IRC Deductibility of Costs Under Article 23 CIRC: CAAD Arbitration on Corporate Tax Assessment 2009

ARBITRAL DECISION

REPORT

1. A…, S.A., Legal Entity No. …, with registered office at …, …, …, in its capacity as incorporating company of the company B… SGPS, S.A., Legal Entity No. …, with registered office in the place of …, No. …, …, filed a request, pursuant to Article 10 of Decree-Law No. 10/2011 of 20/01, for the constitution of the Arbitral Tribunal, in which the Tax and Customs Authority (hereinafter, Respondent or TA) is named respondent, regarding the Order Dismissing the Hierarchical Appeal, as well as, consequently, the prior acts, namely the additional assessment of Corporate Income Tax, No. …, of July 2013, relating to the fiscal year 2009.

2. The request for constitution of the arbitral tribunal was accepted by the Chairman of CAAD and automatically notified to the Tax and Customs Authority on 4-8-2017.

3. In accordance with Articles 5(2)(a), 6(1) and 11(1) of the RAAT, the Deontological Council of this Administrative Arbitration Center (CAAD) appointed as sole arbitrator Professor Doutor Jónatas Machado, who accepted the assignment on 17-10-2017.

4. The parties were duly notified of this appointment, to which they did not lodge any objection pursuant to the combined provisions of Articles 11(1)(b) and (c) and 8 of the RAAT and Articles 6 and 7 of the Deontological Code of CAAD.

5. By virtue of the provision in Article 11(1)(c) and (8) of the RAAT, as per the communication from the Chairman of the Deontological Council of CAAD, the Arbitral Tribunal was constituted on 9.11.2017.

Description of Facts

1. In the request for arbitral pronouncement, A… (hereinafter referred to as the Claimant) requested the annulment, on grounds of illegality, of the Order of the Assistant Director General, acting under delegation of authority, of 19/05/2017, of the Corporate Income Tax Service Directorate, Administration Division, which Dismissed the Hierarchical Appeal, No. …2014… as well as the Order of express partial dismissal of the Administrative Complaint No. …2013…, of 7/4/2014, and the additional assessment of Corporate Income Tax ("CIT") No. ….

2. This results, after offsetting, in an amount payable of € 623.528,63, relating to the fiscal year 2009 (Document 2), embodying a correction to the Claimant's taxable base in the amount of € 201.239,41, increasing it from € 8.141.349,82 to € 8.342.589,23. This additional assessment was issued following the Tax Audit Report (hereinafter Report B…) prepared during the analysis of the Corporate Income Tax return (Form 22) of the Group of Companies. In the case at hand, the correction made to the taxable base of the group of companies is contested, resulting from the correction made in the amount of € 23.165,71 to the declared fiscal loss of company C…, S.A. (C…), for costs recorded (considered for tax purposes) and non-deductible for the purposes of determining the fiscal result (Article 23 of the CITC).

3. More specifically, the issue is circumscribed by the Tax Audit Report to the amount of € 18.985,23 recorded in 2008 as costs and financial losses. At issue is, from the Claimant's perspective, the fact that the contested Corporate Income Tax assessment and administratively appealed is subject to an error regarding the assumptions surrounding Article 23 of the CITC, and should therefore be annulled regarding the adjustments impugned. Also requested was the condemnation of the Tax Authority to pay compensation for the guarantee improperly provided.

4. The TA, pursuant to Article 17 of the RAAT, filed on 18.12.2017 the administrative proceedings and its Response to the Claimant's request for arbitral pronouncement, wherein it argues that the claim should be judged unmeritorious, as not proven, the present proceedings remaining in the legal order as the impugned tax acts, and the Respondent accordingly absolved of the claim.

Arguments of the Parties

1. The arguments and counter-arguments advanced by the parties concern, fundamentally, the interpretation and application to the specific case, regarding the fiscal period in question, of the provision then contained in Article 23(1) of the CITC, which established as follows:

"Expenses are those which are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the source of production (…)."

1. To support its position, the Claimant alleges that the contested assessment is subject to an error regarding the factual and legal assumptions, in view of the fact that:

• It is not the responsibility of the Respondent to control the business management of the Claimant;

• Article 23 of the CITC does not make the deduction of costs dependent upon the prior existence of operating income in the fiscal year;

• The fact that C… (whose corporate purpose is the purchase and sale of real property) has not sold the two real properties of which it is the owner does not mean the absence of activity, but merely that it is awaiting more favorable market conditions;

• The loans obtained by C… from its shareholder D… (€ 330.000,00 in 2001, € 490.000,00 in 2007 and € 150.000,00 in 2009), by way of supply agreements, were intended, inter alia, to cover cash shortfalls and to provide it with the financial means necessary for the normal development of its activity, namely payment of: interest related to the loans, Municipal Property Tax ("MPT"), suppliers and audit, accounting and advertising services;

• C… presents an annual average loss of € 23.245,00;

• There is not, in conclusion, a disproportionality between operating costs and the loans obtained.

1. To the contrary, the Respondent's argument is based on the following topics:

• In Article 23 of the CITC the tax legislator did not establish an absolute correspondence between, on the one hand, accounting costs and, on the other, tax costs, but instead adopted a model of partial dependence that takes as a reference point the accounting standards and the accounting result, to subject it to extraaccounting adjustments.

• Indispensability is not assessed according to a cause-and-effect relationship between costs and income – which would require that only costs for which an objective connection with income could be established could be considered deductible.

• Indispensability should be assessed in a negative manner, understanding that costs which do not have a causal and justified relationship with the enterprise's productive activity are not indispensable.

• The Respondent may disregard expenses declared by taxpayers if and when it appears from its inspection control that the costs (actual) do not have the potential to generate an increase in earnings, regardless of the result (positive or negative) which they produced.

• In light of the rules of experience, there is a manifest disproportionality between the amounts loaned (€ 330.000,00 in 2001, € 490.000,00 in 2007 and € 150.000,00 in 2009) and the operating costs incurred, and equally relevant is the non-payment of salaries to employees and the low amount of MPT paid in 2007, 2008 and 2009, which never amounts to € 6,000.

• The loans contracted are manifestly excessive in relation to the financing needs required by the normal development of an enterprise's activity that only has 2 real properties for sale and intends only to "keep the doors open."

• The loans were not used, for example, in the acquisition of other real properties (that is, in pursuit of their respective corporate purpose), which, in fact, would be an act of management potentially capable of generating possible earnings in a future sale.

• The disproportionality between the amounts loaned and the costs incurred makes it clear that expenses for interest on loans obtained are not suited to the productive structure of the Claimant and to the obtaining of profits.

• The expense recorded as interest on loans obtained, in the amount of € 18.985,23, should not therefore be deductible for the purposes of determining the fiscal result of the year 2009 because it is not demonstrably indispensable for the realization of receipts or income subject to CIT.

• The Claimant merely engages in theoretical discourse on Article 23 of the CITC and provides general and abstract justifications, without minimally demonstrating the necessity of contracting substantial loans for the diminutive activity developed and without justifying the potential associated with the enormous available monetary mass.

• The Claimant does not meet the burden of proof acknowledged and affirmed by the Judgment of the Central Administrative Court of the South, issued on 2004-11-30 in the proceedings No. 07375/02, according to which:

"As regards the qualification of the sums recorded as deductible costs, it falls upon the taxpayer to bear the burden of proof of their indispensability for the obtaining of the receipts or for the maintenance of the productive force, if the TA questions with foundation that indispensability."

• It is not sufficient to point to an annual average loss of € 23.245,00 to justify the contraction of substantial loans to cover losses over 14 years, since this suggests that when the enterprise evaluated the decision to contract those loans it already knew in advance that it did not truly intend to develop its activity, but merely to "keep the doors open."

Arbitral Hearing pursuant to Article 18 of the RAAT

1. On 22 January 2018, at the headquarters of CAAD, the arbitral hearing provided for in Article 18 of the RAAT took place, chaired by the designated arbitrator and secretaried by Dr. António Fontoura de Oliveira, Legal Advisor of CAAD, with a proper record being made of the proceedings now on file. Under oath, the testimony of the four witnesses called by the Claimant was heard, and they were examined by Ms. E…, Counsel for the Claimant, and by Drs. F… and G…, Legal Advisors representing the Director General of the Tax and Customs Authority. Specifically, H…, current administrator of the Holding and of almost all companies in the group, I…, certified accountant of C…, J…, financial director of the B… group and K… (questioned via Skype), who provided services to the B… group.

Final Submissions

1. In its submissions, the Claimant summarized the testimony of the witnesses and reiterated the legal grounds presented in the initial petition.

2. The Respondent maintained without reservation everything it had argued in the response timely submitted and, furthermore, argued that in the event of success of the action, the request for annulment made by the Claimant could never result in a total annulment of the assessment sub judice, but at most in a partial annulment of the assessment in question. The Respondent emphasized that the entire request for arbitral pronouncement is centered on the discussion of the correction made by the Respondent to the taxpayer C…, S.A. ("C…"), in the amount of € 23.165,71 (cf. Articles 11 et seq. of the initial petition), more specifically, in the disregard of expenses recorded as interest on loans in the amount of € 18.985,23 – amount attributed to the request for arbitral pronouncement itself, despite affecting the assessment only in the amount of € 5.384,11 (as per simulation filed on 2-2-2018).

CASE MANAGEMENT

1. No exceptions were raised.

2. The Arbitral Tribunal is regularly constituted (Articles 5(1) and (3)(a), 6(2)(a) and 11 of the RAAT), and is materially competent (Articles 2(1)(a) of the RAAT).

3. The parties possess legal personality and capacity and are duly represented.

4. The proceedings are not affected by any defects, nor were any exceptions raised, and the proceedings may proceed to a decision on the merits of the case.

5. It being the responsibility of the arbitrator to determine the value of the case, without prejudice to the duty of indication incumbent upon the parties, case management appears appropriate for this purpose, pursuant to Article 306(1)-(2) of the CCP, as applied by virtue of Article 29(1)(e) of the RAAT. It follows from subsection (a) of Article 97(A)(1) of the Code of Tax Procedure and Process, under the heading of value of the case, that the value to be considered when an assessment is impugned is that of the amount whose annulment is sought. Now, although the disregard of expenses recorded as interest on loans contracted by company C… in the amount of € 18.985,23 – amount attributed to the request for arbitral pronouncement by the Claimant – is at issue, the truth is that it only affects the value of the assessment whose annulment is sought in the amount of € 5.384,11, being this latter amount corresponding to the economic benefit to be obtained if the present action succeeds. For this reason, the value of the case is fixed at € 5.384,11.

GROUNDS

Facts Established as Proven

1. Based on Documents 1 to 9 filed in the record and the testimony of the witnesses, and without prejudice to other accessory facts related to them contained in the file, the following relevant facts are established as proven for the decision of the case at hand:

• The Claimant company – A…, S.A. – in the course of a merger by absorption, incorporated company B… Holding SGPS, S.A., being the dominant company of the group.

• Company C… was established in 1995, being held 100% by D….

• In 2007 company C… had two real properties in its assets, urban property No. … and urban property No. …, both located in the parish of …, Porto.

• Urban property No. … was acquired as a contribution in kind in 1995 (€ 712.216,53) and property No. … was acquired by sale and purchase in 1996 for the amount of € 36.670,16.

• The Management of C… made the management decision to sell the lots only when an investor interested in offering the price which it considers to be due, in terms of market value, appears (cf. testimony of witness H…).

• Despite making efforts in that direction, until 2009 C… had not yet sold any of the lots of which it was the owner, a situation which continues to the present (cf. testimony of witness H…).

• Since its establishment, company C… did not generate receipts or income, although it bore the costs necessary to maintain its activity, which led it to a deficit situation.

• Among those costs are those necessary for the acquisition of urban property … in 1996, and those related to MPT, accounting and audit services, appraisals of the real properties and real estate promotion (cf. testimony of witnesses H…, I… and J…).

• C… contracted loans from its shareholder, D…, through medium/long-term supply agreements, in the amount of € 330.000,00 in 2001 and € 490.000,00 in 2007.

• The loan in the amount of € 330.000,00 was to be repaid in full in 366 days, but was instead automatically extended for equal successive periods as provided in the supply agreement, and was amortized in 2007.

• The loan contracted in 2007, in the amount of € 490.000,00 was used for the repayment of the loan of € 330,000.00 contracted in 2001, and to pay the accumulated bank overdraft in the amount of € 130,500.00.

• The amount outstanding in 2009 was € 410,000.00, a new loan being contracted in the amount of € 150.000,00 in that same year.

• C… presents an annual average loss of € 23.245,00.

• C… did not proceed to pay salaries to employees (Document 1).

• The amounts of MPT demanded were € 5.774,55 in 2007, € 5.052,73 in 2008 and € 5.242,21 in 2009 (Documents 2, 3, and 4).

• The Claimant provided bank guarantee up to the limit of € 793,760.91 (Document 3).

Facts Not Proven

1. With relevance to the decision on the merits there are no alleged facts which should be considered as not proven, without prejudice to the fact that expenses incurred in the provision of bank guarantee were not proven.

REASONING

Established Facts

1. With regard to the factual matter, the Tribunal does not have to rule on everything that was alleged by the parties, it being incumbent on it to select the facts which matter for the decision and distinguish the proven facts from the unproven (cf. Article 123(2) of the CTPP and Article 607(3) of the CCP, applicable by virtue of Article 29(1)(a) and (e) of the RAAT).

2. The relevant facts for the trial of the case are selected and delimited in accordance with their legal relevance, which is established with reference to the various plausible solutions to the questions at issue in the dispute (Article 596(1) of the CCP, as applied by virtue of Article 29(1)(e) of the RAAT).

3. Thus, having regard to the positions assumed by the parties and the documentary evidence filed in the record, combined with the testimonial evidence produced, the facts listed above were considered as proven, with relevance to the decision.

Question to be Decided

1. The question to be decided relates to the correction made by the TA to the taxpayer C…, S.A. (C…), in the amount of € 23.165,71, more specifically, the disregard of expenses recorded as interest on loans in the amount of € 18.985,23 – amount attributed to the request for arbitral pronouncement. This is the scope of the matter to be decided and it is naturally upon it that the final decision will focus. The same refers to the interpretation and application, as of the date of the fiscal period at issue, of the provision contained in Article 23(1) of the CITC, which established as follows:

"Expenses are those which are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the source of production (…)."

1. The positions being known, in this regard, manifested by the Claimant and the Respondent, it should be emphasized that this provision should be interpreted and applied within the framework of the legal and economic logic underlying the CIT. This is a tax on profits, that is, on net profit and not on gross receipts, and therefore expenses linked to the generation of taxable income must be deducted in order to calculate the net profit which should be taxed. There applies here the general principle that, relative to each source of income, the costs incurred for its obtaining are deducted.

2. From the literal tenor of Article 23(1) of the CITC it is clearly inferred that for a cost to be fiscally deductible it is necessary to be faced with actual expenses. This point appears uncontroversial and is not even in dispute. It also follows from the provision under analysis that it is not absolutely necessary that the expenses be demonstrably indispensable for the realization of income subject to tax. Deductibility also occurs if the expenses are demonstrably indispensable for the maintenance of the source of production.

3. There results from this an important consequence for the decision of the specific case: implied in the wording given to Article 23(1) of the CITC is the understanding that the deduction of interest on loans contracted by C… cannot dispense with an analysis of the use of the credit obtained within the context of its respective economic activity. Thus it is, having regard to the legislative intent of this type of provision, linked, in particular, to the principles of separation between company and shareholders (and directors) and preservation of the tax base, both closely related.

4. The assurance of these two principles requires verification, on the part of the TA, of the presence of a rational and objective business and economic foundation for the transactions and redoubled attention in the face of detection of any significant deviation from the pattern of usual transactions. This verification is relevant for the purpose of dispelling the presumption of truth and good faith of the statements of data and determinations recorded in the accounting or accounts, when these are organized in accordance with commercial and tax legislation, to which Article 75(1) of the GTL refers, within a framework of cooperation between the TA and the taxpayer[1]. In matters of distribution of the burden of proof, it may be said that the taxpayer has the burden of producing adequate accounting information, whereas the TA has the burden of persuasion that the recorded transactions do not have objective economic foundation[2]. In the face of that presumption of truth and good faith, and as results from Article 74(1) of the GTL, it shall fall to the TA to bear the burden of proof of any fact constitutive of any rights which may be available to it[3].

5. The SAC[4] has held that "it is the responsibility of the Tax Administration to bear the burden of proof of the prerequisites of its right to make corrections, demonstrating the factuality which led it to disregard a recorded cost or to alter its value, factuality which must be capable of undermining the presumption of veracity of the operations contained in the taxpayer's accounts and their supporting documents, having regard to the principle of statement and veracity of the accounts in force in our law (Article 75 of the GTL and Article 78 of the TPC), only then does it become the responsibility of the taxpayer to bear the burden of proof that those costs are fiscally relevant, that is, that they were actually borne and that they were indispensable for the realization of the receipts or income subject to tax or for the maintenance of the source of production."

6. The tax provisions intend to harmonize the normal development of industrial, commercial and agricultural activity, in accordance with the standards and criteria generally accepted as normal and economic rationality, with the constitutional and legal objective of preservation of the tax base. If the TA detects a significant deviation from the standard of normality and habituality of the deducted expenses, it has the duty to question those expenses, then passing to the taxpayer the burden of demonstrating, on the basis of a criterion of preponderance of evidence (burden of persuasion)[5], the fulfillment of the prerequisites of indispensability of the same, pursuant to Article 23 of the CITC. In this sense, the TA acted appropriately in scrutinizing the transactions at hand, although it did not succeed in demonstrating that the conclusions it reached were well-founded.

7. The teleological interpretation of Article 23(1) of the CITC refers to the appreciation of the economic substance of the supply agreements in question[6]. And this necessarily requires recognition, by the jurisdictional review authorities, of a reasonable margin of subjectivity and discretion to the TA. However, that discretion is limited, pursuant to Article 55 of the GTL and Article 266(2) of the Portuguese Constitution, being subject, in particular, to the principles of legality, rationality, proportionality in the broad sense and legal certainty and protection of citizens' legitimate expectations[7]. It is also strongly conditioned by the justice of the specific case, having regard to its respective factual particularities and specificities.

8. In the abstract, the absence of economic substance of the transactions may be sufficient to prevent a deduction when it does not conform to economic and tax principles generally accepted by the legislator[8]. It may occur that an expense claiming deductibility intends to conceal a distribution of profits or a payment of salaries. In that purely abstract perspective, the mere fact that the creditor is taxed on the interest received or that the interest can be viewed as a negative income of the debtor does not mean that the latter can automatically deduct the interest paid to the creditor[9]. The attention paid by the TA to this type of transaction is entirely justified, from the point of view of the principles of tax legality. However, the answer to the question of deductibility must necessarily be sought and found through an analysis of the specific case.

9. First, it is important to inquire whether the interest paid by C… corresponds, in light of the wording then contained in Article 23(1) of the CITC, to expenses demonstrably indispensable for the realization of income subject to tax. This wording points to the deductibility of expenses that objectively have an ordinary and normal connection with business activity and the inherent production of taxable profits, in accordance with the principle of taxation of net profit (Nettoprinzip), embodied in Article 23 of the CITC, which implements the taxation of actual income. One seeks to know whether the expenses incurred are, in accordance with business practices considered normal, reasonably apt or suited to generate taxable income, even if in the end, for reasons of various nature arising from the circumstances, their realization ultimately does not occur. Such wording points to the recognition, to the businessman, of a reasonable margin of maneuver in the decision regarding expenses to incur, depending on changing circumstances, and which may prove to be deductible as tax costs even those expenses which, in concrete terms, prove to be unsuccessful and unproductive.

10. That margin of maneuver is not unlimited – in particular in light of the principles of separation between company and shareholders and preservation of the tax base – and does not encompass expenses foreign to the normal process of realization of income subject to tax, in accordance with the normal criteria of economic activity. If assessed in the abstract and solely on the basis of this perspective, perhaps it would not be immediately clear that the loans obtained by C… through supply agreements could be considered adequate and necessary for the obtaining of profits in light of what corresponds to the normal exercise of economic activity. Beyond the immediate benefit of the deduction of interest, the transactions under analysis did not create any reasonable possibility of immediate obtaining of profits. That is to say, they could not be considered demonstrably indispensable for the realization of income subject to tax. In any event, it would have been the responsibility of the TA to demonstrate it, in light of Article 74(1) of the GTL.

11. Differently is the case with the inquiry, which must be made in the second place, as to whether the interest paid corresponds to expenses demonstrably indispensable for the maintenance of the source of production, pursuant to the wording of Article 23(1) of the CITC. The literal tenor of this provision has underlying it the notion, broadly recognized by the tax legislator, that in the life of commercial companies and groups of companies there are various types of operations, such as transformations, mergers, divisions or liquidations, which, although they do not in themselves generate any reasonable expectation of immediate realization of income subject to tax, nonetheless retain all commercial sense, from the point of view of economic rationality and the pursuit of business interest.

12. In the case of the supply agreements in question, and the interest to whose payment they gave rise, the fact that they do not in the abstract generate any reasonable expectation of profit does not mean that, in concrete terms, they are shown to be devoid of economic rationality from the point of view of maintenance of the source of production. It is clear that a definitive judgment on that economic rationality cannot be obtained solely by reference to a jurisprudential orientation[10] or to doctrines of a tax-legal nature, but should instead take into account the factual specificities of the specific case. These are what, when assessed under the point of view of the normal standards of economic activity and the criterion of the prudent and conscientious administrator, will allow distinction, case by case, between expenses incurred in the collective interest of the enterprise and expenses incurred in the individual interest of a shareholder, a group of shareholders or third parties[11].

13. The assessment of the normality, adequacy and economic necessity of a given transaction, from the point of view of a commercial company or a group of companies, depends largely on the economic and financial context in which it is carried out. That assessment cannot be carried out in the abstract or in a vacuum. The same transaction may make no commercial sense in a context of economic growth and be entirely reasonable, from a business point of view, within a prolonged framework of depression, recession, contraction or deflation. Similarly, a debt of the same amount can be considered absolutely unnecessary, excessive and deviant when contracted by an overcapitalized enterprise or adequate, necessary and normal when the debtor is an undercapitalized enterprise. In certain economic contexts, the lines distinguishing the normal from the abnormal and the ordinary from the extraordinary become blurred.

14. In the specific case, on the one hand, in the scenario of economic and financial crisis experienced from the end of 2007, a fact public and notorious by all accounts[12], the restrictions on credit then experienced by enterprises (as well as by families and the State), to which corresponded an increased cost, made intra-group loans a business financing option endowed with indisputable economic rationality. On the other hand, the significant cooling of the real estate market considerably hindered the sale of the real properties at a fair and adequate price[13]. In that context, whoever, such as company C…, held real estate assets for sale and did not have an absolute necessity to sell them at any price, would be better off waiting for a moment economically more propitious to the transaction, risking having to realize significant losses, predictably larger than the expenses incurred (e.g., MPT) for the maintenance of the source of production.

15. This would necessarily imply resorting to external financing to cover existing debts, including the accumulated bank overdraft, and expenses predictably to be incurred in the future, namely those which could result from an expected revaluation of the real properties. This was exactly what occurred. What was at issue was an enterprise that since its establishment had presented no profit. The loan contracted in 2007, in the amount of € 490.000,00 was used for the repayment of the loan of € 330,000.00 contracted in 2001, and to pay the accumulated bank overdraft, a reinforcement of financing of € 150.000,00 being necessary in 2009.

16. Viewed in this context, the loans contracted by C… cannot be considered excessive or deviant from the point of view of realistic and prudent management, attentive to the concrete circumstances of the present and the uncertainties of the future. Similarly, they were not used for any purposes other than satisfying C…'s financing needs. They allowed the preservation of ownership of the real estate assets until the moment when they could be transacted generating capital gains (taxable). In either case, the TA did not prove the contrary, it not being sufficient to allege in the abstract that the loans were excessive.

17. The factual specificities of the specific case, viewed in a holistic and contextual manner, permit characterizing the preservation, by company C…, of ownership of two real properties during a considerable period of time as effective exercise of an economic activity and at the same time linking the supply agreements and that same activity and to C…'s corporate purpose, from the point of view of the principle of specialty of legal entities. Still, this was a transaction of risky outcome, considering the uncertainties which then still hovered over the national economy.

18. The maintenance of real estate assets in portfolio during a considerable period of time by a company that resorts to financing and is not in a position to capitalize the interest inevitably ends up generating annual financial charges which could come to result in aggravated taxation, in relation to the contributory capacity generated, having regard to the temporal limits of tax carryforwards and the absence of total solidarity between fiscal years. This also weighs in favor of the deduction of interest in the specific case, since the justification for this type of deductions normally goes hand in hand with the assumption of economic risk[14].

19. The economic effect of the supply agreements consisted, in the specific case, not in the fact that they were immediately potentially generating profits, but in the circumstance of allowing C… to preserve its real estate assets and await the possible reversal of the economic and financial circumstances then marked by a pronounced crisis, contributing mediately to the obtaining of income in the future. In this sense, the transactions at hand can still be traced back to what constitutes the normal exercise of economic activity in accordance with generally accepted standards, even though within a recessionary or even depressionary framework. They are suited to the pursuit of the collective interest of the company, within a struggle to overcome serious economic difficulties encountered. The concept of indispensability for the maintenance of the source of production is sufficiently ductile to encompass ordinary and extraordinary expenses in economic cycles of growth or contraction.

20. An analysis of the specificities of the specific case permits concluding that the deduction of interest paid on loans contracted by C… is related to the effective exercise of an economic activity. In other words, the supply agreements in question have an economic justification from the point of view of their indispensability for the maintenance of the source of production, for purposes of Article 23(1) of the CITC in the wording then in force. If it were not for the supply agreements, C… would not have had the financial means necessary to acquire the second parcel, to comply with its tax obligations and to satisfy its commitments to suppliers, essential for the maintenance of its activity.

21. Equally relevant is the fact that the parent and subsidiary companies, both resident in Portugal, are part of the same group of companies for tax purposes, being subject to the inherent logic of consolidation, pursuant to the Special Tax Regime for Groups of Companies (SETGC)[15]. One is not, therefore, faced with the risk of abusive tax planning through mechanisms known in the language of international taxation as thin capitalization or hybrid mismatches (e.g., double deduction; deduction/non-inclusion).

22. The interest was a cost in C… and profit in D…, which is also part of the SETGC. The deduction of payments made by the debtor was not followed, on the creditor's side, by a new deduction or a non-inclusion in the taxable base. At no point did the TA demonstrate the existence of a purpose to obtain undue tax advantage or the pursuit of an interest alien to the enterprise[16] or presented reasons which would allow concluding that the costs of the loans were incurred in the pursuit of another interest than the business interest of C…[17].

23. The sole objective of the supply agreements under analysis consisted in the obtaining of greater economic and financial efficiency, there being no tax advantage. On the contrary, a correction made to company C… without the corresponding correction to company D… would create a situation of double taxation, which would certainly not fail to implicate principles such as contributory capacity, actual income, justice, equity, good faith and coherence and non-contradiction of state action (non venire contra factum proprium).

24. In the specific case the supply agreements serve an indisputable purpose of an economic nature, and this did not even coexist with purely tax-related objectives. There being an unequivocal economic purpose (business purpose)[18] and it not having been proven the existence of any other purpose, of an extracompany or tax-related nature, which takes precedence over it as primary or principal, there is no objective reason not to accept the deductibility of the interest paid, pursuant to Article 23(1) of the CITC. The concurrency between economic and tax purposes which normally leads to the application of the principal purpose test (PPT) does not occur here.

The Provision of Bank Guarantee

1. The Claimant provided a bank guarantee, with the objective of suspending the enforcement proceedings instituted by the TA for non-payment of the contested assessment. It is today universally accepted in the arbitral jurisprudence of CAAD[19] that the process of judicial challenge encompasses the possibility of judgment for payment of undue guarantee and is even, in principle, the appropriate procedural means to formulate such claim, which is justified by evident reasons of procedural economy, since the right to compensation for undue guarantee depends on what is decided regarding the legality or illegality of the assessment act.

2. The total or partial compensation of the debtor who, to suspend execution, offers a bank guarantee or equivalent, provided that he/she has maintained it for a period exceeding three years is expressly provided for in Article 53 of the GTL, although in proportion to success in the procedural means which have as their subject matter the guaranteed debt. In the specific case, it is relevant the fact that the subject matter of the dispute concerns solely the disregard of expenses in the amount of € 18.985,23 and has an impact on the assessment limited to € 5.384,11.

3. Regarding the claim for judgment for payment of compensation for undue provision of guarantee, Article 171 of the CTPP establishes that "compensation in case of bank guarantee or equivalent unduly provided shall be requested in the proceedings in which the legality of the enforceable debt is disputed" and that "compensation must be requested in the complaint, challenge or appeal or in case its grounds be subsequent within 30 days after its occurrence." The request for constitution of the arbitral tribunal has the consequence of the arbitral proceedings becoming the one in which the "legality of the enforceable debt" will be discussed, whereby, as appears from the express tenor of that no. 1 of the aforesaid Article 171 of the CTPP, it is also the arbitral proceedings which is adequate to assess the claim for compensation for undue guarantee.

4. Arbitral jurisprudence[20] emphasizes that the cumulation of claims relating to the same tax act is implicitly presupposed in Article 3 of the RAAT, in speaking of "cumulation of claims even if relating to different acts," which allows one to perceive that cumulation of claims is also possible relative to the same tax act and claims for compensation for indemnification interest and judgment for undue guarantee are capable of being covered by that formula, whereby an interpretation in this sense has, at least, the minimum of verbal correspondence required by no. 2 of Article 9 of the Civil Code.

5. In the case at hand, it is manifest that the error of the assessment act, embodied in the disregard of financial charges relating to the reimbursement of supply agreements to D…, is imputable to the Tax and Customs Authority, since the tax inspection and the assessment were undertaken at its initiative and the Claimant in no way contributed to that error being committed.

6. For this reason, the Claimant has a right to compensation for the guarantee provided.

7. However, the charges which the Claimant incurred in providing the bank guarantee were not alleged and proven, whereby it is unfeasible to fix here the compensation to which the Claimant is entitled, which can only be effected in execution of this judgment.

DECISION

This Arbitral Tribunal decides as follows:

1. Judge the arbitral claim well-founded and, in consequence, declare the illegality of the Order Dismissing the Hierarchical Appeal and the additional assessment of Corporate Income Tax, No. …, of July 2013, relating to the fiscal year 2009, object of the present proceedings, to the extent that expenses recorded by C… as interest on loans in the amount of € 18.985,23 are disregarded.

2. Condemn the Tax Authority to pay compensation for undue provision of guarantee, in such amount as shall be fixed in execution of judgment.

3. Condemn the Tax Authority to pay the costs of the proceedings.

Value of Proceedings

The value of the proceedings is fixed at € 5.384,11, pursuant to Article 306(1) of the CCP and Article 97(A)(1)(a) of the Code of Tax Procedure and Process, applicable by virtue of subsections (a) and (b) of Article 29(1) of the RAAT and no. 2 of Article 3 of the Regulation of Costs in Tax Arbitration Proceedings.

Costs

The arbitration fee charged to the Respondent is fixed at € 612,00, pursuant to Articles 12(2) and 22(4), both of the RAAT, and Article 4(4) of the Regulation of Costs in Tax Arbitration Proceedings and Schedule I attached thereto.

Let notification be made.

Lisbon, 12 March 2018

The Arbitrator

Jónatas Eduardo Mendes Machado

[Footnotes as in original Portuguese text]