CAAD 388/2018-T: IRC Non-Deductibility of Bad Debts and Undocumented Accounting Adjustments Under Articles 41, 23 and 45 CIRC

ARBITRAL TAX JURISPRUDENCE

Case No. 388/2018-T

Date of Decision:
31 July 2019

Corporate Income Tax (IRC)

Value of Claim:
€ 254,753.11

Subject Matter:
IRC – Non-deductibility of expenses. Uncollectible debts and accounting regularizations not properly documented. Articles 41, 23(1) and 45(1)(g) of the Corporate Income Tax Code (CIRC).

ARBITRAL DECISION

The arbitrators Dr. Alexandra Coelho Martins (arbitrator-president), Professor Doctor Jorge Bacelar Gouveia and Dr. Paulo Ferreira Alves (arbitrator-members), appointed by the Deontological Council of the Administrative Arbitration Centre ("CAAD") to form the present Arbitral Panel, constituted on 22 October 2018, hereby decide as follows:

I. REPORT

A..., S.A., legal entity number ..., with registered office in ..., parish of ..., municipality of ..., Vila Real, falling under the jurisdiction of the Tax Authority Office of ..., hereinafter referred to as the "Claimant", submitted on 16 August 2018 a request for arbitral determination pursuant to Decree-Law No. 10/2011, of 20 January – Legal Framework for Tax Arbitration, hereinafter "LFTA" – in which the Tax and Customs Authority is the Respondent, hereinafter referred to as "TCA" or "Respondent".

The Claimant seeks the partial annulment of the Corporate Income Tax (IRC) assessment decision issued under no. 2017..., of 3 July 2017, relating to the fiscal year 2013, which reduced its tax losses to € 268,640.91, in addition to an additional amount of autonomous taxation of € 2,054.85 and corresponding compensatory interest of € 250.41, as well as the rejection decision issued on 21 May 2018 of the Appeal against that tax act. Consequently, the Claimant petitions that a tax loss of € 514,254.35 be recognized, as opposed to the amount recognized by the TCA.

It should be noted that the Claimant accepts the assessment of autonomous taxation and corresponding compensatory interest, so the object of the action is limited to the corrected tax losses. As regards these losses, it is also important to note that the Claimant accepts the addition to its taxable income of € 10,463.05 for impairment losses and € 3,424.75 in expenses for which no supporting document was identified; however, the Claimant does not conform to the addition resulting from uncollectible debts and regularizations of errors in accounting entries which it quantifies at € 254,753.11.

As the basis for its claim, the Claimant alleges substantive defects in the tax act due to incorrect interpretation and application, both of Article 41 of the IRC Code, which gave rise to the rejection by the TCA of uncollectible debts as a tax expense, and, regarding the debit movements in income accounts, of Articles 23(1), 45(1)(g) and 123(2)(a) of the same statute.

The Claimant states that the Extrajudicial Recovery Plans demonstrate the uncollectibility of its debts, whose extinction was determined in the Extrajudicial Recovery Agreements. It considers that the debts do not have to appear in the lists of these Extrajudicial Recovery Agreements because such mention is unnecessary and not mandatory regarding debts qualified as subordinated (Article 47(4) of CIRE), as is the case, which can only be paid after all bank debts and common debts are fully liquidated. Since there are not even conditions to pay the other debts (non-subordinated) and therefore, all the more so, the subordinated ones, the extinction of the latter was decided.

It further sustains that the failure to claim the debts does not constitute a legal ground to reject the expense for tax purposes, since it is not provided for in Article 41(1) of the IRC Code, and that in many situations, such claim proves unnecessary for evidence of the uncollectibility of the debts, as occurs in insolvencies "with limited character" [in which there is no claim of debts], or when the revitalization plan provides for non-payment of debts. It concludes, in this matter, that it has presented documents supporting the uncollectibility of the debts for tax purposes.

With regard to proof of communication to the debtor of the recognition of the expense for tax purposes, the Claimant argues that, in accordance with Article 41(2) of the IRC Code, that proof is not subject to formal requirements, so this condition should be considered satisfied by the execution of the Recovery Agreements, which show that the debtor was aware of the expense. It adds that it makes no sense for written communication to the debtor to be required, either because it is not possible to obtain from it the useful effect intended by the legislator, since it will not be subject to taxation [the positive variation] under Article 268 of the Insolvency and Business Recovery Code ("CIRE"), within the context of the recognition of the uncollectible debt resulting from an Extrajudicial Agreement endorsed by the judge, or because it should be understood that, proven the special relationship between the entities, as occurs in the present situation, such amounts to sufficient proof of "existence of communication".

With regard to expenses recorded as debits in income accounts and not accepted by the TCA because they do not meet the requirements of Article 23 of the IRC Code, in the amount of € 4,878.04, the Claimant states that they are mere cancellations of credit movements (transitional) which, by oversight, were recorded in the accounts. Since the credit movements are not supported by invoices, as they resulted from error, the debit movements cannot be supported by credit notes either. It advocates that these mere regularizations of transitional accounting movements have no accounting or tax relevance.

On 16 August 2018, the request for constitution of the Arbitral Panel was accepted by His Excellency the President of CAAD and automatically notified to the TCA.

In accordance with Articles 5(3)(a), 6(2)(a) and 11(1)(a), all of the LFTA, the Deontological Council of CAAD appointed the arbitrators of the Collective Arbitral Panel, who communicated their acceptance of the appointment within the applicable deadline. The Parties, notified of this appointment on 1 October 2018, did not object.

The Collective Arbitral Panel was constituted on 22 October 2018.

Pursuant to Article 17(1) of the LFTA, the TCA was notified on the same date to submit its Reply.

On 26 November 2018, the TCA submitted its Reply, accompanied by the administrative file ("AF"), raising a defence by objection. It maintains that the claim of debts is a requirement for creditors to appear on the final lists of creditors and that, since the Claimant did not claim those debts and therefore does not appear on those lists, the Extrajudicial Agreements cannot bind it, and much less the TCA. It considers that it does not follow from Article 17-F(6) of CIRE that the decision to approve the plan applies to creditors not recognized and not included in the Final List of Creditors, whereby the Agreements only extinguish the subordinated debts that have been claimed and that appear in the list attached to them.

It likewise considers that the obligation to communicate provided for in Article 41(2) of the IRC Code has not been fulfilled. It emphasizes that we are not dealing with insolvent companies but companies facing recovery plans, with assets and capital to pay debts and, relying on Arbitral Decision No. 390/2015-T, reaches a conclusion opposite to that defended by the Claimant. For the Respondent, the existence of special relationships does not militate in a different direction, since the law does not distinguish them.

As for the accounting regularization movements, the Respondent expresses doubts about the Claimant's version, considering there to be a contradiction between the amounts put forward by the latter, and maintains its understanding of their non-deductibility for tax purposes since no supporting documents were presented.

The Respondent concludes for the improcedence of the action and consequent dismissal of the claim. It also considers that the request for witness testimony should be rejected as constituting a useless act.

By decision of 28 November 2018, the Arbitral Panel dispensed with witness testimony, given that the relevant factual matters could only be proven through documentary evidence. The parties were notified and a deadline was set for successive submissions and for issuance of the decision.

On 14 December 2018, the Claimant submitted submissions and on 11 January 2019 the Respondent submitted counter-arguments.

Both Parties maintained the positions previously assumed, with the Claimant invoking that it had claimed its debts.

By decisions of 23 April 2019 and 14 June 2019, taking into account the complexity of the issues raised, the deadline for issuance of the arbitral decision was extended, pursuant to Article 21(2) of the LFTA.

II. PRELIMINARY MATTERS

The Panel was regularly constituted and is materially competent, given the nature of the subject matter of the case (cf. Articles 2(1)(a) and 5 of the LFTA).

The parties have legal personality and capacity, have standing and are regularly represented (cf. Articles 4 and 10(2) of the LFTA and Article 1 of Regulation No. 112-A/2011, of 22 March).

The request for arbitral determination is timely, as it was filed within the deadline provided for in Article 10(1)(a) of the LFTA and the case is free of procedural defects.

III. GROUNDS. FINDINGS OF FACT

A. FACTS FOUND TO BE PROVEN WITH RELEVANCE TO THE DECISION

1. With reference to fiscal year 2013, the Claimant company, A..., S.A., was engaged in hotel and restaurant activities and, supplementarily, tourism animation activities, falling within the general system for determining taxable profit for IRC purposes – cf. Tax Inspection Report ("TIR") attached to the request for arbitral determination ("rad"), document 1.

2. The Claimant held a debt of € 208,457.77 against B..., S.A. ("B...") and a debt of € 32,280.63 against C..., S.A. ("C...") – cf. TIR.

3. In that fiscal year 2013, the Claimant proceeded with the cancellation of the debts outstanding above mentioned of € 208,457.77 and € 32,280.63, relating to B... and C..., respectively – cf. TIR.

4. Said cancellation of debts was recorded in the accounting (income statement) of the Claimant as an expense and, as such, was deducted by it in determining the taxable profit for the fiscal year in question (2013) – cf. TIR.

5. The entire capital stock of the Claimant was held at the time by B..., S.A., as sole shareholder, which in turn was entirely held by D..., founder of Group E... ("Group E...") – cf. Report and Accounts of the Claimant (document 7 – point 32 disclosure of related parties) and Extrajudicial Agreement (document 6a, in particular recital B), attached to the rad.

6. The only shareholders of C... were B... and F..., S.A., with the capital stock of the latter being entirely held, directly or indirectly, by D... – cf. Extrajudicial Agreement (document 6b, in particular recital B), attached to the rad.

7. The debtor companies whose debts were cancelled by the Claimant – B... and C... – underwent a Special Revitalization Process provided for in Articles 17-A to 17-I of CIRE, within which an Extrajudicial Recovery Agreement was concluded for each of them, pursuant to Article 17-E of CIRE – cf. Extrajudicial Agreements (document 6a and document 6b), attached to the rad.

8. The Claimant appears on the list of creditors with recognized debts in the Special Revitalization Process No. .../13...TYLSB of B..., which took place before the 3rd Court of the Commercial Court of Lisbon – cf. document 8 attached to the rad.

9. The Claimant appears on the list of creditors with recognized debts in the Special Revitalization Process No. .../13...TYLSB of C..., which took place before the 4th Court of the Commercial Court of Lisbon – cf. document 8 attached to the rad.

10. The Extrajudicial Recovery Agreements concluded with respect to B... and C... provide that:

a. Real guarantees and credit privileges cover the entirety of Group assets – Recitals of Extrajudicial Agreements – document 6a and document 6b – Q (B...) and P – C...;

b. Subordinated debts are those meeting the characteristics provided for in Articles 48 and 47(b) of CIRE – Clause 1.1 of Extrajudicial Agreements – document 6a and document 6b;

c. With [judicial] approval the entirety of subordinated debts is extinguished, ceasing to be enforceable by their holders – Clause 6.1 of Extrajudicial Agreements – document 6a and document 6b;

d. One of the foreseeable impacts of the Approval of the Agreement is the extinction of subordinated debts – Clause 8.15 of Extrajudicial Agreements – document 6a and document 6b.

1. The Extrajudicial Agreements relating to the Revitalization Plan of B... and C... were approved, with their respective approval sentences becoming final on 29 August 2013 and 24 December 2013 – cf. TIR.

2. The Claimant was subject to an internal inspection procedure for fiscal year 2013, initiated on 4 April 2017 and authorized by Service Order No. OI 2017..., of partial scope, with the objective of correcting the tax loss declared in IRC – cf. TIR.

3. In that context, the Claimant was notified of the Draft Conclusions to exercise, if it so wished, the right to a hearing, which it did, in writing, on 29 May 2017 – cf. TIR.

4. The Claimant was notified of the Tax Inspection Report by official letter 2420, of 22 June 2017, with the following proposals for corrections to the IRC taxable income for fiscal year 2013, in addition to autonomous taxation at the rate of 60%, resulting in the amount of € 2,054.85, not contested in the present action – cf. TIR:

1. As the basis for the corrections of IRC taxable income in question, with relevance to the present arbitral action, the TIR states the following:

"[…]

III. Description of facts and grounds for merely arithmetic corrections to taxable income

1. In 2013, the taxpayer declared tax losses in the amount of € 528,145.15 in section 07 of the annual IRC income declaration form, Model 22.

2. In the course of the external analysis conducted within the scope of DI 2016..., which had as its purpose the consultation and collection of information, intended to confirm the legality of the declared tax losses, the taxpayer was notified in writing to present the supporting documents of the operations, referred to below, which were recorded in the accounts in 2013, with a view to assessing the actual substantive nature of the operations.

[…]

1. In light of the clarifications and documents presented by the taxpayer and the analysis thereof, it is found that situations exist in which the substantive nature of the operations underlying the charges recorded in the accounting as expenses for fiscal year 2013 has not been proven, under Article 23 of the IRC Code, since they are not supported by documents supporting those expenses.

Operations recorded as debits in expense accounts

[…]

1. As for the charges recorded in the accounting as an expense in account 685851000-OGP-PER Reduction of Associated Debts, in the amount of € 208,457.77 and € 32,280.63, under documents no. ... and ..., respectively, point 2, xiii), although the taxpayer submitted documents of the extrajudicial recovery agreement (copy) relating to B..., S.A. and C..., S.A., and the respective accounting records, it did not present the documents underlying the accounting records with a view to the calculation method and demonstration of the risk of impairment, for purposes of determining impairment losses provided for in Article 35(1)(a) of the IRC Code.

[…]

1. For the charges supported by the taxpayer to be characterized as tax expenses, they must be properly documented, as follows from Articles 45(1)(g), 123(2)(a), both of the IRC Code, which is not the case with the operations identified in the foregoing points.

2. Given the lack of supporting documents for the operations subject to accounting record, the operations in question are not documented and therefore the respective expenses cannot be accepted for tax purposes under Articles 23(1) and 45(g), 123(2)(a), all of the IRC Code, whereby they will be subject to correction, for purposes of determining taxable profit, in the amount of € 305,459.20. as shown in the table below.

Operations recorded as debits in income accounts (reduction of income)

1. With respect to accounting records recorded as debits in an income account, account 721121000-PS-Rest.Food, in the amount of € 4,878.04 (€ 2,439.02 x 2), document no. ... and no. ..., respectively, point 2, xvi), the taxpayer did not present the documents supporting the entries made in its accounts nor clarifications on the classification of the operations underlying the records in question.

2. Given the lack of supporting documents for the operations subject to accounting record, referred to in the foregoing point, they are not documented and therefore the respective charges recorded in the accounts as expenses (reduction of income) cannot be accepted as expenses for tax purposes under Articles 23(1) and 45(g), 123(2)(a), both of the IRC Code, whereby they will be subject to correction, for purposes of determining taxable profit.

3. Given the facts referred to in the foregoing points, different results of the activities are presented which manifest themselves through the alteration of the declared losses (to be carried forward), deductions made, as shown in the table below.

1. In this way, the existence of a tax loss in the amount of € 217,807.91 for fiscal year 2013, which may be deducted, results under Article 52(1) of the IRC Code.

Autonomous Taxation

[…]

IX. Right to a Hearing – Grounds.

[…]

1. In the case of charges recorded in the accounting as expenses in account 685851000-OGP-PER Reduction of Associated Debts, in the amount of € 208,457.77 and € 32,280.63, under documents no. ... and ..., respectively, the taxpayer clarified, in points 13, 14, 15, 16 and 17 of the statement of right to a hearing, which result from the cancellation of outstanding debts relating to B..., S.A. and C..., S.A.:

i) They resulted from losses recorded under rubric # 685851000;

ii) They were not and should not have been analyzed under Article 35(1)(a) of the IRC Code;

iii) Only an incorrect classification of the situation under analysis within the tax regime of impairment losses provided for in Article 35 of CIRC (by the TCA) would determine the necessity of requiring the Claimant to demonstrate the calculation method of the impairment loss and corresponding risk of uncollectibility of the debt;

iv) The expense does not result from the recognition of an impairment loss, but rather from the recognition of the debt as an uncollectible debt due to an extrajudicial recovery agreement made under the Insolvency and Business Recovery Code;

v) Given the unequivocal demonstration of the incorrect tax classification by the Services, and considering that the expenses, as uncollectible debts, are properly supported by the extrajudicial agreement that has already been delivered to the Services, there can be no remaining doubts regarding the deductibility thereof.

1. Assuming that the identification of the applicable norm is not correct (Article 35(1) of the IRC Code), taking into account that the uncollectible debts, according to the taxpayer, result "from the debt as uncollectible debt due to an extrajudicial recovery agreement made under the Insolvency and Business Recovery Code" and recorded as debits in account 685851000 – Expenses and losses in subsidiaries, associates and joint ventures – OGP-PER Reduction of Associated Debts, the tax regime applicable to them, at the date of the tax facts (2013), consists of Article 41 of the IRC Code.

2. Notwithstanding what was mentioned previously, the reason for non-acceptance of uncollectible debts as a tax expense for fiscal year 2013 is the same justifying reason; no supporting documents of the uncollectibility of the debts recorded in the accounts were presented, with a view to the calculation method, since the elements presented do not prove the tax uncollectibility thereof as required by Article 41 of the IRC Code, and therefore, if the expenses are not properly documented, they cannot be considered for tax purposes.

[…]

Let us see:

1. From the analysis of the elements provided within the scope of the inspection action, extrajudicial recovery agreement relating to B..., S.A., and C..., S.A., conducted under Article 17-I of CIRE, it is found that:

i) The agreement relating to B..., S.A., whose sentence approving the revitalization plan became final on 29-08-2013 – The agreement is directed at the recovery of the company within the framework of restructuring of Group E... (set of companies dominated directly and indirectly by F..., S.A., including the Company) and of the latter's liabilities, as well as the acquisition of the Company and the other companies integrating Group E... by G..., SGPS, S.A.;

ii) The agreement relating to C..., S.A., whose sentence approving the revitalization plan became final on 24-12-2013 – The agreement is directed at the recovery of the company within the framework of restructuring of Group E... (set of companies dominated directly and indirectly by F..., S.A., including the Company) and of the latter's liabilities, as well as the acquisition of the Company and the other companies integrating Group E... by G..., SGPS, S.A.;

iii) The taxpayer does not appear on the lists of creditors of these agreements, so that these cannot bind it nor is there evidence of the claim of debts within the scope of the extrajudicial recovery agreements of the debtor;

iv) In 2014, the operation was recorded in the amount of € 244,334.00, debited to account 268108000-B..., in contraposition to the credit from account 268100200- G.... The company G..., SGPS, S.A. (G...) acquired control of the companies integrated in Group E...: B..., S.A., H..., S.A., F..., S.A. and I..., S.A..

[…]

1. In accordance with Article 41 of the IRC Code (in effect in 2013), "uncollectible debts may be directly considered expenses or losses of the fiscal period provided that this results from a process of business insolvency and recovery, from a process of execution, from an extrajudicial conciliation procedure for viability of companies in insolvency situations or in situations of economic difficulty (…)", and "the deductibility of debts considered uncollectible (…) remains further dependent on the existence of proof of communication to the debtor of the recognition of the expense for tax purposes, which must recognize that amount as income for purposes of determining taxable profit".

2. For uncollectible debts to be directly considered expenses or losses of the fiscal period for tax purposes, it was necessary that this result from an extrajudicial conciliation procedure for viability of companies in insolvency situations or in situations of economic difficulty, no impairment loss had been recognized or, being so, it proved insufficient and there existed proof of communication to the debtor of the recognition of the expense for tax purposes, which must recognize that amount as income for purposes of determining taxable profit.

3. In addition to the taxpayer not appearing on the lists of creditors of these agreements (provided by the latter), the taxpayer did not demonstrate that it complied with the communication obligation prescribed in Article 41(2) of the IRC Code, and therefore the regime of Uncollectible Debts provided for in Article 41 of the IRC Code is not applicable to the impairment loss under analysis, whereby the value of the debt should not be accepted for tax purposes and should be added for purposes of determining taxable profit under the terms and for the effects provided for in Articles 23(1) and 45(g), 123(2)(a), both of the IRC Code.

[…]

Point 12, Chapter III, of the draft report: Operations recorded as debits in income accounts (reduction of income) – € 4,878.04

1. With respect to operations recorded as debits in income accounts (reduction of income), point 11 and 12 of Chapter III of this report, the taxpayer clarifies, in points 23 and 24 of the statement of submissions, that:

i) "Indeed, following analysis of the various movements identified in the table above, it is concluded clearly, simply and immediately that the TCA would not have considered that these same movements [identified as (i)] cancel themselves out with the other movements contained in the same table (and recorded in the accounts as results from the extract of the respective account already previously sent), which immediately shows that they result from mere regularizations/transitional accounting movements, with no accounting relevance, and, in this sense, tax relevance";

ii) "In this way, demonstrated that the movements questioned by the TCA serve to cancel (duly) movements to credit that were improperly influencing the accounting result, the TCA should consider as accepted the expense in the amount of € 4,878.04".

1. Notwithstanding the movements in question, recorded as debits in income accounts (reduction of income), being mere regularizations/accounting movements, with neutral effect in terms of accounting result, in tax terms, they are not supported by justifying documents for purposes of complying with the requirements of Articles 23(1)(a) and 45(1)(g), and Article 123(2)(a), both of the IRC Code, a provision which requires that, for purposes of determining taxable profit, expenses be properly documented.

2. In the case of operations recorded as debits in account 721121000-PS-Rest.Food, document no. ... and no. ..., respectively, in the amount of € 4,878.04 (€ 2,439.02 x 2), the taxpayer presented, within the scope of the inspection action, invoice (issued) no. 200000022, of 31-12-2013, in the amount of € 0.00, to justify the operations in question and the "detail", extract of the account where the respective movements are shown.

Invoice No. 200000022

1. Furthermore, although this is cancellation of credits, corresponding to cancellation of invoices initially issued, the taxpayer did not present the supporting documents for the accounting entries made (1 and 2), and invoice no. 200000022 presented has a nil value (+ € 3,000.00 - € 3,000.00), which was accepted to justify document no. 50025024.

2. If the expenses are not properly documented, they cannot be considered, even if there is no doubt about their actual occurrence.

3. In this regard, Saldanha Sanches notes, in annotation to the Administrative Supreme Court Decision, Case No. 023768/99, of 27-10-1999, "And as this absence of documentation constitutes a violation of Article 98(3)(a) of CIRC, the Tax Administration reacts, as the law requires it to react, from a formal perspective: if the cost is not documented, and must be documented, such cost cannot be considered: even if there is no doubt about its actual occurrence."

4. In light of acceptance of the documents supporting the respective charges for purposes of the requirements of Articles 23(1)(a) and 45(1)(g), and Article 123(2)(a), both of the IRC Code, the existence of a tax loss in the amount of € 268,640.91 for fiscal year 2013, which may be deducted, results under Article 52(1) of the IRC Code, in the wording applicable as of the date of the tax facts, as shown in the table below.

1. Following this, we will proceed to correct the autonomous taxation initially calculated, from which results unpaid tax of € 2,054.85 [(€ 59,135.79 - € 55,711.04) x 60%].

[…]"

1. Following the aforementioned corrections, additional assessment no. 2017..., of 3 July 2017, was issued, which set the tax losses of the Claimant for fiscal year 2013 at € 268,640.91 and resulted in an additional amount payable of € 2,305.26, as autonomous taxation, including respective compensatory interest, with payment deadline of 4 September 2017 – cf. Assessment and account settlement statement attached to the rad, document 2.

2. The Claimant conformed with the corrections referred to in (2)(a) and (b) of point 14 above, in the aggregate amount of € 13,887.80, disagreeing, however, with the others, in the amount of € 240,738.40 [(2)(c)] and € 4,878.04 (3) – cf. Appeal attached to the rad, document 4.

3. For this reason, it filed an Appeal, which was rejected on 21 May 2018, by Decision of the Chief of the Finance Department's Management Division, under delegation of authority, which did not accept the arguments of the Claimant – cf. document 4 and document 5 attached to the rad.

4. On 16 August 2018, in disagreement with the tax loss corrections identified above, the Claimant submitted to CAAD the request for arbitral determination that gave rise to the present case.

B. FACTS FOUND NOT TO BE PROVEN

With relevance to the decision there are no alleged facts that should be considered not proven.

Nor were submissions made by the parties and presented as facts, consisting of strictly conclusive assertions not susceptible to proof, whose truthfulness must be assessed in relation to the specific consolidated factual matter, given as proven or not proven.

C. STATEMENT OF REASONING REGARDING FACTUAL DETERMINATIONS

With regard to the facts found to be proven, the conviction of the arbitrators was based on critical analysis of the documentary evidence submitted to the case file, while also considering the positions assumed by the parties.

The facts relevant to the trial were selected and delimited based on their legal significance, in light of plausible solutions to the legal questions, in accordance with the combined application of Articles 123(2) of the Tax Procedure Code, 596(1) and 607(3) of the Civil Procedure Code ("CPC"), by reference from Article 29(1)(a) and (e) of the LFTA.

IV. LEGAL GROUNDS

A. DELIMITATION OF THE QUESTIONS

Two corrections to the IRC taxable income of the Claimant are in dispute in the present arbitral case. The first concerns the rejection by the TCA of expenses relating to uncollectible debts, due to alleged breach of the tax deduction requirements provided for in Article 41 of the IRC Code. The second relates to the non-acceptance of the deduction of expenses resulting from accounting records as debits in income accounts, in the amount of € 4,878.04, made without support from justifying documents, by application of Articles 23(1), 45(1)(g) and 123(2)(a) of the same statute.

B. FRAMEWORK – UNCOLLECTIBLE DEBTS

The prerequisites for tax recognition of uncollectible debts as expenses or losses are regulated in Article 41 of the IRC Code, which provided, in the wording in effect as of the date of the facts (2013), the following:

"Article 41

Uncollectible Debts

1 – Uncollectible debts may be directly considered expenses or losses of the fiscal period provided that:

a) This results from a process of business insolvency and recovery, from a process of execution, from an extrajudicial conciliation procedure for viability of companies in insolvency situations or in situations of economic difficulty mediated by IAPMEI - Institute for Support of Small and Medium Enterprises and Investment, from a decision of an arbitral tribunal within the scope of disputes arising from the provision of essential public services or from debts which are time-barred in accordance with the respective legal regime of provision of essential public services and in this case their value does not exceed the amount of (euro) 750; and

b) No impairment loss has been recognized or, if recognized, it proves insufficient.

2 – Without prejudice to the maintenance of the obligation for civil purposes, the deductibility of uncollectible debts as provided for in the preceding paragraph or under Article 36 remains further dependent on the existence of proof of communication to the debtor of the recognition of the expense for tax purposes, which must recognize that amount as income for purposes of determining taxable profit."

It follows from this provision, with relevance to the case before us, that the uncollectibility of debts must, on the one hand, result from a process of business insolvency or recovery and, on the other hand, that the tax deductibility of the expenses or losses resulting from the cancellation of the debts depends on a communication to the debtor of specific content – the creditor's recognition of the expense – so that the debtor in turn recognizes the same amount [of uncollectible debts] "as income for purposes of determining taxable profit".

In this context, it is important to note the regime, in effect at the time, established by CIRE for the Special Revitalization Process ("SRP"), to which both B... and C... resorted to restructure their liabilities and ensure their viability, within which the debts held by the Claimant against these entities were considered uncollectible.

In accordance with the provisions of Article 17-C of CIRE, the SRP is initiated by joint declaration of the debtor and at least one of the creditors, with a view to negotiation and approval of a debtor revitalization plan, following which a judicial administrator is chosen who prepares a provisional list of debts immediately presented at the court registry and published on the Citius portal (Article 17-D of CIRE). Said list of debts may be challenged but, if not, converts to final by mandatory effect of said provision and, consequently, the respective debts are recognized (no. 4).

Notwithstanding the fact that the SRP provides an opportunity for creditors to claim their debts, such claim does not constitute an essential prerequisite or condition for recognition of the debts. Similar to what occurs in the insolvency process, the judicial administrator has not only the duty but at least the power to include in the list of debts all those recorded in the debtor's accounts or otherwise known to it, even if not specifically claimed by their respective holders, so that the list better reflects the real universe of the debtor's liabilities. Thus, debts recognized in the process (SRP or insolvency) are not necessarily coincidental with claimed debts.

On the other hand, it should be noted that it is common for common creditors, given the insufficient assets that characterize debtors subject to processes of this nature, faced with the existence of other secured and privileged debts to be paid with preference over the others, to choose not to claim their debts (common), for reasons of efficiency and in light of cost-benefit considerations. Indeed, it is reasonable that the "common" creditor, whose expectation is that the insolvent assets will not even manage to satisfy the debts ranked in first place (secured and privileged), decides not to expend resources in making a claim of debts (common) which from the outset proves fruitless.

The solution advocated results from the application of Article 129 of CIRE, invoked on a subsidiary basis, given the general applicability of insolvency process rules to respond to questions not specifically regulated in the sparse articles that govern the revitalization process, as supported by doctrine – cf. in this sense CARVALHO FERNANDES and JOÃO LABAREDA, "Insolvency and Business Recovery Code Annotated", Quid Juris, 2013, pp. 140-141, 156.

According to no. 1 of the cited Article 129, the administrator, after the deadline for claims expires, "presents at the court registry a list of all creditors recognized by it and a list of non-recognized creditors, both in alphabetical order, relating not only to those who have made a claim but also to those whose rights are recorded in the debtor's accounting records or which are otherwise known to it."

It is also worth noting that, as those authors maintain (cf. work cited p. 159), with support in the provision of Article 17-F(6) of CIRE, the court's approval of the agreement is binding on creditors who did not participate in the negotiations, which also includes those who did not even claim their debts.

Furthermore, non-claim of debts in the SRP does not even preclude the possibility that, should the process proceed to insolvency, creditors may claim them subsequently, under the provisions of Article 17-G(7) of CIRE.

With respect to classes of debts, Article 47(4) of CIRE classifies debts in 3 categories: i) secured or privileged; ii) subordinated and iii) common. Subordinated debts are defined as those held by persons "specially related to the debtor", such as shareholders, associates or persons who have been with the company [debtor] in a relationship of control or group (by reference to Articles 48(a) and 49(2), both of CIRE).

The fundamental consequence of qualification of a debt as subordinated is its graduation after all others. Only after payment of the rest (first the secured and then the common) is there place for satisfaction of subordinated debts, to the extent of the remaining assets of the insolvent estate. Additionally, they do not confer voting rights at the creditors' assembly, as provided by Article 73(3) of CIRE – cf. CARVALHO FERNANDES and JOÃO LABAREDA, op. cit. pp. 309-310.

It is further worth noting that, absent express provision to the contrary, approval of an insolvency plan entails total forgiveness of subordinated debts, in accordance with Article 197(b) of CIRE, and there is no reason why this regime should not apply to the revitalization plan, given the identity of the interests the provision seeks to protect regarding safeguarding of independent creditors.

Finally, on this matter, reference is made to Article 268 of CIRE, which establishes a set of tax benefits relating to income taxes of individuals and legal entities and which provides in its no. 2 that "[n]ot enter[ed] […] into the formation of the taxable income of the debtor are positive patrimonial variations resulting from alterations of its debts provided for in an insolvency plan, payment plan or revitalization plan."

C. CONCRETE ANALYSIS – UNCOLLECTIBLE DEBTS

PROOF OF UNCOLLECTIBILITY

The debts considered uncollectible by the Claimant, whose tax deduction was rejected by the TCA on the grounds of non-presentation of documents proving uncollectibility, have as debtors B... and C..., two companies that were subject to an SRP and inserted, like the Claimant, within the scope of Group E... (with the Claimant held entirely by B..., its sole shareholder).

From a comparison of Articles 47 to 49 of CIRE, it is concluded that such debts are qualified as subordinated, given the special relationships between the creditor (the Claimant) and the debtors (B... and C...), all these entities being held entirely, directly or indirectly, by D..., in accordance with the proof produced.

It further follows from the factual framework established in the case that the Claimant appears on the Lists of creditors published on the Citius portal for each of the processes (SRP) conducted against B... and C... and that the corresponding Extrajudicial Agreements established a revitalization plan for these entities which was approved and subject to judicial approval, with their respective sentences becoming final still during fiscal year 2013.

In the referred Agreements it is expressly stated, moreover in line with the regime provided for in Article 197(b) of CIRE, that subordinated debts are wholly extinguished and cease to be enforceable by their holders following approval of the Agreements and that real guarantees and credit privileges cover all Group assets, that is, that there is no remaining assets in the "insolvent estate" to satisfy common debts.

It appears, in these terms, unequivocal that the debts held by the Claimant against B... and C..., classified as subordinated debts, were extinguished and ceased to be enforceable as a consequence of approval of the recovery plan agreed in the revitalization processes covering those companies, and are therefore uncollectible.

The Extrajudicial Agreements concluded with respect to debtors B... and C... and their approval by final judicial sentence constitute sufficient documentation of the uncollectibility of the debts held by the Claimant, and it cannot be understood what other documentation could be required. The prerequisite of Article 41(1)(a) of the IRC Code is thus fulfilled, which determines that uncollectibility result from a business recovery process. One cannot thus conclude, as the TCA does, that "the expenses are not properly documented".

The TCA's argument that the debts were not claimed by the Claimant and that therefore it does not appear on the lists of creditors of the Extrajudicial Agreements approved by court, and that such agreements could therefore not bind it, does not hold. Indeed, not only is such restriction not contained in the provision of Article 41 of the IRC Code, which does not mention that debts must be claimed, rendering it devoid of legal basis, but the Claimant appears on the list of creditors in the SRP, although it is not listed in the Annexes to the Agreements.

It should be noted that the extinction of all subordinated debts which results by operation of law and from the Extrajudicial Agreements approved implies the unnecessary specification of such debts in the annexes to the Agreements. Since they are wholly extinguished, subordinated debts need not be listed in the Agreements; they simply, as a consequence of their approval, cease to form part of the debtors' liabilities.

On the other hand, it is irrelevant whether or not the debts were claimed to conclude that the Claimant is bound by the Extrajudicial Agreements approved by final judicial sentence. It is important to note that approval of the Agreements by the judge is, by express legal determination, binding on creditors who did not participate in the negotiations, under Article 17-F(6) of CIRE, which also includes those who did not even claim their debts, as the doctrine concludes.

In this sense, see CARVALHO FERNANDES and JOÃO LABAREDA, op. cit. p. 159; ANA RITA RIBEIRO and MAGDA FERNANDES, "Rights of 'non-claiming' creditors within the scope of the SRP", Journal Julgar, June 2017, pp. 18-21, and FÁTIMA REIS SILVA, "Special Revitalization Process, Practical Notes and Recent Case Law", Porto Editora, 2014, pp. 67-68. This latter judge states that the "approved plan binds all creditors, even those who did not participate in the vote – no. 6 – and is published and publicized in accordance with the provisions of Articles 37 and 38 of CIRE, again, with the necessary adaptations. For creditors who did not participate – namely by claiming their debts – this means that they are nevertheless bound by the exact terms contained in the plan. If the plan provides for payments by category of debts or creditors, the provisions regarding the respective category will apply; if the plan only provides for individually considered payments, creditors not contemplated are not affected, maintaining themselves in the exact terms of enforceability in which they already pre-existed".

Understanding likewise shared by the Court of Appeal of Coimbra, in the Decision of 6 June 2017, issued in case No. 505/16.1T8FND.C1 whose summary is transcribed: "The normative segment of no. 6 of Article 17-F of CIRE, insofar as it provides that 'the court's decision (approving the SRP) binds creditors, even if they did not participate in the negotiations' must be interpreted to mean that it covers all of the debtor's creditors, even those not listed in the list and plan."

With respect to the insufficiency of assets of the debtors to satisfy the Claimant's debts, the Extrajudicial Agreements, in the calculations conducted, conclude that the assets of those are exhausted by the (class of) secured and privileged debts, so that there are not even conditions for payment of all common debts, which are forgiven partially in accordance with the formula contained in the Agreements. Thus, it is manifest the insufficient assets justifying the uncollectibility of the debts which results, in any case, given the nature of subordinated debts (such as those in question), from the legal extinction operated by approval of the negotiated recovery plans.

DUTY TO COMMUNICATE TO DEBTORS

The deductibility of the expense relating to uncollectible debts further depends, as provided for in Article 41(2) of the IRC Code, on "the existence of proof of communication to the debtor of the recognition of the expense for tax purposes, which must recognize that amount as income for purposes of determining taxable profit".

The IRC Code thus establishes, as a condition of tax deductibility, that the taxpayer demonstrate that it communicated to the debtor that it recognized the uncollectible debts as a tax expense (in the period in which such recognition occurred), while simultaneously establishing that the debtor recognize the corresponding amount as income for tax purposes.

The Claimant begins by emphasizing that the law does not impose formal requirements of proof, which means that the proof is free. In this sense, Arbitral Decision No. 390/2015-T, of 18 April 2016, also manifests itself, stating that "no. 2 of Article 41 merely speaks of proof of communication but does not make explicit what this proof consists of, nor does it refer to what formal requirements are necessary for such proof", proceeding in the sense that, for IRC purposes, the "tax legislator does not impose, unlike what is provided in the VAT Code, special communication duties".

Grounded in the free proof regime, the Claimant argues that the Extrajudicial Recovery Agreements which were executed by the debtors and which provide for the extinction of all subordinated debts demonstrate that these were aware of the recognition of the expense by it.

Such inference cannot, however, be followed, since, notwithstanding the free proof regime, which is accepted, the Agreements in question refer to the extinction of debts and contain no mention or information regarding the accounting and tax treatment which, following that extinction, the creditors (here, the Claimant) gave to them. The fact that, according to the law, must be communicated is not the uncollectibility of debts or their extinction, but the consequent "recognition of the expense for tax purposes" and regarding such recognition the mentioned Agreements say nothing, whereby they are not suitable to prove what is required by Article 41(2) of the IRC Code, and the Claimant's position is without merit, as it did not make proof, an obligation which rested upon it, that it proceeded with the communication which the norm under analysis made a condition of tax deduction.

Additionally, it does not appear that the existence of special relationships between the creditor [the Claimant] and its debtors can be equivalent to sufficient proof of "existence of communication" in the sense of Arbitral Decision issued in case No. 532/2017-T, and correspond to facts notoriously known by all involved. Creditor and debtors are distinct companies and even if there is a Group relationship between them, it is not permissible to infer, without more, knowledge of facts relating to the other companies in the group, besides which the law does not make any distinction regarding the communication obligation with related entities.

It remains to assess whether, in this context, as the Claimant argues, communication to the debtor(s) makes no sense and should not constitute an obstacle to the deduction of the expense in the concrete situation, because it is not possible to obtain from it the useful effect intended by the legislator, which is recognition of the tax benefit in the debtor's sphere, since Article 268(2) of CIRE provides that positive patrimonial variations resulting from alterations of debts provided for in a recovery plan do not enter into the formation of the debtor's taxable income for income tax purposes.

Regardless of one of the objectives pursued by the norm (we refer still to Article 41(2) of the IRC Code) being the addition by the debtor to its taxable income of the value of uncollectible debts, we understand that the legal condition does not cease to apply solely because it is, in the concrete case, inapplicable for the debtor to be subject to taxation on that amount. First of all, the intended link of inevitable symmetry (sine qua non between recognition of the expense and income) does not result from the legal text which addresses in distinct segments, on the one hand, proof of communication of recognition of the expense by the creditor to the debtor and, on the other hand, recognition by the latter of the income, not establishing the second as a condition of validity or application of the first.

Moreover, the "useful" objective of implied taxation in the debtor's sphere, invoked by the Claimant, is contingent (i.e., not necessarily verified), since, given the nature of the debtors (particularly in the case of insolvents), it does not appear reasonable to expect that taxation and the purpose of tax revenue will be, in most cases, achievable/achieved, a circumstance to which the tax legislator was presumably not oblivious.

Thus, similarly to what was decided in arbitral case no. 390/2015, it is concluded that the TCA is correct in requiring compliance with the communication duty prescribed in Article 41(2) of the IRC Code to the situation of the present case and, consequently, non-proof of satisfaction of this communication duty results in non-consideration of the expense in the tax period in question.

In the same sense, for VAT purposes, see the decisions of the Administrative Supreme Court ("ASC") in cases No. 0288/14, of 25 June 2015, and No. 0939/12.0BEBRG, of 5 June 2019.

The said communication duty results directly and immediately from the law which provides as a consequence of its breach the non-deductibility of expenses for IRC purposes, whereby the Claimant's claim for annulment of the tax act to the extent it added to its taxable income the values of uncollectible debts of B... – € 208,457.77 – and of C... – € 32,280.63 – is improcedent.

D. GENERAL FRAMEWORK – REDUCTION OF INCOME

The second correction to be assessed concerns the non-acceptance of the reduction of revenue, through recording as debits in income accounts, resulting from the correction of accounting movements which, according to the Claimant, were due to mere oversight. For this purpose, the TCA invokes the provision of Articles 23(1), 45(1)(g) and 123(2)(a) of the IRC Code, which follow are transcribed, concluding that the Claimant did not present justifying documents for the entries:

"Article 23

Expenses

1 – Expenses are those which have been proven to be indispensable for the realization of income subject to tax or for the maintenance of the income-producing source, in particular […]"

"Article 45

Charges Not Deductible for Tax Purposes

1 – The following charges are not deductible for purposes of determining taxable profit, even when recorded as expenses of the tax period:

[…]

g) Charges not properly documented; […]"

"Article 123

Accounting Obligations of Enterprises

[…]

2 – In the implementation of accounting, the following must be observed in particular:

a) All entries must be supported by justifying documents, dated and capable of being presented whenever necessary; […]"

E. CONCRETE ANALYSIS – REDUCTION OF INCOME

The Claimant contests the TCA's correction of the deduction of expenses resulting from accounting movements that merely corrected incorrectly made income entries, due to duplication of records. The error resulted from the recording of an invoice no. 200000022, with nil value (+ € 3,000.00 – € 3,000.00) which generated 3 transitional accounting entries to credit and the subsequent cancellation, or rather, correction, through 3 accounting entries to debit (totaling 6 entries), all exactly in the same amount, of € 2,439.02, with the same description and same date.

The TCA accepted the invoice with nil value as support for 1 debit entry in cancellation of 1 credit entry, not considering, however, the rectification to debit of the other 2 credit entries generated by the duplication record error, exactly of the same amount, date and description, justified, due to lack of justifying document. It considers in this regard that, if expenses are not properly documented, they cannot be considered, even if there is no doubt about their actual occurrence.

The Respondent in its response begins by pointing out the difference between the values of the invoice with "nil" value, which cancels € 3,000.00, and the movements generated in the income account, of € 2,439.02, thus questioning the Claimant's justification.

However, said difference derives from a reasoning error of the Respondent, since the value of € 3,000.00 includes VAT, which is not recorded in income accounts (#7211) but in different accounts, of VAT charged (#2433), which are not in question here, and the breakdown of that value of € 3,000.00 corresponds precisely to € 2,439.02 (of VAT taxable base to be considered as revenue) and € 560.98 (of VAT), as indeed follows from reading the table contained in the TIR.

Thus, contrary to what the Respondent concludes in its Reply, the values are exactly equal to those mentioned by the Claimant regarding the invoice supporting the first cancellation, with the same description and with the same date, with no inconsistency identified in the position sustained by the Claimant, since multiplying the duplicated income value (€ 2,439.02 x 2) yields precisely the value of the correction in question € 4,878.04.

Given the characteristics of the accounting movements referred to which appear in the table reproduced in the TIR and whose pattern – of the same value, date and description – with the credit movement followed, on 3 occasions, by a debit movement, of cancellation of the first, it appears that the explanation given by the Claimant is not only plausible but convincing and manifest. Since the movements in question result from error (of duplication) in accounting entries, there are no underlying supporting documents, as stated by the Claimant, whereby the issuance of credit notes for their cancellation is not required.

We are thus dealing with internal accounting entries and corrections which do not represent operations – active or passive – conducted by the Claimant and which, in the case of debit movements, merely serve to correct the duplication errors evident in accounting records (credit movements) and which, consequently, should not have tax consequences.

Indeed, characterized as corrective movements, that is, mere regularizations of transitional accounting movements without external counterparts, the reductions of income in question do not constitute incurred expenses which may be classified as undocumented charges provided for in Article 45(1)(g) of the IRC Code, first and foremost because they do not correspond to actual expenses or charges incurred by the Claimant, falling outside the scope of the norm in Article 23(1) of the same statute.

F. CONCLUSION

In light of the foregoing, the tax assessment decision identified above, relating to IRC for fiscal year 2013, in the part contested, concerning non-acceptance of the deduction of expenses relating to uncollectible debts (in the amount of € 240,738.40) and of expenses resulting from accounting record as debits in income accounts (in the amount of € 4,878.04), is subject to annulment relative to this latter segment, due to material defect of error in the prerequisites, having been improperly corrected to the Claimant's taxable income in the amount of € 4,878.04, in accordance with Article 135 of the Administrative Procedure Code ("APC"), with correspondence in Article 163(1) of the new APC, applicable by reference of Article 29(1)(d) of the LFTA.

Otherwise, such act remains valid, with the Claimant's claim regarding the correction made by the TCA in the amount of € 240,738.40, concerning uncollectible debts of B... and C..., being improcedent.

Finally, it should be noted that the relevant questions submitted for the Panel's decision were known and assessed, with the exception of those whose decision was prejudiced by the solution given to others.

V. DECISION

In light of all the foregoing, it is decided:

a) To find the request for arbitral determination partially successful and, consequently, to proceed with the partial annulment of the tax act impugned, relating to fiscal year 2013, to the extent that it corrects (by addition) the Claimant's taxable income in € 4,878.04, entailing the partial annulment of the decision of the Appeal which confirmed it in that part;

b) To find the action improcedent in the remaining part.

VI. CASE VALUE

The case value is fixed at € 254,753.11, as indicated by the Claimant and not contested, in accordance with Article 97-A(1)(a) of the Tax Procedure Code, applicable ex vi Article 29(1)(a) of the LFTA and Article 3(2) of the Regulation on Fees in Tax Arbitration Proceedings ("RFTAP").

VII. COSTS

Costs in the amount of € 4,896.00, in accordance with Table I appended to RFTAP, to be apportioned in proportion to default, with € 4,798.08 to be borne by the Claimant and € 97.92 to be borne by the Respondent, in accordance with Articles 12(2) and 22(4), both of the LFTA, Article 4(5) of RFTAP and Articles 527(1) and (2) of the CPC, ex vi Article 29(1)(e) of the LFTA.

Let notification be made.

Lisbon, 31 July 2019

The Arbitrators

Alexandra Coelho Martins

Jorge Bacelar Gouveia

Paulo Ferreira Alves