IRC Deductibility of Financial Charges and Cost Indispensability in Related-Party Financing (CAAD 405/2016-T)

ARBITRATION DECISION

The arbitrators José Pedro Carvalho (presiding arbitrator), Ricardo Rodrigues Pereira and José Eduardo Mendonça da Silva Gonçalves, designated by the Deontological Council of the Administrative Arbitration Centre to form the Arbitral Tribunal, agree as follows:

I. REPORT

1. On 15 July 2016, the commercial company A…, S. A., NIPC …, with registered office at Avenida…, …, …, Porto, filed a request for constitution of an arbitral tribunal, pursuant to the combined provisions of articles 2, no. 1, paragraph a), and 10, nos. 1, paragraph a), and 2, of Decree-Law no. 10/2011, of 20 January, which approved the Legal Regime of Arbitration in Tax Matters, as amended by article 228 of Law no. 66-B/2012, of 31 December (hereinafter, abbreviated as RJAT), seeking the declaration of illegality and consequent annulment of the additional corporate income tax assessment no. 2015…, concerning the fiscal year 2012, and the corresponding settlement statement no. 2015…, under which a tax payable amount of € 315,674.85 was determined, following the express rejection of the administrative complaint filed with a view to annulling those tax acts.

Following the filing of the request for constitution of an arbitral tribunal, the commercial company A…, S. A. was incorporated by merger into the commercial company B…, S.A., NIPC…, with registered office at Avenida…, …, …, Porto and, as a result, the amendment of the procedural subject was requested and granted, with this company becoming the Claimant in this arbitral proceeding.

The Claimant attached 15 (fifteen) documents and listed 2 (two) witnesses[1], and did not request the production of any other evidence.

The Respondent is the AT – Tax and Customs Authority (hereinafter, Respondent or AT).

1.1. In essence and in brief summary, the Claimant alleged the following:

The Claimant has as its corporate purpose promoting the rational use of energy and the diversification of energy sources through the identification, study, design and execution, with its own resources or in association, of installations for electricity production and/or use of residual heat and its subsequent operation and sale of energy, in the form of financing by third parties.

Following a tax inspection of the fiscal years 2011 and 2012, the Tax Inspection Services argued that the Claimant "(…) is financing itself at higher rates than those at which it then finances its associated companies through the financing obtained, that is, it is bearing financial charges with financing that it is channeling to its associated companies and which are not being used in its activity as an autonomous entity, not passing on the totality of these incurred expenses to the entities benefiting from those same financings". Thus, the inspection concluded that "the financial charges corresponding to loans obtained are not fiscally deductible, for purposes of determining the taxable profit for the fiscal years 2011 and 2012, in the proportion of the amounts that were not re-billed to the companies for which the loans were channeled".

The Claimant develops its corporate purpose through the interaction maintained with its subsidiaries and associated companies. Thus, the development of its activity – which is carried out both directly and indirectly (i.e. through its subsidiaries/associated companies and other participations) – necessarily presupposes the granting of intra-group loans, to the extent that such financing is essential to pursuing the activity carried out by its investees and, consequently, to the activity exercised by the Claimant itself.

During the inspection, the Claimant alleged and proved that:

(a) It is remunerated for loans granted to its investee D… (consortium for construction and operation of wind farms);

(b) To finance D…, multiple supply contracts were entered into between the companies in the consortium and D…, depending on the financing needs of the latter company;

(c) In 2011, the Claimant charged an average interest rate of 4.448%, resulting from the application of a fixed rate + Euribor 12M or Mid Swap 5Y value; and

(d) In 2012, the Claimant charged an average interest rate of 5.568%, resulting from the application of a fixed rate + Euribor 12M or Mid Swap 5Y value.

The Claimant notes the fact that article 23 of the Corporate Income Tax Code, and its respective concept of indispensability, is the sole legal ground invoked by the AT for the correction made. However, in its view, expenses must be considered indispensable whenever they aim at obtaining profit by taxpayers, that is, whenever, in abstract terms, they are capable of enhancing the profit of companies.

The Claimant emphasizes that the AT itself, in the inspection report, states that "(…) A… has as its purpose the management, promotion, development, installation and operation of cogeneration and renewable energy projects, including participation in companies or complementary groupings of companies pursuing the same activities."

Thus, the aforementioned corporate purpose establishes all the necessary framework for the financing carried out by the Claimant to its subsidiaries, to the extent that it results from the purpose that it can develop its activity – indirectly – through investees, associated companies and subsidiaries, which pursue activities in the energy sector.

In the Claimant's view, it follows that, as results from the factual situation presented, the costs incurred with the financings whose fiscal deductibility is disputed in these proceedings have already produced and increased profits. For this very reason, the AT would only be questioning the differential between the interest paid and the interest earned, recognizing that gains were obtained.

The financings granted by the Claimant are fundamental to the activity of its investees, allowing them to obtain profits which will subsequently be distributed to the Claimant/will increase the value of the Claimant's stake – i.e. there is a potential for the costs incurred with the loan to have a return mediated by the Claimant, influencing its results in a positive way.

The Claimant contests the AT's line of argument when, on the one hand, it questions the necessity of the cost but, on the other hand, seems to focus only on the value of interest, a matter that transcends deductibility, and should be analyzed only from the transfer pricing perspective, in particular, when the objection raised focuses on the excess interest paid as against the interest earned.

And the Claimant further states that the difference in spreads and variable components in a loan may exist without the operations not being perfectly justifiable and classifiable under market conditions, in particular, by virtue of the different capacity to produce sufficient guarantees between companies or even by virtue of the duration of the credit.

1.2. The Claimant concludes its initial submission requesting the following:

"A) The annulment of the express rejection of the administrative complaint and underlying corporate income tax assessment for 2012 and corresponding settlement statement in the amount of EUR 315,674.85, on the ground that such correction incurs a defect of violation of law, due to error in the legal and factual assumptions, reflected in the erroneous application of article 23 of the Corporate Income Tax Code;

B) The declaration of unconstitutionality of paragraph c) of no. 1 of article 23 of the Corporate Income Tax Code, for violation of article 61 of the Constitution of the Portuguese Republic;

C) The condemnation of the AT to pay compensation for undue guarantee, pursuant to article 53 of the General Tax Law and article 171 of the Tax Procedural Code,

All with the legal consequences thereof."

1. The request for constitution of an arbitral tribunal was accepted and automatically notified to the AT on 17 August 2016.

2. The Claimant did not appoint an arbitrator, and therefore, pursuant to paragraph a) of no. 2 of article 6 and paragraph a) of no. 1 of article 11 of the RJAT, the President of the Deontological Council of the CAAD appointed as arbitrators of the collective Arbitral Tribunal Dr. José Pedro Carvalho, Dr. Ricardo Rodrigues Pereira and Dr. Jorge Eduardo Mendonça da Silva Gonçalves, who communicated acceptance of the appointment within the applicable time period.

3.1. On 29 September 2016, the parties were duly notified of this appointment and did not express any intention to refuse the appointment of the arbitrators, pursuant to the combined provisions of article 11, no. 1, paragraphs b) and c), of the RJAT and articles 6 and 7 of the CAAD Deontological Code.

3.2. Thus, in accordance with the provision of paragraph c) of no. 1 of article 11 of the RJAT, the collective Arbitral Tribunal was constituted on 17 October 2016.

1. On 22 November 2016, the Respondent, duly notified to that effect, filed its Reply in which it raised the plea of res judicata and specifically refuted the arguments adduced by the Claimant, having concluded for the admission of that plea, with the consequent dismissal of the claim, or, should that not be the case, for the dismissal of the present action, also with its consequent dismissal of the claim.

4.1. In essence and also in brief form, it is important to note the most relevant arguments on which the Respondent based its Reply:

The Respondent begins by invoking the plea of res judicata, advancing the following argument:

The present arbitral claim is brought against the act of express rejection of the administrative complaint filed by the Claimant, which was filed outside the legal time limit of 120 days, provided for in article 70 of the Tax Procedural Code.

The untimeliness of the administrative complaint request necessarily has the consequence that the tax act against which a complaint was lodged (after the legal time limit for doing so), became res judicata, and can no longer be attacked with regard to defects giving rise to mere voidability which have been cured by the passage of the legal time limit for lodging a complaint or challenge.

Specifically, the Respondent states that the subject matter of this arbitral claim is the additional tax assessment act which is reflected in the statement of tax assessment showing the breakdown of the various items underlying the calculation of tax/reimbursement due in respect of corporate income tax for 2012, and not the material operation of settlement of accounts resulting from the necessary offsetting transactions between the assessments, the annulled one and the one now being challenged.

Thus, the notification of the 2012 corporate income tax assessment to the Claimant has the constitutive effect of the respective tax-legal situation, the settlement of accounts having the nature of a purely material offsetting act between the challenged assessment and the assessment which preceded it, with determination of a final balance payable or to be received, in the case of the proceedings fixing a time limit for reimbursement by the Claimant of the amount of tax unduly received, in no way affecting its tax-legal situation already fixed by the prior assessment act.

For this reason, in the absence of a timely complaint or challenge of that challenge, any defects giving rise to voidability from which it may suffer are cured, and it becomes res judicata or resolved in the legal order.

The Respondent continues stating that since the tax act in question in these proceedings did not determine a tax liability but rather a reimbursement in favor of the Claimant, the beginning of the time limit for filing an administrative complaint is counted according to the provision of paragraph b) of no. 1 of article 102 of the Tax Procedural Code, that is, it is counted from the respective notification, being counted in accordance with article 279 of the Civil Code by virtue of article 20, no. 1, of the Tax Procedural Code.

Furthermore, because the Claimant adhered to the electronic notification system of the AT – which ensures the actual date on which the taxpayer accesses them and from which the time limits for reacting against the tax acts notified to him begin to run – the regime resulting from article 39, nos. 9 and 10, of the Tax Procedural Code is applicable to it.

In this framework, on the date on which the Claimant filed the said administrative complaint, the corporate income tax assessment act for 2012 had already consolidated in the legal order, becoming res judicata.

Subsequently, the Respondent proceeds to defend itself by challenging, arguing the following which we emphasize here:

For the AT, and in the context of the analysis of the interest rates in question here, it was found that the loans granted are greater than those obtained, which means that the company is financing itself from financial institutions and capital holders, and in turn is financing its associated companies either with the use of the financing obtained or with the use of its own resources, since it grants more financing than that which it obtains.

On the other hand, it was found that the income obtained from the loans granted is less than the expenses in which it incurs to finance itself, a situation which derives from the fact that the company is financing its associated companies at an interest rate lower, and in some cases even without interest, than that which it itself is bearing in its financing.

From the factuality established during the inspection, it resulted that the essential question in these proceedings is whether the financial charges resulting from the financing which the Claimant obtained and with which it financed its associated companies, not passing on the totality of these expenses to the entities benefited, could be classified under article 23 of the Corporate Income Tax Code, or whether, on the contrary, they did not meet the cost admissibility requirements established in this provision.

And from the reasoning of the challenged act it results, for the AT, manifestly demonstrated that the Tax Administration could not accept as a tax cost the financial charges relating to the financing of the Claimant's associated entities and which were not being used in its activity as an autonomous entity. In the AT's view, the argument adduced by the Claimant, either during the inspection or in these proceedings, fails to refute the judgment made by the Respondent in the direction of excluding from the scope of application of article 23 of the Corporate Income Tax Code the financial charges which were thus disregarded for tax purposes, which determined the corrections made.

Thus, notwithstanding the relevance assumed by the legal-economic reality underlying the tax norms, the law requires proof of the indispensability of the expense in obtaining the income and not merely proof of the possibility of obtaining such income. That is, for a given amount to be considered as a cost, it is necessary that it relate to the activity developed by the company itself and not by another company, even if it belongs to the same economic group.

The indispensability referred to in article 23 of the Corporate Income Tax Code, as a condition for an expense to be deductible for purposes of determining taxable profit, does not refer to necessity (expenses as a sine qua non condition of income), nor even to convenience (the expense as convenient for business organization), but requires only an economic causal relationship.

The AT argues that indispensable expense is equivalent to every cost incurred in order to obtain income and which represents an economic loss for the company. Thus, the expenses provided for in that article 23 must relate, first and foremost, to the contributing company itself, that is, for a given amount to be considered as an expense of that company it is necessary that the respective activity be developed by it itself, not by other companies. And it is absolutely consistent that the financings are obtained for the benefit of the activity of the investees and not of itself, now tax costs have as their assumption the activity of the company itself, and costs of the exercise of the activity of another with which it had some relationship cannot be imputed to it for this purpose.

And the premise from which the Claimant starts to support its claim is, for the AT, manifestly wrong, since the indispensability criterion created by the legislator aims to prevent the fiscal consideration of expenses which, although accounted for as costs, do not fall within the scope of the company's activity, and were incurred for the pursuit of other foreign interests.

The fact that the Claimant is an intermediate holding company of Group E…, does not mean that the activities carried out by companies within the group lose their autonomy, especially since among the provision of services it carries out within this structure, where the contributions it makes within it are identified, there is a clear definition of the counterparts received, materialized in the management fee and maintenance fee, there is no reference whatsoever to the financial charges sub judice.

Not being the expenses part of the company's activity, they were incurred not for the pursuit of its interests, but for foreign interests, they cannot be classified within the scope of its corporate purpose. The financial costs incurred by the Claimant are not directly related to any activity included in its corporate purpose, nor do they relate, even indirectly, to its activity.

Consequently, the interest paid by a company with respect to loans in which it is manifestly proven that the funds obtained are diverted from its own exploitation to that of another entity with which it is related cannot be accepted as deductible. The mere possibility that it may come to have in the future profits resulting from the application of such capital in its associated company, or its actual existence, does not by itself determine that such investments can be classified under the concept of tax expenses, because for that it would be necessary that such charges were indispensable for the realization of income or gains subject to tax or for the maintenance of the productive source, and the Claimant failed to make such a demonstration.

Because the entire reasoning of the corrections, which concludes that the financial charges borne by the Claimant are not a tax cost classifiable under article 23 of the Corporate Income Tax Code, clearly demonstrates that they do not derive from the business activity carried out.

Consequently, the interest paid by a company with respect to loans in which it is manifestly demonstrated that the funds obtained are diverted from exploitation and applied to purposes alien to it cannot be accepted as deductible.

Thus, expenses associated with financing which is being used by companies other than the Claimant should be fiscally disregarded, relative to the existing differential between expenses and income derived from the financing obtained and granted. Being certain that there was re-billing of interest, these were lower than those paid, a fact for which only the financial charges which were borne and not re-billed to the actual entities benefiting from the financings were fiscally disregarded.

The Respondent thus concludes its submission:

"In these terms, and in the other matters which Your Excellencies will duly supply, the peremptory unnamed plea of res judicata should be judged to be upheld, with dismissal of the claim.

Should that not be the case, the present request for arbitral pronouncement should be judged to be dismissed, the tax assessment act being challenged remaining in the legal order and the Respondent being dismissed accordingly."

4.2. On the same occasion, the Respondent attached to the proceedings its administrative file (hereinafter, abbreviated as PA).

1. Notified to that effect, the Claimant came to pronounce itself on the matter of the plea raised by the Respondent, saying, among other things, the following:

The tax assessment act comprises all operations intended to determine the amount of tax due, in the specific case, the statement of assessment and the settlement statement.

What matters for determining the beginning of the time limit for filing an administrative complaint is the determination of a tax liability payable as a result of the aforementioned operations and never knowing whether the final result of the assessment is less tax to be reimbursed or more tax to be paid.

And, says the Claimant, the amount whose payment is required is a tax, in this case, the corporate income tax for the fiscal year 2012, which is evidently a tax liability.

To this extent, since the settlement statement results in a tax payable, the Claimant suggests that it is this act which fixes the beginning of the counting of the time limit for filing an administrative complaint.

The Claimant also argues that only in cases where no amount payable is determined in the assessment and in the settlement statement is that the time limit for filing an administrative complaint begins to run from the assessment, pursuant to paragraph b) of no. 1 of article 102 of the Tax Procedural Code.

The Claimant further states that, if that were not understood, if the filing of the administrative complaint were untimely, the AT would then have the duty to convert, in a petition for official review, the administrative complaint filed.

The Claimant concludes by saying that the untimeliness of the filing of the administrative complaint, if verified, would constitute a dilatory plea which would result in dismissal of the proceedings, as results from paragraph k) of no. 4 of article 89 of the Administrative Procedure Code, subsidiarily applicable to arbitral proceedings.

1. On 24 January 2017, the meeting referred to in article 18 of the RJAT took place – in which the matters contained in the respective minutes, which are hereby reproduced, were dealt with – and, furthermore, the examination of C… (giving of party statements) and F… (witness) was proceeded with.

2. Both parties submitted written submissions, in which they reiterated the positions previously taken in their respective pleadings.

II. PRELIMINARY DETERMINATION OF ISSUES

The Arbitral Tribunal was regularly constituted and is competent.

The proceedings do not suffer from any nullities.

The parties have legal standing and capacity to sue, are duly represented and are legitimate.

§1. ON THE PLEA OF RES JUDICATA

The appraisal of this issue requires that we call to attention the norms of the Tax Procedural Code which appear relevant to this effect, namely:

"Article 70

Filing, grounds and time limit for filing an administrative complaint

1 – An administrative complaint may be filed on the same grounds provided for judicial review and shall be filed within 120 days counted from the facts provided for in no. 1 of article 102.

(…)"

"Article 102

Judicial review. Time limit for filing

1 – The review shall be filed within three months from the following facts:

a) Expiration of the time limit for voluntary payment of tax liabilities legally notified to the taxpayer;

b) Notification of other tax acts, even when they do not give rise to any assessment;

c) Service on subsidiary taxpayers in an enforcement proceeding;

d) Formation of the presumption of express rejection;

e) Notification of other acts that may be the subject of autonomous review under this Code;

f) Knowledge of acts harmful to legally protected interests not covered in the preceding paragraphs."

The time limit fixed in the aforementioned article 70 of the Tax Procedural Code is of a substantive nature and, for this reason, is counted in accordance with the provision of article 279 of the Civil Code by virtue of article 20, no. 1, of the Tax Procedural Code, running continuously, without any interruption or suspension.

Having made this legal framework and turning to the specific case, we have that the Claimant was notified, through the electronic notification system "Via CTT", on 02/10/2015 (cf. article 39, no. 9, of the Tax Procedural Code), of the following documents [cf. document no. 1 attached with the Reply]:

(i) "Statement of Corporate Income Tax Assessment" corresponding to assessment no. 2015…, dated 24/09/2015, concerning the fiscal year 2012, in which a tax reimbursement amount of € 1,347,457.66 was determined.

This document contains the following statement: "The Settlement and Compensation Statement and the corresponding collection note follow in a separate envelope".

(ii) "Statement of Settlement of Accounts" with no. 2015…, concerning corporate income tax for 2012, from which the amount payable of € 315,674.85 results, with the reference for payment … and payment due date of 26/11/2015.

Subsequently, on 29 February 2016, the Claimant filed an administrative complaint which had as its subject that additional corporate income tax assessment for fiscal year 2012 and the aforementioned settlement statement [cf. documents nos. 1 and 8 annexed to the Initial Submission].

Thus stated. It results incontestably that the Claimant was legally notified of a tax liability – corporate income tax for the year 2012, in the amount of € 315,674.85 – with a fixed time limit for respective voluntary payment, the expiration of which was fixed by the AT on 26/11/2015.

This is shown, from the start, by the following statements contained in the aforementioned "Statement of Settlement of Accounts": "You are hereby notified to, by the date limit indicated, make payment of the balance determined" and "If payment is not made within the time period referred to above, an enforcement proceeding will be instituted."

Furthermore, contrary to what is advocated by the Respondent, the tax act in question – additional corporate income tax assessment for the year 2012 – is not confined to, nor exhausted in, the aforementioned "Statement of Corporate Income Tax Assessment", as indeed results from the following statement contained therein: "The Settlement and Compensation Statement and the corresponding collection note follow in a separate envelope".

We cannot, in fact, overlook that we are facing an additional tax assessment resulting from an inspection action which resulted in corrections to the taxable matter, which made it necessary to carry out offsetting operations (settlement of accounts) between the values shown in the primary assessment and those resulting from the additional assessment, in order to determine whether or not a tax liability needs to be satisfied by the taxpayer and, if so, its respective amount.

Moreover, if the interpretation advocated by the Respondent were adopted to the effect that the tax act disputed "does not determine any tax liability but rather a reimbursement", it would then be necessary to ask how the amount shown in the "Statement of Settlement of Accounts" was arrived at and on what basis the respective payment was demanded from the Claimant.

Having said this, we then have that, in this case, the time limit for filing the administrative complaint should be counted as follows: 120 days (article 70, no. 1, of the Tax Procedural Code) counted continuously, without any interruption or suspension (article 279 of the Civil Code by virtue of article 20, no. 1, of the Tax Procedural Code), from 27/11/2015 (article 102, no. 1, paragraph a), of the Tax Procedural Code).

Such time limit thus expired on 25/03/2016.

Since the said administrative complaint was filed on 29/02/2016, it is unequivocally timely.

In these terms, the alleged plea of res judicata is judged to be dismissed.

There are no other pleas or preliminary matters that prevent knowledge on the merits and of which it is necessary to know.

III. REASONING

III.1. ON THE FACTS

§1. FACTS FOUND TO BE PROVEN

The following facts are considered to be proven:

a) The commercial company A…, S. A. (hereinafter, A…) was established in July 1991, having as its corporate purpose promoting the rational use of energy and the diversification of energy sources through the identification, study, design and execution, with its own resources or in association, of installations for electricity production and/or use of residual heat and its subsequent operation and sale of energy, in the form of financing by third parties. [cf. document no. 4 annexed to the Initial Submission]

b) The capital structure of A… was changed in mid-2011, coming to belong 100% to "Group E…", since being then already held at 50% by "G…, SL", the latter acquired the 50% that belonged to the former shareholder, "H…". [cf. PA attached to the proceedings]

c) A… thus started to be fully integrated into the "E…" universe, an economic group leading on a global scale in the electricity production sector through the use of renewable resources. [cf. PA attached to the proceedings]

d) This had an impact on its financing structure, since it stopped being financed by third parties and came to be financed by intra-group loans, having ended in 2011 the external financing it had obtained through commercial paper programs. [cf. PA attached to the proceedings]

e) In 2012, A… was related to the entities and held the participations identified below [cf. PA attached to the proceedings]:

f) The investee "D…" constitutes a consortium for the construction and operation of wind farms.

g) Concerning fiscal year 2012, A… declared the following amounts under corporate income tax [cf. PA attached to the proceedings]:

h) In fiscal year 2012, A… presented the following balances with respect to financing, both obtained and granted [cf. PA attached to the proceedings]:

• Loans obtained: € 109,852,918.00;

• Loans granted: € 122,907,861.00.

i) Concerning expenses and income from financing recognized in 2012, these amounted to the following amounts [cf. PA attached to the proceedings]:

• Expenses: € 6,660,596.00, of which € 6,327,230.00 relate to interest on financing obtained from the Claimant's shareholders, B… and CC…, and € 332,049.00 relate to payments due for the provision of bank guarantees, within the scope of such financing;

• Income: € 5,395,492.00 amount which came entirely from financing made to the Claimant's investee D… [cf. document no. 13 annexed to the Initial Submission];

• Net expenses: € 1,265,104.00.

j) By virtue of holding a 17.98% stake in its investee "D…", both A… and "Group E…" were lacking the ability to impose on "D…" an interest rate on the financing different from that which was contractually agreed and practiced (in 2012, an average rate of 5.568%).

k) All contracts and agreements underlying the determination of the interest rates practiced were approved unanimously by the members of the consortium "D…", having not depended on a unilateral expression of will by A…, being that the interest rate of the financing made to D… was equal for all participants in the shareholder consortium thereof and the value of the financing was proportional to each one's participation therein.

l) The financing contracts of the Claimant with B… and CC… were entered into in 2011 and had maturity in 2018, whereas the financing of the Claimant to D… were entered into in 2011 and had maturity the following year, in 2012, being renewable annually. [cf. documents nos. 14 and 15 annexed to the Initial Submission]

m) The objective was for the investee "D…" to be financed by means of project finance, with loans obtained from third parties, which only did not happen given the serious financial crisis that prevailed from 2011 onward.

n) Under service order no. OI2014…, A… was subject to an external general-scope inspection, covering fiscal years 2011 and 2012, which was carried out by the Tax Inspection Division –… of the Finance Directorate of Porto, having begun on 08/01/2014 and ended on 05/05/2015. [cf. PA attached to the proceedings]

o) During the said inspection procedure, the Tax Inspection Services requested that A… indicate, concerning fiscal years 2011 and 2012, which interest rates were practiced on the loans both obtained and granted by it. [cf. PA attached to the proceedings].

p) Following that request, A… provided the following clarification to the Tax Inspection Services [cf. PA attached to the proceedings]:

"Interest on loans obtained (5% + Euribor 6M)

q) Through official letter no. …/…, dated 06/05/2015, from the Tax Inspection Services of the Finance Directorate of Porto, sent by registered mail, A… was notified of the Draft Tax Inspection Report and to, if desired, exercise the right of hearing, with the following corrections being proposed in respect of corporate income tax, concerning fiscal year 2012 [cf. document no. 5 annexed to the Initial Submission and PA attached to the proceedings]:

r) On 02/06/2015, A… exercised the right of hearing on that Draft Tax Inspection Report, having proposed therein that the financing it granted to its associated companies proves to be justified and fully admissible in light of the provision of article 23, no. 1, of the Corporate Income Tax Code (applicable at the time of the facts), and thus the maintenance of the proposed corrections appears manifestly illegal. [cf. document no. 6 annexed to the Initial Submission and PA attached to the proceedings]

s) The corrections to the corporate income tax of A…, concerning fiscal year 2012, mentioned in p), were entirely maintained in the Tax Inspection Report, the exercise of the right of hearing by A... being appraised by the Tax Inspection Services, in the following terms [cf. PA attached to the proceedings]:

t) The aforementioned corrections concerning the taxable matter of corporate income tax for fiscal year 2012 had underlying the following reasoning reflected in the Tax Inspection Report [cf. PA attached to the proceedings]:

u) A... was notified of the Tax Inspection Report through official letter no. …/…, dated 09/06/2015, from the Tax Inspection Division –…of the Finance Directorate of Porto, sent by registered mail with acknowledgment of receipt. [cf. document no. 7 annexed to the Initial Submission and PA attached to the proceedings]

v) As a result of the aforementioned corrections, an additional corporate income tax assessment no. 2015…, concerning fiscal year 2012 and the respective statement of settlement of accounts with no. 2015…, were made, with a total amount of tax payable of € 315,674.85 being determined, with the voluntary payment deadline of 26/11/2015. [cf. documents nos. 2 and 3 annexed to the Initial Submission]

w) A... did not proceed to pay the amount of € 315,674.85, resulting from the said settlement statement with no. 2015….

x) As a result of that failure to pay, enforcement proceeding no. …2015…, was instituted, in the amount of € 316,992.16. [cf. document no. 9 annexed to the Initial Submission]

y) A..., with a view to obtaining suspension of that enforcement proceeding, provided a bank guarantee, issued by Bank DD… and to which number …was assigned, in the amount of € 399,997.31. [cf. document no. 10 annexed to the Initial Submission]

z) On 29 February 2016, A... filed an administrative complaint – the initial request for which is hereby entirely reproduced – which had as its subject the additional corporate income tax assessment no. 2015…, concerning fiscal year 2012 and the respective statement of settlement of accounts with no. 2015…, referred to in the proven fact v), having requested therein the following [cf. documents nos. 1 and 8 annexed to the Initial Submission]:

"…the annulment of the corporate income tax assessment for 2012 and respective compensatory interest, in the amount of EUR 315,674.85, on the ground that such correction incurs a defect of violation of law, due to error in the legal and factual assumptions, reflected in the erroneous application of article 23 of the Corporate Income Tax Code,…"

aa) The said administrative complaint was registered under no. …2016… at the Finance Service of Porto-…. [cf. PA attached to the proceedings]

ab) Until the date of filing the request for constitution of an arbitral tribunal which gave rise to the present proceedings, that administrative complaint was not the subject of any express decision. [cf. PA attached to the proceedings]

ac) On 1 August 2016, the commercial company B…, S. A., NIPC…, with registered office at Avenida…, …, …, Porto, incorporated A… by merger [cf. documents attached to the Claimant's request, filed on 23/08/2016]

ad) The Claimant is an intermediate holding company of "Group E…" which, in addition to holdings in various companies in the energy sector, has resources and technical and human structures that make it possible to create synergies and promote the development of operational activity by the respective subsidiaries.

ae) The development of the Claimant's activity – which is carried out both directly and indirectly, through its subsidiaries/associated companies and other investees – necessarily presupposes the granting of intra-group loans, to the extent that such financing is essential to pursuing the activity carried out by its investees and, consequently, to the activity exercised by the Claimant itself, allowing them to obtain profits which will subsequently be distributed to the Claimant and will increase the value of the Claimant's holdings.

af) The services provided by the Claimant are broken down as follows [cf. PA attached to the proceedings]:

(1) A management fee, to the extent that companies developing energy projects resort to the resources existing in the Claimant's sphere, with a view to their exploitation, namely, in the administrative, technical, financial and commercial areas.

(2) A maintenance fee, since the ACE's "V…" and "W…", within the scope of their activity of energy production in their cogeneration plants, resort to the resources available in the Claimant's sphere, with a view to the exploitation of projects, namely, in the area of equipment maintenance.

ag) On 15 July 2016, the request for constitution of an arbitral tribunal was filed which gave rise to the present proceedings. [cf. CAAD case management computer system]

§2. FACTS NOT PROVEN

With relevance to the appraisal and decision of the case, there are no facts that have not been proven.

§3. REASONING CONCERNING FACTUAL MATTERS

With regard to the factual matters proven, the conviction of the Tribunal was based on the facts alleged by the parties, whose correspondence to reality was not called into question, on the documents and the respective administrative file attached to the proceedings and, further, on the evidence by party statements and testimony that was produced.

With regard to the depositions given by C… and F… – who testified in a clear, objective and impartial manner on the facts to which they were questioned, revealing unequivocal direct knowledge of the same, and therefore their depositions merited full credibility – the same corroborated, in substance, the factuality alleged by the Claimant, relative to which they were questioned.

In particular, with regard to the facts referred to in point i) of the factual matters, the witnesses clarified that the Claimant's financing from its shareholders corresponded to the consolidation of other financings for which the Claimant was a debtor to third parties, and that for reasons of financial policy resulting from the change in the Claimant's shareholder structure they were settled with intra-group funds, and the cost of the new financing falls within market normality, as demonstrated in the transfer pricing file, the Respondent having not pronounced itself on the matter of transfer pricing.

With regard to the facts referred to in points j) to m) of the proven factual matters, the witnesses clarified that the D… project initially provided for third-party financing (banking – project finance), which is what happened in the first two phases of the project, and that it was by force of the financial crisis that had meanwhile prevailed that, in the third phase, the shareholders of D… found themselves in the necessity of making capital available to their investee.

III.2. ON LAW

The Claimant bases the request for declaration of illegality and consequent annulment of the express rejection of the aforementioned administrative complaint and the challenged tax acts on the violation of article 23, no. 1, paragraph c), of the Corporate Income Tax Code, further arguing the unconstitutionality of this same legal norm, for violation of the principle of private initiative, contained in article 61 of the Constitution of the Portuguese Republic.

Article 124 of the Tax Procedural Code, applicable by virtue of article 29, no. 1, paragraph a), of the RJAT, establishes that the tribunal should evaluate as a priority the defects which lead to the declaration of non-existence or nullity of the challenged act and, following that, the defects which lead to its annulment (no. 1). Concerning defects which constitute non-existence or nullity, the judge should have priority knowledge of the defects whose admission, according to his prudent judgment, determines more stable or effective protection of the offended interests. Concerning defects which constitute voidability, the same criterion is established, which will only not be applicable if the challenger has established a relationship of subsidiarity between the defects imputed to the act – which is permitted by article 101 of the Tax Procedural Code – for in that case priority is given to his will (provided that the Public Ministry has not raised other defects) (no. 2).

The rules emanating from this legal norm on the order of knowledge of defects are intended to protect the interest of the challenger with maximum procedural economy, omitting pronouncement on defects invoked when the defect or defects already recognized prevent the renewal of the act with the same meaning. Indeed, the establishment of this order of knowledge of the defects presupposes that, knowing of a defect which leads to the legal elimination of the challenged act, the tribunal will cease to know of the others, for, if the judge had to know of all the defects imputed to the act, the order of knowledge would be indifferent.

The protection of the offended interests is more stable when the decision prevents the renewal of the act harmful to the interests of the challenger and will be more effective when it allows the interested party, in execution of the judgment, to obtain a better satisfaction of his interests, harmed by the annulled act.

Thus, if it is, for example, a defect of violation of law, the annulment of the act will prevent the practice of a new tax act in which the same norm that was at issue in the previous act is applied or not applied, which will result in the impossibility of practicing a new act which imposes taxation on the challenger.

As is inferred from what has been said, it is in consideration of the execution of the annulling judgment and the influence which the type of defect which founded the annulment has on it that the establishment of an order of knowledge of the defects of the challenged act is justified.

In this framework, turning to the specific case, it is then necessary to begin with the assessment of the defect of violation of article 23, no. 1, paragraph c), of the Corporate Income Tax Code, for, if verified, it will definitively eliminate the possibility of imposing a new assessment act of taxation on the Claimant, thereby achieving the most stable and effective protection of his interests.

Furthermore, it will only be important to proceed with the assessment of the issue of unconstitutionality of that same legal norm, as is alleged, if and to the extent that it is concluded that the interpretation and concretization of the solution resulting from the norm prevents the subsumption of the situation sub judice under its legal provision.

The situation sub judice is drawn with simple contours. In fact, verifying that the AT found that the Claimant bore expenses with financing in an amount greater than the respective income, it understood to disregard the excess expenses for the computation of the Claimant's taxable profit, considering it unnecessary, pursuant to the provision of article 23 of the Corporate Income Tax Code, in the wording applicable at the time.

A similar situation, relating to fiscal year 2011 of the now Claimant, was the subject of extensive appraisal within the scope of arbitral proceedings 695/2015T[2], whose contextualization and reasoning are subscribed to in their generality, and to which reference is made.

In the said judgment, prior doctrine and case law on the matter is reviewed, and in particular the consideration that "… the activity of a company will consist of the operations resulting from the use of its assets, in particular its assets and the management of its liabilities".

In summary, as stated in the said judgment, concerning the concept of "indispensability", appraised in the purpose of "for the realization of income subject to tax or for the maintenance of the productive source", the following aspects are noted, contained in its reasoning:

"Indispensability … is appraised in an economic sense: indispensable costs are those incurred in the interest of the company, which are linked with its capacity, by insertion in its lucrative scope (in a mediate or immediate form) …

The Tax Authority cannot review the soundness and opportunity of the company's management economic decisions. It cannot interfere in the freedom and autonomy of the company's management. A cost will be accepted fiscally if it is adequate … to the obtaining of profits, even if it comes to prove to be an unfruitful or economically ruinous economic operation".

Thus, the indispensability criterion is intended to "prevent the fiscal consideration of expenses" incurred for the benefit of "foreign interests".

Concerning the concept of asset and productive source, in the reasoning of the process referred to above, financial assets are considered, including financial holdings, and concerning the question "Does a participated company which becomes indebted and cedes those funds to participated entities, charging them null or below-cost interest, is it developing its own activity or foreign activity (i.e., performing acts of management alien to its interest)?", it establishes that "the deductibility of interest paid by the participant will depend on the fact that such financings contributed to, according to normal management rules, increase the expectation of future benefits or maintain the productive source (financial asset)".

It was understood, in the case, that when the participant finances the investees (its financial assets), in the participant's accounting "the allocation of funds to the investees has as its counterpart the increase in the value of the investment accounted for in the account "41-Financial Investments". The productive source that is financed, in which the position of the investor is reinforced is, in the first place, the set of financial assets" of the participant.

"That is, the productive source materializes itself legally and accounting-wise in the asset of the [participant], which concentrates legal, economic and financially the characteristics of a productive source of the [participant]: it is a set of assets previously acquired by this entity, which grants it rights over the investees, and from it income is expected in the sphere of the acquirer."

"… the AT corrects only the differential of interest and not the totality of the interest paid by the [participant]. …, this logic of tax adjustment appears ill-adjusted. If one wishes to question the differential of prices (interest rates) paid and received, it would be the transfer pricing norms which should apply, and not those of article 23 of the Corporate Income Tax Code".

As is noted in the said judgment, the reading to be made of the norm on which the correction operated by the AT is based, against which the Claimant here objects, can be summarized as follows:

• the judgment on the indispensability of the expenses borne implies that its contribution to obtaining the income or profits subject to tax or to maintaining the productive source is verified, and thus "The legal notion of indispensability is delimited, therefore, on an economic-business perspective, by direct or indirect filling of the ultimate motivation of contribution to obtaining profit" and "the fiscal deductibility of the cost depends only on a causal and justified relationship with the company's activity." (Supreme Administrative Court judgment, rendered on 30-11-2011, in process no. 0107/11[3]);

• "the costs (...) cannot fail to relate, from the start, to the contributing company itself. That is, for a given amount to be considered a cost of that company it is necessary that the respective activity be developed by it itself, not by other companies." (Supreme Administrative Court judgment, rendered on 30-05-2012, in process no. 0171/11);

• "a concept of indispensability which, definitively moving away from the idea of causality between expenses and income, places emphasis on the relationship of expenses with the activity pursued by the taxpayer, that is, considering that the said concept of indispensability is verified whenever expenses are incurred in the interest of the company, in the pursuit of its respective activities." (Supreme Administrative Court judgment, rendered on 04-09-2013, in process no. 0164/12);

• the concept of indispensability is of case-by-case application, and the nexus of economic causality cannot be disconnected from the factuality of the specific case, being that "the Tax Authority cannot evaluate the indispensability of costs in light of criteria focused on the opportunity and merit of the expense. A cost is indispensable when it relates to the company's activity, being that costs alien to the company's activity are only those in which no causal nexus can be discerned with the income or profits (or with the income, in the current expression of the code - cfr. art. 23, no. 1, of the C.I.R.C.), explained in terms of normality, necessity, congruence and economic rationality." (Supreme Administrative Court of the South judgment, rendered on 16-10-2014, process no. 06754/13);

• "The indispensability of the cost must simply result from its connection to business activity. If the cost is not alien to the company's activity, that is, if it relates to the company's normal activity (regardless of whether the degree of intensity or proximity is greater or lesser), and if its existence is accepted (we are not facing an apparent or simulated cost), the cost is indispensable." (Supreme Administrative Court of the North judgment, rendered on 20-12-2011, process no. 01747/06.3BEVIS);

• "from the legal notion of cost provided by art. 23 of the Corporate Income Tax Code does not result that the AT may call into question the principle of freedom of management, reviewing the soundness and opportunity of the company's management economic decisions and considering that only those from which profits directly accrue to the company or which prove convenient to the company can be fiscally assumed. The indispensability referred to in art. 23 of the Corporate Income Tax Code as a condition for a cost to be deductible does not refer to necessity (the expense as a sine qua non condition of profits), nor even to convenience (the expense as convenient for business organization), under penalty of intolerable interference by the AT in the autonomy and freedom of the taxpayer's management, but requires only an economic causal relationship, in the sense that it is sufficient that the cost be incurred in the interest of the company, in order, directly or indirectly, to obtain profits.

The legal notion of indispensability is delimited, therefore, on an economic-business perspective, by direct or indirect filling of the ultimate motivation of contribution to obtaining profit. Indispensable costs are equivalent to expenses incurred in the interest of the company or, in other words, in all acts abstractly capable of being subsumed under a lucrative profile. This objective brings, purposefully, the economic and fiscal categories closer together, through a primarily logical and economic interpretation of legal causality. The indispensable expense is equivalent to every cost incurred in order to obtain income and which represents an economic loss for the company. As a general rule, therefore, fiscal deductibility of the cost depends only on a causal and justified relationship with the company's activity. And outside the concept of indispensability will only be the acts at odds with the corporate purpose, those which do not fit within the interest of the company, above all because they do not aim at profit." (Supreme Administrative Court judgment, rendered on 30-11-2011, process no. 0107/11);

• "The rule is that correctly accounted expenses are tax costs; the indispensability criterion was created by the legislator, not to allow the Administration to interfere in the company's management, dictating how it should apply its means, but to prevent the fiscal consideration of expenses which, although accounted for as costs, do not fall within the scope of the company's activity, were incurred not for its pursuit but for other foreign interests. Strictly speaking, these are not true company costs, but expenses which, in view of their object, were abusively accounted for as such. Without the Administration being able to evaluate the indispensability of costs in light of criteria focused on their opportunity and merit.

The concept of indispensability not only cannot be made equivalent to a strict judgment of imperative necessity, as has already been said, but also cannot be based on a judgment on the convenience of the expense, necessarily made a posteriori. For example, expenses made with an advertising campaign which proved unfruitful cannot, solely as a function of that result, be affirmed to be dispensable.

The judgment on the opportunity and convenience of expenses is exclusive to the entrepreneur. If he decides to make expenses with a view to pursuing the company's purpose but is unsuccessful and those expenses prove, in the end, unfruitful, they do not cease to be tax costs. But every expense he accounts for as a cost and proves alien to the company's purpose is not a tax cost, because it is not indispensable.

We understand (...) that, under penalty of violation of the principle of tax capacity, the Administration can only exclude expenses not directly barred by law under a strong motivation that convinces that they were incurred beyond the corporate objective, that is, in the pursuit of another interest that is not business, or, at least, with clear excess, deviating, in light of the company's objective needs and capabilities." (Supreme Administrative Court judgment, rendered on 29-03-2006, process no. 01236/05).

Densified, in this manner, the criteria for appraisal of the indispensability of expenses, in light of article 23 of the Corporate Income Tax Code, it remains, then, the operation of applying such criteria to the specific case, appraising in that light the arguments of the AT which sustain its position.

In the present framework, concerning fiscal year 2012, it is verified that the financing of the Claimant to its investee D… is exclusively in question, contrasted with the financing obtained by the Claimant from its shareholders B… and CC….

Indeed, although the Inspection Report contains reference to the Claimant having granted loans to various investees, the fact is that, concerning the year 2012 and taking into account the amounts on which the corrections in question are based, contained in points h) and i) of the proven factual matters, as well as the documentation attached to the proceedings, it is verified that, in the year in question, only financing to the aforementioned Claimant's investee, D…, is in question, and thus the subsequent appraisal should stick to that specific situation.

In that matter, it is verified in the proceedings that in the D… project the Claimant was a minority shareholder (participation of less than 20%), that it had been ongoing for several years, having entered its phase 3, that the necessary financing was anticipated to be obtained from third parties (which, as a result of the financial crisis that prevailed, became unavailable for that purpose), and that the conditions agreed for the financing were equal for all shareholders/financiers, being that the participation of these in the financing was proportional to each one's participation in the financed entity.

Concerning the financing to D…, it is also verified that it was short-term financing (one year, renewable).

As regards the financing of the Claimant, it is verified that it results from the consolidation of other pre-existing financings, contracted in the normal exercise of that company's activity, and that they are long-term financings (7 years).

Further concerning both financings, it was not found that any of them had conditions deviating from those normally prevailing in the market, being duly justified in the Claimant's transfer pricing file.

With relevance, also, to the case, it is verified that D… constituted a consortium for the construction and operation of wind farms and that the Claimant's corporate purpose consisted of "promoting the rational use of energy and the diversification of energy sources through the identification, study, design and execution, with its own resources or in association, of installations for electricity production and/or use of residual heat and its subsequent operation and sale of energy, in the form of financing by third parties".

In light of this factual framework, it is believed to result in a relatively evident manner that no other conclusion can be drawn here, as in the cited arbitral proceedings 695/2015T, than that the charges borne by the Claimant with the financing of its investee D… were incurred in the normal pursuit of the Claimant's own activity.

Indeed, with the activity of D… fitting within the Claimant's own and specific purpose, being the latter, ab initio, vocalized to exercise its activity with its own resources or in association, the Claimant effectively exercising its activity by means of participation or association in approximately two dozen companies, and the financing need arising in a framework of financial turbulence which made impossible the possibility of financing by third parties, as was anticipated, nothing else could the Claimant do, in order to ensure the maintenance of D… as a source of its prospective taxable income, than contribute to its investee the part of the financing that it lacked, and which, according to its participation therein, it was incumbent on it to ensure, and under the conditions which, according to the legal terms, the remaining participants in the financed entity resolved to establish.

The circumstance that, concurrently, the Claimant was burdened with financings at a higher rate than the one that was determined in the financing to its investee, in no way prevents the conclusion drawn, first because financings with distinct characteristic features (terms, guarantees, values) may have, as is the case, distinct prices, and then because nothing in the facts ascertained indicates that, as the AT understood, the Claimant is bearing costs relating to a foreign activity, being that what is verified is that the financing costs relate directly to the Claimant's business activity.

In the case in which a participant company does not charge interest (or charges interest at a rate lower than that it bears in its financing) to participated companies, which leads to not obtaining (or obtaining reduced, in light of its cost) income from interest taxed, at the same time that this leads to a tendency toward greater profit imputable to the participation in the case of application of the Equity Method (there being no taxation in the sphere of the participant, in view of no. 8 of article 18 of the Corporate Income Tax Code), and should the participated company come to distribute profits (dividends) these may benefit from exclusion from taxation in the sphere of the participant should the requirements provided for in article 51 of the Corporate Income Tax Code be met.

Notwithstanding such ground not having been invoked by the AT, it will always be said that it is understood that such does not configure an operation with an abusive character, in the context of article 23 of the Corporate Income Tax Code, given the considerations above, as well as the jurisprudence of the CJEU. Thus, as stated in Constitutional Court Judgment no. 753/2014 (Process no. 247/2014), "the abusive character of an operation for purposes of applying an anti-abuse provision cannot arise simply from the existence of special relationships between the parties involved, the finding of the existence of an abusive practice does not result from the nature of the commercial transactions normally carried out by the author of the operations in question, but from the object, purpose and effects of those same operations. — cf. Judgment no. C-103/09, of 22 December 2010".

Indeed, in the Judgment (proc. no.) C-103/09 (Weald Leasing), in its no. 30 it is stated that "it must equally appear from a set of objective elements that the essential purpose of the operations in question is obtaining a tax advantage. Indeed, the prohibition of abusive practices is not relevant in cases in which the operations in question may have some explanation beyond mere obtaining a tax advantage whose granting would be contrary to the objective pursued by those provisions (cf. judgments … Halifax (no. 75) …" and in its no. 44 it is stated that "the finding of the existence of an abusive practice does not result from the nature of the commercial transactions normally carried out by the author of the operations in question, but from the object, purpose and effects of those same operations".

Also, in the Judgment (proc. no.) C-255/02 (Halifax), in its no. 73, it is stated that "the taxpayer has the right to choose the structure of his activity so as to limit his tax liability".

Finally, it is considered in the aforementioned Process no. 695/2015T that "the investments of the [participant], supported by foreign capital for which interest was paid, increased, by virtue of the profitability of the investees, the income recognized in the [participant], by way of the application of the Equity Method. It is true that that income is, by way of article 18, no. 8, of the Corporate Income Tax Code excluded from taxation; but on the economic-financial level they constitute unequivocally income obtained by the [participant]... by virtue of the management of its investments and the respective financing.

In light of what has been said on the Equity Method, and should there be profits in the investees, the payment of dividends (actual or potential) also results from the activity of management of the [participant]... relative to its investees", and as stated above, should the investee come to distribute profits (dividends) these may benefit from exclusion from taxation in the sphere of the participant should the requirements provided for in article 51 of the Corporate Income Tax Code be met.

With respect to this, the question may be raised whether the situations referred to above (profits imputable by application of the Equity Method to which no. 8 of article 18 of the Corporate Income Tax Code will apply, and profits distributed, which benefit from elimination of economic double taxation, verified the conditions of no. 1 of article 51 of the Corporate Income Tax Code), in the sphere of the participant, are a situation and/or situations of negative delimitation of taxable base (non-subjection or non-taxation) and/or of exemption.

The participant, being a commercial company, the corporate income tax is levied on profit (in accordance with no. 1 of article 3 of the Corporate Income Tax Code), in which "profit consists of the difference between the values of net assets at the end and at the beginning of the taxation period, with the corrections established in this Code" (no. 2 of article 3 of the Corporate Income Tax Code).

In the preamble of the Corporate Income Tax Code (contained in Decree-Law no. 442-B/88, of 30 November) it is established that "13 - In the structure of the Corporate Income Tax Code, one of the nuclear issues is that of economic double taxation of profits made available to partners, which relates to the problem, long discussed, of whether there should be separation or integration between the tax on companies and the personal income tax and, in the latter case, in what terms. The choice of system to be adopted depends on several factors and is rooted in the perspective that one has on the economic incidence of the tax that falls on companies.

…

However, regarding profits distributed by companies in which another holds an important participation, …, adopting, in line with the orientation advocated in some legislations and in studies underway within the community framework, a solution that eliminates, in such cases, economic double taxation".

The expression "profits distributed by companies in which another holds an important participation", represents a type of "fiscal criterion" of subsidiary or associated company, the concept and accounting classification of which comes presented in the aforementioned Process no. 695/2015T, and which as stated by it, and cited above, "should there be profits in the investees, the payment of dividends (actual or potential) also results from the activity of management of the [participant]... relative to its investees".

Regarding the profit imputable to the participation in the sphere of the participant, in the case of application of the Equity Method, one must take into account the general case of adoption of the separation theory in the generality of capital companies, according to the considerations below, as well as the realization principle, which result from the concept of income established in paragraph c) of no. 1 of article 20 of the Corporate Income Tax Code:

"Of a financial nature, such as …, dividends, …".

Also, regarding income from capital gains, the realization principle is reflected, given what was established in paragraph h) of no. 1 of article 20 of the Corporate Income Tax Code:

"Realized capital gains".

With respect also to the realization principle, according to TOMÁS CANTISTA TAVARES, in "Corporate Income Tax and Accounting: from realization to fair value", 2011, pages 42 and 43, "Realization relates to the positive components of income", and "The central proposition of this model is enclosed in the structural connection of income to realization … Realization commands the rule of temporal imputation of income – the specialization of periods". Thus, no. 8 of article 18 (Accrual of taxable profit) established at the time of the taxation period of the facts that "The income and expenses, as well as any other patrimonial variations, recognized in the accounts as a result of the use of the equity method do not compete for the determination of taxable profit, and income from distributed profits should be imputed to the taxation period in which the right to them is acquired".

Likewise, by application of the realization principle, also do not compete for the formation of taxable profit "Potential or latent capital gains, even if expressed in the accounts …" (paragraph b) of no. 1 of article 21 of the Corporate Income Tax Code).

With regard to prudence concerning income arising from the application of the Equity Method on the legal plane, no. 3 of article 32 (Limit on the distribution of assets to partners) of the Commercial Companies Code, establishes that "Income and other positive patrimonial variations recognized as a result of the use of the equity method, according to the accounting and financial reporting norms, are only relevant to be able to be distributed to partners, …, when they are realized" [Added by Decree-Law no. 98/2015, of 2 June].

On the accounting level, regarding the profit imputable to the participation by application of the Equity Method, notwithstanding paragraph 58 of NCRF 13 - Interests in Joint Ventures and Investments in Associates, established that "By the equity method, an investment in an entity is initially recognized at cost and the carrying amount is increased or decreased to recognize the investor's share in the results of the investee after the date of acquisition. The investor's share in the results of the investee is recognized in the investor's results. Distributions received from an investee reduce the carrying amount of the investment", the realization principle was reflected in the notes of framework for the account "5712 - Adjustments in financial assets - Related to the equity method - Retained Earnings", which established that "This account will be credited by the difference [it corresponds to considering this difference as a rubric of unrealized capital] between the profits imputable to the participations and the profits that will be assigned to them (dividends) [it corresponds implicitly to the consideration of the part of the imputed profit that was assigned/distributed as realized], with movement in the counterpart account 56 - Retained Earnings".

With regard to no. 1 of article 51 (Elimination of economic double taxation of distributed profits) of the Corporate Income Tax Code, this established that "In determining the taxable profit of commercial companies … the income included in the tax base corresponding to distributed profits are deducted, provided that the following requirements are met: …". As referred to in the paragraph above, on the accounting level, in the application of the Equity Method, it is implicitly considered that the part of the imputed profit that was assigned/distributed is realized.

Thus, notwithstanding the distributed profits by the investee being on the accounting level, in the application of the Equity Method, treated in the sphere of the participant as a reduction of the financial investment in financial holdings, this distribution of profits not being reflected in the participant's result, given the provision in the final part of no. 8 of article 18 of the Corporate Income Tax Code ("…income from distributed profits being imputed to the taxation period in which the right to them is acquired") should be considered in the taxable profit (reflecting its realization as income for tax purposes), being able, however, to be deducted from it, verified the conditions of no. 1 of article 51 of the Corporate Income Tax Code.

J. L. SALDANHA SANCHES, in "Manual of Tax Law", 2007, pages 449 et seq., states that "The doctrinal construction of the concept of fiscal exemption has emphasized some of the central characteristics of this figure, in particular in the field of its distinction from the neighboring figure of non-taxation or non-subjection.

From a formal point of view, we are facing an exemption whenever the law subtracts from taxation, through the provision of a legal preventive fact, situations … which, otherwise, would fall within the scope of the tax norm. The exemption always presupposes an affirmative norm, which, in its provision, covers a certain group of realities and a negative or restrictive norm which, proceeding to a second legal provision, covers a subset of these same realities and makes them non-taxable in whole or in part.

… difficulties in distinguishing, through the mere formal structure of the norm, … led to the use of the purpose of the norm as the principal criterion for this distinction. This criterion distinguishes between delimitation norms, which reduce the scope of fiscal provisions, and norms which contain exemptions. We set aside the formal criteria to adopt material criteria, which attend, principally, to the purpose and meaning of the norm.

In summary, we will be facing a fiscal exemption whenever it is a norm with an extra-fiscal objective, …, instruments of economic policy.

… it is essential to distinguish between the true exemption, in the sense of a norm which derogates from the principle of distribution of tax burdens to achieve extra-fiscal purposes, and other norms, …".

M. H. de FREITAS PEREIRA, in "Taxation", 2010, page 395, states that "The exemption is a benefit by virtue of which, although the prerequisite provided for in law exists as a source or basis of a given taxation, for extrinsic reasons, of political or economic convenience, taxation is removed, temporarily or definitively. It is for this reason that, in legal terms, the exemption has the nature of an autonomous and originating preventive fact and not of a mere negative delimitation of the constitutive fact of the taxable base.

One cannot, therefore, confuse exemption with a situation of non-taxation. On the other hand, not all exemptions can be qualified as tax benefits. Sometimes exemptions are used for technical reasons, namely to avoid double taxation, being part, in that case, of the normal tax regime".

In the work cited above, FREITAS PEREIRA, in pages 100-101 and 106, regarding the issue of economic double taxation, states that "Between the two solutions – considering or not companies as entities different from their respective partners – one can say that it is generalized the separate taxation concerning capital companies. …

From the existence of separate taxation for companies there follows another issue: that of the articulation between this taxation and that of the personal income of the partners regarding distributed profits. It is about seeing how the so-called double taxation of distributed profits is viewed: the profits are first taxed in company tax and, when distributed, in the personal income tax of their respective partners. …

If these conditions of minimum participation and holding period are satisfied, a total "exemption" of the distributed profits is verified at the level of the company … that receives them …".

It results from what has been stated above that:

a) The profit imputable to the participation, arising from the application of the Equity Method, and which does not compete for the formation of the taxable profit of the participant by application of no. 8 of article 18 of the Corporate Income Tax Code, is a situation of non-subjection to corporate income tax, taking into account the general principle of separation and the realization principle.

b) The elimination of economic double taxation of distributed profits, verified the conditions of no. 1 of article 51 of the Corporate Income Tax Code, by the participant, is a situation of exemption in corporate income tax.

Notwithstanding the classification of the two situations above, concerning the concept of "indispensability" in article 23 of the Corporate Income Tax Code, appraised in the purpose of "for the realization of income subject to tax or for the maintenance of the productive source", it is understood that, considering the arguments exposed above, including the concept of "maintain the productive source" (financial asset), in the case, the interest borne by the Claimant is considered deductible for tax purposes.

It is likewise believed that the jurisprudence in whose intended application the tax act in question is based does not ratify it, nor impugn what is concluded here.

Thus, regarding the Supreme Administrative Court judgment of 07/02/2007, rendered in process 01046/05, it is verified that, not only was the financing granted there granted at no cost, but it was found that the amounts financed were not "directly related to any activity of the taxpayer included in its corporate purpose, which is the manufacture of tiles and not the management of social or risk company financing participations, nor do they relate, even indirectly, to its activity", situations which, as was seen, have no parallel to the present proceedings.

The same is to be said regarding the Supreme Administrative Court judgments of 20/05/2009, rendered in process 01077/08 (and not 01077/05, as contained in the Inspection Report), of 30/11/2011, rendered in process 0107/11, and of 30/05/2012, rendered in process 0171/11[4], where the financings in question were gratuitous and the amounts in question were not "directly related to any activity of the taxpayer included in its corporate purpose, which is the undertakings and management of real estate and not the management of social or risk company financing participations, nor do they relate, even indirectly, to its activity.".

As regards the Supreme Administrative Court of the South judgment of 24-04-2012, rendered in process 05251/11, there will equally not be any identity with the situation now sub judice, to the extent that, not only were there equally at issue unremunerated supplementary capital contributions, but the corrections were made because "the Tax Inspection did not accept as fiscally relevant costs with the ground that the financial charges borne relating to bank credits obtained to meet the obligation of supplementary contributions, by reason of the holding of social participations in the other companies within the activity of holding and management of financial participations, do not represent an indispensable expense to the realization of income subject to tax, being able only to be destined to the maintenance of the productive source of the participated company and be in these considered as a cost, which would not be to be considered within the scope of the group of companies since, being companies managing social participations the same benefit from an exclusion of subjection to corporate income tax as regards capital gains under the provision of art. 31 of the Temporary Rules, and thus the income being not subject to tax such costs are not fiscally deductible.".

In this framework, both the express rejection of the administrative complaint no. …2016…, and the corporate income tax assessment no. 2015…, concerning fiscal year 2012, and the respective settlement statement with no. 2015…, according to which a tax payable amount of € 315,674.85 was determined, suffer from error as to the factual and legal assumptions, due to erroneous interpretation and application of the provision of article 23, no. 1, paragraph c), of the Corporate Income Tax Code, which constitutes a defect of violation of law, which implies the declaration of its illegality and consequent annulment.

Given the admission of the requested declaration of illegality and consequent annulment of the challenged acts, due to a defect which prevents the renewal thereof, the knowledge of the invoked unconstitutionality of article 23, no. 1, paragraph c), of the Corporate Income Tax Code, for violation of the principle of private initiative, contained in article 61 of the Constitution of the Portuguese Republic, is rendered moot and unnecessary.

§3. ON COMPENSATION FOR UNDUE GUARANTEE

As is proven, the Claimant did not proceed to voluntary payment of the amount [of € 315,674.85], resulting from the settlement statement with no. 2015…, and consequently an enforcement proceeding was instituted, as a result of which the Claimant was obliged to provide a bank guarantee.

Given the annulment of the tax acts in question, the Claimant is entitled to compensation for the undue guarantee in accordance with article 53 of the General Tax Law and article 171 of the Tax Procedural Code.

Therefore, the liability for compensation arises in respect of a guarantee provided in the context of an unlawful enforcement proceeding which resulted from the enforcement of an illegal tax act.

The amount of compensation shall correspond to the amount of the guarantee provided (€ 399,997.31).

IV. DECISION

For the reasons stated above, the Tribunal decides:

1. To dismiss the plea of res judicata raised by the Respondent.

2. To declare illegal and to annul:

   a) The express rejection of the administrative complaint no. …2016…;

   b) The additional corporate income tax assessment no. 2015…, for fiscal year 2012;

   c) The settlement statement no. 2015….

3. To condemn the Respondent to pay compensation to the Claimant in the amount of € 399,997.31, relating to the undue bank guarantee, in accordance with article 53 of the General Tax Law and article 171 of the Tax Procedural Code.

4. The compensation shall bear legal interest calculated from the date of constitution of the guarantee (01/09/2015) until the date of payment.

5. No pronouncement shall be made regarding the alleged unconstitutionality of article 23, no. 1, paragraph c), of the Corporate Income Tax Code, as this is rendered moot by the decision.

6. The Respondent shall bear the procedural costs, in accordance with article 30 of the RJAT.

Lisbon, [Date]

The Arbitral Tribunal

[Signatures of the three arbitrators]