Process: 396/2015-T

Date: January 11, 2016

Tax Type: IRC

Source: Original CAAD Decision

Summary

This CAAD arbitration case (Process 396/2015-T) addresses the controversial interpretation of Article 45(3) of the Portuguese Corporate Income Tax Code (CIRC) regarding the deductibility of losses from fair value variations in financial instruments. The claimant challenged an additional IRC assessment of €5,189.72 for tax year 2010, arguing that the Tax Authority's literal interpretation of Article 45(3) was incorrect and unconstitutional. The central dispute involves whether fair value losses on equity instruments, which become relevant for tax purposes under Article 18(9)(a) CIRC, should be subject to the 50% deduction limitation established in Article 45(3). The claimant argued that Article 45(3) was designed to limit deductions only for realized, non-reversible losses from actual transfers, not for potential, reversible fair value adjustments that fluctuate with stock market quotations. The company contended that applying the 50% limitation to fair value losses while taxing fair value gains at 100% creates asymmetric treatment that violates fundamental constitutional and tax principles, including equality before the law, proportionality, legal certainty, and taxation according to ability to pay. The claimant emphasized that fair value reductions are inherently reversible and merely reflect unrealized potential losses, distinguishing them from definitive losses arising from actual disposals. The Tax Authority defended the assessment, arguing that Article 18(9)(a) makes fair value adjustments relevant for taxable income determination, and therefore Article 45(3)'s limitations apply. This case highlights the tension between accounting standards (SNC) that require fair value measurement and tax rules that may treat such accounting-driven adjustments differently from realized transactions. The arbitral tribunal was constituted on September 22, 2015, under the RJAT (Legal Regime for Arbitration in Tax Matters), and the case was deemed ready for decision without oral hearings or witness testimony, with the decision date set for January 11, 2016.

Full Decision

ARBITRAL DECISION

I – Report

1.1. A... – Sociedade Gestora de Participações Sociais, S.A., with registered office at ..., no. ...-A, ...-... Lisbon, with Tax Identification Number ..., (hereinafter referred to as "claimant"), having been notified of the additional assessment for Corporate Income Tax (IRC), in the amount of €5,189.72, with identification number 2015..., relating to the tax year 2010, and not conforming thereto, filed, on 24/6/2015, an application for the constitution of an arbitral tribunal and for an arbitral pronouncement, pursuant to the provisions of article 2, paragraph 1, lit. a), of Decree-Law no. 10/2011, of 20/1 (Legal Regime for Arbitration in Tax Matters, hereinafter referred to as "RJAT"), in which the Tax and Customs Authority (AT) is requested, whereby it seeks to have "declared the illegality of the additional IRC assessment and respective compensatory interest" and "determined the payment to the Claimant of indemnificatory interest, pursuant to paragraph 1 of article 43 of the LGT."

1.2. On 22/9/2015, the present Singular Arbitral Tribunal was constituted.

1.3. Pursuant to article 17, paragraph 1, of the RJAT, the AT was cited, as the respondent party, to submit a response. The AT submitted its response on 28/10/2015, having argued in the sense of the total lack of merit of the claimant's claim.

1.4. By order of 4/1/2016, the Tribunal considered, pursuant to article 16, lit. c) and e), and 19, both of the RJAT, that the meeting referred to in article 18 of the RJAT was dispensable, as well as the production of witness evidence, and that the process was ready for decision. Furthermore, the date of 11/1/2016 was set for the pronouncement of the arbitral decision.

1.5. The Arbitral Tribunal was duly constituted, is materially competent, the process is free from defects that would invalidate it, and the Parties have legal personality and capacity, being duly legitimate.

II – Allegations of the Parties

2.1. The claimant herein alleges, in its initial petition, that: a) "the only disputed issue in this process concerns the interpretation and application of the provisions of paragraph 3 of article 45 of the IRC Code, as regards losses resulting from the variation of fair value in financial instruments, which are relevant to the formation of taxable income pursuant to lit. a) of paragraph 9 of its article 18. An interpretation that gave rise to the additional assessment act which is the object of the present request for arbitral pronouncement."; b) "in the case sub judice, the tax administration was satisfied with a literal interpretation of paragraph 3 of article 45 of the IRC Code, drawing conclusions that are not coherent with the model of taxation under IRC"; c) "in the rationale of paragraph 3 of article 45 of the IRC Code lies the limitation of the deduction of expenses that are considered to be borne, resulting from transfers, which generate non-reversible results. That is, which have become consolidated in the legal order, in its quantitative aspect. This is manifestly not the case of losses arising from the reduction of fair value in equity interests. These are, by nature, reversible, everything depending on the evolution of the respective stock market quotations"; d) "the inclusion of fair value reductions in the provision of paragraph 3 of article 45 of the IRC Code, at most, could only be made by analogical application if there were analogy between effectively borne losses and mere potential losses arising from fluctuations in the quotation of securities. Which is manifestly not the case"; e) "to include fair value reductions in the provision of paragraph 3 of article 45 of the IRC Code, as the tax administration intends, creates distortions in terms of the determination of taxable income, clearly incompatible with taxation on real income and violates the principle of taxation according to contributive capacity, also affecting the principles of legal reserve, equality and proportionality"; f) "[to apply the rule of art. 45, paragraph 3, of the IRC Code] within the framework of the SNC [Accounting Standards System] and in cases where the variation of quotation became relevant for tax purposes in certain circumstances (see articles 18, paragraph 9, lit. a), 20, paragraph 1, lit. f), and 23, paragraph 1, lit. j), of the IRC Code) is what prefigures itself as contrary and susceptible to violate basic principles of our tax system – e.g., equality, legality and material justice, contained in paragraph 2 of article 5 of the LGT"; g) "should the tax administration's interpretation prevail, the reductions in the value of shares arising from the application of the fair value model [...] would contribute to the formation of taxable income at half their value. However, increases in fair value [...] would be taxed in full [...]. [...] as a consequence of the interpretation made, the application of that normative provision [art. 45, paragraph 3, of the IRC Code] violates, intolerably, the principle of equality, in its dimension of equality before the law [since] we are [...] faced with the interpretation of a norm in such terms that, from its concrete application, the same reality can be taxed in absolutely different ways, whereby it cannot be in accordance with its legislative rationale. [...]. [...] the only appropriate, plausible interpretation that does not violate the principles of equality, proportionality, legal reserve and material justice is that which leads to identical tax results, regardless of the use of the cost method or the fair value method. Such interpretation is that which limits the scope of paragraph 3 of article 45 of the IRC Code to realized losses arising from onerous transfers, naturally excluding from its scope potential losses, as is the case of losses arising from fair value adjustments"; h) "[the aforementioned rule cannot], as is intended, include in its provision merely potential losses"; i) "fair value reductions – which do not constitute actual losses and result from mere fluctuations in stock exchange quotations – cannot be covered by the provision of paragraph 3 of article 45 of the IRC Code. An interpretation of the law that takes into account the logic and coherence of the model of taxation of income under IRC can only reach this conclusion, under penalty of legitimizing the non-deductibility, in an irreversible manner, of losses that are reversible and, as demonstrated in the example above, of taxing merely potential income that was not actually obtained"; j) "it should be concluded that the assessment is illegal by violation of the principles contained in paragraph 2 of article 5 of the LGT and, further, by violation of paragraph 3 of article 45 of the IRC Code, since its provision does not include expenses resulting from the application of fair value in financial instruments, which are relevant to the formation of taxable income pursuant to lit. a) of paragraph 9 of article 18 [of the IRC Code]"; l) "Such assessment violates the principles of equality, legality and material justice, enshrined in the aforementioned paragraph 2 of article 5 of the LGT, of the principle of tax legality, protected in article 103 of the Constitution of the Portuguese Republic (CRP), thus violating, consequently, as already stated, paragraph 3 of article 45 of the IRC Code itself."

2.2. The claimant seeks that, based on the aforementioned grounds: a) "declared the illegality of the additional IRC assessment and respective compensatory interest"; and b) "determined the payment to the Claimant of indemnificatory interest, pursuant to paragraph 1 of article 43 of the LGT."

2.3. For its part, the AT alleges, in its response, that: a) "by virtue of the aforementioned article 18, paragraph 9, of the IRC Code, adjustments that occur through the application of fair value contribute to the formation of taxable income, whenever they concern financial instruments recognized at fair value through results, i) have a price formed in a regulated market and, ii) the taxpayer does not hold, directly or indirectly, an equity participation exceeding 5% of the respective share capital"; b) "notwithstanding the option to adopt the fair value model, even though in very restricted situations given the provisions of the accounting norms [with the requirements demanded in article 18, paragraph 9, lit. a) of the IRC Code)], the legislator chose to create transitional mechanisms that would protect against the impact that the change in the measurement system would have on the equity capital of companies"; c) "article 18, paragraph 9, lit. a), provides the only applicable rule for the realities envisaged therein, therefore, at most, could be considered as a particular regime of temporal allocation of income/gains and expenses/losses that results from measurement by the fair value criterion in certain precise situations"; d) "it also lacks sense to attempt to argue that the provision of article 45, paragraph 3, of the IRC Code aims at 'the limitation of deduction of expenses borne arising from non-reversible transfers, whereas losses arising from the reduction of fair value in equity interests are reversible' [since] such argumentation seems to forget that the deduction in half of the negative difference between realized gains and losses and other losses and negative patrimonial variations relating to equity interests covered by article 45, paragraph 3, has always applied both to cases in which such losses, as well as other losses and negative patrimonial variations, resulted from operations carried out in regulated markets (stock exchanges) and outside such markets"; e) "the non-application of article 45, paragraph 3, of the IRC Code to the particular situations envisaged in article 18, paragraph 9, lit. a), of the IRC Code would result in a situation of injustice given that it would confer a more unfavorable treatment to situations in which such rule would not apply, even though they were social participations measured at fair value pursuant to the respective accounting norms, given that the loss verified in that effective alienation will be considered for tax purposes in only half; whereas the loss verified in social participations measured at fair value, but contemplated in the provision of article 18, paragraph 9, lit. a) of the IRC Code, in accordance with the Claimant's thesis, would suffer no limitation, being fully considered for purposes of determining taxable matter"; f) "if the legislator did not establish any difference between operations carried out in regulated markets or in unregulated markets, with what legitimacy can an interpretation of article 45, paragraph 3 be constructed that would exclude from its scope, losses, as well as other losses and negative patrimonial variations determined in operations with equity instruments, carried out in regulated markets?"; g) "the legislator, by [giving article 45, paragraph 3, of the IRC Code] a comprehensive and generic wording, chose not to include, in its provision, any weighing of particular circumstances of the concrete operations that give rise to the losses, as well as other losses and negative patrimonial variations [...], thus not allowing the interpreter to claim the right to subtract from its scope any losses or other losses or negative patrimonial variations, as a function of the manner and place of carrying out the concrete operations that gave rise to them"; h) "it is undeniable that underlying the wording given to article 45, paragraph 3 of the IRC Code were considerations and concerns related to the prevention of tax avoidance practices, whose scope has evolved in the direction of its broadening, so as not to exclude operations and situations that, also involving equity interests or other components of equity capital, could produce the same effects as those initially contemplated. Thus, the position advocated by the Claimant in the request for arbitral pronouncement results from a decontextualized reading of the provision of article 45, paragraph 3, which inevitably leads to a reductive interpretation of the scope of the norm"; i) "given the system of taxation under IRC, notwithstanding the fact that potential or latent gains and losses are, in fact, excluded from taxation, even though when expressed in accounts, it is certain that adjustments arising from the application of fair value are fiscally relevant when they respect the requirements prescribed in article 18, paragraph 9, lit. a), by virtue of the provisions of articles 20, paragraph 1, lit. f), 23, paragraph 1, i) and 45, paragraph 3, all of the IRC Code, and therefore, cannot, solely for the reason that potential losses are excluded from taxation, the same occur with these losses, not least because they have effectively fiscal relevance and the taxation regime applicable to them configures an exception to the aforementioned principle informing the system of taxation of income of legal entities"; j) "the legislator, when referring to 'other losses relating or negative patrimonial variations relating to equity interests', did not classify them, leaving an opening for all losses, including expenses/losses resulting from measurement at fair value, to be subsumed therein"; l) "From the provisions under analysis results, therefore, very clearly that there is no, between article 18, paragraph 9, lit. a), and article 45, paragraph 3 of the IRC Code, any contradiction or mutual exclusion"; m) "[the] understanding [of the Claimant according to which] 'the provision of paragraph 3 of article 45 of the IRC Code does not include adjustments arising from the application of fair value in financial instruments, which are relevant to the formation of taxable income pursuant to lit. a) of paragraph 9 of its article 18' [...] is incapable of being accepted, since it constitutes, from the outset, a non-observance of the rule contained in the final part of paragraph 3 of article 45 of the IRC Code [...]. In the case in question, and as is evident, we are not faced with a situation that fits within the first part of the norm, but rather the second, that is, losses resulting from the variation of fair value, and arising from the depreciation of the quotation of shares, in 2010, which would have to be increased in Field 737 of Table 07 of the Claimant's periodic tax return, in half of the value"; n) "contrary to what the Claimant intends, there is no analogical interpretation, given that it is expressly provided in the second part of the norm that losses determined, relating to equity interests, contribute to the formation of taxable income in only half of their value"; o) "income/gains and expenses/losses to which article 18, paragraph 9, lit. a), refers, must inevitably be confronted with the treatment given to them by the provisions of articles 20, 23 and 45 of the IRC Code, respectively. Deeming absolutely irrelevant a hypothetical semantic question fabricated around the dichotomy between the term 'losses' used in article 45, paragraph 3, and the term 'expenses' used in article 23 and in article 18, paragraph 9, lit. a), of the IRC Code. [...] the term 'expenses' used both in the heading given to article 23, within the scope of the changes introduced by Decree-Law no. 159/2009, of 13 July, and in the wording of lit. i) of paragraph 1 of that provision [...] must necessarily be understood in a broad sense, i.e., covering, in substance, expenses proper and losses. That is, although each of those terms has its own meaning, that dichotomy between 'expenses' and 'losses' can only be qualified as a terminological inaccuracy of the legislator without consequences at the level of interpretation of those provisions"; p) "the legislator made a clear choice as regards losses verified in equity interests envisaged in lit. a) of paragraph 9 of article 18 of the IRC Code, which consisted of the attribution of fiscal relevance, regardless of their effective realization, and such choice constitutes, as far as this matter is concerned, a clear departure from the principle of realization"; q) "As regards the fact that the subsumption to the regime of partial deduction provided in article 45, paragraph 3, of the expenses/losses determined pursuant to the terms and conditions referred to in article 18, paragraph 9, lit. a), of the IRC Code, is not accompanied by a symmetric treatment for income/gains, and of the potential injustice that may result therefrom, in truth, there is no legal provision that permits the consideration of only half of its value in the calculation of taxable income. And if the legislator, neither before nor after 2010, introduced any provision enshrining a symmetric solution for income/gains and expenses/losses arising from the application of fair value, pursuant to the terms and conditions referred to in art. 18, paragraph 9, lit. a), neither can the interpreter, whether the AT or the taxpayer, substitute itself in that task."; r) "[there is no the alleged violation of constitutional principles because] the Tax Administration, when interpreting article 45, paragraph 3 of the IRC Code, did so in observance of the provisions of article 9 of the Civil Code, applicable by virtue of paragraph 1 of article 11 of the LGT [and because] the Constitution itself of the Portuguese Republic legitimizes the applicability of special regimes, not requiring the exclusivity of taxation according to real income [...], being here to recall that not all situations measured at fair value are contemplated in article 18, paragraph 9, lit. a), of the IRC Code, such as situations where there is a fair value measurement of social participations but the taxpayer holds more than 5% of the capital or holds less than 5% but opts for the accounting of adjustments resulting from changes in fair value in equity capital accounts. In this way, the requirement set forth in article 45, paragraph 3 of the IRC Code cannot therefore constitute a violation of the principle of taxation by real income or of contributive capacity"; s) "it is also to be ruled out a hypothetical violation of the principle of equality, since the same, provided in paragraph 1 of article 13 of the CRP enshrines the observance of material equality, not merely formal [and, in] the case sub judice, the regime legally provided for and in force at the date of the facts in paragraph 3 of article 45 of the IRC Code, leads us to consider that the purpose of the legislator was, precisely, to broaden the scope of application of the aforementioned norm, so as to encompass other realities (beyond the onerous transfer of social interests), susceptible to lead to the exploitation, by taxpayers, of expedients capable of enhancing some kind of 'tax planning', thus justifying recourse to the aforementioned tax treatment."

2.4. Finally, the AT concludes that "the present request for arbitral pronouncement [should] be ruled without merit, as manifestly unfounded, with the legal consequences thereof."

III – Proven Facts, Unproven Facts, and Respective Grounds

3.1. The following facts are considered proven:

i) The Claimant herein is a company managing equity interests which, in the course of its activity, holds various subsidiaries, among which is included B..., S.A., with registered office at ..., no...., ...-... ..., legal entity no...., this being a company dominated by the Claimant at 100%.

ii) In the present proceedings, there is at issue an additional IRC assessment relating to the tax year 2010, in the part relating to the correction related to the tax treatment of expenses arising from adjustments due to fair value variation in the dominated company identified above. The inspection action that gave rise to the aforementioned assessment had been carried out under the service order no. OI2011…, of the DF of Lisbon, by order of 10/11/2014.

iii) Concretely, the AT understood that the Claimant did not increase, "[in line 737 of] table 07 [of the income statement form mod. 22 of IRC for the year 2010], the value corresponding to 50% of the losses from reduction of fair value, determined in shares, having regard to the provisions of paragraph 9 of article 18, combined with paragraph 3 of article 45 of the IRC Code" (see Annex II to the RIT attached to the proceedings). What implied a merely arithmetic correction in the amount of €74,617.36 for IRC purposes, having, as a consequence, the taxable matter been altered from €155,582.07 to €230,199.43.

iv) The aforementioned dominated company being covered by the RETGS [Special Tax Regime for Groups], the arithmetic correction made to the individual taxable result of the same was reflected in the taxable result of the group in the exercise of 2010, by virtue of article 70 of the IRC Code, changing from €10,619,275.81 to €10,693,893.17 (see RIT attached to the proceedings).

v) Not conforming to the aforementioned correction and corresponding additional IRC assessment, in the amount of €5,189.72, with identification number 2015..., the Claimant herein filed the present request for arbitral pronouncement on 24/6/2015.

3.2. There are no unproven facts relevant to the decision of the case.

3.3. The facts considered pertinent and proven (see 3.1) are based on the analysis of the positions exposed by the parties and the documentary evidence attached to the proceedings.

IV – On the Law

In the present case, the essential question of law that arises is whether a correct interpretation and application was made of paragraph 3 of article 45 of the IRC Code, as regards losses resulting from the variation of fair value in financial instruments, which are relevant to the formation of taxable income pursuant to lit. a) of paragraph 9 of article 18, also of the IRC Code.

Let us see, then.

In light of the argumentation presented by the parties, as well as other elements contained in the present proceedings, it is verified that reason lies with the Claimant herein, for the reasons indicated below and which reflect, in essence, the understanding already expounded in Arbitral Decisions rendered in proceedings no. 108/2013-T, of 25/11/2013, and no. 59/2015-T, of 5/10/2015 (which is cited hereinafter), which dealt with identical questions of law and with whose grounds we agree:

"This is a question that has already been the object of decisions of the CAAD, namely, that rendered in proceedings 108/2013-T, which we shall follow closely. Article 45, paragraph 3, IRC Code, provided that 'the negative difference between gains and losses realized by means of the onerous transfer of equity interests, including their redemption and amortization with capital reduction, as well as other components of equity capital, namely, supplementary contributions contribute to the formation of taxable income in only half of their value.'

It must first be borne in mind that the aforementioned article 45, paragraph 3, IRC Code, stems from a legislative amendment that was guided, according to the Report of the Ministry of Finance for the State Budget of 2003, by 'two priorities, namely, the fight against tax fraud and evasion and the broadening of the tax base', with the amendment of interest here falling within the scope of 'Broadening of the tax base and measures of moralization and neutrality'.

The wording of the rule under analysis resulted from the amendment implemented by Law no. 60-A/2005 of 30 December, and pursuant to the corresponding Report of the Ministry of Finance, the measure in question fell within the scope of 'Fight Against Tax Evasion and Fraud and Other Measures Directed to Budget Consolidation'.

Thus, the norm came to have, with Law no. 60-A/2005, of 30/12, a broader wording, encompassing, in the limitation of losses to 50%, not only the 'negative difference between gains and losses realized by means of the onerous transfer of equity interests', but also 'other losses or negative patrimonial variations relating to equity interests or other components of equity capital, namely supplementary contributions'. [...].

A critical look at article 45, paragraph 3, which would admit, within its scope, not only losses (as defined in article 23) but also negative patrimonial variations (as defined in article 24), as well as costs (as defined in article 23), would lead to the fact that, for example, the acquisition cost of equity interests would only contribute in half of its respective value for the determination of taxable income, which would be, obviously, inconceivable to any minimally reasonable legislator. By 'losses' should be understood facts qualified as such in light of the IRC Code and by 'negative patrimonial variations' should be understood negative patrimonial variations not reflected in the net result of the exercise, as defined in article 24.

One should then conceive, given the panorama set out, that Decree-Law no. 159/2009, of 13 July, came to introduce, as regards the part covered by the acceptance of the application of the fair value model in financial instruments, a special regime of relevance for the calculation of taxable income, justified both by its own objectivity and by the confessed intention of bringing accounting and tax law closer together. This amendment cannot be disregarded when analyzing the legal question to be resolved.

Now, given the current wording of the IRC Code, that statement generates no doubts, as is verified, in particular, by the wording of articles 20, paragraph 1, lit. f) and h), 23, paragraph 1, lit. i) and l), and, especially article 46, paragraph 1, lit. b), by which it is evident in a clear manner the intention of the legislator to distance the adjustments arising from the application of the fair value criterion in financial instruments, as recognized by the IRC Code, from the regime of gains and losses. However, the situation proves to be different when it comes to the former article 45, paragraph 3, IRC Code, this article emerging as an antithesis to that congruence of norms that surround it.

That is: in the regime for which the rule of article 45, paragraph 3 was conceived and instituted, the realization of losses, and other situations enumerated, was dependent on a voluntary action corresponding to the realization thereof. Now, in this context, it will be understandable that the legislator institutes mechanisms to discourage an action susceptible of being considered as undesirable, in this case the realization of losses or other negative patrimonial variations. By providing that such situations will only be relevant in 50% of the amount accounted for, the tax legislator is, objectively, conditioning the actions covered by the legal provision, imposing a negative incentive to the same.

On the other hand, and being in question financial instruments of objectively non-quantifiable value, the disregard in 50% of the negative patrimonial variations verified, would also have a function of 'compensating' the natural tendency of economic operators to, at the fiscal level, inflate losses.

However, the same can no longer be concluded in situations covered by article 18, paragraph 9, lit. a) – such as those in the present case. Here, being in question adjustments arising from the accounting of fair value, determined by objective criteria (with 'a price formed in a regulated market'), there is no doubt or intervention of the taxpayer's will in the verification of the negative or positive patrimonial adjustment. That is, these will occur, or not, independently of the action and will of the taxpayer.

Now, to penalize, in these cases, the taxpayer with a disregard of 50% of the expense incurred, would be wholly unjustified, either from an economic or legal perspective, and even less so, at the accounting level.

Given that, in the regime of the defunct article 45, paragraph 3, the realization of losses, and other situations envisaged, was dependent on a voluntary action corresponding to the realization thereof. Given this factuality, it will be understandable that the legislator institutes mechanisms to discourage an action susceptible of being considered as undesirable, in this case the realization of losses or other negative patrimonial variations. By providing that such situations will only be relevant in 50% of the amount accounted for, the tax legislator is, objectively, conditioning the actions covered by the legal provision, imposing a disincentive to the same.

The non-application of article 45, paragraph 3, IRC Code, to expenses and, concretely, to 'Expenses resulting from the application of fair value in financial instruments', with full consideration of the patrimonial repercussions verified, whether positive or negative, leads to a congruence of taxation whatever the time at which the alienation of the financial instrument occurs.

On the other hand, if one were to apply the rule of article 45, paragraph 3, IRC Code, as the AT intends, from the moment a negative patrimonial change occurs, there will be a disparity between the fiscal relevance of negative and positive patrimonial variations, without any justification. It seems clear that random results and without any substantial foundation to support them could not have been intended by a reasonable legislator.

It is true that the alternative solution, which excludes the application of article 45, paragraph 3, IRC Code, leads to the fact that, in case it occurs, ultimately, a loss, this will end up having been considered at 100%, and not at 50%, as would occur under the principle of realization. However, this positive discrimination (or rather, non-negative discrimination) by opting for the fair value criterion can be justified, from the outset, since in the regime of article 18, paragraph 9, lit. a), any disincentive to the realization of losses no longer makes sense, given that they will be fiscally relevant regardless of their effective realization. One should also not overlook that, on one hand, accounting by fair value is considered more in accordance with the objective of bringing accounting and tax law closer together, an objective confessedly pursued by the legislator of Decree-Law no. 159/2009, of 13 July, and, on the other hand, the circumstance that we are dealing with objectively evaluated realities, without significant room for tax-convenient manipulations. That is, as had been advanced already, the reasons for combating tax fraud and evasion, nor the reasons for budget consolidation, that demonstrably were at the genesis of the rule of article 45, paragraph 3, of the IRC Code, are not verified. [...].

As a consequence of the foregoing, and in obedience to the hermeneutic impositions of article 9, C.Civ., it is understood that article 45, paragraph 3, IRC Code, should be interpreted in the sense that its provision does not include expenses resulting from the application of fair value in financial instruments that are relevant to the formation of taxable income, pursuant to lit. a) of paragraph 9 of article 18.

Given the logical, systematic and rational organization of the legal framework of the rule contained in article 45, paragraph 3, of the IRC Code, in the normative set in which it is inserted and which was explained previously, a clear incongruence is evident between the strict application of this provision, as the AT intends, and the implicit (and erroneous) results to which such application leads. Namely, by carrying out a strict application of article 45, paragraph 3, of the IRC Code, we have a clear violation of the principle of equity." [End of quote.]

In the same sense as the Arbitral Decision cited above, see also the following excerpt from the recent Arbitral Decision no. 208/2015-T, of 25/9/2015: "the question to be resolved in the proceedings [is] whether the accounting loss resulting from the retrospective application of the fair value method and the accounting losses verified in the exercises of 2010 and 2011, arising from the depreciation of the quotation of shares, properly accounted for in accordance with the applicable fair value criterion, and recognized in results, should be considered in full, or only in 50%.

[...]. [One should] consider[-ing] that Decree-Law 159/2009, of 13 July, came to introduce, as regards the part covered by the acceptance of the application of the fair value model in financial instruments, a special regime of relevance for the calculation of taxable income, justified both by its own objectivity and by the confessed intention of bringing accounting and tax law closer together.

This circumstance is, given the current wording of the IRC Code, not susceptible of generating any kind of doubt, as is verified, in particular, by the wording of articles 20, paragraph 1, lit. f) and h), 23, paragraph 1, lit. i) and l), and, especially 46, paragraph 1, lit. b), by which it is evident in a clear manner the intention of the legislator to distance the adjustments arising from the application of the fair value criterion in financial instruments, as recognized by the IRC Code, from the regime of gains and losses.

The regime resulting from the combination of articles 45, paragraph 3, and 46 of the IRC Code, only makes sense from the perspective of the relevance of the patrimonial variations in question under the prism of the aforementioned principle of realization.

It is that, being in question, given such principle, the assessment of patrimonial variation as a function of a transaction, there will always be a voluntary factor in relation to it.

That is, in the regime for which the rule of article 45, paragraph 3 was conceived and instituted, the realization of losses, and other situations enumerated, was dependent on a voluntary action corresponding to the realization thereof. Now, in this context, it will be understandable that the legislator institutes mechanisms to discourage an action susceptible of being considered as undesirable, in this case the realization of losses or other negative patrimonial variations. By providing that such situations will only be relevant in 50% of the amount accounted for, the tax legislator is, objectively, conditioning the actions covered by the legal provision, imposing a negative incentive to the same.

On the other hand, and being in question financial instruments of objectively non-quantifiable value, the disregard in 50% of the negative patrimonial variations verified, would also have a function of 'compensating' the natural tendency of economic operators to, at the fiscal level, inflate losses.

However, those aspects will no longer be present in situations covered by article 18, paragraph 9, lit. a). Here, being in question adjustments arising from the accounting of fair value, determined by objective criteria (with 'a price formed in a regulated market'), there is no doubt or intervention of the taxpayer's will in the verification of the negative or positive patrimonial adjustment. That is, these will occur or not, independently of the action and will of the taxpayer.

Now, to penalize, in these cases, the taxpayer with a disregard of 50% of the expense incurred, would be wholly unjustified, either from an economic or legal perspective. [...]

The non-application of the rule of article 45, paragraph 3, of the IRC Code, to expenses, and concretely to 'Expenses resulting from the application of fair value in financial instruments', with full consideration of the patrimonial repercussions verified, whether positive or negative, leads to a coherence of taxation whatever the time at which the alienation of the financial instrument occurs. That is, at whatever time one chooses to proceed with the alienation of the financial instrument, positive and negative patrimonial changes compensate each other, so that, ultimately, the taxpayer has only added to or subtracted from their taxable income the difference between the acquisition value and the sale value.

Now if one were to apply the rule of article 45, paragraph 3, of the IRC Code, as the Tax and Customs Authority intends, from the moment a negative patrimonial change occurs, there will be a discrepancy between the fiscal relevance of negative and positive patrimonial variations, without any justification, as has been said, since those variations occur in an objective manner and independent of the action or will of the taxpayer. [...].

It seems clear that such results, merely random and without any substantial justification to support them, could not have been intended by a reasonable legislator, which, by imperative of article 104, paragraph 2, of the CRP, must base the taxation of companies fundamentally on their real income. [...]. [...] it is understood that article 45, paragraph 3, of the IRC Code should be interpreted in the sense that its provision does not include expenses resulting from the application of fair value in financial instruments, which are relevant to the formation of taxable income pursuant to lit. a) of paragraph 9 of article 18." [End of quote.]

In summary, and in full agreement with the argumentation of the Arbitral Decisions cited above, it is also concluded, in the present case, that: i) article 45, paragraph 3, of the IRC Code, should be interpreted in the sense that its provision does not include expenses resulting from the application of fair value in financial instruments, which are relevant to the formation of taxable income pursuant to lit. a) of paragraph 9 of article 18 of the IRC Code; ii) such interpretation is in consonance with the interpretive rules of article 9 of the C.Civil and is that which is suited to the rationale of paragraph 3 of article 45 of the IRC Code; iii) Decree-Law no. 159/2009, of 13/7, came to introduce, as regards the part covered by the acceptance of the application of the fair value model in financial instruments, a special regime of relevance for the calculation of taxable income, justified by its own objectivity and its intention to bring accounting and tax law closer together; iv) the application of the rule of article 45, paragraph 3, of the IRC Code, to situations covered by article 18, paragraph 9, lit. a), of the IRC Code, proves to be unreasonable in its results (given that it creates discrepancies in the fiscal relevance of positive and negative patrimonial variations) and distances itself, without justified reason, from the rationale underlying the normative set in which the first rule is inserted.

V – On the Request for Payment of Indemnificatory Interest

In light of the provisions of paragraph 5 of article 24 of the RJAT – in the part stating that "interest, regardless of its nature, is due, pursuant to the provisions set forth in the general tax law and in the Code of Tax Procedure and Process" – it has been understood that such rule permits the recognition of the right to indemnificatory interest in arbitral proceedings.

Justified, by the foregoing, is the analysis of the request for payment of indemnificatory interest to the Claimant.

Indemnificatory interest is due when it is determined, in administrative appeal or judicial challenge, that there has been error attributable to the services from which results payment of the tax debt in an amount exceeding that legally due (see article 43, paragraph 1, of the LGT).

It is, therefore, a necessary condition for the attribution of the aforementioned interest the demonstration of the existence of error attributable to the services. In that sense, see, for example, the following decisions: "The right to indemnificatory interest provided in paragraph 1 of article 43 of the LGT [...] depends on it being demonstrated in the proceedings that such act is affected by error regarding the assumptions of fact or law attributable to the AT." (Decision of the STA of 30/5/2012, proc. 410/12); "The right to indemnificatory interest provided in paragraph 1 of article 43 of the General Tax Law presupposes that it is determined in the proceedings that in the assessment 'there was error attributable to the services', understood as the 'error regarding the assumptions of fact or law attributable to the Tax Administration'" (Decision of the STA of 10/4/2013, proc. 1215/12).

Now, having there been, as follows from what was said in Section IV, error attributable to the services, it is concluded in favor of the request for payment of indemnificatory interest to the Claimant.

VI – Decision

In view of the foregoing, it is decided:

  • To rule the request for arbitral pronouncement as well founded, with the consequent annulment, with all legal effects, of the additional assessment impugned and respective compensatory interest, and the reimbursement of the amount wrongfully paid.

  • To rule the request also well founded in the part concerning the recognition of the right to indemnificatory interest in favor of the claimant.

The value of the case is set at €5,189.72 (five thousand one hundred and eighty-nine euros and seventy-two cents), pursuant to the provisions of article 32 of the CPTA and article 97-A of the CPPT, applicable by virtue of the provisions of article 29, paragraph 1, lit. a) and b), of the RJAT, and article 3, paragraph 2, of the Regulation of Costs in Tax Arbitration Proceedings (RCPAT).

Costs to be borne by the respondent, in the amount of €612.00 (six hundred and twelve euros), pursuant to Table I of the RCPAT, in compliance with the provisions of articles 12, paragraph 2, and 22, paragraph 4, both of the RJAT, and the provisions of article 4, paragraph 4, of the aforementioned Regulation.

Notify.

Lisbon, 11 January 2016.

The Arbitrator

(Miguel Patrício)

Text prepared on computer, pursuant to the provisions of article 131, paragraph 5, of the CPC, applicable by referral of article 29, paragraph 1, lit. e), of the RJAT.

The text of this decision is governed by the spelling prior to the Orthographic Agreement of 1990.

Frequently Asked Questions

Automatically Created

How are losses from fair value variations in financial instruments treated for IRC purposes under Article 45(3) of the CIRC?
Under Article 45(3) of the CIRC, losses from the disposal of equity holdings are generally limited to 50% deductibility. However, there is significant controversy regarding whether this limitation applies to unrealized fair value losses on financial instruments. The Tax Authority interprets Article 45(3) broadly to include fair value losses that become relevant for tax purposes under Article 18(9)(a) CIRC. Taxpayers argue that Article 45(3) should only apply to realized, definitive losses from actual transfers, not reversible fair value adjustments. The key issue is whether fair value variations, which are inherently reversible and depend on market fluctuations, constitute 'losses' within the meaning of Article 45(3), or whether this provision is limited to consolidated, non-reversible losses from disposal transactions.
Can fair value losses on financial instruments be deducted when calculating taxable profit under Article 18(9)(a) of the CIRC?
The deductibility of fair value losses depends on the interpretation of the interaction between Article 18(9)(a) and Article 45(3) of the CIRC. Article 18(9)(a) makes fair value adjustments on financial instruments recognized at fair value through profit or loss relevant for determining taxable income. The dispute centers on whether such losses, once made tax-relevant by Article 18(9)(a), are then subject to the 50% deduction limitation under Article 45(3). Taxpayers contend that limiting deduction of reversible fair value losses to 50% while taxing fair value gains at 100% creates asymmetric treatment violating equality principles. They argue that fair value losses should be fully deductible as they represent potential, not realized, losses. The Tax Authority maintains that Article 45(3) applies to all losses from equity holdings that contribute to taxable income formation.
What is the difference between literal and systematic interpretation of Article 45(3) CIRC regarding financial instrument losses?
The literal interpretation of Article 45(3) CIRC, adopted by the Tax Authority, applies the 50% deduction limitation to all losses from equity holdings, including fair value losses made tax-relevant under Article 18(9)(a). This approach focuses on the text stating that losses from transfers of equity holdings are only 50% deductible. The systematic interpretation, advocated by taxpayers, considers Article 45(3) within the broader IRC framework and its legislative purpose. This approach distinguishes between: (1) realized, definitive losses from actual disposal transactions (which Article 45(3) was designed to limit); and (2) unrealized, reversible fair value adjustments reflecting market fluctuations. The systematic interpretation argues that including reversible fair value losses under Article 45(3) creates incoherence with IRC's taxation model, violates principles of equality (asymmetric treatment of gains vs. losses), proportionality, and ability to pay, and contradicts the distinction between potential and actual income.
How can a taxpayer challenge an additional IRC tax assessment through CAAD tax arbitration under the RJAT?
To challenge an additional IRC assessment through CAAD tax arbitration, taxpayers must file an application for constitution of an arbitral tribunal under Article 2(1)(a) of Decree-Law 10/2011 (RJAT - Legal Regime for Arbitration in Tax Matters). The application must be submitted after notification of the contested assessment. The process includes: (1) filing the arbitration request identifying the contested act and legal grounds; (2) constitution of the arbitral tribunal (singular or collective); (3) citation of the Tax Authority to submit a response; (4) potential hearing under Article 18 RJAT (which may be dispensed with); (5) arbitral decision. In this case, the claimant filed on June 24, 2015, the tribunal was constituted on September 22, 2015, the Tax Authority responded on October 28, 2015, and the tribunal dispensed with the Article 18 hearing and witness evidence, declaring the case ready for decision. Taxpayers can request annulment of the illegal assessment and payment of compensatory interest.
Are fair value adjustments on financial instruments considered reversible or non-reversible for IRC deduction purposes?
For IRC deduction purposes, the classification of fair value adjustments as reversible or non-reversible is central to the Article 45(3) debate. Taxpayers argue that fair value adjustments on financial instruments are inherently reversible because they reflect temporary market fluctuations in stock quotations. Unlike realized losses from actual disposal transactions (which are definitive and non-reversible), fair value losses can be reversed in subsequent periods if market prices recover. This reversibility means they represent potential, not actual, losses. The systematic interpretation holds that Article 45(3) was designed to limit only non-reversible, consolidated losses from transfers, not reversible accounting adjustments. Conversely, the Tax Authority's position implies that once fair value variations become relevant for taxable income under Article 18(9)(a), their reversible or non-reversible nature is irrelevant for applying Article 45(3)'s limitation. This classification has significant tax consequences, determining whether such losses are 50% or 100% deductible.