Deductibility of Financial Charges Under Article 23 CIRC – IRC Arbitral Decision 466/2018-T

ARBITRAL DECISION

The arbitrators Dr. Alexandra Coelho Martins (Presiding Arbitrator), Dr. José Ramos Alexandre, and Dr. Augusto Vieira (Member Arbitrators), designated by the Ethics Council of the Administrative Arbitration Centre ("CAAD") to form the present Arbitral Tribunal, constituted on 5 December 2018, agree as follows:

I. REPORT

A..., S.A., legal entity number..., (hereinafter designated as "Claimant"), with registered office at ... no.... ...-... Lisbon, submitted a request for arbitral pronouncement, under the Legal Regime for Arbitration in Tax Matters ("RJAT"), approved by Decree-Law no. 10/2011, of 20 January, following the dismissal of the Gracious Complaint filed under number ...2017..., presented against the assessments of Corporate Income Tax ("IRC") and corresponding compensatory interest, with reference to the tax years 2013, 2014 and 2015, whose statements of account reconciliation resulted in a value payable of € 43,197.05.

The Respondent is the Tax and Customs Authority ("AT").

The Claimant seeks the annulment of the decision dismissing the Gracious Complaint and of the tax acts assessing IRC and compensatory interest to which it applied, identified in the table below, and likewise the condemnation of the AT to payment of accrued indemnitary interest (which it quantifies at € 6,276.91) and accruing interest, until full settlement.

As grounds for its claim, the Claimant alleges a defect of violation of law, by breach of Article 23, No. 1 of the IRC Code, namely on the grounds that the financial charges corrected by the AT should be deductible, by virtue of:

(a) Such expenses having been effectively incurred and being documentally proven and supported in the Claimant's accounts, having enabled the development of its profitable activity and aimed at generating income in its sphere;

(b) Not all financial charges relating to loans, with banking commissions and stamp duty associated with various operations being evidenced, directly linked to the Claimant's activity and not to loan contracts;

(c) Regarding derivative financial instruments, the inherent charges not relating to loan interest, deriving from a management decision not subject to challenge by the AT, such instruments having been contracted with the intention of obtaining income. The gains from these instruments were taxed when generated, and their respective losses should also be fiscally recognized;

(d) In the case of loan contracts concluded with a banking institution, the funds obtained by the Claimant having been, in part, destined for strengthening its working capital for payment of current expenses relating to salaries, bills, services, among others. One of such loan contracts dates back to 1992 (loan with mortgage) and was destined to finance the construction of the building ..., and not the Claimant's partner companies, which were only established in 2006, 14 years later. Thus, the financial charges associated directly respect the Claimant's activity;

(e) Still regarding banking loan contracts, the part in which the capital was allocated by the Claimant to its partner companies was owing to the financial difficulties they faced and aimed at preventing their insolvency. Such circumstance, were it to occur, would have adverse repercussions on the Claimant's sphere itself, whose banking financing, essential to its real estate purchasing and resale activity, would be compromised if the shareholders holding its capital were declared insolvent, belonging to the same group of companies, with common shareholders and interests. In some cases, the borrowed amounts were returned to the Claimant a few days after having been made available;

(f) In this context, such expenses cannot but be considered indispensable for the realization of profits and for the maintenance of the Claimant's productive source;

(g) Regarding these loans to the Claimant's partner companies, despite having considered in the Gracious Complaint that the associated charges were not fiscally relevant, it changed its position when exercising the right to hearing on the draft dismissal of the Complaint, in the sense now advocated for their deductibility;

(h) The AT's control being a control by negation, which can only disregard expenses that, manifestly, do not have the potential to generate increments or gains, even if indirect, which did not occur in the situation at hand.

The Claimant attached 34 documents and requested witness testimony.

The request for constitution of the Collective Arbitral Tribunal was accepted by the President of CAAD and automatically notified to the AT on 25 September 2018.

In accordance with Articles 5, No. 3, subparagraph a), 6, No. 2, subparagraph a) and 11, No. 1, subparagraph a), all of the RJAT, the Ethics Council of CAAD designated as arbitrators of the Collective Arbitral Tribunal the signatories hereof, who communicated their acceptance of the assignment within the applicable deadline.

On 15 November 2018, the parties were notified of such designation and raised no objection, in accordance with the combined terms of Articles 11, No. 1, subparagraphs a) and b) and Article 8 of the RJAT, and Articles 6 and 7 of the Ethics Code of CAAD.

The Collective Arbitral Tribunal was constituted on 5 December 2018, as communicated by the President of the Ethics Council of CAAD, under Article 11, No. 1, subparagraph c) of the RJAT.

On 22 January 2019, the Respondent filed its Reply, in which it concludes in favour of the dismissal and consequent absolution of the claim, with the maintenance in the legal order of the impugned acts.

To this end, it argues that the impugned tax acts constitute the correct application of law to the facts, since the Claimant made non-remunerated loans to its partner companies while at the same time bearing financial charges resulting from the loans it contracted. Given that the loans granted to the partners were always superior to the loans obtained, it considered the inherent charges entirely non-deductible, due to lack of proof of such expenses in connection with productive activity and with the obtaining of profit/income in the Claimant's sphere.

The Respondent argues that, even when there exists a group relationship, the member companies do not lose their legal personality and tax capacity, which implies that each company has its own expenses. Thus, for expenses to be indispensable, in accordance with Article 23, No. 1 of the IRC Code, they must relate to the taxpayer company itself, rejecting those that were borne to enhance gains of third companies, in line with the jurisprudence of the Supreme Administrative Court ("STA"), which uses the "object or social scope of the entity" as a decision-making parameter.

From the Respondent's perspective, financial charges borne by a company in relation to loans in which it is proven that the funds obtained are diverted from its own operation to that of another with which it is related are not deductible. There, the nexus of indispensability would have to be ascertained in relation to the company benefiting from the free financing, had it borne the charges, and not in the Claimant's sphere.

It adds that the interpretation advocated by the Claimant violates the principle of taxation of the real income of companies, provided for in Article 104, No. 2 of the Constitution, by admitting the deduction of charges not related to the economic activity proper to the taxpayer and outside its social object, but rather with the activity of its partners.

The Respondent requested dispensation from witness testimony, indicating, ad cautelem, one witness. On 31 January 2019, it attached the administrative file ("PA").

The parties were notified, by order of 1 February 2019, to exercise the right to contradictory regarding dispensation from witness testimony, and the Claimant stated that the evidence needed witness testimony to complement it.

By order of 11 February 2019, the Arbitral Tribunal determined the holding of witness testimony, which took place on 15 March 2019, at which the two witnesses listed by the Claimant, B... and C..., were heard, and the witness listed by the AT was dispensed with.

Upon conclusion of the inquiry, the Arbitral Tribunal raised of its own motion the exception of (partial) acceptance of the tax acts, provided for in Article 56 of the Code of Procedure in Administrative Courts ("CPTA"), applicable by reference to Article 29, No. 1, subparagraph c) of the RJAT, and notified the parties to submit successive written submissions, with a deadline of 10 days. Finally, the date for pronouncing the arbitral decision was set and the Claimant was warned to, by the end of the deadline, proceed with payment of the subsequent arbitral fee, in accordance with Article 4, No. 3 of the Regulation of Costs in Tax Arbitration Proceedings ("RCPAT") and communicate such payment to CAAD.

On 26 March 2019, the Claimant submitted written submissions, maintaining what it had stated in the request for arbitral pronouncement, which it considers reinforced by the testimony produced. As to the exception raised by the Tribunal of partial acceptance of the tax acts, it states that the fact that it changed its understanding when exercising the right to hearing on the prior notification regarding the draft decision (of dismissal) of the Gracious Complaint means that it cannot be interpreted that it accepted the act for purposes of Article 56 of the CPTA, so that such exception does not apply in the present case.

The Respondent submitted written submissions on 4 April 2019, maintaining the content of its Reply.

It further adds, regarding the exception matter, that the Claimant expressly stated in the Gracious Complaint request that the financial charges referred to there, which it associated with loans to the partners, were not fiscally deductible and that it accepted the corrections made, as the values had not been used in its activity, but to finance companies in the Group.

Thus, it understands that the Respondent that the exception of partial acceptance of the act is verified, regardless of who raised it.

Regarding the evidence produced, the Respondent considers that the testimony of the witnesses failed to demonstrate the alleged facts, whose proof is documentary, the basis of knowledge of those being indirect knowledge, by "hearsay", since the facts in question predate 2015, the tax year from which they began collaborating with the Claimant.

II. SANITATION

The Tribunal was regularly constituted and is competent ratione materiae, given the configuration of the subject matter of the proceedings (cf. Articles 2, No. 1, subparagraph a) and 5 of the RJAT).

The request for arbitral pronouncement is timely, as it was submitted within the deadline provided for in Article 10, No. 1, subparagraph a) of the RJAT.

The parties enjoy legal personality and capacity, have standing and are duly represented (cf. Articles 4 and 10, No. 2 of the RJAT and Article 1 of Ordinance No. 112-A/2011, of 22 March).

The cumulation of claims is admissible, since, in accordance with Article 3, No. 1 of the RJAT, it is a matter of assessing the same circumstances of fact and the same principles or rules of law, relating to the classification of financial charges incurred by the Claimant in the provision of Article 23, No. 1 of the IRC Code, although relating to different tax years.

The proceedings are free of nullities, with the exception of partial acceptance of the tax acts, contemplated in Article 56 of the CPTA, having been raised of the Tribunal's own motion and hereinafter assessed immediately after the determination of the facts.

III. RATIONALE

1. STATEMENT OF FACTS

Relevant to the decision, the following facts are deemed proven:

A. A..., S.A., here Claimant, is a Portuguese joint-stock company with activity since 1989, which principally carries out the activity of leasing of real estate, under CAE 68200, and has as its object the administration, operation, acquisition and sale of any assets, movable and immovable – cf. information contained in the Tax Inspection Report or "RIT", which is an integral part of the PA and the permanent certificate attached with the request for arbitral pronouncement ("ppa" – Document 8).

B. The Claimant is covered by the general IRC regime and complies with its declarative obligations in IRC and VAT – cf. RIT.

C. In 1992, the Claimant concluded with Bank D..., S.A. ("D...") a loan contract with the objective of financing the construction of the building located at ..., ..., which generated financial charges, in the tax years 2013 to 2015, in the amount of € 144,111.30 – cf. Documents 25, 26 and 29 attached with the ppa and Gracious Complaint procedure.

D. In 2008, D... financed the Claimant in the amount of € 1,000,000.00, and it transferred € 500,000.00 to E..., SGPS, LDA. and € 500,000.00 to F..., SGPS, LDA., companies which together held the entirety of the Claimant's capital – cf. documents attached with the ppa, 20 and 21.

E. This financing contracted by the Claimant (of € 1,000,000.00) generated financial charges, in the tax years 2013 to 2015, in the amount of € 68,860.74, segregated as follows:

(a) 2013 – € 23,768.81;

(b) 2014 – € 24,033.62;

(c) 2015 – € 21,058.31,

– cf. account statements attached with the ppa (Documents 16, 20, 21, 24, 29 and 33) and Gracious Complaint procedure.

F. The companies E..., SGPS, LDA. and F..., SGPS, LDA. had been established in 2006 – cf. documents attached with the ppa (permanent certificates), 27 and 28.

G. On 19 September 2008, the Claimant assumed, by contract of singular transfer of debt, the financing of € 4,000,000.00 that had been contracted by the company G..., SGPS, S.A. with D..., and loaned such amount to its shareholders identified above – cf. documents attached with the ppa, 22 to 24 and RIT.

H. This financing contracted by the Claimant generated financial charges, in the tax years 2013 to 2015, in the amount of € 254,404.80, segregated as follows:

(a) 2013 – € 86,911.10;

(b) 2014 – € 89,267.97;

(c) 2015 – € 78,225.73,

– cf. account statements attached with the ppa (Documents 16, 20, 21, 24, 29 and 33) and Gracious Complaint procedure.

I. On 14 January 2011, the Claimant obtained from D... medium and long-term financing which, in accordance with the corresponding accounting entry, amounted to € 444,000.00, as per the statement of account #25114, and made two bank transfers of € 48,000.00 each to the companies E..., SGPS, LDA. and F..., SGPS, LDA., its partners. Such amounts were returned on 20 July 2011 and 9 November 2011. Otherwise, it paid various operations in the context of its activity, such as salaries, interest, provision of services, among others – cf. documents attached with the ppa, 15-16, 17-19, and Gracious Complaint procedure and RIT.

J. On 23 January 2013, D... concluded with the Claimant a loan contract of € 200,000.00 destined for working capital of the borrower – cf. Document 30 attached with the ppa and Gracious Complaint procedure.

K. This financing contracted by the Claimant generated financial charges, in the tax years 2013 to 2015, in the amount of € 30,741.93, segregated as follows:

(a) 2013 – € 10,323.61;

(b) 2014 – € 10,395.00;

(c) 2015 – € 10,023.32,

– cf. account statements attached with the ppa (Documents 16, 20, 21, 24, 29 and 33) and Gracious Complaint procedure.

L. On 23 January 2013, the Claimant transferred € 85,000.00 to G..., SGPS, S.A., and this amount was returned on 25 January 2013, two days later – cf. Document 32 attached with the ppa.

M. € 70,000.00 were also transferred on 25 January 2013, and € 40,000.00 on 8 February 2013, to F..., SGPS, LDA. – cf. Documents 32 to 34 attached with the ppa.

N. In the tax year 2013, the Claimant incurred financial charges in the total amount of € 273,979.30, of which:

i. € 48.48 – relate to banking commissions and stamp duty not connected with loan interest;

ii. € 1,200.00 – refer to stamp duty of item 17.1.3 of the TGIS, relating to the use of credit at a banking institution;

iii. € 85,905.26 – relate to losses in derivatives, accounted as "Swap" charges and € 14,001.24 with the liquidation of derivatives,

– cf. RIT, documents of the Gracious Complaint procedure contained in the PA and 9 to 14 of the ppa.

O. With reference to 2014, the Claimant incurred financial charges in the amount of € 261,398.70, of which:

i. € 149.86 – refer to stamp duty paid on banking commissions and amounts paid in tax enforcement, not connected with loan interest;

ii. € 72,770.42 – relate to losses in derivatives, accounted as "Swap" charges and € 14,651.01 with the liquidation of derivatives,

– cf. RIT, documents of the Gracious Complaint procedure contained in the PA and 9 to 14 of the ppa.

P. In 2015, the Claimant bore financial charges of € 228,528.54, of which € 62,547.08 are attributable to derivative instruments, accounted as "Swap" charges and € 12,480.86 to the liquidation of derivatives – cf. RIT and Documents 12 to 14 attached with the ppa.

Q. The Claimant has carried out operations with derivatives since 2007, having realized gains with such investments in the years 2007 and 2008, which were accounted as such. From then on it has almost always recorded losses – cf. Document 11 attached with the ppa.

R. The Claimant was subject to an internal tax inspection action, for the tax years 2013, 2014 and 2015, of partial scope, under service orders 0I2017... and 0I2017..., of 9 February 2017, with order of 10 February 2017, and 0I2017... of 10 April 2017, with order of 11 April 2017, for purposes of control in IRC of the deduction of financial charges – cf. RIT.

S. As a result of this inspection action, the Claimant was notified of the Project Report, to exercise the right to hearing on the corrections recommended to the taxable income of IRC declared in those tax years, referring to financial charges considered non-deductible – cf. PA.

T. The Claimant chose not to exercise the right to hearing and the Project became final, with a favorable order from the Head of Division, on 31 May 2017, and the Claimant's taxable income was corrected, with an increase of € 763,279.82, distributed among the tax years 2013 to 2015 as follows:

i. € 273,352.57, for the tax year 2013;

ii. € 261,398.71, for the tax year 2014;

iii. € 228,528.54, for the tax year 2015;

– cf. RIT.

U. As grounds for these corrections, the RIT states:

"[…]

Having analyzed the contracts supporting the loans obtained, the accounting documents and the financial statements of the taxpayer, it is verified that during the years 2013, 2014 and 2015 it resorts to financing through bank loans and grants loans to group companies, without a supporting contract.

In 2013 these loans are accounted for in the SNC sub-accounts '25311 – Group Companies/E..., SGPS, Lda.' and '25312 – Group Companies/F..., SGPS, Lda.', and at the end of the year there was a reclassification of accounts, with the loans granted coming to be reflected in the sub-accounts '2681 – Partners/E..., SGPS, Lda.' and '2682 – Partners/F..., SGPS, Lda.', which present debtor balances.

In the following years the loans granted remain accounted for in sub-accounts of partners (E... SGPS, Lda. and F... SGPS, Lda.), which respectively hold 50% of the capital of A...

Also through the analysis of the accounting documents, as well as the Simplified Business Information relating to each of the years, it is verified that there was no receipt of any interest related to the credit granted.

III. DESCRIPTION OF THE FACTS AND GROUNDS OF THE PURELY ARITHMETIC CORRECTIONS

III.1. Corrections in IRC

III.1.1. Financial Charges not accepted fiscally

Financing obtained

From the analysis carried out on the accounting elements of the tax years 2013, 2014 and 2015, it was verified that the taxpayer resorts to financing through borrowed capital, namely bank financing, accounted for in the various sub-accounts of the SNC account '25 – Financing Obtained' – cfr. Annex 3, which present the final balances, which are set out below:

Charges Borne with Bank Loans

Having analyzed the expense accounts, namely the SNC accounts '68 – Other Expenses and Losses' and '69 – Financing Expenses and Losses' (see Annex 3), it is verified that the taxpayer bore, in the years under analysis, the following charges:

Loan Granted

In addition to the loans it contracted and regarding which it bore the interest referred to above, the Real Estate Company granted credit between 2013 and 2015 to two entities, which together hold the entirety of its capital, accounted for in the year 2013 in the SNC sub-account '2681 – Shareholders/Partners/E..., SGPS, Lda.' and '2682 – Shareholders/Partners/F..., SGPS, Lda.' – cfr. Annex 3, as can be seen in the following table, where the balances at the end of each year are presented.

It should be noted that during the year 2013 the loans granted to the companies that hold the capital of the taxpayer were accounted for in the sub-accounts 25311 – Capital Participants/Group Companies E..., SGPS, Lda.' and '2531225311 – Capital Participants/Group Companies F..., SGPS, Lda.'.

On 31 December the taxpayer proceeded to a reclassification of accounts, settling the aforementioned ones and proceeding to reflect the loans to capital participants in sub-accounts of account 26 – Partners/Shareholders, as set out in the table above.

From the analysis carried out on the elements submitted, the following was verified:

• The sub-accounts '2681 –E..., SGPS, Lda.' and '2682 F...– SGPS, Lda.' present final debtor balances in 2013, 2014 and 2015, and E..., SGPS, Lda. and F..., SGPA, Lda. together hold the entirety of the capital of A...

• The amount that is owed over the three tax years does not accrue any interest, as can be verified from the trial balances (Annex 3) and the financial statements, and thus there is no income or gain associated with these credit granted.

Thus, it is verified that the taxpayer, in the years under analysis, while bearing financial charges, namely interest, resulting from the loans it contracted, granted loans to two companies which together hold the entirety of its capital (50% each of the entities), without having obtained any remuneration for the value of the loans granted.

Legal Framework of Financial Expenses

Given the fact that the taxpayer is bearing financial charges, namely interest, resulting from loans it contracted and is simultaneously granting non-remunerated loans to companies that participate in its capital, it is important to assess whether these charges are or are not accepted fiscally, in light of the provisions of Article 23 of the CIRC.

Under No. 1 of the said article, in the wording applicable until 2013 '…Expenses are considered as those which are comprovedly indispensable for the realization of income subject to tax or for the maintenance of the productive source, namely: (…)

c) Of a financial nature, such as interest on borrowed capital applied in the operation…'

In turn, Article 23 of the IRC Code, in the wording given by Law No. 2/2014, of 16 January, which republished this Code, and applicable in 2014 and 2015, determines the expenses accepted for purposes of determining taxable profit.

Thus, 'For the determination of taxable profit, all expenses and losses incurred or borne by the taxpayer to obtain or ensure income subject to IRC are deductible.'

We can therefore conclude that both in the wording in force in 2013, and after the republication of the CIRC in 2014, three essential requirements are required for the financial charges borne to be valued and accepted as a tax expense: proof (justification), indispensability and the connection with taxable income1.

1 António Moura Portugal: 'The deductibility of costs in Portuguese tax jurisprudence', Coimbra Publisher, 2004, page 108 and following.

The first requirement relates to the effectiveness of the realization of costs which consists in various forms of written support for accounting entries, that is, to their documentary proof.

The second requirement makes the fiscal deductibility of the cost dependent on a justified relationship with the company's productive activity and this indispensability is verified as long as such charges are connected with the obtaining of profit.

The third requirement that comprises the general clause of deductibility in matters of expenses, in the legal formulation introduced by the IRC Code, is the requirement of connection with 'taxable income or maintenance of the productive source'. It follows from the general principle of Article 23 of the CIRC that expenses incurred by the taxpayer, to be fiscally deductible, must be limited to either the obtaining of taxable income or the maintenance of the productive source.

This general clause of deductibility in matters of expenses, in the legal formulation introduced by the IRC code, is the requirement of connection with 'income subject to tax or for the maintenance of the productive source'. It follows from the general principle of Article 23 of the CIRC that expenses incurred by the taxpayer, to be fiscally deductible, must be limited to either the obtaining of income subject to tax or the maintenance of the productive source.

In the case under analysis, it is verified that the taxpayer contracted loans, bearing charges with them, and simultaneously 'grants' non-remunerated financing, of greater value than the value of the loans contracted, to the entities that hold its capital.

From this it follows that the said charges are not directly related to the taxpayer's activity. By not being related to the taxpayer's activity, the requirement of indispensability of the financial charges accounted for by the same is not shown to be met, as established in Article 23 of the CIRC.

Thus, regarding the tax years 2013, 2014 and 2015, the entirety of bank loan interest borne by the taxpayer will not be fiscally accepted.

Determination of Financial Charges not Accepted Fiscally

For determination of the financial charges not accepted for tax purposes, the following was considered:

• The interest accounted for in the sub-accounts '6812317 – Other Expenses and Losses/Stamp Duty/Financial Operations'; '69111 – Financing Expenses and Losses/financial interest obtained/bank loans'; '69112 – Interest on Financing Obtained Swap' and '69141 – Swap Interest/D...' were considered;

• Given that the amount of loans granted is always superior to loans obtained, resulting in a ratio 'loans granted/loans obtained' greater than one, the entirety of financial charges borne by the taxpayer will not be accepted.

For the foregoing, it is proposed the increase of the amounts not accepted as a tax expense, for determination of the taxable result, in the amounts indicated below, which result from the sum of the values entered in the referred sub-accounts:

• € 273,352.57, for the tax year 2013;

• € 261,398.71, for the tax year 2014;

• € 228,528.54, for the tax year 2015.

[…]".

V. The Claimant was notified of the demonstrations of IRC assessment and respective compensatory interest relating to the tax years 2013 to 2015, as follows:

(a) Tax year 2013 - IRC Assessment issued under no. 2017..., dated 9 June 2017, including compensatory interest, with value payable of € 87.60;

(b) Tax year 2014 - IRC Assessment issued under no. 2017..., dated 9 June 2017, including compensatory interest, with value payable of € 1,451.75, whose statement of account reconciliation no. 2017... resulted in the amount payable of € 18,327.01;

(c) Tax year 2015 - IRC Assessment issued under no. 2017..., dated 9 June 2017, including compensatory interest, with value payable of € 24,782.44, whose statement of account reconciliation no. 2017... resulted in the same amount payable,

– cf. Documents 1 to 3 attached with the ppa.

W. The Claimant proceeded to pay the following amounts that were assessed to it in the total of € 124,414.59:

i. On 5 May 2017, € 80,950.74 (€ 40,478.20*2), with reference to the tax year 2013 – cf. Document 4 attached with the ppa and PA;

ii. On 8 September 2017, € 18,463.93, regarding the tax year 2014 – cf. Document 5 attached with the ppa and PA;

iii. On 21 September 2017, € 24,999.92, relating to 2015 – cf. Document 6 attached with the ppa and PA.

X. On 4 October 2017, not fully agreeing with the IRC and compensatory interest assessments identified above, the Claimant filed a Gracious Complaint. In the Gracious Complaint request presented by the Claimant, this partially accepts the AT corrections, as follows:

"39.

In 2008, a loan contract was also granted to the Complainant by Bank D..., S.A. in the amount of € 1,000,000.00 – this is the loan contract no....., identified in the table above as 010.

In this case, it was verified that such amount was loaned to the companies E..., SGPS, Lda. and F..., SGPS, Lda., and € 500,000 was transferred to each of them […].

It is therefore verified that the financial charges borne by the Complainant with this financing, in the amount of €68,860.74 […], are not fiscally deductible, so the Complainant accepts the corrections made.

With regard to the loan contract no......., identified in the table above as 011 […], resulted in financial charges in the amount of €254,404.80 […].

The Complainant accepts the corrections made regarding the financial charges associated with this contract, insofar as, in fact, the loaned values were not fully used in the context of its activity, but rather used for financing companies in the group of which the Complainant is a part.

[…]

It is therefore verified that of the financing obtained by the Claimant in 2013, in the total value of €200,000, only the value of €110,000, referred to in the previous article and corresponding to 55% of the total financing, was not used in the context of the Claimant's activity.

[…]

The Complainant, accepting the correction of financial expenses of €30,741.93, corresponding to 55% of the financial charges borne regarding this contract.

In summary, and considering what we have just stated, the Complainant believes that the corrections identified in the following table should be accepted:

| Year | Stamp duty and bank charges | Derivatives Liquidation | 2011 Restructuring | 2008 Debt Transfer | 2008 Building Construction | 2013 Working Capital | Total |
| | 009 | 010 | 011 | 012 | 013 | |
| 2013 | - € | - € | - € | 23,768.81 € | 86,911.10 € | - € | 5,677.99 € | 116,357.90 € |
| 2014 | - € | - € | - € | 24,033.62 € | 89,267.97 € | - € | 5,717.25 € | 119,018.85 € |
| 2015 | - € | - € | - € | 21,058.31 € | 78,225.73 € | - € | 5,512.83 € | 104,796.87 € |
| Total | - € | - € | - € | 68,860.74 € | 254,404.80 € | - € | 16,908.06 € | 340,173.61 € |

The remaining corrections proposed, in the amount of €421,699.38, lack legal grounds, which is why they must be annulled. […]".

Y. The Claimant was notified of the draft dismissal of the Gracious Complaint, and exercised the right to hearing in which it expressed its complete disagreement with the corrections made by the AT to its taxable income for the tax years 2013 to 2015, including those it had already accepted in the initial request, reverting, as to these, its position – cf. notification letter, draft dismissal and right to hearing contained in the PA.

Z. On 25 June 2018, the Claimant was notified of the order dismissing the Gracious Complaint, from the Head of Division of the Finance Department of Lisbon, on the grounds of lack of clear and unequivocal proof that the expenses in question comply with the requirements of Article 23 of the IRC Code – cf. notification letter and attached information attached with the ppa (Document 7) and contained in the PA.

AA. On 24 September 2018, not conforming with the decision dismissing the Gracious Complaint regarding the IRC and compensatory interest assessments at issue, the Claimant submitted, through the CAAD Processing Management System, the request for arbitral pronouncement that gave rise to the present proceedings.

2. MOTIVATION AND UNPROVEN FACTS

The material facts for judgment of the case were chosen and defined based on their legal relevance, in light of the plausible solutions to the legal questions, in accordance with the combined application of Article 123, No. 2 of the CPPT, Articles 596, No. 1 and 607, No. 3 of the Code of Civil Procedure ("CPC"), applicable by reference to Article 29, No. 1, subparagraphs a) and e) of the RJAT, it not being for the Tribunal to pronounce on all that was alleged by the parties.

Allegations made by the parties and presented as facts were neither deemed proven nor unproven, consisting of statements that are strictly conclusive, incapable of proof and whose validity will have to be assessed in relation to the concrete consolidated statement of facts.

Regarding the proven facts, the conviction of the arbitrators took into account the position assumed by the parties and was based on critical analysis of the documentary evidence produced.

The two witnesses heard, B... and C..., began their collaboration with the Claimant, taking care of its accounting, from 2015 onwards, so they have no contemporaneous and direct knowledge of the facts.

With relevance to the decision there is no other factuality alleged that has not been deemed proven.

3. ON THE LAW

Prior to analyzing the merits regarding the deductibility in IRC of the financial charges incurred by the Claimant in the tax years 2013 to 2015, it is important to assess whether the Claimant partially conformed with the impugned tax acts in the Gracious Complaint, a circumstance which, if verified, implies the verification of the negative procedural requirement of (partial) acceptance of such acts and prevents, to that extent, knowledge of the merits.

3.1. PROCEDURAL REQUIREMENTS: PARTIAL ACCEPTANCE OF TAX ACTS – ARTICLE 56 OF THE CPTA

The acceptance of administrative acts, in which tax acts are included as a sub-species, configures a procedural requirement with express consecration in Article 56 of the CPTA, which provides in the following terms:

"Article 56

Acceptance of the Act

1 - A person may not challenge an administrative act on the ground of its mere annullability if he has accepted it, expressly or tacitly, after it was made.

2 - Tacit acceptance derives from the spontaneous and unreserved performance of fact incompatible with the will to challenge.

3 - […]"

This rule is inserted in the specific discipline of the challenge of administrative acts (Section I, Chapter II, Title II), under the heading "Of legitimacy" (Subsection II), so that the systematic element supports the fact that it constitutes a manifestation of the procedural requirement of legitimacy characterized, as regards the active party to the material relationship, by direct and personal interest in bringing the action. Nevertheless, the administrative doctrine understands that it is not properly a matter of legitimacy, but of an autonomous, unnamed procedural requirement, or of (mere) interest in bringing the action (minority current). Regardless of its respective legal qualification, it is indisputable that its verification configures a prior issue that prevents knowledge of the merits.

VIEIRA DE ANDRADE notes that this figure constitutes "a voluntary legal act to which the law refers a certain legal effect – the loss of the faculty to challenge – regardless of whether the individual intended or not the actual production of this result", arguing that it is an autonomous requirement, distinct from the lack of interest in bringing action and from lack of standing (cf. Acceptance of the Administrative Act, in Bulletin of the Faculty of Law of Coimbra, 2003, pp. 907 et seq.). In similar sense are pronounced MÁRIO AROSO DE ALMEIDA and CARLOS CADILHA IN THE COMMENTARY TO THE CPTA (2005, Almedina, pp. 285-290).

The effect of the loss of the right is connected with the needlessness of judicial protection and the stabilization of the effects of the act, as by accepting it, the taxpayer shows to have lost interest in its challenge.

An identical principle applies in the administrative procedure, losing the legitimacy to complain or appeal "whoever, without reservation, has accepted, expressly or tacitly, an administrative act after it was made", as it is considered a kind of venire contra factum proprium (MÁRIO ESTEVES DE OLIVEIRA et alii, Commented CPA, 2nd Edition, Almedina, 1997 [reprint, 2003], p. 287) – cf. Article 186, No. 2 of the new CPA (article), with correspondence in what was already provided for in Article 53, No. 4 of the 1991 CPA.

In the situation at hand, it is undeniable that in the initial request of the Gracious Complaint presented by the Claimant, it accepted expressly and without reservation part of the corrections that the AT made to the IRC taxable income, relating to the tax years 2013 to 2015.

Specifically, the financial charges incurred in relation to: i) the D... loan of € 1,000,000.00, granted in 2008; ii) the contract of singular transfer of debt, of € 4,000,000.00, also of 2008; and iii) a component, in the amount of € 110,000.00, of the D... loan, obtained on 23 January 2013 (in the total amount of € 200,000.00), insofar as the funds obtained were channeled by the Claimant, through free loans, to other Group companies, which hold, in their entirety, its capital.

Thus, it was the Claimant itself that, in the Gracious Complaint deduced, established the connection between the financial charges incurred by it and the loans made to the companies that hold its capital, identifying them in an autonomous table and quantifying the value which, to this end, it considered not to be fiscally deductible in its sphere, of € 340,173.61, as it did not consider it allocated to its activity, but rather to that of the beneficiary companies.

This explicit manifestation of partial acceptance of the AT's corrections, by the Claimant, constitutes a procedural requirement provided for by law, and entails, in accordance with the cited Article 56, No. 1 and No. 2 of the CPTA, lack of "legitimacy" procedurally, constituting an exception to knowledge of its own motion that prevents the court from knowing the question of the merits, giving rise to the absolution of the instance, in this case only partial, in accordance with Article 89, No. 2 and No. 4, subparagraph e) of the CPTA.

Any modifications of behavior subsequent to the acceptance of the act are irrelevant, namely the manifestation of a different opinion in the phase of hearing on the draft decision (of dismissal) of the Gracious Complaint, with no legal support existing to conclude that, by that means, the prior acceptance of the acts would result eliminated, with retroactive effects.

In light of the foregoing, the exception of (partial) acceptance of the IRC assessment acts is verified, regarding the corrections of financial charges allocated (by the Claimant itself) to loans to other Group companies, in the value of € 340,173.61, so that, in this segment, the Arbitral Tribunal cannot know of the merits, absolving, to that extent, the Respondent from the instance.

3.2. ON THE MERITS

THE FISCAL DEDUCTIBILITY IN ARTICLE 23, NO. 1 OF THE IRC CODE

The exclusive grounds for the corrections promoted by the AT to the Claimant's IRC taxable income is the invoked connection between the financial charges borne by the latter, resulting from loans contracted, and the granting of non-remunerated loans to the partners that participate in its capital, which, according to the AT, implies that such charges are not directly related to the taxpayer's activity and, therefore, that the requirement of their indispensability is not shown to be met, as established in Article 23, No. 1 of the IRC Code, with the consequent fiscal non-deductibility.

In this regard, it is understood, in line with the AT's position, that the non-remunerated granting of financial means to companies holding their own capital does not pass the test of Article 23, No. 1 of the IRC Code, since it does not observe the necessary causal connection between the expenses and their activity and social scope, through which income is aimed to be obtained or ensured, whether in the wording in force until 2013, whether in that which was introduced following the Reform of the IRC, with Law No. 2/2014, of 16 January, whose start of effectiveness produced effects in the tax year 2014.

In this regard, the sense of the Arbitral Decision handed down in proceedings no. 181/2018-T, of 7 March 2019, is followed, which begins by comparing the wording of the rule before and after the said Reform, to conclude that the financial charges associated with loans made, free of charge, to companies holding capital, are not deductible for IRC purposes, for the reasons set out below:

"Until the tax year 2013, the legal configuration of the relationship between expenses and the purpose of obtaining or realization of income subject to tax [IRC] expressly appealed to the criterion of indispensability, with Article 23, No. 1 of the IRC Code providing in the following terms:

'Article 23

Expenses

1 – Expenses are considered as those which are comprovedly indispensable for the realization of income subject to tax or for the maintenance of the productive source, namely:

a) […];

b) […];

c) Of a financial nature, such as interest on borrowed capital applied in the operation, discounts, premiums, transfers, exchange differences, expenses with credit operations, debt collection and issuance of bonds and other securities, redemption premiums and those resulting from the application of the effective interest method to financial instruments valued at amortized cost;

[…]'

The application of the concept of indispensability as a delimiting condition of fiscal deductibility in IRC raised some divergences which, over the years, were settled by the judicial route and promoted, jointly with the doctrine, a greater densification of this concept.

As SALDANHA SANCHES acknowledges, it is 'in the referred concept of indispensability that lies the essential problem of the consideration of business costs and that rests on one of the main points of distinction between the cost actually incurred in the collective interest of the company and what may result only from the interest of an individual shareholder, a group of shareholders or their whole and which cannot, therefore, be considered a cost', adding that 'the requirement of indispensability of costs for the formation of revenues must be assessed by criteria of economic rationality in light of the statutory objectives' – 'The Limits of Tax Planning', Coimbra Publisher, 2006, pp. 215-216.

It is now relatively consensual that the implementation of the general clause of indispensability of expenses does not imply a judgment of opportunity and merit on their realization.

As stated in the rationale of the Decision of the Supreme Administrative Court ('STA') (Full Bench) No. 49/11, of 15.06.11 – it must be interpreted as 'an indeterminate concept whose case-by-case completion results from an analysis of business economic perspective, in the perception of an economic causal relationship between the assumption of a cost and its realization in the interest of the company, considering the corporate object of the commercial entity in question, with actions by the Tax Administration being barred that put in question the principle of freedom of management and autonomy of will of the taxpayer'.

Thus, the 'Administration can only exclude expenses not directly ruled out by law under strong motivation that convinces that they were incurred beyond the corporate objective, that is, in pursuit of another interest than the business one, or, at least, with clear excess, deviating, in light of the objective needs and capacities of the company', as advocated by the Decision of the STA No. 1236/05, of 29.03.06.

What means, in the explanation of the Decision of the STA No. 107/11, of 30.11.11, that 'the indispensability between costs and revenues must be assessed from a positive judgment of subsumption in the corporate activity: the indispensable costs will be equivalent to expenses incurred in the interest of the company (…). As a rule, therefore, the fiscal deductibility of the cost depends only on a causal and justified relationship with the company's activity (…).' […] - Decision of the STA No. 627/16, of 28.06.17.

[…]

With the Reform of the IRC the reference to 'indispensability' of expenses was eliminated, as follows:

'Article 23

Expenses and losses

1 - For the determination of taxable profit, all expenses and losses incurred or borne by the taxpayer to obtain or ensure income subject to IRC are deductible.

2 - The following expenses and losses are deemed to be covered by the previous number, in particular:

a) […];

b) […];

c) Of a financial nature, such as interest on borrowed capital applied in the operation, discounts, premiums, transfers, exchange differences, expenses with credit operations, debt collection and issuance of bonds and other securities, redemption premiums and those resulting from the application of the effective interest method to financial instruments valued at amortized cost;

[…]'

However, the necessary connection between the expenses and the objective of obtaining income subject to tax and the general principle inherent that, for the determination of taxable profit, expenses related to the taxpayer's activity, incurred or borne by him, are deductible is maintained.

According to the Final Report of the Commission for the Reform of Income Tax on Legal Entities – 2013 –, the change aimed at confirming the departure from 'the interpretation of the concept of indispensability as meaning a necessary causal link between expenses and income' and thus contributing to the 'decrease of the significant litigation resulting from the application of the said provision', embracing the established jurisprudence that sustains that the criterion of indispensability was created to prevent the fiscal consideration of expenses that do not fall within the scope of the activity of companies subject to IRC. That is, of charges that were incurred in the pursuit of interests beyond the scope, namely of shareholders.

Since it is this interpretation of the concept of indispensability that is embraced in the assessment of the matter relating to the tax year 2013, the modification of the legal text occasioned by the Reform of the IRC did not affect the previously prevailing understanding, constituting rather a clarification, so the analysis of the tax year 2014 will be made jointly with that of the tax year 2013.

[…]

Taking into account the criteria described above, the granting of free loans to the parent company does not seem capable of being viewed as an activity of management of a financial asset by the Claimant, as it is not the Claimant that holds interests in the parent company, but the reverse. Indeed, there is no asset of which the Claimant is the holder that is underlying this operation of financing the parent company. Also not callable in these circumstances is the argument relating to the exercise of significant influence in management, usually assessed (in the relationship with companies held) by a participation percentage of at least 20%, to deem verified the interest in the investment. For here the significant influence is exercised in the opposite direction […].

The social interest that is implicit in the free provision of the financial means in question is manifestly that of the parent company. Even if the diffuse interest of the economic Group in which the Claimant is inserted were eventually invoked, it does not seem that such could be viewed as an activity of the Claimant itself, since this is a responsibility of the dominant company, within the scope of the management of its financial assets, and not of the Claimant, which configures an autonomous IRC taxpayer endowed with its own tax legal personality.

Unlike what occurs with the management of financial assets, regarding which economic benefits are expected, i.e., income that falls within the scope of tax liability, such as dividends and capital gains, and which, for that reason, can anchor a valid and relevant connection between the financial charges incurred and the activity of the taxpayer, even when capital is ceded free of charge to held companies, in the particular case of loans to the parent company there does not exist the susceptibility that the relationship between the latter and the Claimant generates income, such as said dividends and capital gains, or the increase of taxable gains in the sphere of the latter.

Thus, regarding the non-remunerated financing granted by the Claimant to the parent company, it is concluded that these are not undertaken within the scope of the activity of the former and in order to its social interest, so, in harmony with the Respondent, the financial charges with which those incurred do not pass the sieve of the necessary causal relationship between the incurred expenses and the activity of the Claimant, provided for in Article 23, No. 1 of the IRC Code and, consequently, should not be deducted for IRC purposes."

BURDEN OF PROOF

However, the application of the framework invoked by the AT rests on the verification of an essential prerequisite, relating to the allocation of the financing obtained to the loans made to Group companies which, in the concrete case, was not demonstrated.

Indeed, it was not proven that the financial charges in question, in the amount of € 423,106.21, were connected with the loans granted by the Claimant to the entities that hold its capital, it not being sufficient to establish such nexus, the circumstance that the non-remunerated loans are of greater value than that of the loans contracted. In reality, this value ratio is inconclusive, as it does not allow, by itself, to infer that, from the various financial means at the Claimant's disposal, composed of own capital and borrowed capital, the financing generating the financial charges in question were those that the Claimant actually used to make funds available to its shareholders.

The proof of the prerequisite in question – which postulates a specific allocation, i.e., the unequivocal connection between the charges relating to the financing contracted and the loans free of charge made to the Claimant's shareholders – was incumbent upon the AT, on whom the burden of proof of the prerequisites legitimizing its action rests, as a corollary of the principle of administrative legality, in accordance with the rules for distribution of the burden of proof contained in Article 74, No. 1 of the LGT, in implementation of the general principle enshrined in Article 342, No. 1 of the Civil Code. In this sense, see the Decision of the STA (Full Bench of the Tax Court Section), of 26 September 2018, proceedings no. 406/18.9BALSB, and jurisprudence cited therein in point 2.2.3.

VIEIRA DE ANDRADE notes in this respect that "it must, in principle, fall upon the Administration the burden of proof of the verification of the legal (binding) prerequisites of its action, in particular if aggressive (positive and unfavorable); in return, it will fall upon the administered party to present sufficient proof of the illegality of the act, when these prerequisites are shown to be verified" – "Administrative Justice (Lessons)", 2nd edition, p. 269.

In these terms, the AT did not satisfy the burden of proof that rested upon it, nor did it undertake an inspection action (external) prior to the issuance of the assessment acts, to gather and analyze elements relating to the Claimant's activity in the corrected tax years and appropriate motivation of the tax act.

On the other hand, it is important to note that the effectiveness of the charges incurred, debited mainly by a banking entity and consequently of external origin, was not questioned, nor their contracting in the context of the Claimant's normal activity. What the AT puts in question is the relationship of causality, in 2013 designated indispensability, between the financial charges incurred and the maintenance of the Claimant's productive source and/or the obtaining of income subject to IRC in its sphere.

In this regard, the Claimant succeeded in demonstrating the allocation of the financial charges and funds obtained through bank financing to various purposes relating to its activity of real estate operation.

Compiling the most expressive examples, this was what occurred with the loan contracted in 1992 to finance the construction of a building, which is an important asset held by the Claimant, and which generated financial charges in its sphere in the amount of € 144,111.30, between 2013 and 2015. This loan was not allocated to the financing of the companies that hold its capital, as these were only established in 2006, 14 years later.

Also unrelated to the Claimant's loans to the shareholders are the financial charges incurred with derivatives (swaps) and with the liquidation of these financial instruments which, in the three tax years in question, amounted to € 221,222.76 and € 41,133.11.

It is further noted that the loans granted by the Claimant to Group companies that were returned by January 2013 also cannot have generated financial charges in the tax years at issue in the present proceedings, which are subsequent.

In light of the foregoing, the defect of violation of law invoked by the Claimant is well-founded, and the deduction of the financial charges incurred in the partial amount of € 423,106.21 should be accepted, under Article 23, No. 1 of the IRC Code, considering its connection with that activity. Consequently, the impugned tax acts, of IRC and respective compensatory interest, are partially annullable, in accordance with Article 135 of the CPA, with correspondence in Article 163, No. 1 of the new CPA, applicable by reference to Article 29, No. 1, subparagraph d) of the RJAT.

The decision dismissing the Gracious Complaint that recited on such acts and confirmed them is also partially invalid.

INDEMNITARY INTEREST

The Claimant formulates a claim for condemnation of the AT to payment of accrued and accruing indemnitary interest, a right which is enshrined in Article 43 of the LGT which, in its No. 1, makes it dependent on the occurrence of error attributable to the services which resulted in the payment of a tax debt superior to that legally due. The mentioned rule provides that "[i]ndemnitary interest is due when it is determined, in a gracious complaint or judicial challenge, that there was error attributable to the services from which resulted payment of the tax debt in an amount superior to that legally due".

The IRC assessment acts and compensatory interest charges subject to this action partially suffer from a material defect of violation of law, and there is at issue the wrong application of tax incidence rules by the AT.

In this regard, it has been peacefully understood that Tax Arbitral Tribunals have competence to hand down condemnatory pronouncements in forms identical to those that are admitted in judicial challenge proceedings, thus including those that derive from the recognition of the right to indemnitary interest, under Articles 24, No. 1, subparagraph b) and No. 5 of the RJAT and Articles 43 and 100 of the LGT.

Specifically, Article 24, No. 5 of the RJAT provides that "[p]ayment of interest, regardless of its nature, is due in accordance with the terms provided for in the General Tax Law and in the Code of Tax Procedure and Process".

Returning to the situation under analysis, the Claimant proved the partial substantive illegality of the corrections to its taxable income in the amount of € 423,106.21, so the tax acts of IRC assessment and compensatory interest are, to that extent, partially annullable. The Claimant likewise demonstrated the payment of the entirety of the amounts of tax and interest impugned, in the amount of € 124,414.59.

Such tax payment is, as noted above, annullable in the part in which it results from the assessment of IRC (and compensatory interest) on financial charges borne by the Claimant not accepted by the AT, in the amount of € 423,106.21 (corresponding to approximately 55% of the total correction made), which should have been. This defect, attributable to error in the interpretation and application of the regime provided for in Article 23, No. 1 of the IRC Code, cannot but be attributable to the AT, which issued the tax acts at issue, collecting, with undue character, by illegal, the corresponding tax payment.

In these terms, the legal prerequisites of the right to indemnitary interest are deemed verified, in the part of the assessments that is annulled, calculated on the amount that the Claimant paid unduly, by way of IRC and compensatory interest, in accordance with Article 43 of the LGT and Article 61 of the CPPT.

Finally, it is important to note that the relevant issues submitted for consideration of this Tribunal were known and assessed, as were not those whose decision was prejudiced by the solution given to others, namely that relating to the invocation, by the AT, of the unconstitutionality of the Claimant's interpretation, by violation of the principle of taxation of the real income of companies, provided for in Article 104, No. 2 of the Constitution, as the partial success of the action does not derive from the acceptance of the deductibility of financial charges related to loans to the Claimant's shareholders, but from the demonstrated connection of these with the activity of the Claimant itself and the non-existence (due to lack of proof) of the contrary allegation by the AT.

IV. DECISION

In view of the foregoing, the arbitrators of this Arbitral Tribunal agree to:

(a) Partially find verified the exception relating to (partial) acceptance of the tax acts identified above, in the part in which they relate to IRC and compensatory interest calculated on financial charges of € 340,173.61, with the consequent partial absolution of the instance of the AT;

(b) Partially uphold the claim for annulment of the said tax acts of IRC assessment and compensatory interest, in the part in which they bear on the amount of € 423,106.21 relating to fiscally deductible financial charges;

(c) Partially annul the order dismissing the Gracious Complaint which confirms the tax acts in the part which is hereby annulled;

(d) Partially uphold the claim for indemnitary interest, in the part relating to the annulled amount of IRC and compensatory interest,

all with the legal consequences resulting thereupon.

The case is assigned the value of € 130,691.50, in accordance with Articles 3, No. 2 of the Regulation of Costs in Tax Arbitration Proceedings ("RCPAT"), 97-A, No. 1, subparagraph a) of the CPPT and 306, No. 1 and 2 of the CPC, the latter being ex vi Article 29, No. 1, subparagraph e) of the RJAT.

Costs in the amount of € 3,060.00, in the proportion of € 1,683.00 (55%), chargeable to the Respondent, and € 1,377.00 (45%), chargeable to the Claimant, in accordance with Table I attached to the RCPAT, and with Articles 12, No. 2 and 22, No. 4 of the RJAT, Article 4, No. 5 of the RCPAT and Article 527, No. 1 and 2 of the CPC, ex vi Article 29, No. 1, subparagraph e) of the RJAT.

Lisbon, 2 May 2019

[Text prepared by computer, in accordance with Article 131, No. 5 of the CPC, applicable