CAAD Case 465/2017-T: IRC Deductibility of Swap Costs, OTC Operations & Donations

ARBITRAL DECISION

I – REPORT

On 4 August 2017, A…, S.A., NIPC…, with registered office at Rua…, …, in its capacity as the incorporating company of the company B… SGPS, S.A., NIPC…, filed a petition for constitution of an arbitral tribunal, pursuant to 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 act of additional corporate income tax (IRC) assessment No. 2013…, concerning the fiscal year 2009, as well as of the act of dismissal of the administrative complaint No. …2014…, which had the said assessment act as its object, and of the act of dismissal of the hierarchical appeal which had the aforementioned as its object, in the amount of €87,543.72.

To substantiate its request, the Petitioner alleges, in summary, the illegality of the correction made as a result of a misinterpretation of the facts and the applicable law.

On 04-08-2017, the petition for constitution of the arbitral tribunal was accepted and automatically notified to the Tax Authorities (AT).

The Petitioner did not proceed to appoint an arbitrator, whereupon, in accordance with the provisions of subparagraph a) of paragraph 2 of article 6 and subparagraph a) of paragraph 1 of article 11 of the RJAT, the President of the Deontological Council of CAAD designated the undersigned as arbitrators of the collective arbitral tribunal, who communicated their acceptance of the assignment within the applicable period.

On 17-10-2017, the parties were notified of these designations and did not manifest any intention to refuse any of them.

In accordance with the provision of subparagraph c) of paragraph 1 of article 11 of the RJAT, the collective Arbitral Tribunal was constituted on 09-11-2017.

On 13-12-2017, the Respondent, duly notified for such purpose, submitted its response defending itself (solely) by way of objection.

Pursuant to the provisions of subparagraphs c) and e) of article 16 and paragraph 2 of article 29, both of the RJAT, the holding of the meeting referred to in article 18 of the RJAT was waived.

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

A period of 30 days was set for the rendering of the final decision, following the submission of pleadings by the AT, which period was extended until the end of the period referred to in article 21/1 of the RJAT.

The Arbitral Tribunal is materially competent and is regularly constituted, in accordance with articles 2, paragraph 1, subparagraph a), 5 and 6, paragraph 1, of the RJAT.

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

The proceedings do not suffer from any nullities.

Therefore, there is no obstacle to the examination of the merits of the case.

Everything having been considered, it is necessary to render judgment.

II. DECISION

A. FACTUAL MATTER

A.1. Facts Established as Proven

In the fiscal year 2009, the R… Group was constituted by several entities through direct and indirect shareholdings, with the entity "B…, SGPS, S.A." being the parent company for purposes of the Special Regime for Group Taxation (RETGS).

The "B…, SGPS, S.A." was, as of 31-12-2009, owned 81.517% by the Portuguese law company "C…, SGPS, Lda.", and this entity together with "B…, SGPS, S.A." was subject to cessation of activity with effect on 27-12-2012, by reason of merger by incorporation, with dissolution of the incorporated entities in the entity "D…, SGPS, S.A." (now "A…, S.A."), the Petitioner herein.

In the fiscal year 2009, the group, for IRC taxation purposes, was constituted by the following entities:

• B…, SGPS, S.A.
• E…S.A.
• F… – REAL ESTATE COMPANY, S.A.
• G…, S.A.
• H…, LDA.
• I…, SGPS, S.A.
• J…, S.A.
• K…, S.A.
• L…, S.A.
• M…, S.A.

In the fiscal year 2009, "B…, SGPS, S.A." opted for the application of the Special Regime for Group Taxation (RETGS), being considered the parent company for that purpose.

With regard to the fiscal period of 2009, the taxable profit of the group was calculated by the parent company through the algebraic sum of the taxable profits and tax losses determined in the individual periodic declarations of each of the companies belonging to the group.

"K…, S.A." was subject to an external tax inspection procedure, of general scope, authorized by Service Order No. OI2013…, covering the fiscal year 2009.

The draft report of the tax inspection was notified to "K…, S.A." and B…, SGPS, S.A. through official notice No. …/… of 30-10-2013, through which the following corrections were proposed to the values declared for IRC purposes:

• Disallowance of costs (expenses) recognized as financial charges, not deductible for the purpose of determining the fiscal result for the period 2009: €72,063.08.
• Disallowance of costs (expenses) and tax benefits recognized as non-deductible donations for the purpose of determining the fiscal result for the period 2009: €30,000.00.
• Disallowance of tax benefits by collection deduction in the form of tax credit: €529,733.88.

"K…, S.A." exercised its right of hearing in writing on 13-11-2013, in which it alleges the following:

[content continues with evidence regarding bank overdrafts...]

"K…, S.A." has as its business purpose the production and sale of wines and alcoholic beverages, including the operation of agricultural properties, whether its own or belonging to others, for the purpose of agricultural production, including grapes, and the organization of tourist animation activities and the holding of shareholdings in companies.

In the execution of its activity and in pursuit of the purposes for which it was created, "K…, S.A." is exposed to interest rate risk.

"K…, S.A." entered into derivative financial instruments contracts, for an amount of €50,000,000.00, which had the purpose of hedging interest rate risk.

Through these contracts, the parties agreed that, on the notional amount or theoretical value (€50,000,000.00), "K…, S.A." would pay to the banking entities the product of that amount by the agreed fixed rate and would receive from those same banking entities the product of that amount (notional) by the variable rate.

In the Report and Accounts of "K…, S.A." it is stated that "the Company uses derivative financial instruments with the objective of reducing the interest rate and exchange rate risk to which it is exposed. For this purpose it uses forward sales of foreign currency and interest rate swaps which convert variable rates to fixed rates."

In the item of Financial Costs and Losses (Account 6818000000 – Interest Rate Hedging Forward Fx Interest) was recorded, in fiscal year 2009, the amount of €600,525.69, corresponding to the balance of the interest of "fixed rate paid by K…" and "variable rate paid by the Bank," with respect to the interest rate hedging swap contract referred to.

During fiscal year 2009, the fixed rate was higher than the variable rate, which resulted in payments in the sphere of "K…, S.A."

These costs stem from the fact that "K…, S.A." had fixed the rate to be paid.

"K…, S.A." intended to hedge the risk of reference rates increasing, measured by the amount of the notional contracted, by entering into interest rate swap contracts.

The financial statements as of 31-12-2009 show that debts to credit institutions relating to commercial paper programs were €44,000,000.00, divided between: €24,000,000 short-term, €20,000,000 medium and long-term, and €376,284.00 relating to bank overdrafts used.

"K…, S.A." was a party to the following contracts, which were in effect in the year 2009:

• Contract for opening a multi-purpose credit facility, executed with Bank N…, on 5 September 2001 and amended on 22 May 2002, 15 October 2003, 10 January 2005, 23 June 2006, 14 February 2007, 09 October 2008 and 15 January 2009, with a limit of €10,000,000.00;
• Contract for a deposit account facility and interest rate compensation method, concluded with Bank O…, on 01/01/2003, with a limit of €10,000,000.00;
• Contract for opening a grouped credit facility, concluded with Bank P…, on 29-06-2006, with a limit of €15,000,000.00.

The credits made available under the contracts referred to in the preceding point could be used, up to the contractual limit, by "Q… SGPS, SA" or subsidiaries thereof which were also parties to those contracts.

In addition to "K…, S.A.", 8 (contract referred to in point 20.i.), 2 (contract referred to in point 20.ii.) and 1 (contract referred to in point 20.iii.) subsidiaries of "Q… SGPS, SA" respectively were parties to the said contracts.

The subsidiaries of "Q… SGPS, SA" were jointly and severally liable for the reimbursement of credits that might be used under the contracts referred to, regardless of which specific company had benefited from such credits.

"K…, S.A." identified the hedging operations, in the amount of €50,000,000, in an appropriate model.

Under the various financial contracts referred to above, interest was paid to the third parties that granted them.

In fiscal year 2008, these hedging instruments resulted in "K…, S.A." a taxable income of €547,784.71.

In fiscal year 2007, the same hedging instruments resulted in an income of €22,996.87.

During fiscal year 2009, "K…, S.A." made a donation as an initial endowment of Foundation C…, in the amount of €25,000.00.

"K…, S.A.", pursuant to article 62, paragraph 2 of the EBF, in its Periodic Tax Return Declaration (Form 22) of the IRC, considered that donation as an expense and proceeded to its increase by 20%, in a total of €30,000.00.

The AT understood that the company incorrectly considered the said amount as a fiscally deductible cost.

Foundation C… is a private law institution, without profit purposes, which was constituted on 19 November 2009, with the following purposes:

• The undertaking, support and sponsorship of actions of a technical, promotional, cultural, scientific, educational and training nature that contribute to the development of entrepreneurship and to the modernization and improvement of conditions in the business area;
• The dissemination of knowledge in the area of business sciences, in order to support the community, businesses and businesspeople in responding to the challenges of contemporary society.

Foundation C… was declared on 17 December 2010 to be a foundation of public utility by the Presidency of the Council of Ministers (order 245/2011 of 17-12-2010, DR, 2nd Series, of 06-01-2011).

In article 39/3 of the statutes of Foundation C… it states that "in case of extinction of the Foundation, the destination for its assets shall be fixed as shall be judged most appropriate for the pursuit of the purposes for which it was established, except for goods transmitted, on a gratuitous basis, by C... – Portuguese Business Association which revert to that same association; if this does not exist, the destination shall be fixed as shall be judged most appropriate for the pursuit of the purposes for which the Foundation was established."

The Portuguese Business Association was declared to be an entity of public utility by order of the Prime Minister, of 22 July 1983.

On 27-05-2011, "B…, SGPS, S.A." submitted administrative complaint No. …2011…, seeking to consider the amount of €949,557.80 in field 355 of table 10 of the Individual Tax Return Declaration (Form 22) of the IRC of "K…, S.A." and the Tax Return Declaration (Form 22) of the IRC of the Tax Group, by reference to the IRC for fiscal year 2008.

In the said administrative complaint, "B…, SGPS, S.A." petitioned for the following:

• The consideration of €110,744.83, relating to the R&D tax credit attributed to "K…, S.A."
• The acceptance of €838,812.97, relating to tax benefits of a contractual nature also attributed to K…, S.A."

On 21-11-2012, "B…, SGPS, S.A." was notified of the draft decision of partial dismissal of the aforesaid Administrative Complaint, with the consideration of €110,744.83 being granted, relating to the R&D tax credit, and the acceptance of €838,812.97 being dismissed, relating to tax benefits of a contractual nature.

From the partial dismissal of the administrative complaint, the Petitioner submitted hierarchical appeal No. …2012…, whose examination resulted in the preparation, in DSIRC, of Information No. 2017…, in which the following conclusions/proposals were formulated, endorsed by Order of the General Director, rendered on 09-03-2017, in the said Information:

"B- Return of the proceedings to the Tax Office of Porto so that it may proceed to verify and confirm that the company has fully complied with its contractual obligations, as well as to determine the amounts that are due.

C- In accordance with the principle of exercise specialization provided in article 18 of CIRC, and as established in paragraph 6 of article 5 of Decree-Law 409/99, the deduction that may be due should be accepted in the periods in which the relevant applications were made, that is to say, in the period between 2001 and 2007, with observance of the contractual conditions, notably the relevant applications and the collection attributable to the project."

The Petitioner was notified of the additional IRC assessment No. 2013…, which incorporated the corrections made during the inspection.

From said assessment, the Petitioner submitted administrative complaint No. …2014….

In order to suspend the enforcement proceedings resulting from the failure to pay the additional assessment for fiscal year 2009, the Appellant provided a bank guarantee, in the amount of €784,580.11, bearing the respective costs.

By order of the Tax Office Director of Porto, of 23-10-2015, the Petitioner was notified of the decision dismissing the administrative complaint.

Dissatisfied with the decision, the Petitioner submitted a hierarchical appeal from the decision dismissing the administrative complaint.

By order of 31-05-2017, of the Sub-Director-General, by subdelegation of the Service Division for Corporate Income Tax, Administrative Division, the hierarchical appeal was dismissed as regards expenses with derivative financial instruments, in the amount of €67,543.72 and donations and their increase, in the amount of €30,000.00. With regard to contractual tax benefits, in the amount of €529,733.86, the same were not subject to examination and decision, as they were prejudiced by the dismissal order, of 09-03-2017, rendered in the hierarchical appeal No. …2012….

A.2. Facts Established as Unproven

With relevance to the decision, there are no facts that should be considered as unproven.

A.3. Reasoning of the Factual Matter Proven and Unproven

With respect to factual matters, the Tribunal does not have to rule on everything that was alleged by the parties; rather, it is its duty to select the facts that are relevant to the decision and to distinguish the proven factual matter from the unproven (see article 123, paragraph 2, of CPPT and article 607, paragraph 3 of CPC, applicable by virtue of article 29, paragraph 1, subparagraphs a) and e), of RJAT).

In this way, the facts relevant to the judgment of the case are chosen and delimited in function of their legal relevance, which is established in view of the various plausible solutions of the question(s) of law (see former article 511, paragraph 1, of CPC, corresponding to the current article 596, applicable by virtue of article 29, paragraph 1, subparagraph e), of RJAT).

Thus, taking into account the positions assumed by the parties, in light of article 110/7 of CPPT, the documentary evidence and the procedural file joined to the case, the facts listed above were considered proven, with relevance to the decision, taking into account that, as was written in the Decision of TCA-Sul of 26-06-2014, rendered in case 07148/13, "the evidentiary value of the tax inspection report (…) may have evidentiary force if the assertions contained therein are not challenged."

Allegations made by the parties and presented as facts, consisting of strictly conclusive statements, incapable of proof and whose veracity must be assessed in relation to the specific factual matter consolidated above, were neither proven nor unproven.

B. LAW

At issue in this present arbitral action, as delimited by the Petitioner, is the examination of the legality of the following corrections:

a) correction relating to part of the amount of interest paid under swap contracts, by violation of the provision of article 78 of CIRC;

b) correction relating to tax benefits deducted pursuant to the provision of article 62 of EBF.

Let us examine each of them.

**

With respect to the first of the corrections referred to, as is stated in the Response presented in the case, "the Respondent does not call into question the option for entering into a hedging operation for interest rate risk in order to better protect its interests and ensure operational results, so much so that it does not reject the fiscal deduction of the totality of the interest, merely understanding that, for the hedging of interest rate risk on loans and bank overdrafts, in the amount of €44,376,284.00, it bears expense with interest inherent to swap contracts with a notional or theoretical value of €50,000,000.00, not thereby fulfilling, in the excess part, the concept of symmetric position present in subparagraph a) of paragraph 10 of article 78 of CIRC."

With interest for the decision of the case, article 78 of the applicable CIRC provides:

"1 - In the consideration of revenues or gains and costs or losses relating to derivative financial instruments, except those provided for in the following article, the following must be observed:

a) Where operations are carried out on stock exchanges, in progress at the close of a fiscal year, those revenues or gains and costs or losses are attributable to that fiscal year and determined in accordance with the market value verified on the last day of the same fiscal year in the market in which the operation was effected;

b) Where operations are not carried out on stock exchanges, those revenues or gains and costs or losses are attributable to the fiscal year of the settlement of the corresponding operation, except as to revenues or gains already realized or costs or losses already borne in prior fiscal years.

2 - With respect to the operations referred to in subparagraph a) of the preceding paragraph whose sole objective is to hedge operations to be effected in the following fiscal year, in a market of a different nature and subject to different valuation criteria, the deferral of unrealized gains determined in a fiscal year is permitted, for a maximum of two following fiscal years, to the extent of the unrealized losses still existing in the hedged instrument.

3 - Without prejudice to the provision of paragraph 5, operations that justifiably contribute to the elimination or reduction of real risk arising from a firm commitment, including future commitments to operations carried out in the fiscal year or in prior fiscal years but still in progress, or of a future operation to be carried out with high probability in the following fiscal year, relating to a market of a different nature and subject to different valuation criteria, are considered hedging operations, such that an unquestionable economic relationship is verified between the hedged item and the hedging item and a high correlation between them is quantifiable, so that from such operation the neutralization, total or partial, but substantial, of eventual losses on the hedged item with gains in the hedging operation should be expected.

4 - For purposes of the preceding paragraph, only an operation whose value does not exceed the hedging value considered necessary in view of the correlation existing between the hedging operation and the hedged operation is considered a hedging operation.

5 - The following are not accepted, for tax purposes, as hedging operations:

a) Operations effected as such to hedge risks to be incurred by other persons or entities or by establishments of those carrying out the operations whose revenues are not taxed under the normal taxation regime;

b) Operations effected by investment funds, including funds of funds, venture capital funds, pension funds, insurance companies, credit institutions and other financial institutions, to which articles 8 and 9 are also not applicable;

c) Operations that are not properly identified in an appropriate model.

6 - Non-fulfillment of the requirements referred to in paragraph 3 results, from the date of such non-fulfillment, in the disqualification of the operation as a hedging operation.

7 - If the hedged operation is not effected, to the amount of the tax for the fiscal year in which it would have been effected shall be added the tax that ceased to be assessed by virtue of the provision of paragraph 2, plus corresponding compensatory interest, or, if IRC assessment does not apply, the tax loss declared shall be corrected accordingly.

8 - Without prejudice to the provision of the following paragraph, the deduction of losses determined at the close of a fiscal year, with respect to contracts in progress at the close of that fiscal year, is limited to the amount by which they exceed gains not yet taxed in symmetric positions.

9 - Only costs or losses relating to symmetric positions that are properly identified in an appropriate model, which must be integrated into the tax documentation process referred to in article 121, are deductible.

10 - For purposes of the preceding paragraphs, it is considered that:

a) Symmetric positions are positions in which the values, of capital or income, undergo correlated variations such that the risk of variation of the value of one is compensated by the variation of value, of capital or income in another position, regardless of the nature, location or duration thereof;

b) By position is understood the holding, direct or indirect, of contracts relating to derivative financial instruments, securities, currencies, negotiable debt securities, loans contracted or granted or commitments assumed with respect to these elements."

As is expounded in the Response of the Respondent entity, AT concluded that "the fiscal non-deductibility of expenses with derivative financial instruments (swaps) because the conditions provided for in paragraph 9 of article 78 of CIRC were not met, that is, recognition occurred (accounting and fiscal) of a cost in the amount of €600,525.69, arising from interest rate hedging swaps with a notional amount of €50,000,000.00," since "From the analysis of the accounting elements and Note 49 - Loans Obtained in the annex to the Financial Statements, as of 31.12.2009" the "K…, SA" "maintained debts to credit institutions for commercial paper in the amount of €44,000,000.00, with no correspondence between the value of the hedged operation and the hedging instruments."

The examination of the correctness of the correction in question cannot be carried out without proper understanding and interpretation of the above-mentioned provision of article 78 of the applicable CIRC, on which it is based.

As is well known, and repeatedly affirmed by the doctrine that studies the matter, derivative financial instruments, a recent and complex reality, have multiple purposes, with the purposes of risk management and hedging, investment or speculation and arbitrage standing out.

The said article 78 of the applicable CIRC, whose regime corresponds to the current article 49 also of CIRC, begins by providing that in the consideration of revenues or gains and costs or losses relating to derivative financial instruments, what is provided therein must be observed, setting out two large groups of situations, namely:

a) operations carried out on stock exchanges;
b) operations not carried out on stock exchanges.

With respect to the first group – operations carried out on stock exchanges – the general rule is fixed according to which revenues or gains and costs or losses arising from operations in progress at the close of a fiscal year are attributable to that fiscal year and determined in accordance with the market value verified on the last day of the same fiscal year in the market in which the operation was effected.

With respect to the second group – operations not carried out on stock exchanges – in which the case at hand falls, revenues or gains and costs or losses are attributable to the fiscal year of the settlement of the corresponding operation, except as to revenues or gains already realized or costs or losses already borne in prior fiscal years.

Within the first of the groups referred to, the rule in question continues, in its paragraph 2, specifying that operations – within that first group – whose sole objective is to hedge operations to be effected in the following fiscal year, is permitted, within certain conditions, the deferral of unrealized gains determined in a fiscal year, for a maximum of two following fiscal years.

Paragraph 3 of the rule in question defines those that are considered hedging operations. Note that in the regime established, this definition is only relevant with respect to operations listed in subparagraph a) of paragraph 1, which are those to which paragraph 2 refers, which reserves the possibility of deferral of unrealized gains to operations whose sole objective is hedging.

This delimitation of the scope of hedging operations relevant for purposes of paragraph 2 continues in paragraph 4, which provides that only an operation whose value does not exceed the hedging value considered necessary in view of the correlation existing between the hedging operation and the hedged operation is considered a hedging operation, in paragraph 5 which discriminates three situations in which hedging operations are not accepted for tax purposes as such, and in paragraph 6, which clarifies that non-fulfillment of the requirements referred to in paragraph 3 results, from the date of such non-fulfillment, in the disqualification of the operation as a hedging operation.

Proceeding within the logical systematic of the definition of the terms under which the exceptional regime (in relation to that generally applicable, arising from subparagraph a) of paragraph 1 and paragraph 2) is applicable, paragraph 7 provides that if the hedged operation is not effected, to the amount of the tax for the fiscal year in which it would have been effected shall be added the tax that ceased to be assessed by virtue of the provision of paragraph 2, plus corresponding compensatory interest.

Here arrived, it is necessary to emphasize, for the sake of clarity of the exposition, that all these specifications of the regime in question contained in paragraphs 2 to 7 of article 78 in analysis, relating to hedging operations, are relevant, solely, for purposes of the regime fixed in paragraph 2, basing its ratio legis in the exceptional faculty of deferral of unrealized gains, and in the aspects that the legislator deemed it well to safeguard, so that it would be acceptable to deviate from the rule of subparagraph a) of paragraph 1.

That it is so, leaves no doubt either the conjunction of the succession of preceits in question, or the express mention of paragraph 7, to the tax that ceased to be assessed by virtue of the provision of paragraph 2, a paragraph which, unquestionably, refers to subparagraph a) of paragraph 1.

Following this normative context, paragraphs 8 and 9 of the rule in question provide that, without prejudice to only costs or losses relating to symmetric positions that are properly identified in an appropriate model (which must be integrated into the tax documentation process referred to in article 121) being deductible, the deduction of losses determined at the close of a fiscal year, with respect to contracts in progress at the close of that fiscal year, is limited to the amount by which they exceed gains not yet taxed in symmetric positions.

Finally, paragraph 10 defines what is understood, for purposes of the preceding paragraphs, by "symmetric positions" and by "position."

As has already been seen, it is in this regime enshrined in paragraphs 8 to 10 that the correction now in question is based.

Nevertheless, and as somewhat follows from the exposition just made, and in particular from paragraph 1 of article 78 in question, this regime is of exclusive application to the operations referred to in subparagraph a) of that paragraph 1, that is, to operations carried out on stock exchanges, subject to the general rule according to which revenues or gains and costs or losses arising from operations in progress at the close of a fiscal year are attributable to that fiscal year.

Indeed, from the text of paragraph 8 of article 78 that concerns us, it clearly follows that the limitation on the deduction of losses enshrined therein is restricted to those arising from contracts in progress at the close of the fiscal year.

Now, as has been seen, with respect to the situations subject to the regime of subparagraph b) of paragraph 1 – operations not carried out on stock exchanges – revenues or gains and costs or losses are attributable to the fiscal year of the settlement of the corresponding operation.

Hence, with respect to these, the restrictions, conditions and specialties set out in numbers 2 to 10 of article 78 in question, and concretely, in the three last of those numbers, do not arise.

All of which is well understood, if the regime of article 78 referred to is duly understood in its entirety, a regime which, summarizing the analysis above undertaken, boils down to the fixing of the regime for the consideration of revenues or gains and costs or losses relating to derivative financial instruments, dividing such regime into two groups, corresponding to operations carried out and not carried out on stock exchanges, such that, with respect to the former, revenues or gains and costs or losses are considered continuously, taking into account those arising from contracts in progress at the close of the fiscal year, while with respect to the latter, revenues or gains and costs or losses are attributable to the fiscal year of the settlement of the corresponding operation.

And it is in view of such regime that in paragraphs 2 to 7 an exception is enshrined, within the first group of operations (carried out on stock exchanges), as to unrealized gains, with respect to hedging operations, as defined and with the limitations of the regime established, and that in paragraphs 8 to 10, the deductibility of losses in operations arising from contracts in progress at the close of the fiscal year is limited.

In light of all the foregoing, considering that the regime of paragraphs 8 to 10 of article 78 of the applicable CIRC, on which the correction now in question is based, is not applicable to operations not carried out on stock exchanges, referred to in subparagraph b) of paragraph 1 of the same rule, which is the case, that correction is afflicted by an error of law and should, as such, be annulled, and the arbitral petition is well-founded in that respect.

**

With respect to the correction of €30,000.00, relating to tax benefits deducted pursuant to the provision of article 62 of EBF.

Said amount corresponds to a donation in the amount of €25,000.00, as an initial endowment, which, during fiscal year 2009, K… made to Foundation C…, which was increased, pursuant to the provision of paragraph 2 of article 62 of EBF, by 20% (€5,000.00).

The correction promoted under the inspection action is based on non-compliance with the conditions provided for by paragraph 9 of article 62 of EBF, with AT understanding that "the statutes of the foundation of C… do not provide for the reversion of its assets, neither to the State, nor to the entities covered by article 10 of the IRC Code, in the event of its extinction."

Under subparagraph d) of paragraph 1 of article 62 of the applicable EBF, costs or losses of the fiscal year are considered "donations granted to foundations of exclusively private initiative that pursue predominantly social or cultural purposes, with respect to their initial endowment, under the conditions provided for in paragraph 9."

This said paragraph 9, and for what is relevant to the case, requires, among other things, that "the respective statutes provide that, in case of extinction, the assets revert to the State or, alternatively, be transferred to the entities covered by article 10 of the IRC Code."

This article 10 of CIRC, in its applicable version, refers to the following entities:

a) public bodies of administrative utility;
b) private social security institutions and related entities, as well as legal entities legally assimilated to those;
c) legal entities of mere public utility that pursue, exclusively or predominantly, scientific or cultural purposes, charity, assistance, beneficence, social solidarity or environmental protection.

As results from the proven facts, Foundation C… is a private law institution, without profit purposes, which was constituted on 19 November 2009, with the following purposes:

a) The undertaking, support and sponsorship of actions of a technical, promotional, cultural, scientific, educational and training nature that contribute to the development of entrepreneurship and to the modernization and improvement of conditions in the business area;

b) The dissemination of knowledge in the area of business sciences, in order to support the community, businesses and businesspeople in responding to the challenges of contemporary society.

The statutes of Foundation C…, as relevant to the case, provided that "in case of extinction of the Foundation, the destination for its assets shall be fixed as shall be judged most appropriate for the pursuit of the purposes for which it was established, except for goods transmitted, on a gratuitous basis, by C... – Portuguese Business Association, which revert to that same association; if this does not exist, the destination shall be fixed as shall be judged most appropriate for the pursuit of the purposes for which the Foundation was established."

The Petitioner objects to the correction now in question, arguing that C… is an entity of public utility and the entities to which the assets shall be transferred pursue the purposes for which the Foundation was established, and thus shall also be of public utility.

As also results from the proven facts, Foundation C… was declared on 17 December 2010 to be a foundation of public utility by the Presidency of the Council of Ministers (order No. 245/2011 of 17-12-2010, DR, 2nd Series, of 06-01-2011) and the Portuguese Business Association was declared to be an entity of public utility by order of the Prime Minister, of 22 July 1983, DR, 2nd Series, of 10-08-1983.

Although the Petitioner does not expressly refer to it, it must be arguing its understanding on the basis of subparagraph c) of paragraph 1 of article 10 of the applicable CIRC, considering that from the Statutes of Foundation C… it follows that, in case of extinction thereof, the assets will revert to legal entities of mere public utility that pursue exclusively or predominantly scientific or cultural purposes, charity, assistance, beneficence, social solidarity or environmental protection.

With respect due, it is considered that the Petitioner is not correct.

Indeed, article 10 of the applicable CIRC, and in particular subparagraph c) of its paragraph 1, does not simply refer to legal entities of public utility, but to those among these that pursue, exclusively or predominantly, scientific or cultural purposes, charity, assistance, beneficence, social solidarity or environmental protection.

Now, from the outset, it is not demonstrated that C…, to whom the assets transmitted by it to Foundation C… shall necessarily revert, is an entity that pursues, exclusively or predominantly, scientific or cultural purposes, charity, assistance, beneficence, social solidarity or environmental protection.

This would, in itself, be sufficient to condemn to failure the Petitioner's claim, since paragraph 9 of article 62 of the applicable EBF presupposes that the entire assets of the beneficiary of the donation, upon its extinction, transfer to the State or to some of the entities referred to in article 10 of CIRC, which, from the outset, as regards the assets coming from C…, is not verified.

On the other hand, the Petitioner's argument cannot be validated by the fact that, it is provided for in the statutes of Foundation C… that the remaining part of its assets shall, in case of extinction, be transferred to entities that pursue the purposes for which the Foundation was established, entities which shall necessarily be of public utility.

Indeed, this reasoning shall fail, with respect due, at three levels, namely:

• The statutes refer that in case of extinction, to the assets of the Foundation that did not originate from C…, shall be given "the destination which shall be judged most appropriate for the pursuit of the purposes for which it was established," not defining the type of beneficiary of such assets, but only a purpose ("destination") underlying the determination thereof;

• Even if it were defined that the assets would be transferred to an entity that pursued the purposes that Foundation C… pursues, it does not necessarily follow therefrom that such entity would have to have public utility status, since this status is not a necessary consequence of the pursuit of those purposes;

• And even if it were not so, that is, if it resulted from the statutes of Foundation C… that the beneficiary entity of its assets in case of extinction would have to have public utility status, it would still be necessary that it therefrom resulted that such entity pursues exclusively or predominantly scientific or cultural purposes, charity, assistance, beneficence, social solidarity or environmental protection.

The Petitioner further alleges that "the existence of a relationship of economic causality between the costs and losses borne and the possibility of obtaining revenues subject to IRC is sufficient evidence of the fiscal deductibility of the expenses borne," since "being the founder of an entity of public utility with the objectives, image and visibility of Foundation C… constitutes a vehicle for disclosing to the market the values and mission of K…, which naturally encompass the social responsibility that K… has always demonstrated" and "The status of socially responsible company is extremely relevant to the management of K…, and it is intended that this solidarity profile continues to be observed by its stakeholders (namely, customers and suppliers)."

It is, however, considered that such argumentation is unfounded, in that liberalities are expressly excluded from the calculation of taxable profit, pursuant to paragraph 1, subparagraph a) of article 24 of the applicable CIRC, and article 62 of EBF, constituting a special regime in relation to that general rule, establishes requirements which, in the case and as has been seen, were not observed.

Finally, the Petitioner alleges that "the interpretation by AT of the scope of the aforementioned rules is not, in the understanding of the Appellant, coherent, reasonable, or conducive to the contribution of companies to entities of public utility, and therefore, on the one hand, does not serve the objectives of fiscal efficiency and equity and, on the other hand, does not serve the purpose of increasing the social contribution of companies residing in Portuguese territory."

Such considerations, however, shall only have relevance de iure condendo, and in light of the established law, the legislator's choice was the one referred to – not to accept liberalities as relevant to the formation of taxable profit, except in the cases and observing the requirements duly regulated in law – and such choice is neither demonstrated to be, nor does the Petitioner allege, violative of any constitutional principle that would be imposed on the formulation of legislative commands.

In this way, considering that, in the case, the condition prescribed in paragraph 9 of article 62 of EBF is not verified, as was considered in the tax act examined, the correction in question should be maintained, and the arbitral petition is not well-founded in this respect.

**

The Petitioner finally petitions for recognition of the right to compensation for costs borne with the guarantee provided.

The arbitral decision on the merits of the claim for which no recourse or challenge lies binds the tax administration from the end of the period provided for recourse or challenge, and this must, in the exact terms of the success of the arbitral decision in favor of the taxpayer and until the end of the period provided for the voluntary execution of the sentences of tax courts, restore the situation that would have existed if the tax act subject of the arbitral decision had not been practiced, adopting the acts and operations necessary for such purpose, as expressly results from subparagraph b) of article 24 of the RJAT.

In the same precept "the legislator made clear that the effects provided for therein are 'without prejudice to the other effects provided for in the Code of Tax Procedure and Process.' It is considered in this regard that the legislator is here referring to all the effects that arise from CPPT for the taxpayer, and which are applicable after the consolidation in the legal order of a certain legal-fiscal situation, arising from a final decision whether gracious or judicial."

Notwithstanding the judicial challenge process being essentially a process of mere annulment, therein may be rendered condemnation of the Tax Administration to payment of compensation for undue guarantee, as results from article 171 of CPPT.

As was referred in the decision rendered in Case No. 28/2013-T "it is unequivocal that the process of judicial challenge encompasses the possibility of condemnation to payment of undue guarantee and moreover is, in principle, the appropriate procedural means to formulate such petition, which is justified for obvious reasons of procedural economy, since the right to compensation for undue guarantee depends on what is decided about the legality or illegality of the assessment act. The petition for constitution of the arbitral tribunal has as a corollary that it is to be in the arbitral process that the 'legality of the executable debt' will be discussed, and therefore, as results from the express tenor of that paragraph 1 of the said article 171 of CPPT, it is also the arbitral process that is appropriate for examining the petition for compensation for undue guarantee."

It is concluded thus that this Tribunal is competent to examine the petition for compensation for guarantee improperly provided.

The regime of the right to compensation for undue guarantee consists of article 53 of LGT, which establishes the following:

"1. The debtor who, in order to suspend execution, offers a bank guarantee or equivalent shall be indemnified totally or partially for the damage resulting from its provision, if the debtor has maintained it for a period of more than three years in proportion to the outcome in administrative appeal, challenge or opposition to execution that have as their object the debt guaranteed.

1. The period referred to in the preceding paragraph does not apply when it is verified in administrative complaint or judicial challenge that there was error attributable to the services in the assessment of the tax.

2. The indemnification referred to in paragraph 1 has as its maximum limit the amount resulting from the application to the guaranteed value of the indemnificatory interest rate provided for in this law and may be requested in the administrative complaint or judicial challenge itself, or autonomously.

3. Indemnification for provision of undue guarantee shall be paid by deduction from the revenue of the tax in the year in which payment is made."

In the case at hand, it is manifest that the error with which the assessment act is afflicted, above detected, relating to interest paid under swap contracts, is attributable to the Respondent entity, since the assessments were of its initiative and the Petitioner in no way contributed to such error being practiced.

The Petitioner has, therefore, the right to compensation for the guarantee provided, with reference to the amount whose annulment has been determined and is not yet paid.

However, the expenses that the Petitioner bore for providing the guarantee were neither alleged nor proven, so it is not feasible to fix here the compensation to which it is entitled, which may only be effected in execution of this decision.

**

C. DECISION

In view of all the above, this Arbitral Tribunal decides to render the arbitral petition partially well-founded and, as a consequence:

• To annul the act of additional IRC assessment No. 2013…, for fiscal year 2009, in the part relating to the correction concerning interest paid under swap contracts, as well as the act of dismissal of the administrative complaint No. …2014…, which had the said assessment act as its object, and the act of dismissal of the hierarchical appeal which had the aforementioned as its object, to the extent that they maintained the said part of the assessment;

• To condemn the Respondent to the payment of compensation for undue guarantee, with reference to the value now annulled, in the amount to be fixed, if necessary, in execution of sentence;

• To condemn the parties in the costs of the proceedings, in the measure of their respective non-success, fixing in €847.00 the part charged to the Petitioner, and in €1,907.00 the part charged to the Respondent.

D. Value of the Proceedings

The value of the proceedings is fixed at €87,543.72, pursuant to article 97-A, paragraph 1, a), of the Code of Tax Procedure and Process, applicable by force of subparagraphs a) and b) of paragraph 1 of article 29 of RJAT and paragraph 2 of article 3 of the Regulations on Costs in Tax Arbitration Proceedings.

E. Costs

The amount of the arbitration fee is fixed at €2,754.00, pursuant to Table I of the Regulations on Costs of Tax Arbitration Proceedings, to be paid by the parties, in proportion to their respective non-success, as fixed above, since the petition was partially successful, pursuant to articles 12, paragraph 2, and 22, paragraph 4, both of RJAT, and article 4, paragraph 4, of the cited Regulations.

Let it be notified.

Lisbon, 16 April 2018

The President Arbitrator

(José Pedro Carvalho)

The Arbitrator Vogal

(Rui Ferreira Rodrigues)

The Arbitrator Vogal

(Jorge Bacelar Gouveia)