Process: 443/2017-T

Date: March 5, 2018

Tax Type: IRC

Source: Original CAAD Decision

Summary

In Process 388/2017-T, the CAAD arbitral tribunal examined a dispute concerning the deductibility of costs under Article 23 of the IRC Code. A footwear company challenged supplementary IRC assessments for 2011 and 2012, where the Tax Authority disallowed EUR 77,645.68 and EUR 107,579.20 in leather purchase costs from supplier B... LDA. The Tax Authority argued that inspections revealed B... LDA never produced or acquired leather, lacked adequate business infrastructure, and conducted suspicious cash transactions, rendering the invoices non-representative of real operations. The claimant contested this, asserting it genuinely purchased leather and that the Tax Authority relied exclusively on evidence from the supplier's inspection without corroborating findings from the claimant's own activities. The central legal issue concerned the burden of proof distribution: the Tax Authority must demonstrate legal assumptions justifying supplementary assessment, while taxpayers must prove facts supporting their deduction rights under Article 23. The case highlights critical questions about when accounting records organized per legal requirements can be challenged based on reasoned indications of non-reality, whether extrapolation from supplier irregularities suffices to disallow client deductions, and the evidentiary threshold required for disallowing costs as simulated transactions. The tribunal addressed procedural aspects including hierarchical appeal dismissals and compensatory interest assessments, examining whether strong indications of invoice falsity require corroboration through direct inspection of the claiming taxpayer's operations beyond supplier-focused evidence.

Full Decision

PROCESS No. 388/2017-T

ARBITRAL DECISION

REPORT

On 25 July 2017, the company A..., LDA., taxpayer no..., with registered office at Rua ..., ..., no..., ..., ...-... Vila Nova de Gaia ("Claimant"), submitted a request for arbitral decision with the intervention of a collective arbitral tribunal, pursuant to Articles 2, no. 1, paragraph a), and 10, no. 1, paragraph a), of the Legal Regime for Arbitration in Tax Matters ("RJAT").

The PORTUGUESE TAX AUTHORITY AND CUSTOMS AUTHORITY ("Respondent") is the respondent party.

In the request for arbitral decision, the Claimant asked the arbitral tribunal to declare illegal the supplementary assessments of Corporate Income Tax ("CIT") nos. 2013... and 2013..., relating to the tax years 2011 and 2012, as well as the respective assessments of compensatory interest.

As a consequence, the Claimant petitioned for partial annulment of the tax acts (CIT and compensatory interest) relating to the tax year 2011 and, likewise, for total annulment of the tax acts (CIT and compensatory interest) relating to the tax year 2012, refuting corrections to the taxable base of CIT (corrections to cost of goods sold), in the amounts of EUR 77,645.68 and EUR 107,579.20, resulting from the respective tax inspection action.

The Claimant also petitioned for annulment of the decisions dismissing the hierarchical appeals that it had filed, presented following the dismissal decisions of the administrative complaints relating to the assessments identified above.

The said corrections were based on the disallowance with tax cost of the values of the invoices issued by company B..., LDA., legal person no..., relating to the sale of leather for footwear to the Claimant, because, in the perspective of the Respondent Entity, they did not represent real transactions.

The Claimant disagrees with this position, arguing that in the tax years in question it actually acquired leather for footwear from B..., LDA., its supplier, and therefore the costs incurred with such acquisitions are deductible for tax purposes, within the meaning of Article 23 of the CIT Code.

Furthermore, it states that the indications gathered by the Respondent Entity relate only to the activity of company B..., LDA. and associated enterprises, and that all indications gathered from the Claimant point to the veracity and regularity of the transactions reflected in the invoices disallowed as a cost.

In the Claimant's view, when the Respondent gathers indications (allegedly, strong and sufficient) that certain invoices do not correspond to real transactions, it cannot be satisfied with evidentiary elements gathered solely from the activity of the alleged issuer of the invoices and proceed to an extrapolation of those indications to justify the disallowance of all invoices from that issuer that appear in the accounting records of the taxpayer subject to inspection. For the Claimant, from the moment in which the tax inspection report recognizes that there are indications that company B..., LDA. sold some leather, indications of falsity can only be considered strong and sufficient if they can be corroborated by factual observations made through analysis and inspection of the activity of the client company, which claims to have carried out real transactions and advocates for the consideration as true of the invoices issued by the suspect entity. In this way, for the Claimant, the Respondent failed to meet the burden of proof to which it was bound.

The Respondent sustains the legality of the contested assessments given that it was ascertained within the scope of the inspection and inquiry actions carried out on company B..., LDA. that this company, not being a producer of leather, also never acquired merchandise, either in the national market or in the external market, and therefore could not promote its sale, nor could the invoices issued by it represent true commercial transactions. For the Respondent, the business structure of company B..., LDA., both as regards facilities and in terms of staff, was not capable of supporting the exercise of an economic activity.

The Respondent further invokes that the financial flows between the entities involved in the transactions carried out by company B..., LDA. were always made in cash, despite the high amounts involved, the same occurring in the situation of the Claimant – cheques drawn at the counter.

In support of the non-deduction as a cost of the values represented by the invoices issued by company B..., LDA. and which were accounted for by the Claimant, the Respondent invokes the existence of incongruities and inconsistencies in the Claimant's accounting.

For the Respondent, from the conjunction of Articles 342, no. 1, of the Civil Code, 74, no. 1, and 75 of the General Tax Law results the imposition on the Tax Administration of the burden of proof of the verification of the indications or assumptions of taxation, and on the taxpayer the demonstration of the existence of the tax facts alleged as the foundation of their right. This means that the presumption ceases when the records or accounting, although organized in accordance with the law, suffers from errors, inaccuracies, or there are reasoned indications that it does not reflect the actual taxable matter, falling within this provision the case where the accounting contains indications that those expenses were not incurred, for not representing true transactions.

The Respondent understands that it is not necessary to provide direct proof of simulation or fraud, it being sufficient an evaluation of adequacy between the facts and valuations on which the Tax Administration formally supports its action and the result of that evaluation in the sense that it appears to it that a cost for tax purposes was improperly declared. In other words, it being incumbent on the Tax Administration to bear the burden of proof of the verification of the legal assumptions binding its action, it is incumbent on it, in the case of supplementary assessment of CIT, to bear the burden of proving that the legal assumptions that legitimize its action are verified. Once that proof is made, it is incumbent on the Claimant to bear the burden of proof of the facts it alleges as the foundation of its right to deduction of the costs within the meaning of Article 23 of the CIT Code.

The request for constitution of the arbitral tribunal was accepted on 25 July 2017 by the President of CAAD, and notification of the Respondent was subsequently promoted.

Subsequently, pursuant to Article 6, no. 2, paragraph a), of the RJAT, the Signatories were designated by the President of the Deontological Council of CAAD to constitute the present collective arbitral tribunal, and the respective appointments were accepted in the terms legally provided for.

On 12 September 2017, the parties were notified of that designation, and neither party expressed a will to refuse it, in accordance with the combined terms of Article 11, no. 1, paragraphs a) and b), of the RJAT, and of Articles 6 and 7 of the CAAD Code of Ethics.

The arbitral tribunal was constituted on 27 September 2017, in conformity with Article 11, no. 1, paragraph c), of the RJAT.

On 27 October 2017, the Respondent presented its answer, having previously attached the administrative process.

On 11 December 2017, the hearing referred to in Article 18 of the RJAT took place and witnesses were examined, with oral arguments also being presented by the parties.

PROCEDURAL SOUNDNESS

The arbitral tribunal is materially competent and is regularly constituted, in accordance with Articles 2, no. 1, paragraph a), 5, and 6 of the RJAT.

The parties have legal personality and capacity, are legitimate and are represented, in accordance with Articles 4 and 10 of the RJAT and 1 of Order no. 112-A/2011, of 22 March.

There are no nullities, nor were exceptions raised, and therefore there are no obstacles to the examination of the merits of the case, and it is necessary to decide.

SUBJECT MATTER OF THE ARBITRAL DECISION

The thema decidendum subject matter of the arbitral decision consists of ascertaining whether the transactions for the sale of leather for footwear reflected in the invoices issued by company B..., LDA., accounted for by the Claimant and whose amounts contributed, negatively, to the calculation of its taxable income in CIT, correspond to true commercial transactions and, consequently, whether the respective values assume the nature of a cost deductible for tax purposes in the sphere of the Claimant, within the meaning of Article 23 of the CIT Code.

SUBSTANTIVE FACTS

Facts Proven

The following facts are considered proven:

a. The Claimant is a taxpayer dedicated to the activity of footwear manufacturing (CAE 015201), being subject to the general regime for determination of taxable income for CIT purposes (see pages 1 and 2 of the tax inspection report);

b. With reference to the tax years 2011 and 2012, the Claimant's accounting reflects the invoices discriminated below, relating to supplies of leather for footwear attributed to company B..., LDA.:

Tax Year 2011

Invoice no. 2011212, dated 1 July 2011, in the amount of EUR 14,743.54;

Invoice no. 2011257, dated 1 August 2011, in the amount of EUR 12,662.23;

Invoice no. 2011287, dated 2 September 2011, in the amount of EUR 12,418.39;

Invoice no. 2011358, dated 14 October 2011, in the amount of EUR 12,534.42;

Invoice no. 2011427, dated 23 November 2011, in the amount of EUR 12,469.32;

Invoice no. 2011483, dated 21 December 2011, in the amount of EUR 12,817.78.

Total: EUR 77,645.68

Tax Year 2012

Invoice no. 2012010, dated 11 January 2012, in the amount of EUR 12,387.55;

Invoice no. 2012060, dated 14 February 2012, in the amount of EUR 7,797.76;

Invoice no. 2012079, dated 24 February 2012, in the amount of EUR 11,611.82;

Invoice no. 2012103, dated 13 March 2012, in the amount of EUR 17,992.86;

Invoice no. 2012120, dated 26 March 2012, in the amount of EUR 11,371.77;

Invoice no. 2012132, dated 3 April 2012, in the amount of EUR 14,578.97;

Invoice no. 2012173, dated 8 May 2012, in the amount of EUR 7,288.81;

Invoice no. 2012209, dated 6 June 2012, in the amount of EUR 4,541.88;

Invoice no. 2012267, dated 17 July 2012, in the amount of EUR 11,749.04;

Invoice no. 2012286, dated 30 July 2012, in the amount of EUR 8,258.74;

Total: 107,579.20 (see pages 7 and 93 of the tax inspection report);

c. Invoice no. 2011483, dated 21 December 2011, in the amount of 12,817.78, expressly states that the respective merchandise was delivered at the Claimant's facilities on 21 December 2011, at 10:00, by means of transport via vehicle ...-...-... (see page 93 of the tax inspection report and Article 86 of the request for arbitral decision);

d. The said invoice was recorded in the Claimant's accounting in the month of December 2011 and the merchandise was recorded in inventory in January 2012 (see page 93 of the tax inspection report and Article 86 of the request for arbitral decision);

e. The Claimant's facilities were closed for holidays between 19 and 31 December 2011 (see document no. 2 attached to the administrative complaint);

f. The warehouse forms of the Claimant that document the entry of leather into the warehouse and its respective exit are filled manually (see document no. 7 attached to the administrative complaint; documents nos. 1 to 3 attached to the request for arbitral decision);

g. With reference to the invoices of company B..., LDA., the Claimant has only in its possession warehouse forms relating to black and brown aniline (see page 94 of the tax inspection report and Articles 122 to 124 of the request for arbitral decision);

h. The warehouse form that reflects the entry and subsequent exit of 5,121.25 feet of leather for C... does not attest to reality, since such feet of leather did not leave the Claimant's warehouse destined for C... (see Articles 130 to 133 of the request for arbitral decision);

i. The warehouse form that records the entry of 4,180.00 feet of leather differs from the respective invoice – invoice no. 2012060, dated 14 February 2012, in the amount of EUR 7,797.76 – which mentions 4,516.25 feet of leather (see Article 157 of the request for arbitral decision);

j. With reference to the year 2011, the Claimant does not have in its possession any transport guides (see page 95 of the tax inspection report and Article 165 of the request for arbitral decision);

k. In 2011, the Claimant acquired 176,150 feet of black leather (see document no. 12 attached to the administrative complaint);

l. In 2012, the Claimant acquired 186,799 feet of black leather (see document no. 3 attached to the administrative complaint);

m. Between August and December 2012, the Claimant's acquisitions of black leather amounted to 41,676 feet (see document no. 3 attached to the administrative complaint);

n. Between August and December 2012, the Claimant issued invoices for approximately 16,028 pairs of black leather shoes (see document no. 4 attached to the administrative complaint);

o. In the year 2012, the Claimant sold 3,503 pairs of black leather shoes, corresponding to 17,089.72 feet, manufactured by companies D..., E... and C... (see documents nos. 8, 9 and 10 attached to the administrative complaint);

p. In the year 2011, 2,413 pairs of brown leather shoes were produced and sold by the Claimant (see document no. 11 attached to the administrative complaint);

q. Between August and December 2012, the Claimant acquired 10,271 feet of brown leather (see document no. 5 attached to the administrative complaint);

r. Between August and December 2012, the Claimant issued invoices for 1,533 pairs of brown leather shoes (see document no. 6 attached to the administrative complaint);

s. Under Service Order no. OI2012..., dated 8 October 2012, the Claimant was the subject of a tax inspection action for the tax years 2011 and 2012, in matters of CIT and Value Added Tax (see pages 1 and 2 of the tax inspection report and Article 86 of the request for arbitral decision);

t. This inspection action took place following another inspection action carried out against company B..., LDA., legal person no..., a company supplying leather for footwear, in which the Respondent understood that there were strong indications that the invoices issued by this company would not correspond to real economic transactions (see page 2 of the tax inspection report);

u. The findings of the tax inspection report result in the following conclusions regarding the activity of company B..., LDA.:

"From the observation made of the facilities used by B..., Lda., and subsequently by F..., Lda., no movement was observed that companies that supposedly sold more than eleven million euros of merchandise would presuppose, such as entry and exit of clients, suppliers and vehicles, regular presence of managers and employees. On the contrary, the door and gates of the facilities of B..., Lda. and F..., Lda. are permanently closed and inside there is one female employee, and even this one with infrequent presence.

The inspection actions carried out on the three suppliers of B..., Lda. concluded that they did not have the capacity for the leather trade, that is, the invoices issued by these entities and accounted for by B..., Lda., as being from its suppliers, were fakes, that is, B..., Lda., does not support the acquisition of a single foot of leather through a single true invoice, that is, all invoices representing acquisitions are staged, are false.

It was also concluded that B..., Lda. never acquired leather from anyone, neither from insolvent companies nor from foreign companies, neither in Portugal, Spain, Italy or Tunisia, as it does not identify a single true supplier, any facilities/warehouses or leather loading place, contacts, correspondence, credible payments, anything, that demonstrates the effective acquisition of leather and that the business dimension makes it admissible.

As for the employees listed on the company's payroll, it was concluded that only G... is regularly present in its facilities, while the others would never have exercised any function there, they were used to pretend that the company had many employees.

As for the sales of B..., Lda. and F..., Lda., it was found that:

They issued invoices where they mentioned loadings on days when the Tax Authority technicians were present and they found the non-existence of the same loadings;

During about seven months B..., Lda. supposedly moved more than a million feet of leather, in the value of 1.7 million euros, from a private house of a person who has no connection with the company;

B..., Lda. refers as a means of transport of leather, between its warehouse and the facilities of its clients, a vehicle that did not circulate even a seventh of what it would have to do to cover the kilometers necessary for so many feet of leather delivered and the distance it did circulate was not at the service of B..., Lda.;

On the other hand, that same vehicle is mentioned in the sales invoices of F..., Lda., and it was found that it had practically not circulated in the period in which the invoices claim to have been used as a means of transport of leather;

They issued invoices on days when H... was absent abroad, that is, when they would not have anyone to handle and transport the supposed leather to the clients;

As for client payments, the checks of these are, for the most part, drawn at the counter or, when deposited or those payments made by bank transfer, are immediately withdrawn from the account, losing the money's trail;

In sum, being in the presence of a company in whose facilities no activity of leather trade is recorded, which did not have employees to handle and transport leather, which never acquired a single foot of leather for sale and which never sold a single foot of leather, it must be concluded that an entire staging was set up to trick, to deceive, to defraud, to enrich illicitly. In short, the company is nothing more than a deception, a farce" (see pages 16 and 17 of the tax inspection report);

v. In parallel, the same report results in the following conclusions regarding the activity of the Claimant:

"No raw material is listed in the final inventory of 2011 as described in the B... invoices, despite invoice no. 2011483 being dated 21.12.2011 and, according to the elements in the same, the loading location was at the supplier's facilities and the unloading location at the customer's address at 10:00h on 21.12.2011 and the transport via vehicle ...-...-... (the raw material referred to in that invoice is recorded with entry in inventory in January 2012, despite in accounting terms its cost was recorded in the accounting in December 2011 [...]).

In the final inventory of 2012, the feet of leather in inventory that are listed as having been acquired from B..., Lda. have no expression in the same, which amounts to approximately 2 million euros (this is the indication of 116 feet of brown aniline and 292.75 feet of black aniline in a total value of €715.31).

Copies, front and back, authenticated by the banking institution, of some of the means of payment used in these transactions were requested. The checks used have on the back the identifying elements (as was expected) of B..., Lda.

It is not strange, regarding invoice no. 2012302, dated 21.08.2012, in the value of € 17,996.14, issued by "B..." with the indications of loading location: our facilities, unloading location: customer's address, on the date of 21.08.2012 and the license plate of the vehicle indicated ...-...-... (initially registered by the company with no. ... on 31.08.2012 and subsequently removed from accounting and to which the managing partner stated having consumed in production the leather indicated in it), the correspondence exchange between "B..." and "A..., Lda., in particular the letter of 17 September 2012 [...]. It is not understood, then, what document accompanied the raw material [...].

For closer control of inventory, at the level of raw materials, and as we were informed, so that no gaps arise for production, warehouse forms are prepared manually with records of entries and exits of leather, although the company has a computerized system with capacity for that management [...].

For the invoices of B..., Lda., and at the date of the visit, we were told that only, at that date, the manual forms relating to Brown Aniline and Black Aniline exist, the remaining ones having already been eliminated as they no longer had a balance [...].

Upon request for the warehouse form relating to Black Aniline leather (the most significant raw material in terms of those acquisitions, representing 52% of the leather B...), we were presented with the warehouse form Black Aniline Leather B... and for which we have to refer to the following:

On 25/11/2011, the exit for C... of 5000 feet of Black Aniline Leather B... is indicated, when the current account of this subcontracted supplier, to whom the raw material is debited for supply of the finished product, C..., Lda., (with registered office in the Braga District) has no accounting movement in 2011.

Invoice no. Ml/12/001, of the raw material debited to C... (the only invoice for this entity, from January 2011 to December 2012) to make shoes only has the date of 25.02.2012, and the type of raw material debited to that subcontractor does not correspond to that of the warehouse form presented (Black Aniline Leather B...), as it indicates quality of leather, and colors different from those they intend to justify exits.

Credit Note no. MI/…/… of 05.04.2012, issued by A... Lda. to C..., relating to the return of excess leather from the finished product subcontracted, does not mention the return of any foot of black aniline leather.

The invoice of B... numbered 2011483 dated 21.12.2011, relating to 3,122.50 feet of Camel Aniline leather and 4,213.50 feet of Black Aniline leather, was posted in the accounting in December 2011 in the purchase sub-account, 3121113- Purchases of raw materials, Domestic, normal tax deductible. According to the Black Aniline Leather B... warehouse form presented, the value of that raw material was not taken into account in the final inventory of raw materials of 2011, since it shows zero inventory for that reference of leather and, taking into account that the final inventory of raw materials is prepared based on the information from those manual forms. That is, the raw material was not debited to C... in 2011, nor is it in the Inventory.

In the manual raw material form analyzed, this leather only has entry into warehouse in January 2012.

On 18/01/2012 it is indicated as delivered to D..., Lda., of..., another subcontracted supplier, the quantity of 9,300.00 feet of Black Aniline Leather B.... However, invoices nos. MI/12/003 and Ml/12/005, on 25.02.2012 and 24.03.2012, respectively, to debit the raw material, refers to suede almost entirely (different from aniline), and another leather also different from aniline, in reduced quantities, as well as referring to varied colors. The invoices mentioned above translate the only transactions recorded in the accounting with this client of the raw material.

To confirm that the type of leather that was sent to this shoe maker was not black aniline, its return note no. 2012... of 10.04.2012, to which corresponds the Credit Note Ml/…/… issued by A..., Lda., (returning varied colors and leather of a type quite different from aniline), in which the return of any foot of black aniline leather is not mentioned.

The manual form records the entry of the quantity of 4,180.00 feet relating to invoice 2012060 when the same invoice mentions 4,516.25 feet of leather (the computerized form corresponding records exactly the quantity indicated in that invoice).

Transport guides relating to the year 2011 were requested, and we were informed that they were already destroyed, so there is no possibility of proving other situations besides those found in the documents issued by the company and that are part of its accounting, in particular those recorded in the warehouse form presented.

The warehouse form relating to Brown Aniline B... shows that it was consumed internally by A... and, part, delivered on 30.11.2011 to shoe maker I..., Lda. The internal production orders of the company, according to information from the person responsible for that work area, no longer exist, as after the shoes are delivered to customers, they are eliminated [...]. The subcontracted company I..., Lda. works on a fee basis, billing only the work executed for shoe making, so it makes no discrimination of shoe colors, nor any reference to the raw material worked on. In this way, little more is possible to analyze from this manual form regarding the record of brown aniline coming from invoices of B..., Lda. (note the absence of any other manual warehouse form for leather acquired from B..., Lda.) [...].

Upon request for the computerized form of article M0... which corresponds to black cow leather, where entries relating to invoices of B... were recorded as well as the remaining entries of black cow leather and the respective exits for internal and external production, we have to refer to the following after its analysis:

In that form M... the production orders throughout the year 2011 indicate a consumption of 26,927.05 feet of leather. The purchases from various suppliers are 15,446.66 feet of leather and the inventory at the beginning of the year of this leather was 21,075.63. Now, these quantities were sufficient for production, making the quantities indicated in the invoices of B... recorded in the form in 2011 unnecessary (invoices nos. 2011257 and 2011427, in a total of 12,254.50 feet of black aniline).

In the year 2012, purchases from various suppliers are 46,426.77 feet of black cow leather and production orders indicate consumption of 34,056.78, so those purchases are adequate to them. Thus it stands out that the quantity of 50,757.00 feet of black cow leather recorded relating to the invoices of B... is totally dispensable to accounted production (the company recorded in this year of 2012 the quantity of 50,757.00 feet of black cow leather, including 8,153.25 from invoice no. 2012302, from August 2012, which A..., Lda. ultimately did not record in the accounting).

In the year 2012, the following exits are indicated as doc. 1: in April, 10,400.25; in May, 12,401.00, and in September, 16,975.25. These negative movements in form M0153701 do not correspond to documents relating to production orders and according to the person who performs this administrative function correspond to stock adjustments, intending to adjust what is in the computerized form with actual inventory in the warehouse. Now, there is a visible similarity of quantities between the regularizations mentioned above and the invoices of B... [...].

This situation of regularization is clearly evident in the computerized form M... regarding Jamaica Gold leather, year 2012 [...].

Also in the computerized form M... – Desert Espresso they record the entry of 457 feet of leather on 30.07.2012, doc. 404, and of 2,563.75 from invoice no. 2012286 of 30.07.2012 of B..., doc. 405. The production orders recorded indicate consumption of 295.92 and the inventory balance indicated of 2,724.83 evidence that the quantity from B... invoice was perfectly dispensable.

Conclusion: taking into account the analysis of the available elements in A..., Lda. we were unable to prove the use in production of the raw materials indicated in the invoices issued by B..., Lda. On the contrary, the elements analyzed allow the conclusion that those raw materials were not necessary for production" (see pages 93 to 97 of the tax inspection report);

w. For understanding that the invoices listed in item b. above "have underlying 'simulated transactions'", the Tax Inspection Services disallow the values reflected in them, in the amounts of EUR 77,645.68 and EUR 107,579.20, as deductible costs for tax purposes within the meaning of Article 23 of the CIT Code, having, accordingly, corrected the taxable base of CIT of the Claimant for the tax years 2011 and 2012 (see page 99 of the tax inspection report);

x. At the request of the Tax Inspection Services, the Claimant made available copies of checks, evidencing payments, on the reverse of which appeared the identifying elements of company B..., LDA. (see page 94 of the tax inspection report and Article 112 of the request for arbitral decision);

y. Following the inspection action, the Claimant was notified of supplementary CIT assessments nos. 2013..., of 17 December 2013, relating to the tax year 2011, in the amount of EUR 36,288.35, and 2013..., of 17 December 2013, in the amount of EUR 29,098.94, relating to the tax year 2012, as well as the respective assessments of compensatory interest (see document no. 1 attached to the administrative complaint);

z. The Claimant filed administrative complaints and filed hierarchical appeals in which it contested the legality of the supplementary tax assessments and compensatory interest assessments contested and, by means thereof, the corrections to the taxable base of CIT (corrections to cost of goods sold), in the amounts of EUR 77,645.68 and EUR 107,579.20, resulting from the tax inspection action (see administrative process);

aa. Both the administrative complaints and the hierarchical appeals were dismissed, and the Tax Administration adhered to the grounds set out in the final report of the tax inspection (see administrative process);

bb. On 25 July 2017, the Claimant submitted a request for arbitral decision intended for the annulment of the above tax acts and, likewise, of the decisions dismissing the administrative complaints and hierarchical appeals, based on misqualification of the tax fact and violation of law due to errors in the factual and legal assumptions.

Facts Not Proven

Of the facts with interest for the decision of the case, contained in the request for arbitral decision and the answer, all objects of concrete analysis, those not contained in the factuality listed above were not proven.

C) Reasoning for the Decision on the Substantive Facts

The facts were given as proven based on the tax inspection report, the documents attached to the request for arbitral decision, the documents in the administrative process, and the depositions of the witnesses examined. In this regard, it should be noted that the witnesses indicated by the Claimant demonstrated they had only partial knowledge of the facts, and therefore failed to establish correspondence between warehouse records and accounting records, these being exclusively controlled by the managing partner of the Claimant.

SUBSTANTIVE LAW

The examination of the legality of the CIT assessments for the tax year 2011 and the tax year 2012, as well as the respective assessments of compensatory interest, is placed before this arbitral tribunal, which are directly related to the deduction, in the context of CIT, of the costs incurred in the acquisitions of leather for footwear by the Claimant, during the tax years 2011 and 2012, from B..., LDA (see invoices referred to in b) of the Facts Proven).

As mentioned above, the thema decidendum subject matter of the arbitral decision consists of ascertaining whether the transactions for the sale of leather for footwear reflected in the invoices issued by company B..., LDA., accounted for by the Claimant and whose amounts contributed, negatively, to the calculation of its taxable income in CIT, correspond to true commercial transactions and, consequently, whether the respective values assume the nature of a cost deductible for tax purposes in the sphere of the Claimant, within the meaning of Article 23 of the CIT Code.

The Respondent understands that the invoices accounted for by the Claimant, in the tax years in question – 2011 and 2012 – do not constitute real transactions, that is, they constitute simulated transactions, and therefore does not accept the cost in the context of CIT. The Claimant disagrees with this position, arguing that in the tax years in question it actually acquired leather for footwear from company B..., LDA., its supplier, and therefore the costs incurred with such acquisitions are deductible for tax purposes, within the meaning of Article 23 of the CIT Code. Furthermore, it states that the indications gathered by the Respondent Entity relate only to the activity of company B..., LDA. and associated enterprises, and that all indications gathered from the Claimant point to the veracity and regularity of the transactions reflected in the invoices disallowed as a cost.

The right to deduction of expenses and losses in the context of CIT, consecrated in Article 23 of the CIT Code (CIRC), is a pillar in the determination of the taxable income of taxpayers. This is precisely what Article 23, no. 1 of the CIRC states, when it says that all expenses and losses incurred or borne by the taxpayer to obtain or secure income subject to CIT are deductible (in the previous wording: expenses are those which are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the income source, namely [...]). That is, Article 23 of the CIRC places the right to deduction when expenses and losses are actually incurred or borne by the taxpayer and are documented.

This right to deduction in the context of CIT must be combined with the legal presumption that taxpayer declarations submitted in accordance with the law are true and made in good faith. Thus, we must take into account, in addition to the already mentioned Article 23 of the CIRC, Article 75, no. 1 of the General Tax Law (LGT). In this article of the LGT it reads: declarations of taxpayers submitted in accordance with the law are presumed true and made in good faith, as well as the data and calculations recorded in their accounting or books, when these are organized in accordance with commercial and fiscal legislation.

As mentioned by Serena Cabrita Neto and Carla Castelo Trindade in Tax Litigation, 2017, Almedina, a presumption of veracity is established for taxpayer declarations submitted in accordance with the law, as well as for data appearing in their accounting and books, if they are in accordance with commercial and fiscal legislation. Elisabete Louro Martins considers that this legal presumption of truth and good faith is a corollary of the principle of the taxpayer's participation in determining taxable income [...].

The cited Author Elisabete Louro Martins provides as consequences of this presumption the exemption of the taxpayer from the burden of proof that the information declared and documented in supporting documents, regarding the qualification and quantification of tax facts, corresponds to reality, that is, namely in the context of personal income tax and CIT, that the declared income corresponds to the actual income effectively obtained. To the taxpayer it will then suffice to present the declarations, the accounting or the books, to demonstrate that it has complied with the obligation to cooperate and that its documentation is complete and organized in accordance with the law.

Under Article 74, no. 1 of the General Tax Law (LGT), the burden of proof of the facts constitutive of the rights of the tax administration or taxpayers lies with whoever invokes them. That is, both the tax administration and the taxpayer bear the burden of proof of the facts constitutive of their right, proceeding always from the presumption that declarations of taxpayers submitted in accordance with the law are true and made in good faith, as well as the data and calculations recorded in their accounting or books, when these are organized in accordance with commercial and fiscal legislation.

In this regard, it is important to refer, among others, to the Judgment of the Supreme Administrative Court (STA), delivered on 16 November 2016, in case no. 0600/15, which states: II - In order for the Tax Administration to proceed with the correction of taxable income by disallowance of costs borne by invoices existing in the taxpayer's books and regarding which it considers that the operations therein contained have not actually been carried out, it does not have to provide proof of the existence of a simulated agreement (existence of divergence between the statement and the actual intentions of the parties as a result of an agreement between the declarant and the declaratory, with the intent to deceive third parties – see Art. 240 of the Civil Code) to satisfy the burden of proof that rests on it. III - It is sufficient for the Tax Administration to prove the factuality that led it not to accept those costs, factuality that must be capable of shaking the presumption of veracity of the transactions in the taxpayer's books and the respective supporting documents, only then does it become incumbent on the taxpayer to bear the burden of proof of the right which it claims (the right to exercise the right to deduct the costs from taxable income) and which is not recognized by the Tax Administration, that is, the burden of proof that the transactions were actually carried out and the assumptions on which its right to that deduction depend are met. In the same sense, Judgment of the STA, delivered on 19 October 2016, in case no. 0511/15, Judgment of the STA, delivered on 16 March 2016, in case no. 0400/15.

It is necessary, therefore, to determine whether, in the case sub judice, the Respondent demonstrated and proved the factuality that led it not to consider the invoices, that is, it must determine whether it alleged and proved facts that shook the presumption of veracity of the transactions in the books of the Respondent and the respective supporting documents.

What matters is to know whether the Respondent alleged and proved facts that shake the presumption of veracity of the transactions between the Claimant and its supplier, in this case, B..., LDA., and therefore, the transactions of the suppliers of the Claimant with other entities are not at issue.

The CIT assessments for the tax year 2011 and the tax year 2012, subject matter of the present arbitral decision, are based, essentially, on facts ascertained in the context of an inspection carried out on company B..., LDA. The Respondent transported into the inspection report for the Claimant the grounds and conclusions of the said inspection of B..., LDA. to support its right to issue an assessment in relation to the Claimant.

As the Respondent itself refers in its answer (see Article 6 of the answer), this inspection action was carried out following another inspection action on a supplier of leather for footwear B... Unipessoal, Lda. In this, strong indications of false invoicing of the activity allegedly carried out were found, since it was concluded that there were no actual economic transactions and that it was only accounting movement to take advantage of VAT deduction, fundamentally. Furthermore, the Respondent refers (see Article 16 of the answer), it was proven, in the context of the inspection action on company B... that A..., LDA., could not have purchased leather from B... because this company does not exercise, nor has ever exercised any activity of leather trading, because it did not buy a single foot of leather, and therefore would not be in a position to sell it.

Under Article 76, no. 1 of the LGT, the information provided by the tax inspection makes a case when substantiated and if based on objective criteria, in accordance with the law. Article 115, no. 2 of the Code of Tax Procedure (CPPT) completes by saying that official information has evidential force only when properly substantiated, in accordance with objective criteria.

In this regard, it is important to refer to the Judgment of the Supreme Administrative Court (STA), delivered on 17 April 2002, in case no. 026635, which, although dealing with VAT, it is important to highlight part of its reasoning, when it states that it is not enough that the administration say it is convinced, but also that it says why it was convinced and that this result can be objectively assessed and controlled by the court in the light of appropriate criteria. And being so, to emit its judgment on whether the administration's consideration should be regarded as materially substantiated, the court cannot restrict itself merely to the existence of formal substantiation and to the elements manifested therein, contrary to what the appealed judgment understood, but must form its own probative judgment on the correspondence to the factual and legal reality of the elements on which the administration said it was basing its consideration and evaluate, then, on them whether it should be regarded as correct. It will thus be incumbent on the administration to prove, also in court, the factual assumptions sufficient, among those stated in the substantiation of the act, so that the court can judge whether the administrative judgment should be regarded as, objectively and substantively, substantiated. In this perspective, the court a quo could not take into account the facts invoked by the administration in substantiation of the act, such as the vicissitudes of the books and activity of the issuer of the invoices whose tax it deduced that it did not prove them.

In the inspection report for the Claimant is reflected the line of reasoning and evaluation followed by the Respondent and the actions it carried out (see points t), u) and v) of the Facts Proven). That is, the Respondent used the inspection report of B... to, through a transcription of grounds and conclusions, without additional relevant documentation and proof, extract facts to support the conclusion that the transactions between the Claimant and that company were fictitious.

In light of the body of evidence produced, the conviction of the tribunal is, to the contrary, in the sense that the Claimant made acquisitions of leather from B..., LDA., and there is no reason to deny the coincidence between such acquisitions and those evidenced by the invoices that it has in its accounting. The tribunal also became convinced that the Claimant's consumption in the manufacture of footwear, whether by itself or through another party to whom it contracted that manufacturing, exceeds the quantities set forth in those invoices.

It is true, on the other hand, that some doubts remained for the tribunal, not dissipated, regarding the dates of delivery of the materials invoiced, their transport, entries and exits from warehouse, etc., but such doubts result (as the witness testimony proved) from poor control of warehouse movements and coordination with invoicing, some negligence in the filling and verification of documents, or even in their absence (transport documents). However, if all that reveals poor organization of the Claimant, with repercussions on the control of entries and exits of raw materials and finished products, it does not call into question what is relevant here: the acquisitions made by the Claimant from B..., LDA, which the Respondent considered non-existent, but which are supported by invoices and which this tribunal understands to correspond to reality.

In truth, the Respondent did not prove facts capable of shaking the presumption of veracity of the transactions in the Claimant's books and the respective supporting documents.

By the documents attached with the Administrative Complaint and Hierarchical Appeal, i.e., documents presented on the administrative level and which are part of the administrative process, and by the documents attached to the request for arbitral decision and, further by the witness testimony presented, the Claimant demonstrated the veracity of the transactions between it and its supplier company B..., LDA.

DECISION

Accordingly, the Claimant's request is judged to be well-founded, and the acts of assessment of CIT and compensatory interest assessments contested are annulled, as well as the decisions dismissing the respective administrative complaints and hierarchical appeals.

The value of the case is fixed at € 65,387.19, in accordance with Article 97-A of the Code of Tax Procedure (CPPT), applicable by force of the provision in paragraph a) of Article 29, no. 1 of the RJAT and Article 3, no. 2 of the Regulation on Costs in Tax Arbitration Proceedings (RCPAT).

Costs, in the amount of € 2,448.00, in accordance with Table I annexed to the RCPAT, at the charge of the Respondent, given that the request was judged to be well-founded, and in compliance with the provision in Article 22, no. 4 of the RJAT.

Let notification be made.

Lisbon, 5 March 2018

The arbitrators

(José Baeta de Queiroz)

(Jaime Carvalho Esteves)

(Alexandre Andrade)

Frequently Asked Questions

Automatically Created

What are the requirements for deducting costs under Article 23 of the Portuguese IRC Code?
Under Article 23 of the IRC Code, costs are deductible when they are indispensable or relevant for obtaining taxable income or maintaining the income source, are properly documented, and correspond to real transactions. The taxpayer bears the burden of proving that expenses were actually incurred and represent genuine business operations. When accounting is organized according to law, costs are presumed deductible unless the Tax Authority demonstrates reasoned indications that records do not reflect actual taxable matter or that transactions are simulated.
Can the Tax Authority disallow cost deductions based solely on evidence gathered from a supplier's inspection?
The Tax Authority cannot disallow cost deductions based exclusively on evidence from a supplier's inspection without considering the client's specific circumstances. According to the claimant's argument in this case, when indications suggest certain invoices may not represent real transactions, the Tax Authority must corroborate these findings through analysis and inspection of the client company's activities. Simply extrapolating irregularities found at the supplier level to all clients is insufficient. The Tax Authority must meet its burden of proving that legal assumptions justifying the supplementary assessment apply to the specific taxpayer being assessed.
What happens when invoices are deemed not to reflect real transactions for IRC purposes?
When invoices are deemed not to reflect real transactions for IRC purposes, the associated costs are disallowed as tax-deductible expenses under Article 23 of the IRC Code. This results in supplementary IRC assessments increasing the taxable base, plus compensatory interest on the additional tax due. The Tax Authority must demonstrate through reasoned indications that accounting records contain errors, inaccuracies, or evidence that expenses were not genuinely incurred. Direct proof of simulation or fraud is not required; adequacy evaluation between facts and valuations suffices to establish that a cost was improperly declared.
How does the CAAD arbitral tribunal evaluate the burden of proof in cases of simulated invoices?
The CAAD arbitral tribunal evaluates the burden of proof in simulated invoice cases by applying Articles 74 and 75 of the General Tax Law together with Article 342(1) of the Civil Code. The Tax Authority bears the initial burden of proving verification of legal assumptions that legitimize supplementary assessment action, including demonstrating reasoned indications that invoices do not represent real transactions. Once this threshold is met, the burden shifts to the taxpayer to prove facts supporting their deduction rights under Article 23 of the IRC Code. The tribunal examines whether the Tax Authority provided adequate evidence (business structure, financial flows, accounting inconsistencies) and whether the taxpayer demonstrated the reality of commercial operations.
What remedies are available after an unfavorable decision on a hierarchical appeal regarding IRC additional assessments?
After an unfavorable decision on a hierarchical appeal regarding IRC additional assessments, taxpayers can request arbitral decision before CAAD (Centro de Arbitragem Administrativa) as demonstrated in this case. The request must be filed within specified legal deadlines pursuant to Articles 2(1)(a) and 10(1)(a) of the RJAT (Legal Regime for Arbitration in Tax Matters). Alternatively, taxpayers may file judicial appeals before administrative and tax courts. The arbitration request can seek annulment of both the supplementary assessments and the hierarchical appeal dismissal decisions, as well as annulment of compensatory interest assessments. Arbitration provides a faster alternative to traditional court litigation.