IRC Deductibility of Impairment Losses for Bank of Portugal Supervised Entities – CAAD 392/2016-T

Arbitral Decision

The arbitrators Cons. Jorge Manuel Lopes de Sousa (arbitrator-president), Prof. Doctor Daniel Taborda and Prof. Doctor Vasco Valdez (arbitrators-members), appointed by the Deontological Council of the Centre for Administrative Arbitration to form the Arbitral Tribunal, constituted on 10-11-2016, agree on the following:

1. Report

A… SGPS, SA, with the single registration number at the Registry of Commercial Records of Lisbon and with the identification of legal entity…, with headquarters at Av…, n.º…, … - … Lisbon (hereinafter designated as "Claimant"), came, pursuant to the provisions of arts. 2.º, n.º 1, al. a) and 10º of Decree-Law n.º 10/2011, of 20 January (Legal Regime for Arbitration in Tax Matters - RJAT), to submit a request for arbitral ruling, with a view to examining the legality and annulment of the IRC assessment n.º 2016…, relating to the tax year 2010.

The Respondent is the TAX AUTHORITY AND CUSTOMS AUTHORITY.

The request for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax Authority and Customs Authority on 04-08-2016.

Pursuant to the provisions of subsection a) of n.º 2 of article 6.º and subsection b) of n.º 1 of article 11.º of RJAT, in the wording introduced by article 228.º of Law n.º 66-B/2012, of 31 December, the Deontological Council appointed as arbitrators of the collective arbitral tribunal Mrs. Cons. Fernanda Maçãs, Mr. Prof. Doctor João Ricardo Catarino and Mr. Prof. Doctor Daniel Taborda, signatories hereto.

Following decisions of the President of the Deontological Council, the Arbitral Tribunal came to be constituted by the signatories, who communicated their acceptance of the appointment within the applicable period.

The parties were notified of the appointment of the Arbitrators and did not express their intention to refuse the appointment of the arbitrators, pursuant to the combined provisions of article 11.º n.º 1 subsections a) and b) of RJAT and articles 6.º and 7.º of the Deontological Code.

Thus, in accordance with the provision of subsection c) of n.º 1 of article 11.º of RJAT, in the wording introduced by article 228.º of Law n.º 66-B/2012, of 31 December, the collective arbitral tribunal was constituted on 10-11-2016.

The Tax Authority and Customs Authority responded in defence, arguing that the request should be judged unfounded.

By order of 17-01-2017, a hearing was dispensed with and it was decided that the proceedings would continue with written submissions.

The parties filed submissions.

The arbitral tribunal was regularly constituted, in accordance with the provision of arts. 2.º, n.º 1, subsection a), and 10.º, n.º 1, of DL n.º 10/2011, of 20 January, and is competent.

The parties are duly represented, possess legal personality and capacity, are legitimate and are represented (arts. 4.º and 10.º, n.º 2, of the same statute and art. 1.º of Ordinance n.º 112-A/2011, of 22 March).

The proceedings do not suffer from any nullities and there are no exceptions nor any obstacle to the examination of the merits of the case.

2. Facts

2.1. Proven Facts

Based on the elements contained in the file and documents attached with the request for arbitral ruling, the following facts are considered proven:

a) The Claimant A… SGPS, SA was incorporated on 26-12-2008, with the object of managing equity investments in other companies, as an indirect form of carrying on economic activities, its shareholders being B… with 51% and C… with 49%;

b) On 31-12-2010, the Claimant held the following financial interests:

– D…, SA 100.00%

– E… (E…) 19.00%

– F… 19.50%

– G… 0.68%

– H… 0.44%;

c) In the tax year 2010, the Claimant recognised an expense relating to impairment in relation to the 19% stake held in E… SGPS, in the amount of € 7,638,493.00, which was accounted for as available-for-sale financial assets and was valued at historical cost in account …;

d) In the Model 22 Declaration, relating to 2010, the Claimant did not make any addition to its taxable profit in Field 737 of Table 07, by virtue of the consideration of only 50% of other losses relating to equity interests or other components of equity, pursuant to art. 45.º, n.º 3 of the IRC Code;

e) The Claimant was subject to an external inspection action, of multi-purpose scope, for the year 2010 carried out by the Finance Department of Lisbon, in compliance with Service Order n.º OI2016…, of 11-01-2016;

f) In that inspection action, a correction was made to the Claimant's taxable profit for the year 2010, in the amount of €3,819,246.50, but, given the deadline for assessing taxes for the year 2010, the correction to the taxable base of €3,819,246.50 only had effect in the amount of €3,068,854.48, which corresponds to the amount of tax losses initially generated in the year 2010, which were deducted by the taxpayer in the year 2011;

g) In the Tax Inspection Report drawn up in that inspection action, the content of which is given as reproduced, reference is made, among other things, to the following:

III. DESCRIPTION OF FACTS AND GROUNDS FOR PURELY ARITHMETICAL CORRECTIONS TO TAXABLE BASE AND TAX

III - 1. IRC

III. 1.1 - 50% of other losses relating to equity interests (final part of n.º 3 of art.º 45º of CIRC) - 3,819,246.50 euros

From the analysis carried out on the income return declaration Model 22 for the year 2010, it was found that the taxpayer did not make any addition to its taxable profit in field 737 of table 07, relating to 50% of other losses relating to equity interests or other components of equity, pursuant to the final part of n.º 3 of art.º 45.º of CIRC.

According to the report and accounts for 2010, it was found that an expense was recognised relating to impairment in relation to the 19% stake held in E… SGPS (hereinafter designated E…), in the amount of €7,638,493.00 (annex 1, pages 1 and 2).

The financial interest held in E… is classified as available-for-sale assets and is valued at historical cost in account 180011.

In the Notes to the Financial Statements on 31 December 2010 the … mentions the most relevant accounting principles used in the preparation of the financial statements, which are summarised below:

" 2.1. Financial Assets

(...)

2.1.2 Financial Assets Held for Sale

In this category are recorded equity securities not classified at the time of their acquisition as trading securities, covering essentially equity instruments held with a view to stability, that is, those that are expected to remain in the portfolio for more than one year.

Financial assets available for sale are measured at fair value. Gains or losses resulting from revaluation are recognised in equity under the heading "Revaluation Reserves".

With respect to financial assets recorded at cost, namely unquoted equity instruments and whose fair value cannot be determined reliably, impairment analyses are carried out on a periodic basis.

The amount of the impairment loss determined is recognised directly in the results of the period. Impairment losses on these assets cannot be reversed.

Having regard to the provisions of art.º 32.º of the Statute of Tax Benefits, deferred taxes are not calculated with respect to this category of securities.

At the time of sale, or if impairment is determined, the accumulated variations in fair value are transferred to the results of the period.

Dividends on equity instruments classified in this category are recognised as income at the moment when the Company establishes its right to receive them.

(...)

1. Financial Assets Available for Sale

On 31 December 2010 and 31 December 2009, this item was composed of:

Equity Instruments

• Valued at Historical Cost

It should be noted that the evaluation carried out on the subsidiary E… resulted in the recognition, in 2010, of an impairment of 7.6 million euros which was directly charged to the results of the period.

It should further be noted that, in accordance with the report and accounts, in order to develop its activity in the fiscal year 2010, the company incurred various expenses, including payment to I… of 50% of the price of the valuation report of the subsidiary E….

In the year under analysis, the company achieved total gains of 23.5 million euros, of which 4.7 million euros relates to dividends received from the subsidiary E….

The net result achieved in fiscal year 2010 was 5.8 million euros, a value lower by 8.3 million euros than that of the previous year. Fundamentally, this decline is due to the recognition of impairment in the investment in E….

a) Available-for-sale financial assets

In accordance with the description in the Report and Accounts for the fiscal year 2010, and as mentioned above, the item "available-for-sale financial assets", with respect to financial assets recorded at cost, namely unquoted equity instruments and whose fair value cannot be determined reliably, impairment analyses are carried out on a periodic basis, and the amount of the impairment loss determined is recognised directly in the results of the period.

I… carried out an evaluation of the company E… (annex 1, pages 3 and 4) and presented the respective "...Economic and financial valuation report that supports a valuation reference for the equity of E… [...] with a base value of €901.6 million."

From the analysis of the extract of the expense account 76301 - "Impairment losses (Nic) prov. imp. (Nca) – available-for-sale financial assets - Securities - Equity instruments issued by residents" (annex 1, page 5), it appears that the taxpayer recorded in fiscal year 2010, the impairment detected in the 19% stake held in E…, based on the aforementioned valuation report prepared by I… (annex 1), recorded under the item "available-for-sale financial assets", which in fiscal year 2010 amounted to €7,638,493.00 and whose determination is detailed in the following table:

Thus, since impairment losses on equity interests are included in other losses or negative patrimonial variations relating to equity interests referred to in the aforementioned n.º 3 of art.º 45.º of CIRC, the amount of €7,638,493.00, included in the results of fiscal year 2010, may only be accepted for tax purposes in 50%, so the tax loss should be corrected by the amount of €3,819,246.50, based on the arguments explained below.

a.1) Accounting Treatment

IAS 39 - "Financial Instruments: Recognition and Measurement" aims to establish principles for recognising and measuring financial assets, financial liabilities and certain contracts for the purchase and sale of non-financial items.

Section 58 of IAS 39 states that "An entity shall assess at each reporting date whether there is any objective evidence that a financial asset or group of financial assets is impaired. If such evidence exists, the entity shall apply (...) Section 67 (for available-for-sale financial assets) to determine the amount of any impairment loss."

Thus, in accordance with Section 59 of the same IAS, "a financial asset or a group of financial assets is impaired and impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (a 'loss event') and if that loss event (or events) has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated. (...)"

Furthermore, in Section 67 of the aforementioned IAS, when there is a decline in the fair value of an available-for-sale financial asset that has been recognised directly in equity and there is objective evidence that the asset is impaired (see Section 59), the cumulative loss that had been recognised directly in equity must be removed from equity and recognised in results even if the financial asset has not been derecognised.

Section 68 further states that "The amount of the cumulative loss that is removed from equity and recognised in results under paragraph 67 shall be the difference between the cost of acquisition (net of any reimbursement and amortisation of capital) and the current fair value, less any impairment loss on that financial asset previously recognised in results."

On the other hand, the Bank of Portugal defines in its instruction n.º 7/2005:

"Pursuant to the provision of subsection b) of number 1 of n.º 1.º of Notice n.º 3/95, the Bank of Portugal determines, for compliance by all institutions referred to in number 4º of Notice n.º 1/2005, the following:

1. The provisions referred to in subsection b) of number 1 of n.º 1.º of Notice n.º 3/95 correspond to the impairment determined in accordance with the relevant provisions contained in the International Accounting Standards (IAS) applicable as adopted, at each moment, by Regulation of the European Commission.

2. With respect to financial assets, and in accordance with the relevant provisions of International Accounting Standard 39, there is impairment or impairment losses are incurred in a financial asset or group of financial assets if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (a 'loss event') and if that loss event (or events) has an impact on the flows of estimated future cash from the financial asset or group of financial assets that can be reliably estimated.

It may not be possible to identify a single, discrete event that caused the impairment. Rather, the combined effect of several events may have caused the impairment.

The objective evidence that a financial asset or group of assets is impaired includes observable data that draw the attention of the holder of the asset to, in particular, the following loss events:

a) evident financial difficulty of the issuer or debtor;

b) breach of any contract, such as default or delay in payment of interest or principal;

c) significant probability that the borrower will enter bankruptcy or another financial reorganisation;

d) disappearance, for that financial asset, of a liquid and sufficiently deep market, if due to financial difficulties of the issuer."

Also, in accordance with Notice n.º 3/2005, of 21 February, of the Bank of Portugal, credit institutions are required to establish provisions, in particular for impairment on securities and financial interests.

From the foregoing, it is clear that the recognition of an impairment constitutes a loss, moreover, recognised in results accounts, in the case in question in the aforementioned account 76301 - "Impairment losses (Nic) prov. imp. (Nca) - available-for-sale financial assets - Securities - Equity instruments issued by residents."

a.2) Tax Treatment

For tax purposes, the banking sector presents its own regime in the IRC Code, in its n.º 2 of art.º 35.º and in art.º 37.º, for impairment losses, intended to cover specific credit risk and country risk and for losses on securities and other investments. In accordance with this regime, impairment losses when mandatorily constituted, by virtue of the rules issued by the Bank of Portugal, of a generic and abstract character, by entities subject to its supervision and by branches in Portugal of credit institutions and other financial institutions with registered office in another Member State of the European Union, intended to cover specific credit risk and country risk and for losses on securities and other investments, may be deducted for tax purposes. Article 37.º of CIRC establishes the conditions under which these impairment losses may be accepted.

Section 4 of art.º 37.º of CIRC provides that the "...annual accumulated amounts of impairment losses and other value corrections, referred to in n.º 2 of article 35.º, shall not exceed the minimum values resulting from the application of the rules issued by the supervisory entity."

However, n.º 3 of art.º 45.º of CIRC provides a restriction on the deductibility of losses relating to equity interests, which contribute to the formation of taxable profit in only half of their value, including here both the negative difference between the gains and losses realised through the onerous transfer of equity interests, including their redemption and amortisation with reduction of capital, as well as other losses or negative patrimonial variations relating to equity interests or other components of equity, namely supplementary contributions.

Thus, all losses relating to equity interests are included in this rule, that is, both the negative difference between the gains and losses realised as well as other potential losses, such as, for example, expenses resulting from the application of fair value to own equity instruments.

This regime does not make an exception for losses relating to equity interests of credit institutions.

Thus, in the case where there is objective evidence that the financial assets described above are impaired, this must be accounted for, however, these losses are subject to the limitation provided for in n.º 3 of article 45.º of CIRC and contribute to the formation of taxable profit only in half of their value.

In view of the foregoing, the taxpayer should have increased its taxable profit by €3,819,246.50 (€7,638,493.00 x 50%) in field 737 of table 07 of the Model 22 IRC declaration for the fiscal year 2010.

III.1.2. - Statute of Limitations (article 45º of LGT) and Loss Carryforward (article 52º of CIRC)

Pursuant to n.º 3 of article 45.º of LGT and in the event that loss carryforward has been made, the statute of limitations for the right to assess is that of the exercise of that right.

In accordance with article 52.º of CIRC, tax losses determined in a given fiscal year are deducted from taxable profits, if any, in one or more of the four subsequent fiscal years (wording given by Law n.º 3-B/2010 of 28 April, legislation at the time of the facts).

Section 4 of the aforementioned legal provision provides that "when corrections are made to the tax losses declared by the taxpayer, the deductions made must be altered accordingly, however, no annulment or assessment, even additional, of IRC shall be made if more than six years have elapsed in relation to the year to which the taxable profit relates."

In these terms, it is proposed that the loss for tax purposes for the year 2010, in the amount of €3,068,854.48, be corrected since its carryforward to the fiscal year 2011 is verified. Given that the statute of limitations has already expired, pursuant to the provisions of n.º 1 of art.º 45º of LGT, to assess taxes for the year 2010, the correction to the taxable base of €3,819,246.50 shall only have effect in the amount of €3,068,854.48 relating to the tax losses that were deducted by the taxpayer in the year 2011 and for which the corresponding adjustment of losses is intended.

h) As a result of the inspection action, IRC assessment n.º 2016… was issued, which fixed the amount to be reimbursed at €4,110,840.04, in relation to fiscal year 2010 (document n.º 1 attached with the request for arbitral ruling, the content of which is given as reproduced);

i) On 13-07-2016, the Claimant submitted the request for constitution of the arbitral tribunal that gave rise to the present proceedings.

2.2. Unproven Facts

There are no facts relevant to the decision of the case that were not proven.

2.3. Grounds for the Determination of Facts

The proven facts are based on documents submitted by the Claimant with the request for arbitral ruling and, subsequently, by the Tax Authority and Customs Authority.

3. Law

3.1. The Disputed Issue and the Parties' Positions

The Claimant is a company managing equity investments that holds 100% of a credit institution (the financial leasing and factoring company D…, SA), so it is an entity subject to the supervision of the Bank of Portugal, as follows from articles 3.º, subsection g), 11.º and 117.º, n.º 1, of the General Regime of Credit Institutions and Financial Societies (Decree-Law n.º 298/92, of 31 December, in the wording resulting from the republication effected by Decree-Law n.º 1/2008, of 3 January), in force in 2010.

In an inspection action, the Tax Authority and Customs Authority made a correction to the Claimant's taxable profit for the fiscal year 2010, in the amount of €3,819,246.50, relating to 50% of the impairment losses recognised in results by the Claimant relating to "Available-for-Sale Financial Assets" ("AFSFA"). Of this amount, the Tax Authority and Customs Authority only considered it appropriate to make a correction in the amount of €3,068,854.48, as this is the amount of tax losses that were deducted by the taxpayer in the year 2011 and there was no time to make an additional assessment relating to fiscal year 2010.

The Claimant considered these losses deductible from taxable profit in their entirety, while the Tax Authority and Customs Authority only considered them deductible in 50% of their value, by application of the regime provided for in n.º 3 of article 45.º of the IRC Code, in force in the year 2010.

Only the legality of this correction is questioned in the present proceedings.

Decree-Law n.º 35/2005, of 17 February, transposed into the domestic legal order Directive n.º 2003/51/CE, of the European Parliament and of the Council, of 18 June, which amends Directives n.ºs 78/660/CEE, 83/349/CEE, 86/635/CEE and 91/674/CEE, of the Council, relating to the accounts and consolidated accounts of certain types of companies, banks and other financial institutions and insurance companies, providing for the possibility of entities to which International Accounting Standards (IAS) do not apply to opt for their application in accordance with Regulation (EC) n.º 1606/2002, of the European Parliament and of the Council, of 19 July.

In its article 13.º, n.º 1, subsection a), Decree-Law n.º 35/2005 attributed competence to the Bank of Portugal for the definition of the subjective scope of application of International Accounting Standards, as well as the definition of the accounting standards applicable to consolidated accounts, with respect to entities subject to its supervision, a regime that was maintained by article 5.º, n.º 1, of Decree-Law n.º 158/2009, of 13 July, which approved the Accounting Standardisation System (SNC).

By virtue of the Notice of the Bank of Portugal n.º 1/2005, published in the Official Journal n.º 41/2005, Series I-B of 28 February, the scope of application of International Accounting Standards (IAS) - International Accounting Standards/International Financial Reporting Standards (IAS/IFRS), as well as the accounting standards applicable to the consolidated and individual accounts of entities subject to the supervision of the Bank of Portugal, was defined.

In n.º 2 of this Notice n.º 1/2005 it is stated that "without prejudice to the provisions of the following numbers, the institutions to which this notice applies must prepare financial statements on an individual basis and on a consolidated basis in accordance with international accounting standards (IAS), as adopted, at each moment, by regulation of the European Union and, as well, with the conceptual framework for the presentation and preparation of financial statements that frames those standards".

In addition to the regime contained in the following numbers, the Bank of Portugal, in the exercise of its regulatory power, has issued notices and instructions that impose on entities subject to its supervision the application of Adjusted Accounting Standards (AAS), which generally correspond to International Accounting Standards (IAS) and Financial Reporting (IAS/IFRS), with the exceptions specifically provided for.

The essential divergence between the Parties is restricted to the application of article 45.º, n.º 3, of CIRC (in force in 2010), and is summarised as follows:

– the Claimant takes the view that this n.º 3 of article 45.º does not apply to impairment losses constituted by entities subject to the supervision of the Bank of Portugal falling within n.º 2 of article 35.º and article 37.º of CIRC, so they count in full as a negative component of taxable profit;

– the Tax Authority and Customs Authority takes the view that n.º 3 of art. 45° of the IRC Code is applicable to impairment losses relating to equity interests, included in its final part, so they contribute to the formation of taxable profit in only half of their value.

The Claimant formulated the following conclusions in the request for arbitral ruling:

a) The TA determined that the amount of €3,819,246.50, relating to 50% of the impairment losses recognised in results by A… SGPS, relating to its equity investment in the company E…, an interest recorded in "Available-for-Sale Financial Assets" ""AFS"" be added to the taxable base of the Claimant;

b) The legal grounds underlying such correction point us, in essence, to the application of the limitations contained in n.º 3 of art. 45.º of the IRC Code to impairment losses on securities recorded in ASFA portfolios;

c) For its part, the arguments supporting such applicability will also point, in practice, to a single and only argument, namely, the literal element of interpretation of legal rules;

d) Well, a good interpretation of the law cannot dispense with the historical element of interpretation, the systematic element and its rational or purposive element;

e) In fact, the intention of the legislator, when extending, in 2006, the scope of application of n.º 3 of art. 45.º of the IRC Code, was clearly not to include therein the provisions for impairment constituted mandatorily by credit institutions relating to equity interests recorded as "ASFA";

f) Furthermore, on the plane of principles, an exceptional and restrictive rule can never be applied which limits the deductibility of expenses on the basis of "moralising" purposes, to costs whose accounting recognition by the taxpayer is not only not at its discretion, but is, furthermore, imposed on it by a supervisory entity;

g) Thus, if we apply to impairment losses on equity interests, mandatorily recognised by credit institutions in results, simultaneously the provision of art. 37.º of the IRC Code and the provision of 45.º, n.º 3 of the same statute (assuming – in our view wrongly – that the latter provision covers such expenses), we would, in fact, be annulling, through the application of a general rule, the objectives pursued by a particular and special rule;

h) General rules should not prevail over particular rules, nor general rules over special rules; applying the limits provided for in n.º 3 of art. 45.º of the IRC Code to impairment losses on equity interests recognised by institutions subject to the supervision of the Bank of Portugal, more than disrespecting basic rules of hierarchy of rules, is to forget the essence of the task of interpretation, namely, to reconstruct, from the texts, the legislative thought, taking especially into account the unity of the legal system, the circumstances in which the law was drafted and the specific conditions of the time in which it is applied;

i) In short, applying n.º 3 of art. 45.º of the IRC Code to the provisions for impairment constituted/deducted by the Claimant, in 2010, relating to equity interests qualified as "ASFA", is nothing more than applying a legal rule without first taking care to understand what rule it is, what its ratio is, what its history is and what its relationship is with the other rules of the tax legal order in which it is inserted; it is applying it without first interpreting it;

j) If this correction is maintained, it will remain, therefore, a manifestly unlawful act, by violation of the provision of art. 45º, n.º 3 of the IRC Code.

The Tax Authority and Customs Authority defends, in summary, the following:

– article 45.º, n.º 3, of CIRC has as its underlying purpose the attenuation of the effects of tax base erosion practices and the legislator, in giving it a comprehensive and generic wording, chose not to include, in its provision, any consideration of particular circumstances of the specific operations that give rise to losses, and other losses and negative patrimonial variations;

– it is undeniable that underlying the wording given to art.º 45.º, n.º 3 were considerations and concerns related to the prevention of evasive practices, the scope of which evolved in the sense of its expansion, so as not to exclude, furthermore, operations and situations that, involving equally equity interests or other components of equity, could produce the same effects as those initially contemplated;

– the concept of "losses" inherent in article 45º, n.º 3 of CIRC has an open formulation, within the scope of which all types of losses relating to equity interests fall, including potential losses;

– what can be extracted from articles 35.º, 23.º, n.º 1, subsection h) and 37.º, n.º 4, of CIRC is that the legal provisions cited above show that entities subject to the supervision of the Bank of Portugal and branches in Portugal of credit institutions and other financial institutions with registered office in another Member State of the European Union: (1) may deduct, for tax purposes, impairment losses intended to cover less-values of securities; and (2) that the maximum limit of deduction to be made in each fiscal year cannot exceed the minimum values resulting from the application of the rules of the Bank of Portugal;

– it does not follow from those rules that the deduction of impairment losses on securities must correspond to the minimum value resulting from the application of the rules of the Bank of Portugal, but rather that this is the maximum limit accepted as deductible;

– there is no support in the letter and the ratio of n.º 3 of art.º 45.º of the IRC Code that supports the Claimant's thesis that impairment losses on securities, referred to in n.º 2 of art.º 35.º and n.º 4 of art.º 37.º are not covered by the limitation of deduction to 50% of their value;

– the Report of the Proposed State Budget for 2003 presents a list of six legislative amendments of various nature, under the heading "Expansion of the tax base and moralisation and neutrality measures", so it cannot be concluded that we are dealing with a rule with an anti-abuse vocation;

– in what particularly concerns the measure in question (inserted in n.º 3 of art.º 42.º of the IRC Code), the objectives in view were, undoubtedly, the expansion of the tax base and the introduction of a factor of neutrality and balancing between the regime applicable to the positive difference between gains and losses realised in the disposition of equity interests, in case of reinvestments;

– as to the subsequent amendment, made by addition to that normative, by Law n.º 60-A/2005, of 30 December, with the aim of also including in its scope "other losses or negative patrimonial variations relating to equity interests or other components of equity, namely supplementary contributions" the same had the purpose of covering all losses associated with investment in equity interests, so as to avoid discriminatory treatment between similar realities;

– this legislative measure appeared integrated (cfr. Draft Report to the State Budget for 2006 - Summary Table 9) in a set of eight measures relating to different taxes, presented under the heading "Combat of Tax Evasion and Fraud and Other Measures Directed at Budgetary Consolidation", so that, having regard to the special nature and design of the remaining seven measures, it can only be concluded that the addition to n.º 3 of art.º 42.º (current 45.º) was inserted in the last category (Other Measures Directed at Budgetary Consolidation);

– the term "loss" was (and still is), sometimes, used as a type of "cost" or expense;

– since provisions for investment securities were not deductible for tax purposes, until the amendment of n.º 2 of art.º 35.º of the IRC Code by Decree-Law n.º 159/2009, neither could provisions for losses on investment securities be included in n.º 3 of art.º 42.º (current art.º 45.º) nor, moreover, were they taken into account by n.º 2 of art.º 43.º (current 46.º) of the IRC Code, for the purposes of calculating gains or losses realised upon disposal;

– until fiscal year 2010, provisions for depreciation of investment securities were not accepted fiscally as deductible in their entirety, therefore, it would have been futile for the legislator to attempt to include them in the scope of n.º 3 of art.º 42.º;

– the amendment introduced to n.º 2 of art.º 35.º and to n.º 4 of art.º 37.º, of the IRC Code (by Decree-Law n. 159/2009) by determining that impairment losses on securities (trading and investment) could be deductible for tax purposes within the minimum limits established by the rules emanating from the supervisory entity, that decision repercussed on the definition of the scope of the rule of n.º 3 of art.º 45.º and equally on n.º 2 of art.º 46.º, as regards the calculation of gains and losses;

– being the Claimant a SGPS, subject to the tax regime provided for in n.º 2 of art.º 32.º of the EBF, the gains or losses to be determined in the disposition of equity interests held in company E…, SGPS do not contribute to the formation of taxable profit and, thus, the impairment losses recorded in previous years would have to be subject to the necessary adjustments, deducting or adding to taxable profit, the part of impairment losses that, in fiscal years prior to the year of disposition, would have influenced the calculation of taxable profit, so as to achieve, in its fullness, the effect intended with the aforementioned rule of the EBF;

– even when the Bank of Portugal imposes on some institutions the accounting recognition of impairment losses on credits resulting from normal activity in an amount greater than the minimum limit contained in Notice of the Bank of Portugal n.º 3/95, it does not follow therefrom the integral deduction of the losses recorded for tax purposes, since, also, in those cases, the minimum limit resulting from the rules issued by that supervisory entity, of a generic and abstract character, remains applicable;

– the tax act contested does not violate the principle constitutionally enshrined, according to which taxation should be imposed on actual income, since such principle enshrined in n.º 2, of art. 104.º of the CRP, is the general rule, which admits exceptions, such as, among many others, the limitations on the deductibility of expenses for tax purposes, provided for in article 45.º of CIRC; the interpretation of the Claimant is manifestly non-compliant with the constitutional principle of equality;

– the interpretation of the Claimant violates the principle of equality, beyond the principles of contributive capacity and justice;

– N.º 3 of art.º 45.º was introduced in CIRC with the State Budget Law for 2003, applying to actual losses resulting from the onerous transfer of equity interests, being part, according to the Report of the Proposed Budget that introduced it, of a set of measures with the objective in fact of combating tax evasion, in view of the decline in IRC revenue, of large companies, with the intention of expansion of the tax base and introduction of measures of moralisation and neutrality of the tax;

– not taking into account here the directives that led to the creation of the provision in question, distorting its interpretation as in the sense defended by the Claimant, violates frontally the principle of equality, disregarding what is the primacy of the legislator's discourse;

– it would violate the principle of equality, both in its aspect of contributive capacity and in its legal aspect, to leave outside the scope of article 45.º, n.º 3, financial entities under the supervision of the Bank of Portugal.

3.2. Decision of the Disputed Issue

It is not questioned in the proceedings, nor in the tax inspection, that the Claimant was obliged by the regulation issued by the Bank of Portugal to constitute the impairment loss in question, so it may be deducted for tax purposes, in accordance with n.º 2 of article 35.º of CIRC, in the wording applicable in 2010 (resulting from the republication effected by DL n.º 159/2009, of 13 July).

3.2.1. Literal and Systematic Elements

Articles 35.º, n.º 2, 37.º and 45.º, n.º 3, of CIRC establish the following:

Article 35.º

Fiscally Deductible Impairment Losses

2 - There may also be deducted for tax purposes impairment losses and other value corrections accounted for in the same tax period or in prior tax periods, when mandatorily constituted, by virtue of rules issued by the Bank of Portugal, of a generic and abstract character, by entities subject to its supervision and by branches in Portugal of credit institutions and other financial institutions with registered office in another Member State of the European Union, intended to cover specific credit risk of country risk and for losses on securities and other investments.

Article 37.º

Banking Sector Companies

1 – The annual accumulated amount of impairment losses and other value corrections for specific credit risk and for country risk referred to in n.º 2 of article 35.º cannot exceed what corresponds to the application of the mandatory minimum limits by virtue of the notices and instructions issued by the supervisory entity.

2 – The impairment losses and other value corrections referred to in the preceding number are only accepted when relating to credits resulting from normal activity, not including credits excluded by the rules issued by the supervisory entity and also the following:

a) Credits in which the State, Autonomous Regions, local authorities and other public entities have provided a guarantee;

b) Credits covered by real rights over immovable property;

c) Credits guaranteed by credit insurance contracts or security, except for the amount corresponding to the percentage of the mandatory deductible;

d) Credits in the conditions provided for in subsections c) and d) of n.º 3 of article 36.º

3 – The losses on investments referred to in n.º 2 of article 35.º must correspond to the total of the differences between the cost of investments resulting from the recovery of credits resulting from normal activity and the respective market value, when the latter is less than the former.

4 – The annual accumulated amounts of impairment losses and other value corrections, referred to in n.º 2 of article 35.º, shall not exceed the minimum values resulting from the application of the rules issued by the supervisory entity.

5 – The regime contained in the present article, in everything not specially provided for here, is subject to the specific applicable regulation.

6 – When the annulment of provisions for general credit risks, as well as of impairment losses and other value corrections not provided for in n.º 2 of article 35.º, occurs, those that have been accepted as tax expense in the tax period of their constitution are considered income of the tax period, in the first place.

Article 45.º

Non-Deductible Expenses for Tax Purposes

3 – The negative difference between gains and losses realised through the onerous transfer of equity interests, including their redemption and amortisation with reduction of capital, as well as other losses or negative patrimonial variations relating to equity interests or other components of equity, namely supplementary contributions, contribute to the formation of taxable profit in only half of their value.

From the literal content of article 35.º, n.º 2, and article 37.º of CIRC results the deductibility of impairment losses mandatorily constituted by virtue of rules issued by the Bank of Portugal, of a generic and abstract character, by entities subject to its supervision, with the limitations indicated in the latter.

The thesis of the Tax Authority and Customs Authority is principally based on the letter of article 45.º, n.º 3, of CIRC in making reference to "other losses or negative patrimonial variations relating to equity interests or other components of equity", which literally may encompass all losses beyond the "negative difference between gains and losses realised through the onerous transfer of equity interests".

To determine the scope of the law, as with any text, it is not sufficient to consider isolatedly the literal content of each rule, as it is of paramount importance the context in which it is inserted, as well as the overall regulation connected with the matter, especially in cases where the literal contents lead to doubtful or conflicting results.

From this perspective, it should be noted that article 45.º, n.º 3, of CIRC, is not a special rule for determining the taxable base of entities subject to the supervision of the Bank of Portugal (unlike articles 35.º, n.º 2 and 37.º). Its scope of application will naturally be limited by the systematic framework that was given to it, on the assumption that the legislator knew how to adequately express its thought, as must be presumed (article 9.º, n.º 3, of the Civil Code).

In fact, CIRC includes in Subsection I of Section II of its Chapter III the "General rules" for determining the taxable base of IRC, which includes article 23.º, n.º 1, subsection h), which establishes that losses from impairment are considered expenses.

In Subsection IV of that Section II is established the specific regime of "Impairments and provisions" which includes articles 35.º, n.º 2 and 37.º, which are specific rules for the tax relevance of impairment losses relating to entities subject to supervision of the Bank of Portugal.

Article 45.º of CIRC, was not inserted among the "General rules" (Subsection I), nor in Subsection IV ("Impairments and provisions"), but in Subsection V relating to "Regime of other expenses", which, immediately, suggests that the field of application of article 45.º will not encompass expenses whose regime is provided for in other subsections, including in Subsection IV.

Thus, it is manifest that the systematic framework of articles 35.º, n.º 2, 37.º and 45.º, n.º 3, of CIRC leads to the conclusion that the latter will not be applicable to the tax relevance of impairment losses whose regime is specially regulated provided for in those articles 25.º, n.º 2, and 37.º.

This systematic framework of article 45.º of CIRC, in the wording of Decree-Law n.º 159/2009, of 13 July, is essentially the same as that which already existed in the previous version, resulting from the republication effected by Decree-Law n.º 198/2001, of 3 July.

In fact, with terminological differences resulting from the adoption of the Accounting Standardisation System:

– already before Decree-Law n.º 159/2009, the same Subsection I of Section II of Chapter III of CIRC contained the "General Rules", which included article 23.º with the generic indication of "Costs or losses", among which was referred in subsection h) of n.º 1 the "provisions";

– already then Subsection IV established the "Regime of provisions" which included, in subsection d) of n.º 1 of article 34.º, "those mandatorily constituted, by virtue of an imposition of a generic and abstract character, by companies subject to the supervision of the Bank of Portugal";

– the Law n.º Law 53-A/2006, of 29 December, which added article 35.º-A relating to "Specific provisions of banking and insurance sector companies" was included in the aforementioned Subsection IV;

– article 42.º (corresponding to article 45.º) was included in Subsection V, relating to "Regime of other expenses".

It was this same Law n.º 53-A/2006 that added to article 42.º, n.º 3, (later article 45.º) the expression "as well as other losses or negative patrimonial variations relating to equity interests or other components of equity, namely supplementary contributions" in which the Tax Authority and Customs Authority seeks to frame the impairments in question.

In light of the aforementioned systematic framework, having the legislator of Law n.º 53-A/2006 expressly regulated in a novel manner, with the addition of article 35.º-A, the regime of "specific provisions of banking sector companies" and there being no reference therein to the application of the regime of article 42.º, n.º 3, framed in "regime of other expenses", it is justified to conclude that this rule will have its field of application limited to "other expenses" qualified as "losses", different from the expenses whose tax relevance was specially provided for in other subsections.

3.2.2. Teleological Element

As has been affirmed in several arbitral decisions ( [1] ), concerning the issue of the applicability of article 45.º, n.º 3, of CIRC to adjustments resulting from the application of fair value to financial instruments, the restriction on the deductibility of losses and negative patrimonial variations can only be justified as aimed at preventing practices by taxpayers tending to manipulate losses and prejudice tax revenues, triggering tax relevance at the moment and terms most fiscally advantageous to them.

Such rule, whether in its original wording, resulting from Law 32-B/2002, of 30 December, or in that given to it by Law 60-A/2005 of 30 December, is explained objectively and subjectively (that is, in light of the express motivation by the legislator) by needs linked to combating fraud and tax evasion and to the expansion of the tax base, directed at the desired consolidation of the budgetary accounts of public finances.

In fact, in accordance with the Report of the Ministry of Finance for the State Budget of 2003 ( [2] ), the legislative intervention in the area in question (IRC) was guided by "two priorities, namely, the combat of fraud and tax evasion and the expansion of the tax base" (page 33), fitting the amendment that interests us here within the scope of "Expansion of the tax base and moralisation and neutrality measures" (page 53).

In the Report of the aforementioned Budget for 2006 ( [3] ) it is stated that the measure in question was framed within "COMBAT OF TAX EVASION AND FRAUD AND OTHER MEASURES DIRECTED AT BUDGETARY CONSOLIDATION" (page 31).

It is, thus, to be understood that this rule, in the part that was added by the wording of Law n.º 53-A/2006, only has application when faced with situations in which it is possible the fiscal management of the negative components of taxable profit, in the line of what concluded the judgment of the Supreme Administrative Court of 17-02-2016, case n.º 01401/14, in which it was understood that "the rule, in any of its versions, integrates an anti-abuse measure, to the extent that the legislator will have intended (in addition to the expansion of the tax base) to avoid the manipulation of the fiscal result".

In the situation in question, faced with impairment losses constituted imposed by the regulation of the Bank of Portugal ( [4] ), no moralisation ground avails nor are there any needs relating to the combat of fraud and tax evasion, because the tax relevance of the losses does not depend on an act of will by the taxpayer and the valuation is objectively fixed.

On the other hand, and for the same reasons, equally lacks any sense any measure of conditioning the will of the taxpayer, in the sense of favouring economically more "desirable" conduct and, as such, conforming to the interests of the expansion of the tax base and budgetary consolidation, since those hypothetical conducts in dissonance with the rules issued by the Bank of Portugal would be illegal. ( [5] )

From the foregoing, it is to be concluded that the correction effected by the Tax Authority and Customs Authority suffers from a defect of violation of law, by erroneous interpretation and application of article 45.º, n.º 3, of CIRC, which justifies the annulment of the assessment based on it, in accordance with article 163.º, n.º 1, of the Code of Administrative Procedure, subsidiarily applicable in accordance with article 2.º, subsection c), of LGT.

3.3. Principles of Equality, Contributive Capacity and Justice

The Claimant argues that the interpretation of the Tax Authority and Customs Authority violates the constitutional principles of equality and taxation of companies by actual profit.

The Tax Authority and Customs Authority argues that the interpretation of the Claimant violates the principle of equality, beyond the principles of contributive capacity and justice.

The principle of equality does not prohibit the establishment of distinctions in tax treatment, but only distinctions devoid of objective and rational justification.

Having the rule of article 42.º, n.º 3, of CIRC (later article 45.º), in the part that was added by Law n.º 53-A/2006, the objective of compensating the negative tax effects of foreseeable practices by taxpayers in the sense of choosing the moments that are fiscally most advantageous to them to recognize losses or negative patrimonial variations relating to equity interests or other components of equity, there is reason to distinguish between the situations in which that recognition results from a choice by the taxpayer, in which the reason for being of the rule applies, and those in which it embodies the fulfilment of a legal obligation and in which, therefore, there does not occur an undesirable fiscal practice.

On the other hand, this regime, with this interpretation, is applicable to all entities that are faced with the obligation to recognize losses or negative patrimonial variations, in particular all those that, by legal imposition, are subject to the supervision of the Bank of Portugal.

As to the principles of contributive capacity and justice, it is not apparent how they are violated by the non-application of a rule of the type that is in question, which provides for a partial restriction on the deductibility of losses and negative patrimonial variations in situations in which, in parallel, there is no restriction on the tax relevance of the corresponding gains and positive patrimonial variations.

What is just and is in harmony with the principle of taxation of companies being based fundamentally on their actual income, enunciated in article 104.º, n.º 2, of the CRP, is the full relevance for the determination of the taxable base of all income and expenses, as well as all other positive or negative components of taxable profit, as, moreover, is the general rule enshrined in articles 17.º and 18.º, n.º 1, of CIRC and realised as to impairment losses, in the rule of full deductibility, which is contained in subsection h) of n.º 1 of article 23.º of CIRC, in the wording in force in 2010.

But, that principle of article 104.º, n.º 2, of the CRP allows for the possibility of exceptions, as results from the use of the expression "fundamentally", which will have to have an acceptable explanation.

The rule of article 42.º, n.º 3, of CIRC (later article 45.º), in the part that was added by the wording of Law n.º 53-A/2006, constitutes a deviation from that rule, explained by reasons relating to discouraging conduct that causes erosion of the tax base and reduction of tax revenues, which have nothing to do with the dimension of contributive capacity nor with the realisation of justice in the taxation of income, since losses and negative patrimonial variations are not indicators of the existence of taxable income, but rather of its absence.

On the other hand, we are not, in the case of entities subject to supervision of the Bank of Portugal, faced with full relevance of impairment losses for the formation of taxable profit, since it is limited, in accordance with article 37.º, n.º 4, of CIRC.

Furthermore, contrary to what is referred to by the Tax Authority and Customs Authority, neither are we faced with the global inapplicability of article 45.º, n.º 3, to entities subject to supervision of the Bank of Portugal, since the regime provided for in articles 35.º, n.º 2 and 37.º applies only to impairment losses that are mandatorily constituted, as provided for in the former, with the application of that article 45.º, n.º 3, to all the remaining losses and negative patrimonial variations relating to equity interests or other components of equity held by entities subject to the supervision of the Bank of Portugal.

From the foregoing, there is no violation of these constitutional principles, since there is justification for the rule of article 45.º, n.º 3, of CIRC in the part added by Law n. 53-A/2006, in the interpretation here adopted.

3.4. Issues of Prejudiced Jurisdiction

Since the request for arbitral ruling is to be judged well-founded by a defect of violation of article 45.º, n.º 3, of CIRC, it becomes prejudiced, as the examination of the remaining issues raised becomes unnecessary, in particular the defect of statute of limitations on the right to assess, raised by the Claimant in its submission.

4. Decision

In these terms, the members of this Arbitral Tribunal agree to:

· Judge the request for arbitral ruling well-founded;

· Annul IRC assessment 2016…, relating to fiscal year 2010.

5. Value of the Case

Article 3.º, n.º 2, of the Regulation of Costs in Tax Arbitration Proceedings establishes that "the value of the case is determined in accordance with article 97.º-A of the Code of Tax Procedure and Process".

Article 97.º-A of CPPT establishes, in what is of interest here, the following:

1 – The amounts to be considered, for the purposes of costs or other amounts provided for in law, for actions that take place in tax courts, are the following:

a) When an assessment is contested, the amount of the importance whose annulment is sought;

b) When the act of fixation of the taxable base is contested, the value contested;

From these rules it is concluded that, when the Taxpayer seeks the annulment of an amount assessed, the value of the case is that of that amount.

In the case at hand, we are not faced with a situation that fits within subsection a), since in the contested assessment the payment of any amount is not determined, but rather a value to be reimbursed is fixed.

On the other hand, the Claimant states, in article 98.º, at the end of its request for arbitral ruling, that it understands that "the correction to its taxable profit, in the amount of €3,819,246.50, corresponding to 50% of the provisions for impairment, constituted in accordance with the discipline of the Bank of Portugal, based on the improper application of the provision of art. 45.º, n.º 3 of the IRC Code, cannot but be annulled, as manifestly unlawful" and formulates, finally, conclusion j) that "if this correction is maintained, it will remain, therefore, a manifestly unlawful act, by violation of the provision of art. 45º, n.º 3 of the IRC Code".

In this context, what is relevant for the purpose of determining the value of the case is, in principle, the contested value of the act of fixation of the taxable base, which, interpreting the request for arbitral ruling, is to be considered the contested act.

The value of the correction to the taxable base of fixation of the taxable base is €3,819,246.50, but, in the case in question, as the Tax Authority and Customs Authority understood that there had occurred the statute of limitations on the right to assess in relation to fiscal year 2010, it only considered relevant the value of the tax loss that was used in the assessment of fiscal year 2011, which was €3,068,854.48.

Having this loss of €3,068,854.48 been used for the purpose of the IRC assessment relating to fiscal year 2011, it is understood that the value of that effect should be the value of the case, as it is ultimately the "amount whose annulment is sought", to which priority should be given in accordance with that article 97.º-A of CPPT.

The effect of an alteration of €3,068,854.48 in the taxable base of IRC in fiscal year 2011, in which the tax rate of 12.5% up to €12,500) and 25% as to the amount in excess was in force, is €1,562.50 (12,500 x 0.125= 1,562.50), as regards the 1st part, and €764,088.62, as regards the 2nd part (3,068,854.48 – 12,500 = 3,056,354.48 x 0.25= 764,088.62).

Thus, the value of the case is fixed at €765,651.12.

6. Costs

Taking into account the value of the case indicated, fixed in accordance with art. 22.º, n.º 4, of RJAT, the amount of costs is fixed at €11,016.00, in accordance with Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, to be borne by the Respondent.

Lisbon, 27-03-2017

The Arbitrators

(Jorge Manuel Lopes de Sousa)

(Daniel Taborda)

(Vasco Valdez)

[1] In particular the judgment of 25-11-2013, rendered in case n.º 108/2013-T, the jurisprudence of which was followed, in essence, in the arbitral judgments of 09-06-2015 (case n.º 58/2015-T), of 18-06-2015 (case n.º 776/2014-T), of 25-09-2015 (case n.º 208/2015-T), of 14-12-2015 (case n.º 473/2015-T), of 17-06-2016 (case n.º 738/2015-T) and of 14-12-2016 (case n.º 393/2016-T).

[2] Available at: http://www.dgo.pt/politicaorcamental/Paginas/OEpagina.aspx?Ano=2003&TipoOE=Proposta+de+Or%u00e7amento+do+Estado&TipoDocumentos=Lei+%2F+Mapas+Lei+%2F+Relat%u00f3rio.

[3] Available at: http://www.dgo.pt/politicaorcamental/Paginas/OEpagina.aspx?Ano=2006&TipoOE=Proposta+de+Or%u00e7amento+do+Estado&TipoDocumentos=Lei+%2F+Mapas+Lei+%2F+Relat%u00f3rio.

[4] As is accepted in the Tax Inspection Report (pages 11 and 12), in stating that the accounting treatment of impairment loss results from IAS 39, §§ 58, 59, 67 and 68, the application of which is determined by Instruction n.º 7/2005 of the Bank of Portugal, issued in accordance with subsection b) of n.º 1 of article 1.º of Notice n.º 3/95, of 30 June.

[5] Following closely the grounds of the judgment of 25-11-2013, rendered in case n.º 108/2013-T.