Presumption of Profit Distribution to Shareholders Under Article 6(4) CIRS – IRS Tax Arbitration 388/2017-T

ARBITRAL DECISION

I – REPORT

Request

A…, S.A., legal entity number …, with registered office at …, …, …-… …, hereinafter referred to as the Applicant, submitted, on 23-06-2017, pursuant to the provisions of paragraph a) of section 1 of Article 2 and Article 10 of Decree-Law No. 10/2011, of 20 January, which approves the Legal Regime for Arbitration in Tax Matters (RJAT), a request for an arbitral decision, in which the Respondent is the AT - Tax and Customs Authority, with a view to:

• The annulment of the decision rejecting the gracious reclamation No. …, issued by means of a dispatch of 23-03-2017 by the Head of Division of the Finance Directorate;

• The annulment of the Personal Income Tax (IRS) assessments numbers 2016… (2012) and 2016… (2013) on which the gracious reclamation No. … mentioned above was based;

• The condemnation of the Respondent to pay compensatory interest.

Grounds for the Request

To support its request, the Applicant alleges, in summary:

• The company sold to two of its shareholders quotas representing the capital of B…, Lda., a civil company in the form of a limited liability company.

• The acquiring shareholders of said quotas did not proceed to their payment immediately, remaining indebted to the company for the respective price.

• The case concerns the application to the specific situation of the presumption contained in section 4 of Article 6 of the Personal Income Tax Code (CIRS) which states that "entries recorded in any current accounts of partners, recorded in commercial or civil companies under commercial form, when not resulting from loans, provision of work or exercise of corporate positions, are presumed to be made as profits or advance payment of profits".

• Article 73 of the General Tax Law (hereinafter GTL) determines that the presumptions established in tax incidence rules always admit proof to the contrary.

• It is established jurisprudence that it is the responsibility of the AT – Tax and Customs Authority to prove the "base fact" on which the law triggers a presumption.

• In this case, the base facts are (i) the existence of financial flows, (ii) recorded in a current account of partners, (iii) which do not result from loans, provision of work or exercise of corporate positions.

• With respect to the amount owed for the price of the quota transfers, there is no doubt that these are not loans, nor do they result from the provision of work or exercise of corporate positions since they are the price of an asset transfer.

• The AT never proved that there were financial flows between the company and the partners in question, so the situation could never be subject to proof of a loan contract.

• The AT also did not prove that the debt resulting from non-payment of the transferred assets was recorded in a current account of partners.

• The accounting [of the operation] in an account of other debtors (account 27) is in accordance with substance and shows that the company correctly treated the sale of an asset to a partner as it would treat a sale to a third party, that is, it is an operation that does not concern the corporate relationship from which a distribution of profits could be presumed.

• With respect to the alleged lack of justification for the price of the quota transfer and the suspicion that the value of the quota transfer is above market value, we do not understand any relevance to the correction of IRS.

• Indeed, if the AT believes that the agreed price is above market value, it would have had to provide proof of this and, consequently, correct downwards the IRS (value converted into dividends) and the capital gains recognized by A…. Which it did not.

• The pertinence of the question raised by the AT regarding who bore the costs of purchase or construction of the fractions owned by B… and consequently of its partners is not understood.

• The property, in full ownership, is owned by the company B…, Lda., its acquisition/construction being much earlier than the date of acquisition of quotas by A….

• Not having the AT proved that there were financial flows that were recorded in a current account of partners, it was proved that it is a commercial debt from the sale of an asset, whose price is justified with an accounting entry in appropriate accounts.

• It was demonstrated by the Applicant that there were no financial flows with respect to the debt for the price of assets and that, finally, the Applicant never recorded profits, which is why there were no distributable results at the date.

• As attempts to obtain bank financing that would allow them to pay what they owed to the company proved unsuccessful, the acquiring shareholders of the quotas relieved themselves of their debts by giving in payment to the company shares representing its own capital.

• The debt recorded in "administrators" is in account 27 811016 (administrators), which is not a current account of partners, and concerns advances for company expenses, pending the respective supporting documents, in order to be able to account for these costs in the company.

Response

Regularly notified, and after the period for voluntary revocation of the challenged acts, the Tax Authority responded to the challenge, defending the maintenance of the assessment acts, and alleging, in summary, the following:

The trial balances reported to 2012.12.31 and 2013.12.31 present the following balances:

The balances of E… and C… refer to amounts not paid by shareholders for the acquisition of quotas, the Members of the Administration account to payments of personal accounts with the company's credit card, and the Dr. D… account to transfers made in its favor, according to the respective bank statements.

Section 4 of Article 6 of the IRS Code provides:

"4 - Entries recorded in any current accounts of partners, recorded in commercial or civil companies under commercial form, when not resulting from loans, provision of work or exercise of corporate positions, are presumed to be made as profits or advance payment of profits."

Now, since such amounts were not received as salaries or bonuses, we are dealing with capital income, namely an advance on account of profits, which, by virtue of the entry into force of Decree-Law 192/2005, of 7 November, and in accordance with paragraph c) of section 3 of Article 71 of the CIRS, became subject to withholding tax at the liberatory rate of 26.5%, with the debtor companies having the obligation to deliver this amount to the State, with the option of inclusion, in accordance with Article 40-A of the CIRS, by the beneficiary.

Thus, the taxpayer did not proceed to the withholding and delivery of IRS on profit advances, as required by section 2 of Article 101 and paragraph c) of section 3 of Article 71 of the Personal Income Tax Code, in the amounts of:

Whereas the taxpayer who received the income did not proceed to the inclusion in accordance with Article 40-A of the Personal Income Tax Code, the tax that should have been withheld does not have the nature of payment on account of the tax due finally, in accordance with section 7 of Article 71 of the CIRS, such amount must therefore be demanded from the company.

As stated by the Applicant in Article 16 of the request for arbitral decision (the "RAD"), the case concerns the application of Article 6, sections 4 and 5, of the CIRS, namely:

"4 - (1) Entries recorded in favor of [partners], (2) in any current accounts of partners, (3) recorded in commercial or civil companies under commercial form, (4) when not resulting from loans, provision of work or exercise of corporate positions, (5) are presumed to be made as profits or advance payment of profits.

5 - The presumptions established in this article may be rebutted on the basis of a judicial decision, administrative act, declaration from the Bank of Portugal or recognition by the Tax and Customs Authority." (interlinear numbering, underlining and bold added by us)

The Applicant appears to draw from section 4 of Article 6 of the CIRS, as stated in Article 19 of the RAD, the necessity of the existence of "financial flows", by reference to the expression "entries".

For better understanding of the meaning of "entry" at the accounting level, since the concept is not defined in any code, legal regulation or in the SNC itself, we expose the following excerpt from the Financial Accounting notes, as taught at ISCTE:

"Entry corresponds to the recording of patrimonial facts in the accounts, using the Double-entry Method. We can classify entries according to the number of accounts moved:

• Simple Entries, 1 Debit corresponds to 1 Credit;

• Compound Entries, 1 Debit implies several Credits, several Debits imply 1 Credit or several Debits imply several Credits.

We can classify entries according to their nature:

• Opening Entry, are the first entries to be recorded in the account, correspond to the recording in the account;

• Current Entries, correspond to the entries that characterize the company's business, being carried out during the economic period;

• Adjustment Entries, are the entries that occur at the end of the economic period with the aim of correcting the balance sheet accounts and income statements, are included in end-of-period work;

• Profit Determination Entries, correspond to the transfer of various results through the transfer of their respective revenues and expenses;

• Reversal Entries, corresponds to the accounting correction of a previous entry;

• Account Closure Entries, correspond to the closing entries of accounts, occur at the end of the period, after preparation of the balance sheet;

• Reopening Entries, corresponds to the opening of initial balances that correspond to the carried forward balances from the previous period."

That is, an "entry" is nothing more than a recording of a patrimonial fact in an account.

Since "recording" in accounting means the registration of operations carried out by the company.

"Account", in turn, means a grouping of patrimonial elements or management elements with common (homogeneous) characteristics.

And we emphasize patrimonial fact, because the same does not correspond to the meaning we derive from the concept of "financial flows", which, in the Applicant's understanding, seems to correspond to "delivery of money" (cf. Article 22 of the RAD) from the company to the partners.

Now, if the concept of "patrimony" corresponds to "the set of assets, rights and obligations reducible to a pecuniary value, allocated to a certain person, singular or collective".

Being that, the following are considered elements of "patrimony":

• Assets: money, vehicles, buildings, shares, etc.
• Rights: debts of third parties: debts of clients to the company, salary advance or loans to employees.
• Obligations: debts to third parties: State, banks, suppliers.

We thus have that the set of material assets, rights and obligations, which belong to an individual or a company, is called patrimony.

From which we infer that "patrimonial fact" is nothing more than all changes that imply changes in patrimony, or rather, patrimonial variations, whether of assets, rights or obligations.

Therefore, reducing the concept of "entry", which, as we have seen, can integrate registrations of changes in patrimonial facts (material assets, rights and obligations), as the now Applicant has been arguing, since the previous hearing in the RIT proceedings, to "delivery of money" is clearly a reduction of a concept that only residually incorporates this patrimonial change, and has no correspondence either with the letter or with the spirit of the law.

Furthermore, in Article 6, section 4 of the CIRS, the legislator mentions "current accounts of partners", a concept that is also not defined by law nor in the SNC itself.

On this point, apparently the Applicant perceives the concept of "current accounts of partners" as a reference to the accounts of the Chart of Accounts of the SNC, which seems to us again reductive.

We understand that this concept of "partner current account" should be understood as the recording of the flow of patrimonial facts, in the sense mentioned above, occurring between the Applicant and the partners, and not in the sense of "partner accounts" as provided in the Chart of Accounts of the SNC.

As argued by the Applicant that "it was demonstrated by the applicant that there were no financial flows with respect to the debt for the price of asset transfers and that, finally, the A… does not record distributable results", we understand that indeed it was demonstrated that no financial flows occurred with respect to the debt for the price of asset transfers, namely the payment of the agreed amount regarding the properties "transferred" to C… and E….

Indeed, the transfer of ownership of the above-described properties took place in the RIT proceedings, in favor of the aforementioned partners, only through the payment of the quotas in the amounts of € 526.15 and € 1,052.85, having been valued at € 150,000.00 and € 300,000.00, as was later established as the acquisition value thereof.

As for the claim by the Applicant that A… does not record distributable results, we note only that the rule of Article 6, section 4, of the IRS, does not require such a result for the application of the presumption of distribution of profits to the partners.

Regarding Article 35 of the RAD, we understand that document 6 (Balance Sheet) does not prove the alleged facts.

Strictly speaking, accounting aims to reflect reality through accounting entries, however such entries do not prove reality per se.

We argue therefore for the lack of proof of the allegation, since the Balance Sheet aims to provide information about the financial position of an entity (cf. 19 of the Conceptual Framework of the SNC), and not to prove the alleged facts.

Furthermore, "the balance sheet should faithfully represent the transactions and other events from which result assets, liabilities and equity of the entity at the reporting date that satisfy the criteria of recognition" (cf. 33 of the Conceptual Framework of the SNC).

Now, the SNC does not say that the Balance Sheet proves the transactions, it only states that it should faithfully represent those transactions.

More accurate regarding the case sub judice seems to be in fact paragraph 35 of the Conceptual Framework of the SNC – Substance over Form:

"If information is to represent faithfully the transactions and other events it is intended to represent, it is necessary for them to be accounted for and presented in accordance with their substance and economic reality and not merely in accordance with their legal form. The substance of transactions or other events is not always consistent with that conveyed by their legal form or perceived form. For example, an entity may transfer an asset to another entity in such a way that legal title passes to that entity; however, arrangements may exist that ensure that the entity continues to enjoy the economic benefits embodied in the asset. In such circumstances, reporting a sale would not represent faithfully the transaction effected (if, indeed, a transaction has occurred).

Applying the rule to the case under analysis, we find that in addition to the Balance Sheet, the Applicant failed to present evidence of the transfers made to pay the value of the properties as agreed with partners C… and E….

Given the lack of such proof of payment, the aforementioned partners acquired the properties for an amount not corresponding to the agreed patrimonial value,

which in turn allowed the AT to activate the mechanism provided in Article 6, section 4 of the CIRS, embodied in a presumption.

Being that such mechanism, in accordance with section 5 of Article 6 of the CIRS, allows the Applicant to rebut the said presumption of distribution of dividends to the partners, by presenting proof to the contrary, which it failed to do.

As mentioned by the AT in the gracious reclamation proceedings, we add that "As previously stated, we understand that the "base fact" consists of the existence of entries made in any current accounts of the partners, recorded in commercial or civil companies under commercial form.

Meeting Provided for in Article 18 of the RJAT and Submissions

Having been requested by the Applicant for the production of testimonial evidence, on 07-12-2017 the Arbitral Tribunal meeting provided for in Article 18 of the RJAT took place, in which the questioning of witnesses was conducted.

In the same meeting, a deadline was set for the parties to submit final written submissions.

Submissions of the Applicant

In its submissions, the Applicant alleged, as relevant, the following:

• Given the family context of the Applicant's shareholding structure and the fact that it was subject to a tax inspection from which resulted the non-deductibility in the Applicant of the costs related to the properties to which the quotas in the company B… Lda. are associated, urgency was detected in the transfer of these same quotas, being this the reason for the quota transfer contracts;

• The price at which the quotas were transferred took into account the value of the residential fractions to which they are associated, having been valued by independent experts, as evidenced by the documentation attached to the administrative proceedings;

• Having been the initial intention, on the part of the acquiring shareholders of the transferred quotas, to pay them in cash following recourse to bank credit, this proved to be impossible because the transfers did not have as their object the property fractions but rather quotas of the company owning the property;

• It was in this context that the shareholders/acquirers of the quotas ended up delivering to the Applicant its own shares in payment of the quotas acquired;

• The value attributed to the own shares took into account the values of the equity of the company contained in the balance sheet of the Applicant for 2016;

• The Applicant did not record any results to distribute, which is why it could not have distributed any results;

• The two quotas transferred (by the Applicant) in the company B…, Lda. represented 21.05% of the capital thereof, having been acquired by the Applicant through a non-cash contribution to its capital;

• The valuation of the quotas made at the time of acquisition was not done at market value;

• The company B…, Lda. has other partners, in addition to the Applicant, who have no relationship and never had any family relationship with the shareholders of the Applicant, from which it is concluded that the company B…, Lda. was not a vehicle specially used by the Applicant or its shareholders;

Submissions of the Respondent

In its submissions, the Respondent, in addition to reiterating all the arguments previously made in the response and summarizing the testimonial statements, did not add anything of relevance to the decision of the case that should be specially reproduced.

II - PROCEDURAL STAGE

The collective Arbitral Tribunal was properly constituted on 20-09-2017, with the arbitrators being appointed by the Ethics Council of the CAAD, with the respective legal and regulatory formalities complied with (Articles 11, section 1, paragraphs a) and b) of the RJAT and 6 and 7 of the Ethics Code of the CAAD), and is competent as to the subject matter, in accordance with Article 2 of the RJAT.

The Parties have legal capacity and standing and are properly represented.

No procedural defects were identified.

III – QUESTIONS TO BE DECIDED

The questions to be considered and decided are, essentially, the following:

• To determine whether, having the Applicant sold to two of its shareholders two quotas it held in a civil housing company, and having the acquiring shareholders remained indebted to the company for the stipulated price for said acquisitions, such operation is presumed to be a distribution of profits or advance of profits, in accordance with and for the purposes of Article 6, section 4 of the CIRS; and

• To clarify whether the balances in favor of the Applicant recorded in account 27811016 "members of the administration" and in account 27811018 "Dr. D…" can equally be presumed as distributions of profits or advance of profits, in accordance with and for the purposes of Article 6, section 4 of the CIRS.

IV – FINDINGS AND NON-FINDINGS OF FACT

The following are the facts established as relevant to the decision of the case:

• The Applicant was notified of the Personal Income Tax assessments to be collected at source numbers 2016 … and 2016 …, referring, respectively, to the years 2012 and 2013.

• From these assessments, it filed a gracious reclamation on 30-11-2016, which gave rise to process number …

• The gracious reclamation referred to in 2) was rejected on 24-03-2017 by the Finance Directorate of ….

• On 28-12-2012, the Applicant executed a quota transfer contract, by which it transferred to shareholder C… a quota in the company B…, Lda., with the nominal value of 526.15 euros, for the price of 150,000.00 euros.

• By means of the quota transfer contract, the transfer of the right of use and habitation of the ground floor left fraction of the urban property located on Rua…nº…, Lisbon, associated with the quota, was stipulated.

• In the said quota transfer contract, it was stipulated that of the agreed price, the amount of 15,000.00 would be paid on the date of the contract, a second amount of 45,000.00 would be paid within six months from the date of the contract, and the remaining amount (90,000.00 euros) would be paid within one year from the date of the contract.

• On 31-12-2013, the Applicant executed a second quota transfer contract, by which it transferred to shareholder E… a quota in the company B…, Lda., this with the nominal value of 1,052.85 euros, for the price of 300,000.00 euros.

• By means of the quota transfer contract, the transfer of the right of use and habitation of the … floor left fraction of the urban property located on Rua … nº…, Lisbon, associated with the quota, was stipulated.

• In this second quota transfer contract, it was stipulated that of the agreed price, the amount of 30,000.00 would be paid on the date of the contract, a second amount of 90,000.00 would be paid within six months from the date of the contract, and the remaining amount (180,000.00 euros) would be paid within one year from the date of the contract.

• The ground floor left fraction of the urban property located on Rua…nº…, Lisbon, whose right of use and habitation is associated with the quota transferred by the Applicant to shareholder C… was valued on 30 December 2010, by the company F… SA, at approximately 150,000.00 euros.

• The … floor left fraction of the urban property located on Rua … nº…, Lisbon, whose right of use and habitation is associated with the quota transferred by the Applicant to shareholder E… was valued on 30 December 2010, by the company F… SA, at approximately 300,000.00 euros.

• Shareholder D… has inhabited the ground floor left fraction of the urban property located on Rua…nº…, Lisbon for several years.

• Shareholder E… has inhabited the … floor left fraction of the urban property located on Rua … nº…, Lisbon for several years.

• The trial balances of the Applicant reported to 2012.12.31 and 2013.12.31 present the following balances:

• In 2012, a credit was recognized in the Applicant's accounting in account 27811017 in the amount of 150,000.00, regarding shareholder C….

• In 2013, a credit was recognized in the Applicant's accounting in account 27811020 in the amount of 300,000.00, regarding shareholder E….

• The credits recognized in 2012 and 2013 in the Applicant's accounting relate to the price of the quota transfers.

• In the year 2012, a credit was recognized in the Applicant's accounting in account 27811016 against "Administrators" in the amount of 53,350.00 euros.

• In the year 2013, a credit was recognized in the Applicant's accounting in account 27811016 against "Administrators" in the amount of 91,428.76 euros.

• The "members of the administration" identified in this account at that date were, at the date, shareholders of the Applicant.

• In the year 2012, a credit was recognized in the Applicant's accounting in account 27811018 against "Dr. D…" in the amount of 3,900.00 euros, which remained so in 2013.

• The "Dr. D…" identified in this account was, at the date, administrator and shareholder of the Applicant;

• The Applicant, at its General Assembly of 17/09/2016, approved the acquisition of its own shares held by its shareholders E… and C…, by dation in payment of the debts they had to the company, corresponding to the quota transfer contracts referred to in 4) and 7).

Not Established:

• That the Applicant proceeded to the payment of the assessed tax.

• That the credit balance in the amount of 91,428.76 euros in account 27811016 corresponds to advances made by the Applicant to administrators for payment of obligations of the Applicant.

• That the credit balance in the amount of 3,900.00 euros in account 27811018 corresponds to costs of the Applicant.

• That the shareholders C… and E… made a dation and payment to the Applicant, having as its object shares of the Applicant, to pay the debts resulting from the quota transfer contracts.

The facts established as proven were so on the basis of documents attached to the proceedings and on the basis of testimonial evidence produced, with some of them also being established as proven on the basis of the Tribunal's conviction formed from the submissions of the Parties and their non-contestation.

VI – DECISION

APPLICABLE LAW AND INTERPRETATION RULES

The Parties agree that the solution to this dispute involves the correct interpretation of sections 4 and 5 of Article 6 of the CIRS. These rules establish the following:

Article 6
Presumptions relating to income of category E

(...)

4 - Entries recorded in favor of [partners], in any current accounts of partners, recorded in commercial or civil companies under commercial form, when not resulting from loans, provision of work or exercise of corporate positions, are presumed to be made as profits or advance payment of profits.

5 - The presumptions established in this article may be rebutted on the basis of a judicial decision, administrative act, declaration from the Bank of Portugal or recognition by the Tax and Customs Authority.

Article 11 of the General Tax Law establishes the principles that should govern the hermeneutic exercise of tax rules, providing as follows:

Article 11
Interpretation

1 - In determining the meaning of tax rules and in qualifying the facts to which they apply, the general rules and principles of interpretation and application of laws are observed.

2 - Whenever proper terms of other branches of law are employed in tax rules, the same should be interpreted in the same sense they have there, unless otherwise directly provided for by law.

3 - If doubt persists about the meaning of the incidence rules to be applied, account should be taken of the economic substance of the tax facts.

4 - Gaps resulting from tax rules covered by the reserve of law of the Assembly of the Republic are not susceptible to analogical integration.

Section 1 of Article 11 of the General Tax Law commands that in determining the meaning of tax rules and in qualifying the facts to which they apply, the general rules and principles of interpretation and application of laws are observed. It therefore refers to Article 9 of the Civil Code:

Article 9
(Interpretation of law)

1. Interpretation should not be limited to the letter of the law, but should reconstruct from the texts the legislative intent, taking especially into account the unity of the legal system, the circumstances in which the law was elaborated and the specific conditions of the time in which it is applied.

2. However, the interpreter cannot consider legislative intent that does not have in the letter of the law a minimum of verbal correspondence, albeit imperfectly expressed.

3. In establishing the meaning and scope of the law, the interpreter will presume that the legislator adopted the most correct solutions and knew how to express its intent in appropriate terms.

Now, section 1 of Article 9 of the Civil Code expressly states that interpretation should not be confined to the letter of the law. The interpreter must seek, from the source, to grasp the rule, that is, the manifestation of an intended duty to be. It is already clear that the literal expression is relevant. However, the interpreter may well feel the need to collect other hermeneutic elements to identify the rule. For this reason, the legislator opens the door to the possibility of reconstructing from the texts the legislative intent, taking especially into account the unity of the legal system, the circumstances in which the law was elaborated and the specific conditions of the time in which it is applied. This legal opening does not authorize an interpretation that does not have in the letter of the law a minimum of verbal correspondence but aims, of course, to free the interpreter-applicant from a reading manifestly out of step and, for that reason, unjust, especially since, as clarified in section 3 of Article 9 of the Civil Code, the "interpreter will presume that the legislator adopted the most correct solutions".

THE PRESUMPTION IN SECTION 4 OF ARTICLE 6 OF THE CIRS RELATING TO INCOME OF CATEGORY E

General

There is no doubt that section 4 of Article 6 of the CIRS establishes a presumption of income of category E. Let us recall the provision:

1. Entries recorded in favor of [partners], in any current accounts of partners, recorded in commercial or civil companies under commercial form, when not resulting from loans, provision of work or exercise of corporate positions, are presumed to be made as profits or advance payment of profits.

A presumption is an inference that the law or the judge draws from a known fact to establish an unknown fact. In the case at hand, an inference is drawn from a known fact – the entry recorded in favor of the company in any current accounts of the partners, when that entry does not result from loans, provision of work or exercise of corporate positions – of another fact whose existence is unknown – the distribution of profits or advance payment on account of profits.

As it must be, Article 73 of the General Tax Law very clearly determines that "the presumptions established in tax incidence rules always admit proof to the contrary". The Constitutional Court has admitted the non-unconstitutionality of the use of presumptions to determine the tax base provided that their rebuttal is permitted, in obedience to the principle of equality, which requires that the imposition of tax obligations be made according to each person's contributory capacity.

Essential for the admissibility judgment of this type of presumptions is that the taxpayer be allowed to rebut them, that is, to demonstrate that, notwithstanding the verification of the known fact, the unknown fact did not occur. Whoever has a legal presumption in its favor is excused from proving the fact to which it leads, being, however, in the case of rebuttable presumptions, given the opportunity to demonstrate the contrary to whoever is harmed by it.

In tax matters, as seen, presumptions are necessarily rebuttable and their rebuttal can be made, as a rule, in accordance with Article 64, section 1 of the Code of Tax Procedure (CPPT): "The interested party who wishes to rebut any presumption provided for in tax incidence rules must, for this purpose, if not wishing to use the means of gracious reclamation or judicial challenge of the tax act based on it, request the opening of the proper contradictory procedure". However, from this rule one cannot necessarily infer that the rebuttal of the presumption can be done by any means when the law, in certain cases, explicitly states which means of proof may be used to displace it. It is that section 5 of Article 6 of the CIRS expressly states that the presumptions established in that article may be rebutted on the basis of a judicial decision, administrative act, declaration from the Bank of Portugal or recognition by the Tax and Customs Authority. If, in these cases, any means of proof were possible, that provision would have no useful effect. If the legislator elaborated a specific rule for this purpose, such must be interpreted in the sense that it is not intended that the rebuttal can be done by any means of proof.

However, this stringent judgment as regards the rebuttal of the presumption does not dispense with a prior requirement. The base of the presumption must imperatively be proved with the corresponding facts that integrate it, under penalty of the case being decided in a sense unfavorable to the party burdened with that burden, namely the AT, and, in the face of such lack, the result that was intended to be achieved with the legal presumption cannot be said to have been achieved, that is, in the case, that such entry in the partner's current account corresponds to a distribution of profits or advance payment on account of profits. The same is to say that in order to establish as proven the unknown fact, it is imperative to demonstrate the known fact. Only thus is the intended inference authorized.

Now, according to the Applicant, the facts integrating the presumption in the present case are these:

• The existence of financial flows;

• The recording in a partner's current account; and

• That said recording does not result from loans, provision of work or exercise of corporate positions.

The Respondent, for its part, contests the necessity of financial flows existing. Section 4 of Article 6 of the CIRS, in fact, does not appear to require the presence of financial flows, since it uses a word that cannot be taken as a synonym: entry. As the Respondent correctly explains, entry corresponds to the recording of patrimonial facts in the accounts. This concept does not even suggest that we are before financial flows.

The Entries Relating to the Purchase and Sale of Quotas of Company B…, Lda.

That the accounting entries in the accounts of the Applicant relating to shareholders E… and C… do not result from loans, provision of work or exercise of corporate positions is accepted by both Parties. Therefore, for the Respondent to benefit from the presumption of distribution of profits or advance payment on account of profits, it must demonstrate that there is the competent recording in a partner's current account.

Both the Applicant and the Respondent accept the existence of the accounting entries that appear in the company's books. There is, therefore, no dispute as to the existing entry. The dispute lies in the interpretation that can be made of that entry and of the law. It is this point that it is incumbent on this arbitral tribunal to clarify.

As has already been said, we must interpret the rule in section 4 of Article 6 of the CIRS in the general terms of law. The CIRS cannot be interpreted as if it were something it is not. And manifestly the CIRS is not a treatise on accounting. The legislative intent that dictated the formulation of the rule appears to be this: entries recorded in favor of the company, in any current accounts of the partners (emphasis added) fall under the scope of the presumption. This problem is only apparently accounting-related. It is above all a legal problem.

If the legislator, comprehensively, refers to any current accounts, it does not cease to allude to current accounts (emphasis added). We must grasp the meaning of the concept of current accounts, because in truth, it results from the law that not all accounts will be involved… but only the current accounts… A partner's current account will be that in which the frequent, habitual debits and credits with certain persons are recorded, whether they are suppliers, clients, or, in the case that concerns us, in their capacity as partners.

What the law, with the presumption under analysis, sought to resolve was the qualification of the entries recorded in partners' current accounts, when the amounts registered do not have an expressly declared legal "cause". Now, accounting does not condition our legal perception, certainly, but the reverse is not true. That is, we will always have to analyze the substantive situation, the concrete transaction, to understand whether the accounting entry is appropriately made, whether it reflects, with completeness and truth, the operation intended to be recorded.

In the present case, the accounting entries relating to shareholders E… and C… were not made in a partner's current account. This fact, however, does not assume any relevance in itself, since the verification of the tax fact cannot remain at the taxpayer's disposal, which would always happen, in our view, if taxation remained dependent on being recorded in the entry that accounting and law impose. Therefore, we do not stop at the mere finding that no entry was made in a partner's current account. The problem is much more substantial than that. The issue is to determine whether that entry should have been made in a partner's current account. With respect to shareholders E… and C…, the credit balance in favor of the company does not result, in the proper sense, from a partner's current account. It results rather from the sale of an asset. In the case we have public deeds of quota transfer. The intent was to allow shareholders who were already living in those apartments to have themselves the right to inhabit them, with them bearing the costs that the company would bear with them, without being able to claim those costs as tax deductible. Furthermore, the Respondent is a company with several shareholders, all family members, and it does not emerge from the records that similar transactions had taken place with other shareholders. The normal thing is that profits (when they exist, and here, in truth, they do not) tend to be distributed among partners according to the capital held by each. There is no perceived reasonableness, any economic rationality, in a behavior aimed at remunerating the capital of only some shareholders.

The records demonstrate that the transactions that occurred are not such as to justify the recording of the debt of shareholders E… and C… in a partner's current account, understood in the context of the effects of section 4 of Article 6 of the CIRS. What occurred without question was a purchase and sale of assets, the quotas of company B…, which the Company no longer wanted to have in its patrimony, being perfectly reasonable to give such assets the opportunity to be bought by the shareholders to whom they most directly pertained, for being they the ones who inhabit, for many years, the apartments associated with each of the transferred quotas. This means that in this tribunal's understanding, it cannot, with respect to the accounting entries that we have just analyzed, prevail the understanding that there was a distribution of profits or an advance payment on account of profits.

The Entries Relating to "Members of the Administration" and "Dr. D…"

According to the clarification request made by the Respondent and its respective explanation, the "members of the administration" and "Dr. D…" accounts refer to "transactions carried out with credit card and other bank transactions". From the analysis of the excerpt attached to the Final Report submitted by the Respondent, these entries are intended for payments of various expenses to the partners, with no documentary evidence existing that these are loans, provision of work or exercise of corporate positions, and therefore falling within the presumption established in the cited rule, whereby the Tax Administration understands that these entries fall within the presumption established in section 4 of Article 6 and are subject to the withholding tax rate established in Article 71 of the CIRS.

A more detailed analysis of these transactions makes it possible to understand that these are expenses incurred by administrators of the Applicant and not, in the proper sense, its shareholders. Who is in a position to use the company's credit card and to incur expenses on its behalf is, in fact, not the shareholders, but only the administrators, acting in that capacity. Even if the administrators are also shareholders, and we certainly know that in the case of the Applicant, not all of them are, only administrators can be in a position to incur expenses allegedly because they are representing the company. As is evident, it is not fiscally irrelevant that administrators do not account for, until the end of the period, sums for travel, trip or representation expenses.

However, nor here, strictly speaking, are we before a partner's current account, for the purposes of section 4 of Article 6 of the CIRS, since what is involved is the exercise of the function of administrator and not that of partner, whereby the Respondent cannot avail itself of the presumption on which it bases the acts of assessment now challenged.

In truth, within the scope of the arbitral tribunal's powers of cognition, the possibility of the facts of the records being subsumable to any other tax incidence rules is not relevant. The arbitral tribunal need only assess the legality of the assessment acts, annulling them if it finds that they do not conform to the legal order, which will always occur when the grounds for the acts impair their validity. This is also a contention of mere illegality, which has as its object the declaration of invalidity or annulment of the challenged acts.

DECISION

Pursuant to and on the grounds set forth above, the arbitral tribunal decides:

• To annul the decision rejecting the gracious reclamation No. …, contained in the dispatch of 23-03-2017 of the Head of Division of the Finance Directorate;

• To annul the IRS assessments numbers 2016 … (2012) and 2016 … (2013) on which the gracious reclamation No. … was based, with all legal consequences.

VALUE OF THE ECONOMIC UTILITY OF THE PROCEEDING

In accordance with section 2 of Article 306 of the Code of Civil Procedure (CPC), paragraph a) of section 1 of Article 97-A of the Code of Tax Procedure (CPPT) and section 2 of Article 3 of the Regulation on Costs in Tax Arbitration Proceedings, the proceeding is assigned the value of € 159,847.61 (one hundred and fifty-nine thousand eight hundred and forty-seven euros and sixty-one cents).

COSTS

For the purposes of section 2 of Article 12 and section 4 of Article 22 of the RJAT and section 4 of Article 4 of the Regulation on Costs in Tax Arbitration Proceedings, the amount of costs is fixed at € 3,672.00 (three thousand six hundred and seventy-two euros), in accordance with Table I attached to said Regulation, to be borne entirely by the Respondent.

Let it be notified.

Lisbon, Administrative Arbitration Centre, 08 March 2018

The Arbitrators

(José Baeta de Queiroz)

(Nina Aguiar)

(Nuno Pombo)

[1] Art. 349 of the Civil Code.

[2] Cf., among others, very recently, Decision 211/17. With undeniable interest for the case at hand, see, for example, Decision 452/03.

[3] V. DIOGO LEITE DE CAMPOS, BENJAMIM SILVA RODRIGUES and JORGE LOPES DE SOUSA, General Tax Law Annotated and Commented, 4th ed., 2012, p. 650.

[4] Art. 350, section 1 of the Civil Code.

[5] Art. 350, section 2 of the Civil Code.

[6] Decision of the Supreme Administrative Court of 18.12.2002, rendered in Process 01435/02.

[7] Decision of the Central Administrative Court of the South of 13.04.2010, rendered in Process 03461/09.

[8] Decision of the Central Administrative Court of the South of 11.01.2011, rendered in Process 04357/10.

[9] Art. 2, section 3 paragraph d) of the CIRS.

[10] Decision of the Central Administrative Court of the South of 13.04.2010, rendered in Process 03461/09.