, the issue raised in the present proceedings constitutes a true prejudicial question with framing in article 15 of the Code of Administrative Court Procedure ("CPTA"), pursuant to article 29(1)(b) of the RJAT. In this endeavor, it is incumbent upon this Single Arbitral Tribunal to suspend the present instance, until the question in discussion regarding the legality of invoice requirements and material proof of the alleged service provisions is resolved in Case no. 379/2018-T and consolidated in the legal order."

Duly notified for such purpose, the Claimant came to exercise the right of contradiction by refuting the arguments put forward by the Respondent on this question, and concluding in the sense that "[t]here is, therefore, no relationship of prejudiciality between the present proceedings and the referred case no. 379/2018-T, with both proceedings having objects perfectly delimited by reference to taxes, regimes and distinct objectives that do not conflict with one another, with the decision rendered in one of them (such as the one attached by the Tax Authority to these proceedings) unable to affect the judgment of the other."

Now,

In fact, on 12 March 2019, the Respondent, through a request, proceeded with the attachment of the arbitral decision rendered on 11 March 2019, within the scope of the above identified Case no. 379/2018-T, from which it results that the (here and there) Claimant requested the constitution of the Arbitral Tribunal with a view to obtaining a declaration of illegality of the VAT assessment acts, carried out in consequence of corrections promoted following a partial scope inspection procedure carried out on VAT and IRC, with reference to fiscal years 2014 and 2015,

... with the Arbitral Tribunal having judged the request formulated by the Claimant totally devoid of merit, on the basis that it understood that: "(...) the invoices suffer from the defect of violating article 36(5) of the VAT Code."

It should be noted that, notwithstanding the factual grounds being the same under consideration in this and that Arbitral Tribunal, the truth is that the legal grounds are different, since different legal rules apply, either of the VAT Code or of the IRC Code for purposes of examination of the legality of the acts in question, in each pending case.

Specifying: while in that arbitral case what was at issue was compliance with the requirements provided in article 36 of the VAT Code in the invoices issued by company E... to the Claimant relating to fiscal years 2014 and 2015, for purposes of deduction of the corresponding tax….

… in the present case, the question that arises is whether the Claimant managed to prove the indispensability of the expenses it incurred and which are supported in those invoices and other documents it presented for purposes of determining the taxable base, under article 23 of the IRC Code.

In this sequence, notwithstanding that a decision has already been rendered within the scope of the arbitral case regarding which the Respondent considered there to be a relationship of prejudiciality with the present case, this Arbitral Tribunal understands that such relationship, in reality, does not exist, since, as the Claimant rightly points out, "(...) the two taxes (i.e., IRC and VAT) are based on distinct matrices, comply with different criteria of rigor and demand and admit, for that reason, totally autonomous analyses.".

For which reason, this Arbitral Tribunal understands that it will not grant the request for suspension of the present arbitral case formulated by the Respondent, whereby the same will follow its normal course.

On the Application of Article 23 of the IRC Code

Thus, let us proceed to the examination of the legality of the IRC assessment acts relating to fiscal years 2014 and 2015, and to the resolution of the issue to be decided which is whether the Claimant managed to prove the indispensability of the expenses it incurred and which are supported in two invoices issued by company E..., Lda, and other documents it presented, for purposes of determining the taxable base, under article 23 of the IRC Code.

Let us see,

The Claimant invokes that, during the course of the inspection procedure, it provided "(...) the clarifications which constitute Annex 4 to the respective Tax Inspection Report Project (...) attaching to the procedure hundreds of documents evidencing the services provided by company E..., Lda, during fiscal years 2014 and 2015. (...) More specifically, the Claimant reiterated, in the exercise of the right to a hearing, that company E..., Lda, provided continuous support to the Claimant in the said fiscal years 2014 and 2015, both in advisory services and specialized administrative support in diverse areas, resorting to specialized technical work of its own, or to external collaborators hired for such purpose, according to the requests and needs of the Claimant. The Claimant equally emphasized that the services provided by company E..., Lda, enabled the simultaneous development of various activities generating taxable income in VAT and IRC contexts, activities which otherwise would have been impossible to carry out due to lack of human resources for their implementation."

Indeed, the Claimant further argues, in support of its thesis, that "(...) without prejudice to the generic nature of the descriptions contained in the two invoices issued by company E..., Lda, it is verified that the Claimant attached to the tax inspection procedure a detailed description of the services provided by that entity (and implicit in the invoices issued by it), as well as hundreds of documents evidencing their performance and content (...). Such elements would have allowed the Tax Inspection Services – as it is reasonable to admit – to verify compliance with the material premises upon which the admissibility of such invoices depended since they enabled a detailed analysis of the content of the services concretely provided and their relevance in the context of the Claimant (especially their relevance for obtaining income subject to IRC, as required by article 23 of the IRC Code. In fact, the Claimant proved the content of the services provided by company E..., Lda in the most objective and detailed manner that could be required of any taxpayer, that is by attaching to the inspection procedure not only the details of the services acquired, but equally, the material result of their concrete performance (...) for which reason it is imperative to conclude that, the invoices under consideration being admissible and suitable for purposes of deduction of the respective VAT, they should equally be considered admissible and suitable for proof of the corresponding expenses deductible in IRC, in the terms prescribed by article 23(4) and (6) of the IRC Code."

For its part, the Respondent understands that "the Claimant has not demonstrated with the wealth of attached documentation proof of the effectiveness of the services provided in light of the inconsistencies detected during the inspection procedure. The documents attached during the right to a hearing and reiterated within the request for arbitral pronouncement do not contain information complementary to the invoices, with the Respondent not possessing the additional elements necessary to verify whether the substantive requirements relating to the exercise of the right to deduction were met."

Let us see,

Law no. 2/2014 of 16 January reformed the taxation of income of corporate entities, and consequently, altered numerous provisions of the IRC Code, initially approved by Decree-Law no. 442-B/88, of 30 November 2013.

Of interest for the present proceedings, it should be highlighted the amendment to article 23 of the IRC Code, which had impact not only on the notion of fiscal expense but also as regards the formal requirements for its proof.

Indeed, the wording of article 23 of the IRC Code, prior to the 2014 IRC reform, was as follows:

"Article 23

Expenses

1 — Expenses are considered to be those which are demonstrably indispensable for the realization of income subject to tax or for maintenance of the income-producing source, in particular:

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

b) Those relating to distribution and sale, encompassing transportation, advertising and placement of goods and products;

c) Of a financial nature, such as interest on foreign capital applied in exploitation, discounts, premiums, transfers, exchange differences, costs of credit operations, debt collection and emission of bonds and other securities, redemption premiums and those resulting from application of the effective interest method to financial instruments valued at amortized cost;

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

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

f) Of a fiscal and parafiscal nature;

g) Depreciation and amortization;

h) Adjustments in inventories, impairment losses and provisions;

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

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

l) Realized losses;

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

2 — Unlawful expenses are not accepted as expenses, in particular those resulting from conduct which reasonably indicates violation of Portuguese criminal law, even if occurring outside the scope of its territorial application.

3 — Expenses incurred in the fiscal period with the onerous transfer of capital shares, regardless of the title under which the operation takes place, are not accepted when held by the alienator for a period of less than three years and provided that:

a) The capital shares have been acquired from entities with which there are related-party relationships, under article 63(4);

b) The capital shares have been acquired from entities resident in Portuguese territory subject to a special taxation regime.

4 — Expenses incurred in the fiscal period with the onerous transfer of capital shares, regardless of the title under which the operation takes place, are also not accepted whenever the alienating entity has resulted from transformation, including modification of corporate purpose, of a company to which a different tax regime was applicable regarding these expenses and less than three years have elapsed between the date of verification of that fact and the date of the transfer.

5 — Expenses incurred in the fiscal period with the onerous transfer of capital shares, regardless of the title under which the operation takes place, to entities with which there are related-party relationships, under article 63(4), or to entities resident in Portuguese territory subject to a special taxation regime, are also not accepted, as well as losses resulting from changes in the valuation model relevant for tax purposes, under article 18(9), which result, in particular, from accounting reclassification or from changes in the assumptions referred to in article 18(9)(a)."

Therein were provided the necessity of meeting two essential requirements for a cost to be taken into account for purposes of determining taxable profit, namely: proof and its indispensability;

… after the reform, such requirements obtained different scopes, with that of proof being expressly specified in articles 23(3), (4) and (6) of the IRC Code; that of indispensability was simply eliminated.

Thus, article 23 of the IRC Code, with the heading "Expenses and Losses", after the 2014 legislative amendment, which began to apply to fiscal years 2014 and onwards, now provides the following:

"1 - For determination of taxable profit, all expenses and losses incurred or incurred by the taxpayer to obtain or ensure income subject to IRC are deductible.

2 - The following expenses and losses are considered to be included in the preceding paragraph, in particular:

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

b) Those relating to distribution and sale, encompassing transportation, advertising and placement of goods and products;

c) Of a financial nature, such as interest on foreign capital applied in exploitation, discounts, premiums, transfers, exchange differences, costs of credit operations, debt collection and emission of bonds and other securities, redemption premiums and those resulting from application of the effective interest method to financial instruments valued at amortized cost;

d) Of an administrative nature, such as remuneration, including those attributed as profit-sharing, allowances, material of regular consumption, transportation and communications, rents, litigation, insurance, including life, sickness or health insurance and 'Life' branch operations, contributions to savings-pension funds, contributions to pension funds and any supplementary social security schemes, as well as expenses for cessation of employment benefits and other post-employment or long-term benefits of employees;

e) Those relating to analyses, rationalization, research, consulting and development projects;

f) Of a fiscal and parafiscal nature;

g) Depreciation and amortization;

h) Impairment losses;

i) Provisions;

j) Losses from reductions in fair value in financial instruments;

k) Losses from reductions in fair value in consumable biological assets that are not multi-year forestry operations;

l) Realized losses;

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

3 — Deductible expenses pursuant to the preceding paragraphs must be documented, regardless of the nature or support of the documents used for such purpose.

4 - In the case of expenses incurred or incurred by the taxpayer with the acquisition of goods or services, the supporting document referred to in the preceding paragraph must contain, at least, the following elements:

a) Name or business name of the supplier of goods or service provider and of the purchaser or recipient;

b) Tax identification numbers of the supplier of goods or service provider and of the purchaser or recipient, whenever they are entities with residence or stable establishment in Portuguese territory;

c) Quantity and usual denomination of the goods acquired or the services provided;

d) Value of the consideration, in particular the price;

e) Date on which the goods were acquired or on which the services were performed.

5 — (Repealed).

6 - When the supplier of goods or service provider is obligated to issue an invoice or legally equivalent document under the VAT Code, the supporting document for acquisitions of goods or services referred to in paragraph 4 must necessarily take that form."

Indeed, the requirement of proof now comes specifically provided in articles 23(3), (4) and (6) of the IRC Code, with it being specified in paragraph 3 that such proof must be documentary "regardless of the nature or support of the documents used for such purpose." (paragraph 3);

… paragraph 4 provides that in the case of expenses incurred or incurred by the taxpayer with the acquisition of goods or services, the referred supporting document should contain, at least, the following elements:

"a) Name or business name of the supplier of goods or service provider and of the purchaser or recipient;

b) Tax identification numbers of the supplier of goods or service provider and of the purchaser or recipient, whenever they are entities with residence or stable establishment in Portuguese territory;

c) Quantity and usual denomination of the goods acquired or the services provided;

d) Value of the consideration, in particular the price;

e) Date on which the goods were acquired or on which the services were performed."[1]

Paragraph 6 of article 23 provides that, when there is an obligation to issue an invoice, this should be the representative document of the expense incurred, thus verifying an approximation, as to the formalities of the document, between the deductibility of expense in IRC and the deductibility of VAT paid.

In summary, for expenses enumerated in paragraph 1 of article 23 of the IRC Code to be considered deductible for tax purposes, two fundamental requirements must be met:

• that they are documented (pursuant to paragraphs 3, 4 and 6)
• that they are incurred or incurred by the taxpayer to obtain or ensure income subject to IRC.

Paragraph 1 of article 23-A of the IRC Code provides, however, a set of charges which, although they may be recorded as expenses of the taxation period, are not deductible for purposes of determining taxable profit.

This is the case, for example, as stated in paragraph c) of the referred legal provision, of "charges whose documentation does not comply with articles 23(3) and (4), as well as charges evidenced in documents issued by taxpayers with a nonexistent or invalid tax identification number or by a taxpayer whose cessation of activity has been officially declared under article 8(6)."

Curiously, this paragraph c) of article 23-A(1) of the IRC Code only excludes the deductibility of charges whose documents do not comply with articles 23(3) and (4) - it makes, however, no reference to non-compliance with article 23(6) of the same article.

In fact, the 2014 IRC reform sought to clarify the conditions of deductibility of fiscal expenses, with its Preliminary Draft stating the purpose of eliminating interpretative divergences on the issue of documentary proof of recorded expenses and inherent litigation.

Thus, the general principle that expenses and losses incurred or incurred by the taxpayer to obtain or ensure income subject to IRC are deductible is outlined by formal requirements, whereby the taxpayer must consequently possess and retain documents that prove them.

Such documents must contain the essential elements of identification of the operations, their participants, value and date, and, where operations which give rise to an obligation to issue an invoice under the VAT Code, such documents must take that form - of an invoice -.

In fact, the dilemma that arises is to ascertain what consequence flows from non-compliance with formal requirements for the taxpayer, which in the case of invoices depends on their issuance by a third party, the service provider, with the AT assuming the position that, faced with insufficient elements contained therein, it entails disregard of the expense for purposes of determining the taxable base of IRC, due to non-compliance with a formal requirement.

Now, in the case at issue, the Claimant recorded as a cost two invoices issued by company E... which, according to the Respondent's understanding, suffer from "insufficient discrimination of the services actually provided (…) in accordance with article 36 of the VAT Code (…)."

It so happens, however, that, during the course of the inspection procedure, the Claimant, upon notification, provided various clarifications and "(...) proceeded to enumerate (see Annex 4), that the services provided were in the area of consulting, support and research in various projects, namely:

• Education for Health Articles for the client company: F..., Lda (G... Group: Magazines in paper and online Telenovelas and TV...);

• Health education activities also integrated activities in H..., Lda and I..., S.A. with the provision of contents and formatting for materials promoting health and safety in the workplace;

• Support in the production and continuous review of technical documents, also participating in the preparation of executive summaries of projects and documentary strategy and consulting for the accreditation process of I..., SA by the Directorate General of Health (DGS); preparation of careful reports and infographics strategy consulting;

• Planning of national training action projects for the staff of I..., S.A." (See article 38 of the Respondent's Reply)

Furthermore, the Respondent states regarding this matter that "[f]rom the clarifications provided, it was further ascertained that payments made to E... were made throughout the year, or paid in a phased manner and depending on client payments, agreed credit and the availability of payment by the Claimant, and were secured by the cash fund which were managed by accounting, with account settlements in continuity or at year-end." (article 66 of the Reply)

The Respondent further states that "[a]s concerns the emails enumerated in the exercise of the right to a hearing and mentioned in the request for arbitral pronouncement, these are associated, according to what is described therein, with tasks or works that have names such as for example "Project...", "Training", "Telenovelas/TV...", "I.../Group...", "Master's Thesis", among others. However, the rigor that appears to exist in the emails is not extensible to the invoices, as these have generic descriptions such as "other works" and "logistical support" and in none of them is there reference to names as those indicated in the prior right to a hearing and in the request for arbitral pronouncement or to services. (articles 70 and 71 of the Reply).

Indeed, in the case at issue, given all the clarifications provided by the Claimant during the administrative procedure, and all the array of documents attached to the proceedings, it is manifest that – as results from item k) of the facts established as proved – various information/complementary documentation regarding the actions developed by E... for the Claimant throughout fiscal years 2014 and 2015 are contained in the proceedings,

… namely, that company E... provided support to the Claimant in advisory services and specialized administrative support in diverse areas, resorting to specialized technical work or with collaborators for the preparation of magazine articles,

… such services which, according to the Respondent, are not properly contemplated in the invoices issued by such company to the Claimant, which suffer from insufficient description, to which is added the fact that their payment is made in cash.

Indeed, the Respondent does not question the materiality of the operations in question, i.e., does not doubt that company E... actually provided those services to the Claimant, it places, rather, in question, that the invoices in question refer to those same services by virtue of the generic description contained therein.

However, as we can extract from the Tax Inspection Report (page 19), the expenses supported by invoices issued by E..., Lda, were recorded in the accounting of the Claimant, namely in the "line supplies and external services, sub-account 62211 – 'specialized works'", notwithstanding the fact that they were "paid in cash, all at once, crediting the account 111-'Cash' and debiting accounts 243222-'VAT Deducted' and 281 – 'Expenses to be Recognized'." (page 20 of the Tax Inspection Report attached to the proceedings).

Thus, and complementarily, from the set of referred documents result the essential elements of information required under paragraph 4 of article 23 of the IRC Code, whereby the Respondent's argument that the expenses would not be deductible due to non-compliance with articles 23(3) and (4) is not correct, with paragraph 3 admitting that documentary proof be effected by any means, i.e., "regardless of the nature or support of the documents used for such purpose."

In this sequence, another question arises: that of ascertaining whether operations whose material existence was demonstrated, and which are documented in the various elements the Claimant attached to the proceedings, which contain the essential elements of identification, not being recorded in the invoices issued by E... in the form required by the VAT Code, a form now also recognized in the IRC Code, are or are not fiscally deductible by application of paragraph 6 of article 23 of the IRC Code.

On this matter the Arbitral Tribunal has already pronounced itself, namely in the decision of the Collective Tribunal rendered in Case no. 217/2018-T to which we will make reference for its clarity of exposition and total adequacy to the concrete case, which clarified the following:

"The provision in question was introduced with the IRC Reform to resolve divergent interpretations regarding 'evidentiary documentation' issues, as the Preliminary Draft of the Reform states, making it obligatory to possess an invoice for purposes of deduction of expenses in IRC. Notwithstanding, it appears that the inclusion of this new formal requirement – the possession of an invoice – which now appears in article 23(6) of the IRC Code, is placed at the level of proof of operations, ad probationem, and not at that of their material premises, ad substantiam, and is intended to complement measures to combat fraud and tax evasion.

In this manner, we believe that the considerations of RUI MORAIS prior to the IRC Reform remain valid to the effect that, for documentary proof of expenses, "the taxpayer should be admitted to complement proof of the existence of the cost through recourse to any means admitted in law", as "non-acceptance, for reasons of a merely formal nature, of the deductibility of a cost which was actually incurred, would correspond to taxation for profit which does not exist, to a tax which does not underlie corresponding taxpaying capacity." – cf. Notes to IRC, Almedina, 2007, pp. 79-80. The jurisprudence of the SAT points in the same direction, as, by way of illustration, that contained in the Decisions of 5 July 2012, case no. 658/11, and 14 September 2011, case no. 433/11.

Having arrived in the concrete situation at the conclusion, unequivocally, that the expenses were actually incurred by the Claimant in the exercise of its activity, are supported by documents (albeit not by invoices) and that there exists no risk of fraud, it appears that the same should be considered deductible.

From the outset, by a literal argument, as article 23(6) of the IRC Code does not establish the non-deductibility of expenses due to lack of an invoice. On the other hand, article 23-A, which enumerates expenses not deductible for tax purposes, makes a reference in paragraph c) of paragraph 1 to articles 23(3) and (4), but not to paragraph 6 which provides for the obligation of an invoice, which cannot fail to signify a distinction in the treatment and effects which befit expenses not properly documented, in the sense of those which lack essential elements of identification of transactions (enumerated in paragraph 4), and expenses which are documented through documentary means with mention of all such elements, but not supported in an invoice, as occurs in this case."

Thus, having regard to the fact that the Claimant managed to prove, through the various documents presented, the materiality of the services provided by company E..., as to the operations performed within the scope of its activity, in particular with the fact that such company provided continuous support to the Claimant, both in advisory services and specialized administrative support in diverse areas, resorting to specialized technical work of its own, or to external collaborators hired for such purpose, according to the requests and needs thereof, and that such services enabled the simultaneous development of various activities generating taxable income in VAT and IRC contexts,

… being possible to ascertain, from the set of documents, the essential elements required by paragraph 4 of article 23 of the IRC Code, in particular the name or business name of the supplier of goods or service provider and that of the purchaser; the tax identification numbers of the supplier of goods or service provider and of the purchaser; the quantity of goods acquired or services provided, the value of the consideration and the date on which the goods were acquired or services were performed,

… and there not arising any risk of fraud and tax evasion, the Arbitral Tribunal understands that the present request is to be granted, in light of the interpretation it makes of articles 23 and 23-A of the IRC Code, and that, consequently, the costs incurred by the Claimant should be considered costs deductible for purposes of determining taxable profit for fiscal years 2014 and 2015.

VII. Decision

In accordance with the foregoing, the Tribunal hereby decides:

• To render the request for arbitral pronouncement meritorious and proved;

• To annul, as illegal, the Corporate Income Tax (IRC) assessment acts no. 2018... and no. 2018..., relating to fiscal years 2014 and 2015, and respective compensatory interest, in the amount of €10,386.40 and €10,262.66, respectively, totalling €20,841.83 (twenty thousand, eight hundred and forty-one euros and eighty-three cents).

VIII. Value of the Case:

The value of the case is set at €20,841.83 (twenty thousand, eight hundred and forty-one euros and eighty-three cents), pursuant to article 97-A(1)(a) of the Code of Tax Procedure and Process, applicable by virtue of paragraphs a) and b) of article 29(1) of the RJAT and article 3(2) of the Regulation of Costs in Tax Arbitration Proceedings, taking into account the sum of values contained in the account settlement statement relating to fiscal years 2014 and 2015, whose Corporate Income Tax assessments are contested in the present proceedings.

IX. Costs:

Costs charged to the Respondent in accordance with article 22(2) of the RJAT, article 4 of the RCPAT, and Table I attached thereto, which are fixed in the amount of €1,224.00.

Let notice be given.

Lisbon, 17 April 2019

The Arbitrator

(Jorge Carita)

[1] Paragraph 4 of article 23 of the IRC Code replicates the requirements of invoices provided in article 36(5) of the VAT Code, albeit in somewhat less exacting form, as it permits supplementary external proof that the operations were performed. Furthermore, it should be noted that in VAT, such external document encompasses within itself a right – the right to deduction of the tax - while in IRC, such document is merely evidentiary of that operation. In this sense it is commonly referred to that while in VAT the supporting document has a substantive purpose, in IRC its purpose is merely evidential.