CAAD 391/2018-T: Deductibility of Swap Contract Losses for IRC – Tax Arbitration Ruling 2019

ARBITRAL DECISION

I – REPORT

1. On 16 August 2018, A..., S.A., Tax ID No. ..., with registered office..., Union of Civil Parishes of ... and ..., ...-... ..., filed a request for constitution of an arbitral tribunal, under the combined provisions of Articles 2 and 10 of Decree-Law No. 10/2011, of 20 January, which approved the Legal Regime for Arbitration in Tax Matters, with the wording introduced by Article 228 of Law No. 66-B/2012, of 31 December (hereinafter, abbreviated as LRAT), seeking the declaration of illegality of the acts of additional assessment of Corporate Income Tax ("CIT") No. 2018..., of 5 April 2018, demonstration of interest accrual No. 2018... and demonstration of account adjustment No. 2018..., of 9 April 2018, all relating to the 2014 fiscal year, determining a total amount of tax payable of € 224,372.66.

2. To support its request, the Claimant alleges, in summary, that:

i. The Additional Assessment whose annulment it requests was issued as a result of an inspection procedure that had as its object the CIT for 2014 of the Claimant, in the course of which the AT made a correction to the taxable profit thereof, in the amount of € 780,840.40, by virtue of disregarding a negative equity variation that amounted to € 3,904,202.00 resulting from FDD and recognized in the years 2010 to 2014 (inclusive), in the proportion of one-fifth;

ii. This concerns the Facility Agreement concluded between the Claimant, and other companies of the same economic group, and B..., C... and D..., under which the borrowers obligated themselves to conclude with the lenders the Hedging Agreements;

iii. Although these constitute swaps which, from an accounting perspective, do not allow for their accounting as hedging swaps, by virtue of some of their characteristics, this shall never prevent their deductibility for tax purposes;

iv. Since the FDD is not qualified as a hedging operation for purposes of Article 49 of the CIT Code, the fair value adjustments of the derivative are nevertheless recognized in results in the fiscal year in which they occur and are considered tax-relevant (under the general terms of No. 1 of the same article), with the consequence only that the fair value adjustment in the covered instrument is not recognized;

v. Prior to the transition of the accounting standards from the Official Accounting Plan to the SNC, there was no fair value measurement rule, which implied its retrospective application for purposes of comparability;

vi. Pursuant to the provisions of Article 5, No. 1 and 5, of the Decree-Law, the Claimant caused to concur for the formation of taxable profit the effects on equity resulting from the adoption of the SNC;

vii. Despite the accounting classification that it was required to recognize, the Claimant demonstrated that the Hedging Agreements constituted a contractual requirement, without which, moreover, there could be a declaration of default by the lending financial institutions, if they agreed thereto;

viii. The Hedging Agreements were concluded and maintained precisely to ensure hedging of the interest rate risk associated with the Facility Agreement, fulfilling solely and exclusively such purpose and no other, which in short means that without them the Claimant would not have obtained the necessary financing for the development of its activities;

ix. Article 49 of the CIT Code does not impose any limitation on the deductibility of FDD materialized in the Hedging Agreements;

x. The herein Claimant demonstrated the obvious connection between such FDD and its activities, insofar as the destination of the funds borrowed under the Facility Agreement falls unquestionably within the normal scope of the activities of the borrowers, in accordance with their respective corporate objects;

xi. The Hedging Agreements constitute, in themselves, a source producing taxable income in CIT, which demonstrates that there is no justification for the AT to refuse the legitimate deduction of one-fifth of the loss that the same generated;

xii. Were it to be understood otherwise, the principles of equality, taxation in accordance with the taxpayers' tax capacity, and also taxation according to actual profit would be undermined, in violation of the provisions of Article 104 of the Constitution of the Portuguese Republic.

1. On 17-08-2018, the request for constitution of the arbitral tribunal was accepted and automatically notified to the AT.

2. The Claimant proceeded to appoint an arbitrator, having appointed Mr. Dr. José Almeida Fernandes, pursuant to Article 11/2 of the LRAT. Pursuant to No. 3 of the same article, the Defendant appointed as arbitrator Mr. Dr. Jorge Carita.

3. The arbitrators appointed by the parties were appointed and accepted their respective assignments.

4. Following a request submitted by the arbitrators designated by the parties for the presiding arbitrator to be appointed by the Deontological Council, a presiding arbitrator was appointed pursuant to Article 6, No. 2, paragraph b) of Decree-Law No. 10/2011, of 20 January, with the wording introduced by Article 228 of Law No. 66-B/2012, of 31 December and Article 5 of the Regulation for Selection and Appointment of Arbitrators in Tax Matters, Dr. José Pedro Carvalho, who, within the applicable timeframe, also accepted the assignment.

5. On 15-10-2018, the parties were notified of these appointments, and neither manifested the will to refuse any of them.

6. In accordance with the provisions of No. 7 of Article 11 of the LRAT, with the wording introduced by Article 228 of Law No. 66-B/2012, of 31 December, the collective Arbitral Tribunal was constituted on 06-11-2018.

7. On 10-12-2018, the Defendant, duly notified for this purpose, filed its response defending itself by contestation.

8. Pursuant to the provisions of paragraphs c) and e) of Article 16, and No. 2 of Article 29, both of the LRAT, the holding of the meeting referred to in Article 18 of the LRAT was dispensed with.

9. Having been granted a deadline for the presentation of written submissions, the same were presented by the parties, pronouncing themselves on the evidence produced and reiterating and developing their respective legal positions.

10. It was indicated that the final decision would be notified by the end of the deadline set out in Article 21/1 of the LRAT.

11. The Arbitral Tribunal is materially competent and is regularly constituted, pursuant to Articles 2, No. 1, paragraph a), 5 and 6, No. 2, paragraph b), of the LRAT.

The parties have legal capacity and standing, are legitimate and are legally represented, pursuant to Articles 4 and 10 of the LRAT and Article 1 of Administrative Order No. 112-A/2011, of 22 March.

The proceedings do not suffer from any defects.

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

Everything considered, it is necessary to render

II. DECISION

A. FACTUAL MATTERS

A.1. Facts established as proven

1. Pursuant to Service Order No. OI2017..., the Claimant was subjected to an internal inspection action of partial scope, to the CIT for the 2014 fiscal year.

2. On 29 September 2017, the Claimant was notified to provide clarifications in the context of the internal inspection procedure instituted, through Official Letter No. 2017..., together with a request to transmit to the AT the documents evidencing the deductibility of the amounts reflected in fields 704, 705 and 775 of its CIT Model 22 statement, relating to the 2014 fiscal year.

3. The Claimant responded to the aforesaid request, on 11 October 2017, providing the information requested by the AT and contained in its tax documentation file with reference to the 2014 fiscal year.

4. In the course of the aforesaid inspection, the AT considered that irregularities were found in the determination of the Claimant's taxable profit, resulting from the improper deduction of the amount of €780,840.40, relating to a negative equity variation resulting from derivative financial instruments (swaps), considered and deducted by the Claimant in field 705 of Table 07 of the Model 22 Statement relating to the 2014 fiscal year.

5. The corrected amount corresponds to one-fifth of the negative equity variation of €3,904,202.00, determined by the Claimant and recorded in results in the 2010 tax period, as a result of the measurement of derivative financial instruments at fair value.

6. In line with the qualification and tax treatment given to the swap contracts, in each of the fiscal years 2010, 2011, 2012, 2013 and 2014, the Claimant proceeded to the deduction of one-fifth, pursuant to the provisions of No. 1 of Article 5 of Decree-Law No. 159/2009, of 13 July, following the adoption of the SNC.

7. On 5 March 2018, through Official Letter No.... of 28 February 2018, the Claimant was notified to, if it so wished, exercise the right of hearing on the draft tax inspection report, which it did on 19 March 2018.

8. The Annex I to the draft RIT provides, among other things, that:

i. "In the transition to the SNC, A... applied retrospectively the fair value measurement method, having recognized the cumulative negative fair value of the FDD contracted (one by A..., another by the merged E...) at the date of the tax transition, 30 September 2010.

The banking entities with which the FDD contracts were concluded have the possibility to cancel/terminate the contract at any moment, which is why the FDD do not meet the requirements necessary to be considered hedging.

Wording of Article 49 of the CIT Code:

"1 - For the purposes of forming taxable profit, save those provided in No. 3, income or expenses resulting from the application of fair value to derivative financial instruments, or to any other financial asset or liability used as a restricted hedging instrument limited to hedging foreign exchange risk."

Taking into account that FDD are not considered hedging, fair value variations should be tax-relevant.

Thus, the negative equity variation occurring on 30.09.2010, which results from the first-time adoption of IFRS, should concur in the formation of taxable profit under the transitional regime provided for in Article 5 of Decree-Law No. 159/2009, i.e., in the 2010 period and in the following four (1+4)."

ii. "In the transition, there was the recognition of the negative fair value of the swaps contracted by the Co. (one by A..., another by the merged E...).

In accordance with the information obtained, the swaps are speculative, as they do not meet the criteria to be considered hedging.

Pursuant to Article 49, the expenses and income resulting from the application of fair value to FDIs concur in the formation of taxable profit, except where the exclusive objective of the derivative is to hedge cash flows, in which case the income or expenses generated by the FDI, in the part considered effective, are deferred until the moment when the expenses or income of the covered element concur in the formation of taxable profit.

Since the swaps are speculative, the fair value variations associated therewith should concur in the formation of taxable profit."

1. The RIT further provides, among other things, that:

i. "(...) it was clarified and documented that the banking entities with which the FDD contracts were concluded have the possibility to cancel/terminate the contract at any moment, as set forth in the contracts and is transcribed: "Early termination: optional early termination: Applicable";

ii. "Being speculative swaps, as qualified in a document from the Claimant itself, negative fair value variations do not concur in the formation of taxable profit as these are expenses that do not meet the requirements of indispensability for obtaining the income subject to tax or for maintaining the income source, and, pursuant to Article 49 of the CIT Code, "only expenses related to financial instruments hedging the risk referred to in Article 49 of the CIRC, may be deducted for tax purposes, with speculative swaps being excluded, with no relation to the activity, with no direct relationship with any other element that guarantees the pursuit of the company's objectives."

1. The Claimant received notice of Official Letter No...., of 27 March 2018, from the Tax Inspection Services of the Finance Department of ..., with the final tax inspection report.

2. The Claimant was notified of the tax act embodied in the additional assessment of CIT No. 2018..., of 5 April 2018, in the demonstration of interest accrual No. 2018... and in the Demonstration of account adjustment No. 2018..., of 9 April 2018, all relating to the 2014 fiscal year, determining the total amount of € 224,372.66 to be paid, with the payment deadline on 17 May 2018.

3. The aforesaid notification took place through the Via CTT platform, having been made available on 12 April 2018.

4. On 21 June 2018, the Claimant made the payment of the Additional Assessment referred to, in the context of the tax enforcement proceedings No. ... 2018..., instituted for the coercive collection of the respective amount, for the total amount of € 225,184.63.

5. On 22 July 2008, a financing contract ("Facility Agreement") was concluded between:

a. the Claimant, together with other companies of the same group, including E..., Ltd., subsequently incorporated by merger into the Claimant; and

b. three financial institutions, Bank B... S.A. ("B..."), C..., S.A. ("C..."), and D..., S.A.

1. The Claimant was one of the borrowers in the Facility Agreement, having entered into financing under the terms of clauses 4.1 and 6 thereof.

2. Pursuant to clause 16, paragraph j), of the Facility Agreement, the borrowers commit themselves, among other obligations, to conclude with B... and C... and to maintain, with full legal effect, contracts of derivative instruments hedging interest rate risk ("Hedging Agreements"), in turn defined in point 88 of clause 1,1 of the Definitions Agreement as contracts that must be concluded by the borrowers on the terms of Annex III to the Facility Agreement.

3. Pursuant to clause 24.1, paragraph c), of the Facility Agreement, the violation of the aforesaid obligation constituted sufficient grounds for the financial institutions lenders to declare default by the borrowers of the Facility Agreement.

4. By letter dated 16-08-2018 and addressed to the Claimant, the bank C..., declared, among other things, that:

"We confirm that, in accordance with Clause 16 (General Covenants), paragraph (j), of the Facility Agreement, one of the obligations imposed on A..., S.A. as a condition for the granting of financing under the Financial Contracts was the conclusion of a contract for hedging interest rate risk - called a Hedging Agreement - so that the same was in force in accordance with the terms defined in Annex III of the Definitions Agreement."

1. Pursuant to Annex III to the Facility Agreement, the Hedging Agreements required of the borrowers, among which the Claimant, should consist of interest rate swap contracts and would cover no less than 75 (seventy-five) percent of the interest rate exposure relating to the Financing Contracts, until 31 March 2019.

2. The aforesaid interest rate swap contracts were formalized through ISDA Master Agreements of 22 July 2008, and Swap Transaction confirmation letters of 24 July 2008.

3. Pursuant to the aforesaid contracts, the Claimant was obliged to pay the amount equivalent to the application of a fixed interest rate (5.05% and 5.06%, respectively), in exchange for receiving the amount equivalent to the application of the variable EURIBOR reference rate.

4. Pursuant to clause 8 of the Facility Agreement, the borrowers obligated themselves to remunerate the financing obtained at an interest rate equivalent to the sum of the variable EURIBOR reference rate and a margin.

5. In the tax periods from 2012 to 2015, the measurement of the Derivative Financial Instruments in question at fair value determined the determination of gains subject to taxation.

A.2. Facts established as not proven

There are no facts that should be considered as not proven that are material to the decision.

A.3. Reasoning for the established and unestablished factual matters

Regarding the factual matters, the Tribunal is not required to pronounce itself on everything that was alleged by the parties; rather, it has the duty to select the facts that matter for the decision and to distinguish the proven from the unproven facts (cf. Article 123, No. 2, of the TCPT and Article 607, No. 3 of the CPC, applicable ex vi Article 29, No. 1, paragraphs a) and e), of the LRAT).

Thus, the relevant facts for the judgment of the case are chosen and delineated based on their legal relevance, which is established in light of the various plausible solutions to the legal question(s) (cf. former Article 511, No. 1, of the CPC, corresponding to the current Article 596, applicable ex vi Article 29, No. 1, paragraph e), of the LRAT).

Thus, taking into account the positions assumed by the parties, in light of Article 110/7 of the TCPT, the documentary evidence and the administrative files attached to the proceedings, the facts listed above were considered proven, with relevance to the decision, bearing in mind that, as was written in the Decision of the TCA-South of 26-06-2014, rendered in process 07148/13, "the probative value of the tax inspection report (...) may have probative force if the assertions contained therein are not contested."

Allegations made by the parties, presented as facts, consisting of strictly conclusive statements incapable of proof and whose truthfulness must be assessed in relation to the concrete factual matters consolidated above, were neither established as proven nor as unproven.

B. ON THE LAW

As is consensual between the parties, at issue in the present arbitral proceedings is the assessment of the legality of the correction relating to the disregard of the tax deductibility of the amount corresponding to one-fifth of the negative equity variation of €3,904,202.00, determined by the Claimant and recorded in results in the 2010 tax period, as a result of the measurement of derivative financial instruments at fair value, considered and deducted by the Claimant in field 705 of Table 07 of the Model 22 Statement relating to the 2014 fiscal year, by application of the transitional regime provided for in Article 5, No. 1, of Decree-Law No. 159/2009, of 13 July.

As established jurisprudence of the STA holds, "It is exclusively in light of the reasoning expressed by the AT when making the additional assessment (...) that the legality of such tax act should be assessed," thus, one must first depart from the reasoning embodied in the RIT, thereby limiting, at a first level, the issues to be decided.

Looking at the RIT, it is found that the factual and legal grounds for the corrections made can be synthesized as follows:

a. The deductibility of the expenses in question cannot be validated against the regime of Article 49 of the CIRC applicable;

b. This deductibility cannot equally be validated against the general requirements for deductibility of expenses, since:

i. they are "speculative" swaps;

ii. the company's activity does not consist of the practice of speculation, the latter being far from its business objective and not contributing to it, so the expenses would not be indispensable for the realization of the income subject to tax nor for the maintenance of the income source.

Given such reasoning, and verifying the position of the parties in the present arbitral proceedings, it is found that the parties are, fundamentally, in agreement regarding two issues, namely:

a. The deductibility of the expenses in question does not result solely from the regime of Article 49 of the CIRC; and

b. This deductibility must also be assessed against the general criteria of Article 23.

Thus, with respect to the first point, which occupies almost all of the reasoning in the RIT, and therefore where the AT has expended most of its effort in reasoning, it is found that this is ultimately accepted by the Claimant, insofar as it recognizes that:

i. "if the operations are not exclusively risk-hedging operations, the basic rule applies, which is that income or expenses will positively or negatively influence the formation of taxable profit under general terms";

ii. The disqualification of a derivative financial instrument as hedging, pursuant to Article 49 of the CIRC applicable, implies only the application of the general taxation regime.

iii. "it does not follow from Article 49 of the CIT Code any limitation on the deductibility of FDD losses materialized in the Hedging Agreements, such limitation could only be based on a purported disconnection between such FDD and the Claimant's activity."

That is, and in short: the Claimant accepts that, for purposes of the regime of Article 49 of the CIRC applicable, the FDD in question is not qualifiable as hedging, so there is no place for the application of the special regime enshrined in Nos. 2 and 3 of that norm, as the AT concludes in the RIT.

However, in the Claimant's understanding, from the aforesaid finding it does not ipso facto result in the disregard of any expense with an FDD that is not, under that norm, qualifiable as hedging, but rather the application of the general regime of deductibility of expenses resulting from the application of fair value to an FDD in terms combined from Articles 18, No. 9, paragraph b), 23 and 49, No. 1 of the CIT Code.

This latter assertion is also not contested by the AT, either in the RIT or in the arbitral proceedings.

Thus, the RIT was concerned with noting that:

"since the company's activity does not consist of the practice of speculation, the latter being far from its business objective and not contributing to it, we are dealing with expenses that, under Article 49 of the CIRC, are expenses not accepted for tax purposes because they are not indispensable for the realization of the income subject to tax or for the maintenance of the income source. Thus, in accordance with that article, only expenses related to financial instruments hedging risk, referred to in Article 49 of the CIRC, may be deducted for tax purposes, with speculative swaps being excluded, with no relation to the activity, with no direct connection with any other element that guarantees the pursuit of the company's objectives."

That is: it is implicit in the RIT that the non-application of the special regime of Article 49 does not alone result in the exclusion of the deductibility of the expenses that were disregarded there, and that such exclusion is also based on the absence (in the perspective of the RIT) of a relationship between these and the Claimant's activity.

This same position is reiterated in the arbitral proceedings, where the Defendant affirms, among other things, that:

a. "According to the AT, expenses are not accepted for tax purposes because they are not indispensable for the realization of the income subject to tax or for the maintenance of the income source.";

b. "to losses and equity variations determined in FDD that are not covered by Article 49 of the CIT Code, general rules apply, which is to say the rules of Article 23 of the same Code.";

c. "what matters here is that the losses translated by the negative equity variation determined in the fair value measurement of the swap contracts do not pass either through the filter of the principle of indispensability or through the requirement to serve for the obtaining or guarantee of income, since they do not fit within the scope of the business activity pursued and are associated with random factors and under the control of third parties.";

d. "to losses and equity variations determined in FDD that are not covered by Article 49 of the CIT Code, general rules apply, meaning they are subject to the deductibility requirements set forth in Article 23 of the CIT Code, since paragraph a) of No. 9 of Article 18 of the same Code contains only a rule for the timing of adjustments resulting from the application of fair value, from which no criterion or condition for assessing deductibility emanates.";

e. "it is not clear how losses or equity variations resulting from the measurement of swaps at fair value can be considered deductible either in light of the principle of their indispensability for obtaining the income subject to tax or for maintaining the income source (in the version of No. 1 of Article 23 in force until 01.01.2014) or under the current version of this norm relating to "expenses incurred or borne by the taxpayer to obtain or guarantee income subject to CIT"."

That is, and in short, Claimant and Defendant are in agreement that, in the words of the former, disqualification of a derivative financial instrument as hedging, pursuant to Article 49 of the CIRC applicable, implies only the application of the general taxation regime, and in the words of the latter, "to losses and equity variations determined in FDD that are not covered by Article 49 of the CIT Code, general rules apply, meaning the rules of Article 23 of the same Code."

Given the foregoing, and in the first place, it must be concluded that it is not incumbent on the present arbitral proceedings to discuss or assess whether the expenses in question are covered by the special regime of Article 49 of the CIRC.

As has been seen, both parties agree that they are not.

On the other hand, it must also be concluded that it is equally not incumbent on the present arbitral proceedings to discuss or assess whether the expenses in question should, or should not, have their deductibility assessed in light of the general criteria for deductibility of expenses, as provided in Article 23 of the CIRC applicable.

On this matter too, the parties agree that they should.

Regarding this matter, and before proceeding, it is necessary to note the following: nowhere in the RIT does the AT expressly mention Article 23 of the CIRC.

Nonetheless, it should be considered that, for a reasonable recipient placed in the position of the actual recipient of the reasoning embodied in the RIT, the reference to such a norm is implicit, such that it can be considered that the non-fulfillment of the regime of that article is one of the grounds of the tax act, given, in particular, the passage of the RIT transcribed above for this purpose.

Moreover, this is ultimately acknowledged by the Claimant itself, which states that "the AT came to allege that presumably "expenses not accepted for tax purposes because they are not indispensable for the realization of the income subject to tax or for the maintenance of the income source" were at stake."

Thus, it is considered that the legality of the correction made by the AT and contested by the Claimant should be analyzed, taking into account the general regime of deductibility of expenses, resulting from Article 23 of the CIRC applicable.

Having reached this point, there emerges in a definitive and clear manner the sole and true issue that is presented for this Arbitral Tribunal to resolve "in light of the reasoning expressed by the AT when making the additional assessment," and which will be, in short, to determine whether the expenses in question should not be accepted in light of the general criteria for deductibility of expenses, because:

• they are "speculative" swaps; and/or

• the company's activity does not consist of the practice of speculation, the latter being far from its business objective and not contributing to it, so the expenses would not be indispensable for the realization of the income subject to tax or for the maintenance of the income source.

With due respect to other opinions, it is considered that the answer to the specific issue posed cannot but be in the negative.

Thus, and first of all, from the perspective of the general regime of deductibility of expenses, swaps are not individualized in any exceptional rule, and even less so swaps that, from an accounting perspective, cannot be qualified as hedging, so they should be framed and assessed like any other contractual relationship in which the taxpayer obligates itself, that is in light of whether or not it was incurred "by the taxpayer to obtain or guarantee the income subject to CIT," as this concept has been understood by doctrine and jurisprudence.

On the other hand, companies, by nature, when engaging in commerce, always have, in their scope of activity, to a greater or lesser degree, the practice of "speculative activities," provided these are understood in a non-criminal or derogatory sense, as the Defendant itself acknowledges to be the case, stating that:

"It is even less understandable that it is affirmed (...) that the AT inscribes the swap contracts as being instruments of speculation, in a "clearly derogatory conception" that attributes to the Claimant "a blameworthy conduct". (...) this type of judgment does not emerge from the AT's pronouncement at any moment."

Thus, and for example, a company that acquires real property, equity interests, raw materials or any other asset, may legitimately do so with speculative purposes, that is, with the expectation that variations in external circumstances that it does not control will generate gains, which will naturally be taxed, but which may generate losses, which if they occur will, equally naturally, be deductible.

Hence, considering the grounds invoked by the AT in support of the corrections whose legality is now being examined, it must be concluded that these grounds are not capable of supporting the corrections made, since neither the fact that swaps are at issue, even if they are accounting-wise qualifiable as speculative, is capable of precluding, of itself and in light of the general rules regarding the relevance of losses and gains, the relevance, for the calculation of taxable profit of CIT taxpayers, of the losses or gains that they entail, nor can it be simply asserted that to these, and to the Claimant in particular, it is tax-wise prohibited to conclude contracts for the purpose of obtaining "speculative" gains, understood in the manner defined above, which is the manner at issue here.

In any event, ad abundantiam, it may be further stated that in light of the facts determined in the proceedings and established as proven, there can be no doubt that:

i. the execution of the swap contracts was a condition of the conclusion of the financing contract contained in the factual matter;

ii. that financing contract, by virtue of which the Claimant obligated itself to execute the swap contracts, was concluded "by the taxpayer to obtain or guarantee the income subject to CIT," that is, within the scope of the Claimant's normal business activity.

Now, in light of such facts, it is considered that one cannot conclude otherwise - with no indication, nor even suggestion, of a context of tax fraud or evasion - than by the fulfillment of the legal requirements that condition the deductibility of the expense now at issue.

Indeed, in light of the facts established as proven, it must be concluded that the business necessity of executing the swap contracts, in this case, is the same necessity of executing the financing contracts, since those are a condition of these.

Hence, the expenses with the swap contracts should, in the opinion of this Tribunal, be considered expenses with the financing itself, constituting, in essence, a part of the price thereof.

Roughly compared, the situation sub iudice would be analogous to that of a company that acquires real property for its activity, but in which the seller of the property only agreed to sell it together with certain furniture and/or machinery.

In this case, it is considered that, even if the furniture or machinery are not, in any way, in whole or in part, of any business utility to the acquirer, the part of the cost that is attributable to their acquisition should not have its deductibility disregarded.

Indeed, regardless of whether the furniture and/or machinery are or are not business-necessary to the acquirer, it should be considered that their acquisition was still a cost of the acquisition of the property whose business necessity is not questioned.

A situation, in some way similar, was already the subject of the Decision of the TCA-North of 13-09-2013, rendered in process 00595/06.5BEPNF, relating to partial waiver of shareholder loans, resulting from an agreement for the assignment of equity interests.

In that decision, it was held that "What emerges impressively from the proceedings is that such an act was inserted in a complex negotiating process that involved concessions from both sides with a view to safeguarding the interests of each contracting party," and it was further stated that "the waiver of shareholder loans and the sale of equity interests were, by the will of the contracting parties, inserted in an overall consideration, constituted a 'global agreed price' (...) waiver of part of a credit does not ipso facto constitute a liberality, and the concrete circumstances that determined it must be examined."

That is, in a case in which there was - considered in isolation - an apparent liberality, which is the epitome of an anti-business act, the TCA considered, in an understanding that is entirely subscribed to, that the situation must be viewed in its entirety, in order to determine whether the act in question is actually inserted or not within the scope of the taxpayer's business activity.

Thus, also in the case sub iudice, regardless of the issue of whether "speculative" swaps, for accounting purposes and in the abstract, should or should not be considered business-justified, it will matter to assess whether in the concrete context in which those products were subscribed, such subscription occurred or not for business reasons.

Now, from this point of view, it does not appear susceptible to great doubt, taking into account the concrete circumstances that determined them, and in light of the factual matters determined, that the swap contracts at issue are inserted "in a complex negotiating process that involved concessions from both sides with a view to safeguarding the interests of each contracting party," and that "were, by the will of the contracting parties, inserted in an overall consideration, constituted a 'global agreed price'."

It should be noted further, in this regard, that in its arguments, the Defendant ultimately pronounces itself, in some way, on these issues, noting the following:

a. the essential character of the Hedging Agreement for the lending entities;

b. the fact that the Hedging Agreement was concluded with two of the financing entities - Bank B... and C...; and

c. the possibility assured to the Banks to cancel/terminate the contract at any moment;

from which it concludes that the "combination of these three aspects makes it necessary to conclude that the position of the borrowers was strongly conditioned by the decision-making power and the protection of the interests of the lending entities and counterparties in the Hedging Agreement."

Now, precisely, all these circumstances do nothing more than evidence the actual necessity for the Claimant to execute the Hedging Agreement "to obtain or guarantee the income subject to CIT."

Indeed:

• given that the Claimant had needs – which are normal, moreover – for financing, and it is not contested or in any way called into question by the AT such financing needs; and

• being essential, as noted by the Defendant, the execution of the Hedging Agreement for the entities that satisfy that unquestionably business need of the Claimant;

no doubts can be generated about the business necessity that the Claimant had to execute that Hedging Agreement, and the consequent business nature of the gains and losses arising therefrom.

The deductibility of the expenses that the Claimant incurred with such contracts should not, therefore and for the foregoing reasons, be disregarded based on the general rules governing the deductibility of expenses, the correction made by the AT, and now contested by the Claimant, being defective due to error in the factual premises, and consequent error in law, and should, as such, be annulled.

Since these have been the concrete grounds for the corrections made, nothing else shall be incumbent on this Tribunal to assess, in particular, with respect to the application of the transitional regime provided for in Article 5 of Decree-Law No. 159/2009, of 13 July, since this was not contested by the AT, the knowledge of the remaining issues raised by the Claimant also being thereby prejudiced.

As to the request for indemnitary interest filed by the Claimant, Article 43, No. 1, of the LGT establishes that indemnitary interest is due when it is determined that there was error attributable to the services that results in the payment of the tax debt in an amount greater than that legally due.

In this case, the error that affects the annulled assessment act is attributable to the Tax and Customs Authority, which made it without the necessary legal basis.

The Claimant is thus entitled to be reimbursed the amount it paid (pursuant to the provisions of Articles 100 of the LGT and 24, No. 1, of the LRAT) as a result of the annulled act and, further, to be indemnified for the improper payment through the payment of indemnitary interest, by the Defendant, from the date of that payment, until its reimbursement, at the legal suppletive rate, pursuant to Articles 43, Nos. 1 and 4, and 35, No. 10, of the LGT, Article 559 of the Civil Code and Administrative Order No. 291/2003, of 8 April.

C. DECISION

It is therefore decided in this Arbitral Tribunal to render a decision entirely in favor of the arbitral request filed and, in consequence:

a) Annul the acts of additional assessment of Corporate Income Tax ("CIT") No. 2018..., of 5 April 2018, demonstration of interest accrual No. 2018... and Demonstration of account adjustment No. 2018..., of 9 April 2018, all relating to the 2014 fiscal year;

b) Condemn the AT to pay indemnitary interest, in accordance with the terms set forth above.

D. Value of the Case

The value of the case is fixed at € 224,372.66, pursuant to Article 97-A, No. 1, a), of the Code of Tax Procedure and Process, applicable by virtue of paragraphs a) and b) of No. 1 of Article 29 of the LRAT and No. 3 of Article 3 of the Regulation of Costs in Tax Arbitration Proceedings.

Let notification be made.

Lisbon, 06 May 2019

The Presiding Arbitrator

(José Pedro Carvalho)

The Arbitrator Member

(José Almeida Fernandes)

The Arbitrator Member

(Jorge Carita – with dissenting opinion)

DISSENTING OPINION

Although I agree with the final direction of this Arbitral Decision, I would like to make the following observations:

At issue in the present arbitral proceedings is the classification of contracts designated as "swaps" of interest rates, included in Annexes II and III of the Tax Inspection Report of 27/03/18, from the Tax Inspection Services of the Finance Department of..., under No. 1 of Article 5 of Decree-Law No. 159/2009, which would determine that the effects on equity resulting from the first-time adoption of international accounting standards (NICs) adopted pursuant to Article 3 of Regulation No. 1606/2002 of the European Parliament and Council, of 19/7, which were tax-relevant pursuant to the Code of Corporate Income Tax (CIRC) and related legislation, resulting from the recognition or non-recognition of assets or liabilities, or from changes in their measurement, concurred, in equal parts, in the formation of the taxable profit of the first tax period in which those standards were applied and the following four tax periods. Invoking that legal provision, the Claimant would deduct, according to the Tax and Customs Authority (AT), improperly, in the model 22 declaration of the 2014 fiscal year, in Field 705 of Table 07, one-fifth of the negative equity variation resulting from the adoption of NICs.

That article is a transitional norm, aimed at placing tax treatment on the adjustments resulting from the recognition or non-recognition of assets or liabilities or from changes in their measurement as a consequence of the adoption of NICs.

Such adjustments would only be tax-relevant to the extent that expenses, income and equity variations reflected in the balance sheet equity of the first fiscal year of application of NICs were also tax-relevant, that is, concurred in the formation of taxable profit for the respective fiscal year. The application of this transitional regime to financial instruments that, after the entry into force of NICs, continued to be covered, regardless of the variant, by the realization regime would be excluded.

Article 49 of the CIRC, added by Article 3 of Decree-Law No. 159/2009, establishes, in No. 1, that for the purposes of forming taxable profit, save those provided in No. 3, income or expenses resulting from the application of fair value to derivative financial instruments, or to any other non-derivative financial asset or liability but used as a hedging instrument restricted to foreign exchange risk hedging, concur.

Such legal provision is, therefore, inapplicable to derivatives not measured at fair value, in which case income or expenses only concur in the formation of taxable profit when realized.

The same provision also expressly excludes from fair value operations whose exclusive objective is to hedge cash flows or to hedge the net investment in a foreign operational unit, in which, according to No. 3, income or expenses generated by the hedging instrument, in the part considered effective, are deferred until the moment when the expenses or income of the covered element concur in the formation of taxable profit, that is, in the specific case of interest rate "swaps" with exposure to the variability of bank loan interest, until such interest is reflected in results.

With all the respect, which is considerable, that the reasoning expounded in this Arbitral Decision merits, we are of the opinion that outside the scope of application of that No. 1, contrary to what this Tribunal advocates, No. 1 of Article 49 of the CIRC is not applicable.

Thus, if the operations in question were considered as hedging, they would not be covered by the transitional regime of No. 1 of Article 5 of the cited Decree-Law, which is, moreover, the position of the AT expressed in the IRC Manual, edited by the Training Services Department, Lisbon, 2016, page 241.

It should be noted that the Claimant itself supports the hedging nature of the operations in question, since it accounted for them as such; that the "swap" contract is perfectly compatible, without the fact that it excludes its hedging nature, with a clause providing for unilateral denunciation by either party, regardless of the interest of the other in the continuation of the contractual relationship (Maria Clara Calheiros, "The contract of 'swap', Coimbra, 2000, pages 176 and 177); that the absence of a hedging function is not compatible with the dependence of credit granting on the condition of subscription of the derivatives referred to, which explicitly results from the contracts attached; and that if the provisions on hedge accounting had been observed, that No. 1 of Article 5 of Decree-Law No. 159/2009 would in no way be applicable.

On the other hand, we are of the opinion that tax proceedings are not governed by the principle of dispositivity, but by the principle of inquisitoriality, the Arbitral Tribunal not being bound by the qualification of facts made by the Claimant and Defendant.

In the event of the absence of the hedging function, because fair value measurement does not cover exposure to the variability of the interest rate of debt instruments measured at amortized cost, especially bank loans, as results from paragraph a) of Paragraph 12 and paragraph a) of Paragraph 14, applicable "ex vi" paragraph b) of Paragraph 16 of NCRF 27, the No. 1 of Article 5 of Decree-Law No. 159/2009 would still not be applicable.

The cited Tax Inspection Report would not, however, be based on the legal provisions cited, which abstractly could justify the correction, but on the purportedly speculative character of the contracts. No. 1 of Article 49 of the CIRC would, thus, be applicable only to the credit institution that is the counterparty to the interest rate "swap", but not to its customers.

According to the settled jurisprudence of the Supreme Court of Justice, expressed in the Decision of 3/05/2016, Proc. 7/14.5TVPR, nothing prevents "swap" contracts on interest rates from being used for purely speculative purposes, shared or not by the parties, based on the foreseeable evolution of those rates and without connection to any other contract.

The application of No. 1 of Article 49 of the CIRC does not, thus, depend on the non-speculative character of the contract, which may be a purpose of only one of the parties, or of both, even if one of these is the customer of the credit institution.

It should be noted that the STA itself has argued that the qualification as cost depends on whether the operation contracted is in the interest of the taxpayer of CIT, set forth in its corporate object.

Not, thus, deductible are expenses with operations effected exclusively in the interest of third parties.

In light of that jurisprudence, the interest of the taxpayer cannot be merely factual or reflexive, depending on a direct economic connection between the expense and the obtaining of income, which, in this case, would not be evidenced.

It was not demonstrated that, by nature, the aforesaid derivative instruments were contracted exclusively in the interest of the credit institutions. The interest was mutual, and, therefore, they generated positive and negative equity variations for the parties involved.

To that extent, even if the negative equity variations had not been framed in paragraph b) of No. 1 of Article 23 of the CIRC, because they were not the consideration for the acquisition of any service, they would still be latent losses, tax-relevant when measured at fair value.

On the other hand, tax contention is merely one of annulment and not one of jurisdiction.

The tribunal cannot substitute the reasoning of the impugned act, at the risk of invading, outside the cases provided for in law, the scope of administrative function.

I thus understand, with all respect, that this Arbitral Decision, even in the direction of annulment, could have been reasoned differently.

Lisbon, 06 May 2019

The Arbitrator Member

(Jorge Carita)