CAAD 410/2018-T: Deductibility of Business Expenses, Client Gifts, Travel Costs and Capital Losses on Credit Sales Under IRC

ARBITRAL DECISION (consult full version in PDF)

I – REPORT

1. On 28 August 2018, A..., S.A., NIPC ..., with registered office in ..., ... - ...-... Lisbon, filed a request for constitution of an arbitral tribunal, under the combined provisions of Articles 2 and 10 of Decree-Law No. 10/2011 of 20 January, which approved the Legal Regime for Arbitration in Tax Matters, as amended by Article 228 of Law No. 66-B/2012 of 31 December (hereinafter, abbreviated as RJAT), seeking the declaration of illegality of the following tax acts:

i. Additional Corporate Income Tax Assessment No. 2018..., of 14 May 2018, interest calculation statements No. 2018... and 2018... and account settlement statement No. 2018..., of 16 May 2018, relating to the 2013 tax year, determining the total amount of € 1,509,787.28 payable, with payment deadline on 25 June 2018;

ii. Additional Corporate Income Tax Assessment No. 2018..., of 18 April 2018, interest calculation statements No. 2018... and 2018... and account settlement statement No. 2018..., of 20 April 2018, relating to the 2014 tax year, determining the total amount of € 230,154.23 payable, with payment deadline on 30 May 2018;

iii. Additional Corporate Income Tax Assessment No. 2018..., of 18 April 2018, interest calculation statement No. 2018... and account settlement statement No. 2018..., of 24 April 2018, relating to the 2015 tax year, determining the total amount of € 48,334.36 payable, with payment deadline on 4 June 2018;

in the total amount of € 1,788,275.87.

1. To substantiate its request, the Applicant alleges, in summary, that:

a. The expenses it incurred and deducted for tax purposes in the corresponding tax years with gifts of various goods to clients and with travel and accommodation are relevant expenses for tax purposes, in accordance with Article 23 of the Corporate Income Tax Code;

b. Beyond the mentioned expenses having been important expenditures for the pursuit of its activity, aimed at retaining Clients and Suppliers of the Applicant, it is not the responsibility of the Tax Authority to judge the merit of such investment or the alleged "dispensability" thereof, in a business management perspective;

c. This understanding has been widely supported by Doctrine and Jurisprudence, which understand that autonomy in business management must be safeguarded from any scrutiny regarding the "dispensability" of expenses by the Tax Authority, always and unquestionably inadmissible;

d. Having the Tax Authority not validly questioned the truthfulness of the expenses or their documentary support, these should be accepted as expenses for tax purposes under Article 23 of the Corporate Income Tax Code;

e. Regarding the expenses incurred by the Applicant with the alienation of credits below their respective nominal value, it has been fully demonstrated that the impairment losses were "restored," even though no movement in a revenue account was necessary for this, as this is not required of the Applicant;

f. What is at issue is, in fact, capital losses determined following the alienation of the credits, by the amount consistent with the possible conditions under which the Applicant was able to recover from an independent third party the credits that admittedly presented very difficult collection prospects, still obtaining revenue in the order of hundreds of thousands of euros, instead of opting, as the Tax Authority seems to suggest would have been the best option, for non-cession of the credits in question and consequent acceptance of a high and increasing risk of total loss instead of a 95% loss...;

g. As has been advocated by Doctrine and Jurisprudence, the operation should be framed as a capital loss, with the tax deductibility thereof not dependent on criteria such as verification of the requirements provided in Articles 35, 36 and 41 of the Corporate Income Tax Code, but solely and exclusively on the general requirements provided in Article 23, No. 1 of the Corporate Income Tax Code;

h. For if this were not the case, the Applicant would be subject to double taxation on the same amount, violating the constitutional principles of legality, taxation according to taxpaying capacity and taxation of companies on actual profit, as an emanation of the principles of tax equality and justice, contained in Articles 103 and 104 of the Portuguese Constitution;

i. The Additional Assessments should be annulled, as the tax corrections on which they are based are vitiated by illegality - if not unconstitutionality.

1. On 29-08-2018, the request for constitution of the arbitral tribunal was accepted and automatically notified to the Tax Authority.

2. The Applicant proceeded to nominate an arbitrator, having nominated His Excellency Dr. António Moura Portugal, under Article 11, No. 2 of the RJAT. Under No. 3 of the same article, the Respondent nominated as arbitrator Her Excellency Dr. Carla Castelo Trindade.

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

4. Following a request presented by the arbitrators designated by the parties that the presiding arbitrator be designated by the Ethics Council, the presiding arbitrator was designated under Article 6, No. 2, paragraph b) of Decree-Law No. 10/2011 of 20 January, as amended by Article 228 of Law No. 66-B/2012 of 31 December and Article 5 of the Regulation on Selection and Designation of Arbitrators in Tax Matters, the present Reporter, who, within the applicable period, also accepted the duty.

5. On 25-10-2018, the parties were notified of these designations, having manifested no desire to refuse any of them.

6. In accordance with the provision in No. 7 of Article 11 of the RJAT, as amended by Article 228 of Law No. 66-B/2012 of 31 December, the collective Arbitral Tribunal was constituted on 15-11-2018.

7. On 27-12-2018, the Respondent, duly notified for this purpose, presented its response defending itself by contestation, and sustaining, in summary, the verification of the substantive grounds underlying the disregard of the expenses supported by the Applicant, which relate to the failure to meet the requirements and conditions provided for in No. 1 of Article 23 of the Corporate Income Tax Code for their deductibility, with the assessments in question and the corrections to taxable income not being vitiated by any defect, and should be maintained in the legal order.

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

9. Having been granted a period for submission of written pleadings, these were submitted by the parties, pronouncing themselves on the evidence produced and reiterating and developing their respective legal positions.

10. It was indicated that the final decision would be notified by the end of the period provided for in Article 21, No. 1 of the RJAT.

11. The Arbitral Tribunal is materially competent and is properly constituted, under Articles 2, No. 1, paragraph a), 5 and 6, No. 2, paragraph b), of the RJAT.

The parties have legal personality and capacity, are properly legitimized and are legally represented, under Articles 4 and 10 of the RJAT and Article 1 of Order No. 112-A/2011 of 22 March.

The proceedings are not vitiated by any nullities.

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

Having examined everything, it is necessary to deliver

II. DECISION

A. FACTUAL MATTER

A.1. Facts Established as Proven

1. The Applicant was subject to a partial-scope external tax inspection procedure concerning Corporate Income Tax and Value Added Tax for the tax years 2013, 2014 and 2015, commencing on 17 October 2017.

2. In the course of the inspection procedure, the Tax Inspection verified that the Applicant had recorded in account 6234 – gift articles, expenses relating to the acquisition of various goods intended as gifts without the supporting documents identifying their respective recipients.

3. The amounts recorded in that account were:

a. 2013 - €24,619.13 (0.2% of turnover);

b. 2014 - €3,412.65 (0.04% of turnover);

c. 2015 - €1,564.36 (0.02% of turnover).

1. The following amounts spent on gifts of traveller's cheques, season tickets for spectacles from ..., Gift Value Cards (...), bottles of wine, ... Feminine were subject to correction for failure to meet the requirements on whose verification the deductibility of the expenses listed in No. 1 of Article 23 of the Corporate Income Tax Code depends:

a. 2013 - €21,545.00;

b. 2014 - € 2,383.50;

c. 2015 - € 1,330.95.

1. The Tax Inspection further verified that amounts were recorded in account 6251 – Travel and Accommodation – expenses supported by documents indicating the completion of air travel and accommodation in hotels abroad, without documentation being presented showing who carried out the travel and accommodation expenses and for what purposes.

2. Considering it verified that it was impossible to assess whether the said expenses met the requirements of No. 1 of Article 23, the Tax Inspection proceeded to disregard the expenses as deductible and effected the following corrections to the Applicant's taxable income:

a. 2013 - €38,327.04;

b. 2014 - €5,177.25;

c. 2015 - €4,235.59.

1. In the 2013 tax year, the Tax Authority further proceeded to disregard the deductibility of impairment losses associated with credits alienated at a value lower than their respective nominal values, in the amount of €4,479,246.80, equivalent to the difference between the nominal values of the credits and the value at which they were ceded, as shown in the following table:

2. As well as the disregard, in the 2014 tax year, of the tax deduction of losses in the amount of € 1,867,733.65, resulting from the alienation of credits on clients of €1,986,950.53, by the value of €119,216.90, as shown in the following table:

3. The Applicant was duly notified to, if it wished, exercise the corresponding right to a hearing.

4. In a request dated 3 April 2018, the Applicant submitted a statement under the right to a hearing.

5. The Tax Authority maintained entirely, in the Tax Inspection Report, the corrections it had proposed, which are summarized as follows:

a. Non-acceptance of the deductibility of expenses with gift articles, such as traveller's cheques and gift cards, in the amount of € 25,259.45 in the three tax years;

b. Non-acceptance of the deductibility of expenses with travel and accommodation in the amount of € 47,739.88 in the three tax years; and

c. The non-acceptance of the recognition as expenses of the amounts resulting from the alienation, below their nominal value, of credits held by the applicant, in the amount of € 6,346,980.26, in the three tax years.

1. The Tax Inspection Report contains, in what is relevant to the case, the following:

[Content omitted as indicated in original Portuguese document]

1. The Tax Authority then effected the following corrections:

[Content omitted as indicated in original Portuguese document]

1. Having, consequently, issued the tax acts subject to the present arbitral action.

2. The amounts of tax assessed therein were paid on 18 June 2018 (regarding the 2013 assessment), on 30 May 2018 (regarding the 2014 assessment) and on 7 June 2018 (regarding the 2015 assessment).

A.2. Facts Established as Not Proven

Relevant to the decision, there are no facts that should be considered as not proven.

A.3. Reasoning of the Proven and Not Proven Factual Matter

Regarding the factual matter, the Tribunal does not need to rule on everything alleged by the parties; rather, it has the duty to select the facts that matter for the decision and to distinguish the proven from the not proven matter (see Article 123, No. 2 of the Tax Procedure Code and Article 607, No. 3 of the Code of Civil Procedure, applicable under Article 29, No. 1, paragraphs a) and e), of the RJAT).

Thus, the facts pertinent to the judgment of the case are chosen and delimited according to their legal relevance, which is established in light of the various plausible solutions to the question(s) of law (see former Article 511, No. 1 of the Code of Civil Procedure, corresponding to the current Article 596, applicable under Article 29, No. 1, paragraph e), of the RJAT).

Thus, taking into account the positions assumed by the parties, in light of Article 110, No. 7 of the Tax Procedure Code, the documentary evidence and the proceedings filed with the case, the facts listed above were considered proven, relevant to the decision, taking into account that, as written in the Decision of the Central Administrative Court – South of 26-06-2014, delivered in process 07148/13, "the probative value of the tax inspection report (...) may have probative force if the assertions contained therein are not impugned."

No rulings were made as proven or not proven regarding allegations made by the parties and presented as facts, consisting of assertions that are strictly conclusory, incapable of proof, and whose truthfulness must be assessed in relation to the concrete factual matter consolidated above.

B. ON THE LAW

As is procedurally settled, there are essentially three issues to be resolved in the present arbitral proceedings, all of which relate to the matter of expense deductibility in three specific tax years: 2013, 2014 and 2015.

In the order presented by the Applicant, the issues concern the non-acceptance of the deductibility of:

a) expenses with gifts;

b) expenses with travel and accommodation; and

c) expenses inherent to the alienation, below nominal value, of credits held by the Applicant.

All these issues relate to the more general problem of the deductibility of expenses in Corporate Income Tax, regulated in the first instance by Article 23 of the Corporate Income Tax Code, which, in the period covered, was regulated by legal norms with different wording, as follows:

• 2013 tax year: "Expenses shall be considered those that are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the income-producing source, namely:...";

2014 and 2015 tax years:

"1 - For the determination of taxable profit, all expenses and losses incurred or borne by the taxpayer to obtain or guarantee income subject to Corporate Income Tax are deductible. (...)

3 - The deductible expenses under the preceding numbers must be documented, regardless of the nature or support of the documents used for this purpose."

Notwithstanding the different wording, with known repercussions, at least at the level of clarifying the interpretations to be made on the matter, it is believed that the different content of the norms applicable to the different tax years in question will not affect the solution to be given to the issues to be resolved.

Let us then examine each of them.

A.

With respect to the first of the topics indicated, it is verified that the Tax Authority understood, in summary, that since it was not possible to identify the recipients of the gifts, the expenses in question could not be accepted under Article 23 of the Corporate Income Tax Code.

As is not disputed in the proceedings, the expenses in question relate to gifts, that is, gratuitous dispositions in favor of third parties, effected by the Applicant.

And, as is known, Corporate Income Tax taxpayers are, as a rule and paradigm, business entities, whose main activity is aimed at obtaining profit, which is inherently averse to the performance of gratuitous patrimonial dispositions.

For this reason, the Corporate Income Tax Code, in both applicable versions, provides in Article 24/a) that the following do not contribute to the formation of taxable profit "negative patrimonial variations (...) that consist of liberalities."

However, not all gratuitous patrimonial dispositions will constitute liberalities, since for them to be such, they must have what is called animus donandi.

To this end, Article 940, No. 2 of the Civil Code provides that "There is no donation (...) in gifts conforming to social customs."

Thus, gifts conforming to social customs should not be considered liberalities, insofar as they do not have the spirit of liberality, but rather the intention to conform to those customs.

With no doubt, commercial gifts constitute an established and socially accepted and valued practice, and thus fall within that concept of gifts conforming to social customs, and are therefore not, for Corporate Income Tax purposes, considered liberalities.

Given this, and as also recognized by both parties to the dispute, the consideration as a cost of the expenses incurred with commercial gifts, in order to negatively contribute to the calculation of the taxable profit of the taxpayers who practice them, implies that these comply with the general requirements for deductibility of expenses.

Regarding the burden of proof in this matter, it has been understood by national jurisprudence that:

"1. Only costs that do not have a causal and justified relationship with the company's productive activity are 'not indispensable,' that is, the indispensability of tax expenses must be understood 'as relating to the connection of costs to the activity developed by the taxpayer.'

1. It is certain that the burden of proof of the indispensability of costs does not fall on the taxpayer.

2. However, if the tax administration, acting subject to the principle of legality, in a reasoned manner, raises doubt about the justified relationship of a particular expense to the activity of the taxpayer, necessarily and logically, as it is better positioned to do so, it is incumbent on the latter to provide an explanation of the 'economic congruence' of the operation, which is not satisfied by abstract and conclusory allegations that the expense falls within the company's interest and/or the existence of a justified relationship with the activity developed, instead requiring that the taxpayer alleges and proves concrete, verifiable facts capable of demonstrating the reality and truthfulness of the business activities that gave rise to the recorded expenses, in order that, among other things, the tax authority's supervisory function is not rendered impossible."

In the case at hand, it is found that the provision of No. 3 of the summary of the cited Decision is verified, that is, the Tax Authority raised a reasoned doubt about the justified relationship between the specific articles declared as gifts by the taxpayer and the latter's activity.

And essentially, it bases such doubt on the non-identification of the recipients of such gifts.

As such ground cannot fail to be judged as sustained, it must be considered that "necessarily and logically, as it is better positioned to do so, it is incumbent on the latter to provide an explanation of the 'economic congruence' of the operation, which is not satisfied by abstract and conclusory allegations that the expense falls within the company's interest and/or the existence of a justified relationship with the activity developed, instead requiring that the taxpayer alleges and proves concrete, verifiable facts capable of demonstrating the reality and truthfulness of the business activities that gave rise to the recorded expenses, in order that, among other things, the tax authority's supervisory function is not rendered impossible."

The Applicant, although providing the clarifications noted in the Tax Inspection Report, did not present, as likewise noted in the Report, any document, whether internal or other element of evidence, that would indicate the identity of the recipients of the gifts in question or the concrete circumstances in which they were made.

On this matter, it should first be noted that the universe of the practice of gifts within the scope of commercial activity may include realities ranging from small promotional items (key chains, pens) to the gift of goods of more substantial value (as in this case; for example, bottles of wine valued at €198.00 each).

And naturally, the circumstances specific to the performance of each gift may vary greatly, to the extent that it is not possible – and probably for this reason does not exist – the formulation of specific rules relating to the documentation by taxpayers of such practices.

Moreover, by the very nature inherent in "social customs," including commercial ones, that legitimize gifts, it will certainly not be required that for each gift, or for a particular type of gift, even if of more significant value, the taxpayer making the gift require the recipient to issue a receipt or any other type of declaration attesting to the receipt of the gift.

Notwithstanding the foregoing, it is believed that from what has been stated it cannot be concluded that taxpayers are dispensed from the duty, regarding expenses they incur with the performance of commercial gifts, to furnish themselves with a minimum of documentation, even if internally prepared, that shows, if not the individual recipients, at least the general circumstances and context in which the articles gifted were given, so as not to completely empty the possibility of the Tax Authority's control over the assumptions corresponding to the deductibility of the respective expenses.

Now, in this case, that is what occurs.

The Applicant, although providing a generic clarification that the gifts in question were intended for clients and/or suppliers, was unable to specify, minimally, and even if not nominally, which clients and suppliers were allegedly recipients of the gifts, to indicate the concrete circumstances in which the gifts were made, nor to furnish any other element, even testimonial, that would provide any basis for the Tax Authority's control over the matter.

Therefore, given that the burden of proof incumbent on the Applicant has not been duly fulfilled, it cannot be found, it is believed, beyond any reasonable doubt, that the "gifts" in question were in fact intended for clients and/or suppliers thereof.

We are here, therefore, before a case analogous to that which was the subject of the Decision of the Central Administrative Court of the North of 25-09-2008, delivered in process 00350/04.7BEBRG, "knowing the origin, nature and purpose of the payments, not knowing only the identity of the recipient."

Here, as there, it must be concluded, it is believed, that in this situation, there is "non-acceptance of the cost, (...) by way of non-fulfillment of the requirement of indispensability of the expenses incurred (...) for the realization of income or gains subject to tax or for the maintenance of the income-producing source, under Article 23 of the Corporate Income Tax Code," which is what the Tax Authority did.

The relevant considerations of the jurisprudence referred to cannot thus fail to be deemed applicable regarding the deductibility of the expenses in question.

It should also be noted that no judgment of interference by the Tax Authority in company management is being ratified here, since what is at issue is not whether a particular gift to a particular person is suitable or consistent with obtaining gains subject to Corporate Income Tax, but whether the exit of the company's patrimony of particular articles and/or values, without knowledge of the recipient or the concrete circumstances in which it occurred, allows consideration of such exit as suitable or consistent with obtaining gains subject to Corporate Income Tax.

Believing that the answer to this question cannot be other than negative, the arbitral request should, in this part, be dismissed.

B.

The second issue to which it is necessary to provide an answer in the present arbitral action concerns the deductibility of expenses recorded in account 6251 – Travel and Accommodation, supported by documents indicating the performance of air travel and accommodation in hotels.

Regarding this matter, the Tax Inspection Report begins by noting that "the taxpayer recorded in account 6251 - Travel and Accommodation various documents relating to expenses with air travel and stays in hotels outside Portugal," and therefore "As the taxpayer's activity develops exclusively in national territory, it was questioned (notified) to indicate the reason for these expenses and their relationship to the income obtained in 2013, 2014 and 2015."

With respect to these considerations, it should first be noted that, contrary to what the Tax Authority states, the stays disregarded by it do not relate solely to stays outside Portugal, and in the list of disregarded invoices there are several invoices relating to accommodations in ... and one relating to accommodation in ....

The Tax Inspection Report continues, substantiating the correction in question, stating that "As verified by the taxpayer's response, the latter did not present the reasons that led to the performance of the expenses in question, nor presented justification for the years under analysis of the necessity thereof, or correlated them with the income obtained," and concluding that "the amounts itemized in the table below per tax year, relating to expenses with travel and accommodation are not accepted for tax purposes under Article 23 of the Corporate Income Tax Code, since the taxpayer did not prove their indispensability or that they were necessary to obtain or guarantee income subject to Corporate Income Tax."

As stated above, it is settled jurisprudence that "It is certain that the burden of proof of the indispensability of costs does not fall on the taxpayer."

As already stated, this situation changes when the Tax Authority "raises doubt about the justified relationship of a particular expense with the taxpayer's activity."

Now, first and foremost, that is what must be verified in this case.

And, having examined the Tax Inspection Report, what is found is that the Tax Authority raised doubt about the relationship of the expenses in question with the Applicant's activity, merely because they were "expenses with air travel and accommodation in hotels outside Portugal," when "the taxpayer's activity develops exclusively in national territory."

Now, on the one hand, as has already been seen, the expenses questioned by the Tax Authority did not concern solely accommodation in hotels outside Portugal.

On the other hand, from the circumstance that a taxpayer develops its activity exclusively in national territory, in a particular time period, there follows no logical incompatibility or, based on the normal course of things, against the performance of travel and accommodation abroad.

Thus, the doubt raised by the Tax Authority regarding the relationship between the expenses in question and the taxpayer's activity cannot be considered founded.

On this point, reference should be made to the Decision of the Supreme Administrative Court of 23/09/2015, delivered in process 01034/11, which determines that "It is exclusively in light of the reasoning expressed by the Tax Authority when conducting the additional Value Added Tax assessment that the legality of that tax act must be assessed."

On the other hand, it must be understood that Article 23 of the Corporate Income Tax Code, in its paragraphs enumerates a series of exemplary situations of the requirement raised in its body, which should not, in line with what Prof. Teixeira Ribeiro understood in light of the previous Corporate Income Tax Code, be understood in any way other than that when costs or losses, duly documented, are specifically listed in Article 23, their indispensability is presumed, accordingly dispensing the taxpayer from the corresponding proof, and this is precisely the purpose of the enumeration (derived, moreover, from the use of the expression "namely").

In light of these criteria and considerations, it cannot be concluded other than that, in this concrete circumstance, it was incumbent on the Tax Authority to demonstrate that the expenses in question were not incurred in order to assure taxable gains in Corporate Income Tax, and that it fails to make any such proof.

It should be noted that the Tax Authority does not question, in the Tax Inspection Report, that no elements were brought to the procedure to clarify what concrete persons carried out the trips and stays and the reasons that motivated them.

Were that the case, the solution to be given to the present case could perhaps be different, designedly in line with the reasoning explained regarding the preceding question.

However, what the Tax Authority questions in the Tax Inspection Report, and it is to that, in obedience to the jurisprudence of the Supreme Administrative Court cited above, that the Tribunal must confine itself, is that the Applicant carries out its activity exclusively in national territory, and the trips and stays in question relate to abroad (which, as has been seen, is not entirely true).

Now, from this does not follow, as has been seen, any antinomy indicating between the company's business activity and the performance of such trips and stays, nor, much less, does it permit conclusion as to the dispensability of the expenses in question or that they were not necessary to obtain or guarantee income subject to Corporate Income Tax.

Thus, the Tax Authority's burden of proof not having been fulfilled, underlying the correction effected, of demonstrating the dispensability of the expenses in question or that they were not necessary to obtain or guarantee income subject to Corporate Income Tax, the arbitral request cannot, in this part, fail to proceed.

C.

The last issue that is at stake in the proceedings concerns the tax treatment to be given to the cession of partially uncollectible credits made by the Applicant to B....

In factual terms, the following should be noted, regarding the matter in question:

• The credits result from the development of the taxpayer's normal activity;

• The temporal requirement, at the date of account closure, was met in relation to the default of customer debts;

• The taxpayer made efforts to collect the debts;

• The credits were sold to an entity independent of the taxpayer;

• The purchaser of the credits is an entity specialized in the market for the acquisition of assets;

• The sale of the credits was made for a value of approximately 5% of its nominal value;

• There was no "double" deduction or benefit for the Applicant by way of the alienation, or, in other words, the Applicant did not benefit from the deduction of the expense as impairment loss and the deduction of the capital loss from the alienation of the credit for a value below the nominal value.

Accounting-wise, the Applicant initially recorded an impairment, which had no effect for tax purposes and was reversed upon the sale of the uncollectible credits, realizing an accounting capital loss.

It is thus verified that the operations described were aimed at obtaining immediate reimbursement of credits, albeit for a value less than what they would be worth under normal conditions, generating a capital loss.

According to the Applicant, this capital loss is fully deductible under Article 23, No. 2, paragraph l) of the applicable Corporate Income Tax Code.

The Tax Authority recognizes this factuality but makes a different legal framing: it contends that it is necessary to apply to the expense relating to the alienation of the credits the deductibility requirements stated in No. 1 of Article 23 of the Corporate Income Tax Code, taking into account the particular criteria defined in Articles 35, 36 and 41 (2013 tax year) and Articles 28-A, 28-B and 41 (2014 tax year) of the same Code, for the assessment of the risk of uncollectibility and consequently to determine the deductibility/non-deductibility of the expense.

Thus, and as stated in the Tax Inspection Report, it is the Tax Authority's understanding that "the application of the requirement of indispensability of expenses obliges consideration of the situation of the assets (credits) that are the object of alienation. This means that their acceptance depends significantly on the question of the very possibility of collection and the requirements of uncollectibility."

In this sequence, the Tax Authority also concludes that: "In conclusion: it is verified that the taxpayer alienated credits held over clients below their respective nominal value, generating expenses that could only be accepted if the provisions of Articles 23, 28-A (Wording of the 2014 and subsequent tax years) and 28-B (Wording of the 2014 and subsequent tax years), 35 and 41 all of the Corporate Income Tax Code were fulfilled."

In the terms already noted, "It is exclusively in light of the reasoning expressed by the Tax Authority when conducting the additional Value Added Tax assessment that the legality of that tax act must be assessed."

From this perspective, it must be concluded, from the outset, that the Tax Authority is without reason when it states in the Tax Inspection Report that the expenses in question "could only be accepted if the provisions of Articles 23, 28-A (Wording of the 2014 and subsequent tax years) and 28-B (Wording of the 2014 and subsequent tax years), 35 and 41 all of the Corporate Income Tax Code were fulfilled."

This tax treatment, as is known, applies to impairment losses on credits, and, based on the economic similarity it detects between the two operations, the Tax Authority defends its application to realized capital losses.

Now, and as is clear, there is a manifest difference between the realities encompassed by one figure and the other.

Simply put, impairments are expenses resulting from the depreciation of an asset relative to its accounting value: by virtue of various events, the realizable value becomes lower than the recoverable value.

Capital losses, on the other hand, are alienations of assets for a value less than accounting value, that is, for a loss to be recognized as an expense from a capital loss, the asset must cease to be in the legal sphere of the taxpayer. Capital losses are always the result of an alienation of an asset.

And for these two different situations, the legislator, within its freedom to shape the tax system, deemed it appropriate to establish different legal regimes with respect to the requirements for their consideration as expenses.

As was written in the Decision delivered in arbitral process No. 717/2016T of the CAAD:

"The literal meaning of Article 23 shows that the concept of impairment losses relating to credits does not correspond to that of realized capital losses from their alienation.

As the Applicant rightly states, "the very terminology underlying the recording of impairments or the derecognition of uncollectible credits as opposed to the terminology underlying capital losses resulting from the sale of a particular asset confirms this understanding: while in the first case it is a matter of assessing the validity of the judgment as to 'realizable value'; in the second case it is merely a matter of confirming what 'realized value' of that asset is.'"

The distinction between the two situations is clear and is correctly made by the Applicant, with support in the Decision of the Central Administrative Court of the North of 29-11-2013, delivered in process No. 1666/07.6BEPRT, attached with the request for arbitral pronouncement as document No. 15, in which it is stated, on page 60:

"Uncollectible credits" and cession of credits at a value less than recorded are different realities with distinct tax treatments. One thing is to have a "lost credit" whose uncollectibility is known to be definitive because it results from one of those judicial processes provided for in Article 39. Another is to cede a credit for a value less than recorded. These cases presuppose that the debt is collectible but the company decides to cede the credit with loss.

To uncollectible debts Article 39 of the Corporate Income Tax Code applies: direct acceptance of the cost is admitted only if the requirements provided for in law are met.

To the second situation Article 23 of the Corporate Income Tax Code applies. This means that in these cases the taxpayer will have to prove the indispensability of the cost. It cannot, naturally, do so by invoking the uncollectibility of the credit. And as stated above in the consideration and fulfillment of the concept of indispensability, the analysis of a concrete cost must be done in the exercise of corporate activity, that is, in terms of its objective within the company's activity.

And the reasons for the different treatment of those impairment losses and realized capital losses are well evidenced by the Applicant by stating that "in the cases of Articles 35, 36 and 41 of the Corporate Income Tax Code, we are dealing with merely potential losses, not yet realized and which, for that reason, require the fulfillment of objective requirements for validation by an entity external to the taxpayer itself (whether the debtor who does not comply after being called upon to do so, in the case of impairments, or the court that declares the insolvency of the debtor, in the case of uncollectible credits).

Thus, in the case at hand, with capital losses realized in the 2012 tax year from the alienation of credits regarding which no previous relevance had been given for tax purposes as impairment losses, the deductibility of those capital losses as expenses of that tax year is dependent only on the general requirements provided for in No. 1 of Article 23 of the Corporate Income Tax Code, specifically that they be demonstrably "indispensable for the realization of income subject to tax or for the maintenance of the income-producing source."

As has been settled jurisprudence, to satisfy the requirement of indispensability provided for in Article 23, No. 1 of the Corporate Income Tax Code, it suffices that expenses be incurred in the interest of the company and be connected with its activity, regardless of whether profits have been obtained with them or whether their relevance to the maintenance of the income-producing source has been confirmed."

No grounds are discerned to diverge here from what was set forth there, all the more so given that, as the arbitral decision cited has been submitted for review by the Supreme Administrative Court, for alleged conflict of judgments, that high court, although rejecting the appeal, took care to confirm that: "the legal issue under analysis centers on the tax deductibility of the capital loss realized by the Appellant with the alienation of credits below par, without any forgiveness or reduction of the amount owed."

This same point had already been stated by the Central Administrative Court of the South in its Decision of 13-11-2014, delivered in process 05295/12, where it can be read that "Strictly speaking, the losses associated with the alienation of the credits in question are not costs of the tax year but only capital losses, arising from the alienation of the credits and equity interests at a price below their nominal value."

The same Court, came in its Decision of 15-09-2016, delivered in process 09691/16, to state that:

"9. Article 23, No. 1, paragraph i) of the Corporate Income Tax Code provides that costs or losses are considered, namely capital losses realized. It must be understood that the mere mention of "capital losses realized" in paragraph i) of No. 1 of the said Article 23 of the Corporate Income Tax Code does not by itself confer the acquisition of all requirements for the values thus considered to be accepted as negative components of income, as they cannot fail to be, as happens with all other costs or losses in the same norm enumerated, subject to the scrutiny of the body of No. 1 of that provision, so that they appear to be demonstrably indispensable for the realization of income or gains subject to tax or for the maintenance of the income-producing source.

1. According to doctrine, capital loss can be defined as a loss of economic value of a business asset due to physical causes (deterioration), technical (obsolescence) or economic causes, the latter being derived from a decline in market price. In Corporate Income Tax, the legislator provides that realized capital losses (as opposed to latent capital losses) are losses suffered regarding elements of fixed assets through onerous transmission, whatever the title by which it is made (see Article 43, No. 1 of the Corporate Income Tax Code). Capital losses are given by the difference between the realized value, net of charges inherent to it, and the acquisition value deducted from the reintegrations or depreciations made (see Article 43, No. 2 of the Corporate Income Tax Code). The realized value is defined in the various paragraphs of No. 3 of Article 43 of the Corporate Income Tax Code.

2. The question of the proof of the dispensability of the cost depends on the concrete case, constituting a dialogical process. In a first moment, the taxpayer asserts the indispensability of the cost through its accounting (see Article 75, No. 1 of the General Tax Law; Article 76, No. 2 of the Tax Procedure Code), with the Tax Authority placing it in doubt. From here on, the intensity of the taxpayer's proof duties varies with the circumstances of the case and the degree of normality of the situation. If we are dealing with a cost that suggests confusion of patrimonial spheres or other types of fraud, the intensity of proof is greater for the taxpayer than for the State Treasury. Otherwise, there is no increase in the intensity of the taxpayer's proof duties."

It is, thus, exclusively in light of the criteria for the deductibility of expenses and losses arising from capital losses, provided for in Article 23 of the Corporate Income Tax Code (No. 1/l until 2013, and No. 2/l from 2014 onwards), that the deductibility of the expenses at issue should be assessed, therefore the corrections effected by the Tax Authority, based in the Tax Inspection Report, are vitiated from the outset by error of law, in considering that those expenses could only be accepted if the provisions of Articles 23, 28-A (Wording of the 2014 and subsequent tax years) and 28-B (Wording of the 2014 and subsequent tax years), 35 and 41 all of the Corporate Income Tax Code were [cumulatively] fulfilled, the latter four norms, as has been seen, not being applicable to the case.

The Respondent herself appears, moreover, in the proceedings, to recognize this very thing, by stating that "the Applicant is right when it states that potential losses are not at issue resulting from the annulment or write-off of credits considered uncollectible because the situations provided for in Article 41 of the Corporate Income Tax Code are verified."

It is true that, in the same passage, it adds that the Applicant "errs in considering that the capital loss determined in the cession of credits does not have to be justified and evaluated in light of the general criteria for the deductibility of expenses."

Notwithstanding that no grounds are discerned, among the Applicant's allegations, corresponding to such (obviously unfounded) pretension, it must be noted that it is precisely this effort of justification and evaluation "in light of the general criteria for the deductibility of expenses" that is absent from the Tax Inspection Report that constitutes the substantiation of the assessments contested.

Indeed, with respect to the application of Article 23 of the Corporate Income Tax Code, it has been settled that in general terms "The concept of indispensability of costs, to which Article 23 of the Corporate Income Tax Code refers, relates to costs incurred in the interest of the company or borne within the context of activities deriving from its corporate purpose. Only when costs result from decisions that do not meet such requirements, particularly when they present no affinity with the company's activity, should they be disregarded."

And with respect to the application of the criterion in question to capital losses, the Supreme Administrative Court states that:

"I - In the understanding that doctrine and jurisprudence have adopted for purposes of ascertaining the indispensability of a cost (see Article 23 of the Corporate Income Tax Code in the wording in force in 2001), the Tax Authority cannot scrutinize the soundness and opportunity of the economic decisions of company management, on pain of interfering in the freedom and autonomy of company management.

II - Thus, a cost or loss will be accepted for tax purposes if, in a judgment made at the moment it was effected, it is appropriate to the company's productive structure and to the obtaining of profits, even if it later proves to be an unprofitable economic operation or economically ruinous, and the Tax Authority may only disregard those that do not fall within the scope of the taxpayer's activity and were incurred, not in its interest, but for the pursuit of extraneous objectives (when it can be concluded, in light of the rules of common experience, that it had no potential to generate profits).

III - The Tax Authority cannot disregard in the formation of taxable profit the capital loss resulting from the sale of equity interests of a company that engages in the same activity as the taxpayer, if it does not question that the acquisition and sale of those equity interests falls within the corporate purpose and does not question the reality of the acquisition and sale prices nor their conformity with market values. It cannot, in particular, disregard that capital loss on the basis of lack of demonstration of indispensability (see Article 23 of the Corporate Income Tax Code in the said wording) based on an inexigible and even impossible lack of identification of the "future profits arising from that capital loss."

IV - Moreover, this understanding of indispensability amounts to the requirement of a relationship of necessary and direct causality between costs and profits long rejected by doctrine and jurisprudence."

Examined the tax inspection report, it is clear that the Tax Authority conducted a descriptive and chronological exercise of the facts (pp. 19 to 22), followed by a compartmentalized exercise of subsuming them to the norms it considered relevant to the case: Articles 23, 28-A (2014), 28-B (2014), 35, 36 and 41, evidencing, as has been seen, an incorrect statement of the problem – the problem is one of analysis of the deductibility of an expense resulting from a capital loss (alienation below nominal value) and not an impairment of credits.

On the other hand, it is also verified that, induced by the legal framework it applied to the case, the Tax Authority passed over the analysis of the problem in function of the general requirements for the deductibility of expenses contained in Article 23 of the Corporate Income Tax Code, focusing instead on the regime of uncollectibility of credits, which, as has been seen, is inapplicable, in this case.

And it is precisely in this latter domain that the deductibility of the charge should be assessed, as the Respondent herself recognizes, and the answer cannot but be affirmative.

Now, from the substantiation contained in the Tax Inspection Report it is not possible to extract a single argument that permits putting in question the deductibility of the charge in light of the general requirements of Article 23 (indispensability and connection to the income-producing source).

With all requirements for the cost to be deductible met (and in this case they all are and are recognized in the Tax Inspection Report, namely: existence, accounting, temporal requirement, substantiation, connection to taxable income), one cannot use indispensability (in this case, for the 2013 tax year) as a concept that permits the Tax Authority to meddle in the conduct of the taxpayer's affairs.

Whether the cession was necessary or not was for the taxpayer alone to evaluate at the moment in which it formulated the decision to cede the credit under the conditions in which it did.

That is beyond doubt, having reviewed the documentation filed with the proceedings, that the transaction was not effected between related parties, there was no abuse of formalities, nor any benefit to third parties or payments of money to the shareholders, and even the Tax Authority itself does not question any or some of those circumstances.

That is, returning here to the words of the Decision of the Supreme Administrative Court cited above, nothing emerges from the Tax Inspection Report to the effect that the operation of cession of credits in question was carried out by the taxpayer "not in its interest but for the pursuit of extraneous objectives," nor that it is verified that, regarding the operation in question, "it does not question that (...) falls within the corporate purpose and does not question the reality of the prices ... nor their conformity with market values," and, moreover, "It cannot, in particular, disregard that capital loss on the basis of lack of demonstration of indispensability (see Article 23 of the Corporate Income Tax Code in the said wording) based on an inexigible and even impossible lack of identification of the 'future profits arising from that capital loss.'"

Thus, there will be no doubt that the framing made by the Tax Authority that results in the non-deductibility of the realized capital loss is vitiated by error of fact and consequent error of law, and therefore, the cost being to be considered fully deductible under Article 23, No. 2, paragraph l) of the applicable Corporate Income Tax Code, violated by the correction effected and now in question, the arbitral request should, in this part, proceed.

In light of the decision thus made, the knowledge of the remaining issues raised by the Applicant in the matter is rendered moot.

Regarding the request for indemnity interest made by the Applicant, Article 43, No. 1 of the General Tax Law establishes that indemnity interest is due when it is determined that there was error attributable to the services as a result of which payment of tax debt is made in an amount greater than legally due.

In this case, the error affecting the partially annulled assessments is attributable to the Tax Authority and Customs Authority, without necessary legal support.

The Applicant thus has the right to be reimbursed of the amount it paid (under Articles 100 of the General Tax Law and 24, No. 1 of the RJAT) by virtue of the acts partially annulled and, further, to be indemnified for the undue payment through the payment of indemnity interest by the Respondent, from the date of that payment until its reimbursement, at the legal default rate, under Articles 43, Nos. 1 and 4, and 35, No. 10 of the General Tax Law, Article 559 of the Civil Code and Order No. 291/2003 of 8 April.

C. DECISION

Given the foregoing, the Arbitral Tribunal decides the arbitral request herein to be partially granted and, consequently:

a) To annul the additional assessment acts in the part corresponding to expenses with travel and accommodation; and

b) To annul the additional assessment acts in the part corresponding to expenses with the alienation, below nominal value, of credits held by the Applicant.

c) To order the Respondent to pay indemnity interest, in the terms fixed above.

D. Case Value

The case value is fixed at € 1,788,275.87, under Article 97-A, No. 1, a) of the Tax Procedure and Process Code, applicable by virtue of paragraphs a) and b) of No. 1 of Article 29 of the RJAT and No. 3 of Article 3 of the Regulation on Costs in Arbitration Proceedings in Tax Matters.

Notify.

Lisbon, 6 April 2019

The Presiding Arbitrator

(José Pedro Carvalho)

The Arbitrator

(António Moura Portugal)

The Arbitrator

(Carla Castelo Trindade)