CAAD Ruling on Municipal and State Surcharge (Derrama) in IRC Group Taxation – Process 473/2015-T

ARBITRAL DECISION

The Arbitrators Advisor Jorge Lopes de Sousa (designated by the other Arbitrators), Dr. Ricardo da Palma Borges and Prof. Dr. Ana Maria Rodrigues, designated, respectively, by the Claimant and the Respondent, to form the Arbitral Tribunal, constituted on 09-10-2015, hereby agree on the following:

1. Report

A…, SGPS, S.A., legal entity number…, currently with registered office at street…, number…, …, …, …, …-… Viseu, (hereinafter referred to as "A…" or "Claimant"), parent company of "Fiscal Group B…", came, pursuant to the combined provisions of articles 2, no. 1, paragraph a), and 10, nos. 1 and 2, of Decree-Law no. 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter referred to only as LFATM) to request the constitution of a collective arbitral tribunal with appointment of an arbitrator by the party and request for an arbitral pronouncement, in order to declare the partial illegality of the self-assessments of Corporate Income Tax (and corresponding municipal and state levies) of Fiscal Group B… for the fiscal years 2012 and 2013, with respect to the amounts of € 640,922.55 (2012) and € 1,320,032.52 (2013), respectively, in a total of € 1,960,955.07, with its consequent partial annulment, as well as the declaration of illegality and annulment of the decision on the administrative claim that rejected the annulment requests that the Claimant submitted.

The Claimant further requests the reimbursement of those sums, increased by compensatory interest, counted from 01-09-2013 and from 01-09-2014, respectively.

The Respondent is the TAX AND CUSTOMS AUTHORITY (AT).

The Claimant designated as Arbitrator Dr. Ricardo da Palma Borges, pursuant to the provisions of article 6, no. 2, paragraph b) of the LFATM.

The request for constitution of the arbitral tribunal was accepted by the President of the CAAD and automatically notified to the Tax and Customs Authority on 07-08-2015.

Pursuant to the provisions of paragraph b) of no. 2 of article 6 and no. 3 of the LFATM, and within the deadline provided in no. 1 of article 13 of the LFATM, the chief executive of the Tax Administration Service designated as Arbitrator Prof. Dr. Ana Maria Rodrigues.

The Arbitrators appointed by the Parties agreed to designate Advisor Jorge Lopes de Sousa as president arbitrator, who accepted the designation.

Pursuant to and for the purposes of the provisions of no. 7 of article 11 of the LFATM, the President of the CAAD informed the Parties of this designation on 24-09-2015.

Thus, in conformity with the provisions of no. 7 of article 11 of the LFATM, having elapsed the deadline provided in no. 1 of article 13 of the LFATM without the Parties having anything to say, the Collective Arbitral Tribunal was constituted on 09-10-2015.

The Tax and Customs Authority submitted a Response, in which it defended the dismissal of the request for arbitral pronouncement.

By order of 12-11-2015, the holding of the meeting provided for in article 18 of the LFATM was dispensed with and it was decided that the proceedings would continue with successive written submissions.

The Parties submitted their submissions.

The Arbitral Tribunal was regularly constituted and is competent.

The parties have legal personality and capacity and are legitimate (articles 4 and 10, no. 2, of the same statute and article 1 of Regulation no. 112-A/2011, of 22 March) and are duly represented.

The proceedings do not suffer from any nullities.

2. Facts

2.1. Proven Facts

a) The Claimant is the parent company of Fiscal Group B…, subject to the special tax regime for groups of companies (RETGS);

b) Fiscal Group B… which included, with effect from 01-01-2013, C…, S.A., legal entity number…, with registered office at Street…, number…, …, …, …, …, Viseu, with share capital of € 34,450,000 (hereinafter referred to as "C"), company that incorporated by merger, with effects retroactive to 01-01-2013, D…, SGPS, S.A., legal entity number…, hereinafter referred to as "D", a company that also integrated, until its extinction by merger, Fiscal Group B…;

c) The Claimant, in its capacity as parent company of Fiscal Group B…, proceeded to self-assess Corporate Income Tax ("CIT") and corresponding municipal and state levies for the fiscal years 2012 and 2013 by means of submission of the respective Model 22 declarations (Documents nos. 2 and 3, attached to the request for arbitral pronouncement, the contents of which are taken as reproduced);

d) Subsequently, the Claimant submitted replacement declarations of those declarations (Documents nos. 4 and 5 attached to the request for arbitral pronouncement, the contents of which are taken as reproduced);

e) During the second quarter of 2007, Fiscal Group B… acquired 3,574,575 shares representing the share capital of "E…, SGPS, S.A." (hereinafter E…), at that date named "F…, SGPS, S.A.", a company listed on the Lisbon Stock Exchange (Euronext Lisbon), with the acquisition cost amounting to € 38,703,397;

f) During the period 2008, D…, and its successor C…, as a consequence of its extinction by merger in 2013, held a total of 3,423,560 shares of E… in its assets, with the total acquisition cost amounting to € 35,393,792;

g) The acquisition of the aforementioned shares gives the Claimant, as well as to D…, a holding representing less than 5% of the share capital of E…, with neither the Claimant nor C…/D…, individually or jointly, and more broadly Fiscal Group B…, holding directly or indirectly a participation in E… equal to or greater than 5%;

h) Until 31 December 2009, the shareholdings in question were measured in the financial statements of the two companies at acquisition cost, pursuant to the accounting principles defined in the Official Chart of Accounts (OCA);

I) Following the approval of the Accounting Standardization System (ASS), from 01-01-2010, the Claimant and D… began to measure, in their financial statements, the shareholdings held in E…'s capital in accordance with Accounting and Financial Reporting Standard 27 (AFRS 27);

G) By virtue of the first-time adoption of the new accounting rules, the Claimant and D… determined negative equity variations associated with the measurement of the shareholdings held in E… according to fair value, in the amounts of € 23,196,890 and € 20,542,389, respectively, which represent the difference, on 31.12.2009, between the acquisition cost of the shareholdings and their fair value on that date;

H) On 29-12-2010, the Claimant made a Binding Information Request in order to confirm the Tax Authority's understanding of the tax treatment of that equity variation, namely with respect to the limitation of the deduction to 50% contained in article 45, no. 3 of the CIRC;

I) In response to the Request, the Corporate Income Tax Services Directorate informed that "In the event that a loss is identified due to reduction in fair value, article 45, no. 3 of the CIRC, establishes that 'other losses relating to equity components contribute to the formation of taxable income in only half of their value', concluding that 'Given that the reductions in fair value of these equity components are qualified as losses, they should be considered, pursuant to the aforementioned article 45, no. 3, of the CIRC, at 50% of their value';

J) The Claimant and D…, following the Tax Authority's understanding, considered, for tax purposes, in the self-assessments of CIT for 2012 and 2013, only 50% of the negative equity variations relating to the shareholdings in E…, arising from the transition to the new accounting framework regarding the recognition of fair value (distributed over five tax periods);

K) With respect to the appreciation that occurred in 2012 and 2013 with the financial participation in E…, the Claimant and D… considered it at 100% in the self-assessments for these fiscal years;

L) On 30-01-2014, the Claimant requested a new binding information, in which the Tax and Customs Authority confirmed that this was the appropriate framework, pursuant to document no. 14 attached to the request for arbitral pronouncement, the contents of which are taken as reproduced, in which it concluded that:

"18. When there are revenues associated with gains in the value of assets revalued at fair value and whose variation in value should be recognized in results, as is the case in the present situation, these gains contribute to the formation of taxable income in their entirety, before and after the entry into force of Law no. 2/2014, of 16.01".

"19. Regarding losses resulting from the measurement at fair value of own capital instruments provided for in paragraph a) of no. 9 of article 18 of the CIRC, which were identified up to 2013, these contributed, only at 50% for purposes of determining taxable income. From 2014 onwards, with the entry into force of the CIT Reform Law, these losses become fully tax-deductible (100%)."

M) On 19-03-2015, the Claimant submitted an administrative claim regarding the self-assessments for the years 2013 and 2014 (document no. 6 attached to the request for arbitral pronouncement, the contents of which are taken as reproduced);

N) The aforementioned administrative claim was rejected by order of 28-05-2015, issued by the Director of Finance of …, who expressed agreement with the information contained in document no. 6 attached to the request for arbitral pronouncement, the contents of which are taken as reproduced, in which it states, among other things, the following:

"15. Paragraph a) of no. 9 of article 18 of the CIRC (in the wording in effect at the time of the facts) establishes that adjustments arising from the application of fair value contribute to the formation of taxable income when they relate to financial instruments recognized at fair value through results, provided that, being own capital instruments (e.g., shares), they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a participation in the capital exceeding 5% of the respective share capital, these adjustments, both at the tax level and at the accounting level, are considered gains by increases or losses by reduction of fair value.

1. According to the provision of no. 3 of article 45 of the CIRC (also, in the wording in effect at the time of the facts) '(...) other losses or negative equity variations relating to equity components or other components of own capital, namely supplementary contributions, contribute to the formation of taxable income in only half of their value', whereby, considering the reductions in fair value as equity components, these losses will always be considered at 50% of their value.

2. This is because the underlying rationale of no. 3 of article 45 of the CIRC is to introduce greater balance in the treatment both of income relating to equity components and of losses. Being that, given the broad wording of this provision, by using the expression 'other losses (...) relating to equity components', this necessarily includes losses resulting from adjustments arising from the application of fair value, such as those provided for in paragraph a) of no. 9 of article 18 of the CIRC.

3. Now, this understanding is widely disseminated by the Tax and Customs Authority, for example, in the binding information requests requested by the present claimant (BIR …/2010 and BIR …/2014, both from the Corporate Income Tax Services Directorate).

4. The claimant in its contestation of this understanding argues 'that both gains and expenses associated with fair value variations that occurred during the period of holding of the shareholdings should contribute to the formation of taxable income at 100% of their value', with no. 3 of article 45 of the CIRC not applying.

5. To assess the arguments put forward by Group B…, it is necessary to make a review through the changes that led to this understanding.

6. Now, with the approval, at the accounting level, of the Accounting Standardization System (ASS), on 31 December 2009, there was a change from the Official Chart of Accounts to the Accounting Standardization System. This change implied an alteration of model, from a model with legal emphasis to a model based on an economic approach, with the recognition, measurement, presentation and disclosure criteria being significantly different.

7. It was also established that whenever the ASS is silent, one should resort, in a supplementary manner, to International Accounting Standards adopted pursuant to Regulation no. 1606/2002 and to IAS/IFRS issued by the IASB and their respective Interpretations.

8. This change brought about an alteration to the CIRC and complementary legislation in order to adapt the rules for determining taxable income to IAS. It so happened that differences continued to exist between the accounting criteria defined in the ASS and the tax criteria established in the CIRC. Thus, the net result ascertained on an accounting basis continued to be the starting point for determining taxable income, with this accounting result being adjusted to arrive at taxable income in function of differences - positive or negative - between tax accounting criteria and positive or negative equity variations which, pursuant to the CIRC, should contribute to the determination of the tax result.

9. This close link between accounting and taxation led to the fact that whenever there are no specific tax rules, the accounting treatment arising from the ASS is adopted.

10. In this way, on an accounting basis, Group B…, used the provision of AFRS 27, which determines that gains or losses in the variation of fair value be taken directly to results. Moreover, according to IAS 39, a gain or loss resulting from a financial asset classified at fair value through results should be included in the net result of the period.

11. This AFRS 27 adopts the fair value model (and for this reason is fiscally accepted for the respective gains) with respect to financial instruments recognized at fair value through results in cases where the determination of fair value is reliable.

12. Now in the field of the approximation between accounting and taxation, at the tax level, with the adaptation of the CIRC to the ASS, the tax legislator adopted the fair value model in the recognition of the period's revenues and expenses, although such recognition is confined to exceptional cases, in that, for tax purposes, the principle of realization continues to apply, as a general rule. This principle, in which the result is only ascertained, as a general rule, with the transfer of ownership of the property, by contrast to cases in which only potential gains or losses are relevant (e.g., fair value adjustments reflected in results) and which are contemplated in no. 9 of article 18 of the CIRC.

13. Thus, revenues and expenses are considered for tax purposes in the period in which the elements or rights that gave rise to them are alienated, exercised or settled, accepting fair value adjustments. However, this understanding applies only in certain cases, such as the present case of the claimant, that is, in financial instruments recognized at fair value through results.

14. It is the understanding of the Tax Authority and of legal doctrine that with respect to financial instruments recognized at fair value through results, if required with respect to own capital instruments (e.g., shares), for reasons of reliability in the determination of value, they must have a price formed in a regulated market and the participation be equal to or less than 5% of the respective share capital (paragraph a) of no. 9 of article 18, paragraph f) of no. 1 of article 20 and paragraph i) of no. 1 of article 23). Outside these conditions, gains or losses are only considered for tax purposes when realized (article 46 of the CIRC, in the wording in effect at the time of the facts). It being the consensual understanding that negative fair value variations relating to equity components are deductible only at 50%, in light of the broad wording of no. 3 of article 45 of the CIRC, in effect during the period 2013, whereby no basis is seen in the arguments of the claimant.

15. The claimant also bases its claim on a decision issued by the Administrative Arbitration Center (CAAD) in the context of case no. 108/2013-T, in which the interpretation of the Tax and Customs Authority is not accepted.

16. However, it should be noted that the case law of the CAAD does not constitute an immediate source of Tax Law and that, although no. 4 of article 68-A of the LGT determines that the AT should review its generic guidance taking into account, in particular, the case law of the superior courts, it is not observed that a single decision can determine a change in understanding, which was taken on the basis of the legal norms in effect and with the systematic organization of the CIRC.

17. We consider, therefore, that the taxation subject to the claim does not suffer from any defect that could compromise its validity, there being no elements that contradict its result, not accepting, consequently, the claimant's claim in the sense of claiming that the expenses associated with fair value variations that occurred during the period of holding of the shareholdings should contribute to the formation of taxable income at 100% of their value.

V. Conclusion

In light of the foregoing, it is proposed to REJECT the present administrative claim, in accordance with the grounds set out in this information.

O) The self-assessment of CIT and state and municipal levies, as well as the autonomous taxation for the years 2012 and 2013 are paid, since the Claimant in both years had values to recover, referred to in field 368 of tables 10 of the model 22 declarations;

P) On 24-97-2015, the Claimant submitted the request for arbitral pronouncement that gave rise to the present proceedings.

2.2. Unproven Facts

There are no facts relevant to the decision of the case that have not been proven.

2.3. Basis for the Decision on Facts

The decision on facts is based on the documents attached to the request for arbitral pronouncement and on the administrative proceedings, with no controversy regarding the facts.

3. Law

Decree-Law no. 159/2009, of 13 July, amended the CIRC, carrying out the adaptation of the rules for determining taxable income to international accounting standards as adopted by the European Union, as well as to national accounting standards that aim to adapt accounting to those standards.

Regarding adjustments arising from the application of fair value, no. 9 of article 18 of the same Code provides as follows:

"9 – Adjustments arising from the application of fair value do not contribute to the formation of taxable income, being attributed as revenues or expenses in the tax period in which the elements or rights that gave rise to them are alienated, exercised, extinguished or settled, except when:

a) They relate to financial instruments recognized at fair value through results, provided that, in the case of own capital instruments, they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a participation in the capital exceeding 5% of the respective share capital; or

b) This is expressly provided for in this Code."

In article 5 of that Decree-Law, a transitional regime was established, as follows, insofar as is relevant here:

"Transitional Regime

1 - The effects in own capital arising from the first-time adoption of international accounting standards adopted pursuant to article 3 of Regulation no. 1606/2002 of the European Parliament and of the Council, of 19 July, that are considered tax-relevant pursuant to the Code of Corporate Income Tax and its complementary legislation, arising from the recognition or non-recognition of assets or liabilities, or from changes in their measurement, contribute, in equal parts, to the formation of taxable income of the first tax period in which those standards apply and of the four following tax periods."

It is accepted by the Parties that the financial participations in question should be accounted for in accordance with the fair value criterion and that the adjustments were recognized through results.

The corrections made by the Tax and Customs Authority were based on the interpretation it made of the regime of article 45, no. 3, of the CIRC, in the wording in effect in 2012-2013, which it understood to be applicable to adjustments arising from the application of the fair value model in financial instruments, whose counterpart is recognized through results.

In this manner, the issue to be resolved in the proceedings is duly delimited, which is, then, to know whether the accounting loss resulting from the retrospective application of the fair value method, duly accounted for and recognized in results, should be taken into account in full, or only at 50%, in each of the four tax periods following the first in which those accounting standards were applied.

3.1. Normative Framework

Article 45, no. 3, of the CIRC, in the wording given by Decree-Law no. 159/2009, of 13 July, establishes the following:

"3 – The negative difference between capital gains and capital losses realized through paid transfer of equity components, including their redemption and amortization with reduction of capital, as well as other losses or negative equity variations relating to equity components or other components of own capital, namely supplementary contributions, contribute to the formation of taxable income in only half of their value."

The general rule on the determination of CIT taxable income is article 17 of the CIRC which establishes that:

"1 – The taxable income of legal persons and other entities mentioned in paragraph a) of no. 1 of article 3 is constituted by the algebraic sum of the net result of the period and the positive and negative equity variations verified in the same period and not reflected in that result, determined on the basis of accounting and possibly corrected pursuant to this Code."

Regarding adjustments arising from the application of fair value, no. 9 of article 18 of the same Code provides as follows:

"9 – Adjustments arising from the application of fair value do not contribute to the formation of taxable income, being attributed as revenues or expenses in the tax period in which the elements or rights that gave rise to them are alienated, exercised, extinguished or settled, except when:

a) They relate to financial instruments recognized at fair value through results, provided that, in the case of own capital instruments, they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a participation in the capital exceeding 5% of the respective share capital; or

b) This is expressly provided for in this Code."

Article 20, no. 1, of the CIRC specifies the concept of revenues establishing, insofar as is relevant here, the following:

"Revenues are considered those resulting from transactions of any nature, as a consequence of a normal or occasional action, basic or merely accessory, namely:

(...)

f) Revenues resulting from the application of fair value in financial instruments;

(...)

h) Capital gains realized;".

Article 23, no. 1, of the CIRC defines the concept of "expenses," establishing the following:

"1 – Expenses are considered those that are demonstrably indispensable for the realization of revenues subject to tax or for the maintenance of the source of income, namely:

(...)

i) Expenses resulting from the application of fair value in financial instruments;

(...)

l) Capital losses realized;".

Regarding positive equity variations, article 21, no. 1, of the CIRC provides that:

"Positive equity variations not reflected in the net result of the tax period also contribute to the formation of taxable income, except:

(...)

b) Potential or latent capital gains, even if expressed in the accounting records, including revaluation reserves under fiscal legislation;"

With respect to negative equity variations, article 24, no. 1, of the CIRC states that:

"Under the same conditions referred to for expenses, negative equity variations not reflected in the net result of the tax period also contribute to the formation of taxable income, except:

(...)

b) Potential or latent capital losses, even if expressed in the accounting records;".

Regarding capital gains and capital losses, article 46, no. 1, of the same Code provides that:

"1 – Capital gains or capital losses realized are considered those obtained or suffered through paid transfer, whatever the title by which it is operated and, as well, those arising from loss or those resulting from permanent allocation to purposes unrelated to the activity carried out, concerning:

(...)

b) Financial instruments, with the exception of those recognized at fair value pursuant to paragraphs a) and b) of no. 9 of article 18."

3.2. Analysis of the Issue

In the analysis of this issue, the reasoning of the arbitral award of 25-11-2013, handed down in case no. 108/2013-T (subsequently followed in the award of 09-06-2015, handed down in case no. 58/2015-T), will be closely followed, which merits the agreement of the signatories.

The aforementioned article 45, no. 3, of the CIRC results from the renumbering of the previous article 42, no. 3, carried out by Decree-Law no. 159/2009.

This no. 3 of article 42 in question was, in turn, introduced by Law no. 32-B/2002, of 30 December, with the following wording:

"The negative difference between capital gains and capital losses realized through paid transfer of equity components, including their redemption and amortization with reduction of capital, contributes to the formation of taxable income in only half of its value."

According to the Ministry of Finance Report for the 2003 State Budget (p. 33), the legislative intervention in the area in question (CIT) was guided by "two priorities, namely, combating tax fraud and evasion and broadening the tax base", with the amendment of interest falling within the scope of "Broadening the tax base and moralizing and neutrality measures" (p. 51).

The current wording of the rule under analysis resulted from the amendment implemented by Law no. 60-A/2005 of 30 December, and pursuant to the corresponding Ministry of Finance Report (p. 31), the measure in question fell within the scope of "COMBATING TAX EVASION AND FRAUD AND OTHER MEASURES AIMED AT BUDGET CONSOLIDATION".

The no. 9 of article 18 of the CIRC in effect obtains its justification directly from the preamble of Decree-Law no. 159/2009, of 13 July, which introduced it in the said Code, where it can be read:

"Still in the field of the approximation between accounting and taxation, the application of the fair value model in financial instruments, whose counterpart is recognized through results, is accepted, but only in cases where the reliability of the determination of fair value is principally assured. Thus, own capital instruments that do not have a price formed in a regulated market are excluded. Furthermore, the application of the principle of realization was maintained with respect to financial instruments measured at fair value whose counterpart is recognized in own capital, as well as equity components that correspond to more than 5% of the share capital, even if recognized at fair value through results. (...)

In the same sense, assets covered by the regime of tax capital gains and losses are identified as tangible fixed assets, intangible assets, investment properties, financial instruments, with the exception of those in which adjustments arising from the application of fair value contribute to the formation of taxable income in the tax period."

These expressed intentions have correspondence in that rule of no. 9 of article 18, as well as in the introduction, by the same statutory instrument, of paragraphs f) and i) of no. 1 of articles 20 and 24 of the CIRC, as well as of paragraph b) of no. 1 of article 46.

Within the set of amendments introduced by the aforementioned Decree-Law no. 159/2009, of 13 July, it should also be noted that where previously there was talk of revenues and gains (article 20), one now talks of revenues, and where previously there was talk of costs or losses (article 23), one now talks of expenses.

Prior to the adoption of fair value, equity variations relating to financial instruments were irrelevant from the point of view of the formation of taxable income of each period, by virtue of the rule of article 21, no. 1, paragraph b) of the CIRC, which established that they did not contribute to the formation of taxable income "potential or latent capital gains, even if expressed in the accounting records, including revaluation reserves authorized by law". Only at the moment of realization of the capital gain or loss did the equity variation verified assume tax relevance.

This tax framework, which amounted to a single taxation (which occurred only once throughout the entire period of holding of the financial instruments), dependent on a voluntary action of the taxpayer (in that the transaction of the instruments generating the equity variation, condition of the tax relevance of that variation, would only occur if and when the taxpayer so wished) and in which the valuation of the equity variation was fixed as a function of the concrete transaction that triggered its tax relevance provided fertile ground for accounting and tax manipulations, since the taxpayer could choose to trigger the tax relevance at the moment and terms in which it was fiscally most beneficial for it.

On the other hand, and given the relevance of the taxpayer's will in the mechanism of tax relevance of the equity variation, the system established was suitable for the adoption of mechanisms to condition that will, in order to conform it to economically more desirable behaviors, which, in this case, involve the preference for realizing capital gains, to the detriment of realizing capital losses.

It is in this context that the emergence of the rule of the previous article 42, no. 3, of the CIRC, which precedes the current article 45, no. 3, of the same, is explained.

Such a rule, both in its original wording, resulting from Law no. 32-B/2002, of 30 December, and in that given to it by Law no. 60-A/2005 of 30 December, is explained objectively and subjectively (that is, in light of the motivation expressed by the legislator) by needs linked to combating tax fraud and evasion and to broadening the tax base, directed to the desired budget consolidation of the public accounts.

The acceptance of the application of the fair value model in financial instruments, carried out by Decree-Law no. 159/2009, of 13 July, came to introduce, in the part covered, a radically different model, both in terms of valuation and of tax relevance of equity variations relating to the holding of such instruments.

Indeed, the legislator's intention when adopting the fair value model, duly evidenced, was, assumed and expressly, to maintain "the application of the principle of realization with respect to financial instruments measured at fair value whose counterpart is recognized in own capital, as well as equity components that correspond to more than 5% of the share capital, even if recognized at fair value through results".

Already with respect to "financial instruments" that correspond to less "than 5% of the share capital", "whose counterpart is recognized through results, (...) in cases where the reliability of the determination of fair value is principally assured", the legislative intention was to accept "the application of the fair value model", excluding the principle of realization.

In consonance with this legislative intention, article 18, no. 9, of the CIRC came to provide that, as a general rule, "Adjustments arising from the application of fair value do not contribute to the formation of taxable income, being attributed as revenues or expenses in the tax period in which the elements or rights that gave rise to them are alienated, exercised, extinguished or settled.", which constitutes an evident and deliberate surfacing of the assumed principle of realization.

However, the same rule, in its paragraph a), establishes the exception to this regime, "when: a) They relate to financial instruments recognized at fair value through results, provided that, in the case of own capital instruments, they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a participation in the capital exceeding 5% of the respective share capital;".

That is, when the "revenues or expenses (...) relate to financial instruments recognized at fair value", "contribute to the formation of taxable income" "provided that":

a) They are recognized "through results";

b) They are "own capital instruments";

c) They "have a price formed in a regulated market"; and

d) "The taxpayer does not hold, directly or indirectly, a participation in the capital exceeding 5% of the respective share capital".

Provided these conditions are met:

a) Revenues resulting from the application of fair value in financial instruments are considered [article 20, no. 1, paragraph f), of the CIRC]; and

b) Expenses resulting from the application of fair value in financial instruments are considered [article 23, no. 1, paragraph i) of the CIRC].

In this way, where previously we had a single tax relevance, at the moment of the transaction of such instruments, we now have a continued tax relevance. That is, given the new norms comprising the regime of tax relevance of accounting at fair value of financial instruments, revenues or expenses resulting from the application of fair value to these now directly affect the formation of taxable income [article 20, no. 1, paragraph f), and article 23, no. 1, paragraph i), of the CIRC] of the very year in which they occur, provided that certain conditions are met (article 18, no. 9, of the CIRC), which include the formation of price in a regulated market, with equity variations not being taxed as capital gains or losses [article 46, no. 1, paragraph b), of the CIRC].

In this context, there cease to be any needs relating to combating tax fraud and evasion, not only because the tax relevance of equity variations ceases to be conditioned by an act of will of the taxpayer, but also because the valuation is objectively fixed.

On the other hand, and for the same reasons, any measure to condition the taxpayer's will also lacks meaning, in order to favor economically more "desirable" behaviors and, as such, in conformity with the interests of broadening the tax base and budget consolidation.

Notwithstanding these amendments introduced by Decree-Law no. 159/2009, of 13 July, the previous article 42, no. 3, of the CIRC, renumbered to article 45, no. 3, maintained its validity, with its wording unchanged.

Hence the question arises, as it does in the proceedings, whether such a rule will apply, or not, to variations relating to financial instruments, which contribute to the formation of taxable income, pursuant to article 18, no. 9, paragraph a), of the CIRC.

In a first analysis, based exclusively on the literal wording of no. 3 of article 45, an affirmative answer to this question is suggested, in light of the breadth of provision of this rule.

But a careful and coordinated interpretation of the relevant norms for analyzing the issue, which have been indicated, leads to a different conclusion.

In fact, article 45, no. 3, of the CIRC states that:

"The negative difference between capital gains and capital losses realized through paid transfer of equity components, including their redemption and amortization with reduction of capital, as well as other losses or negative equity variations relating to equity components or other components of own capital, namely supplementary contributions, contribute to the formation of taxable income in only half of their value."

The analysis of the normative text reveals clearly that the legislator chose, to include in it, three types of situations that should be considered, based on the presumption of good legislative technique, as distinct, namely:

a) "The negative difference between capital gains and capital losses realized through paid transfer of equity components";

b) "Other losses (...) relating to equity components or other components of own capital";

c) "Other (...) negative equity variations relating to equity components or other components of own capital".

Let us see, then, whether the situation in the proceedings comes under any of the listed situations.

The situation referred to under paragraph a) above will be manifestly inapplicable, not only because there was no realization effected through paid transfer, but also because article 46, no. 1, paragraph b), of the CIRC excludes the situations described in article 18, no. 9, paragraph a), from the concept of capital gains realized.

In this way, the possibilities remain for integrating the situation in the proceedings into one of the situations listed in paragraphs b) and c) above.

The apparent indiscriminate breadth of the provisions in question may, however, be reasonably mitigated if one notes that "losses" and "other negative equity variations" will be concepts, not redundant, but endowed with their own distinct meaning.

To understand this fact, it will be necessary to go back to articles 23 and 24 of the same Code, paying attention to the terminological evolution carried out by article 159/2009, of 13 December.

Indeed, before the entry into force of the latter statute, the aforementioned articles of the CIRC stated, respectively, that:

– "Costs or losses are considered those that are demonstrably indispensable for the realization of revenues or gains subject to tax or for the maintenance of the source of income, namely the following: (...)";

– "Under the same conditions referred to for costs or losses, negative equity variations not reflected in the net result of the fiscal year also contribute to the formation of taxable income, except: (...)".

It is therefore verified that at the time of consecration of the current wording of article 45, no. 3, of the CIRC, this Code expressly distinguished, for what is relevant here, three types of situations, namely:

a) Costs;

b) Losses;

c) Negative equity variations not reflected in the net result of the fiscal year.

The provision of article 42, no. 3 (predecessor of the current 45, no. 3), should be considered, thus, as reported to these concepts, defined in articles 23 and 24, in the versions prior to Decree-Law no. 159/2009.

In this way, and for obvious reasons, from the provision of that rule, costs relating to "equity components or other components of own capital" should be excluded, including there only losses (as defined in article 23) and negative equity variations (as defined in article 24), relating to those components.

And that this is so, that is, that the expression "other losses or negative equity variations" used in the current article 45, no. 3, of the CIRC does not have an indiscriminately broad sense, but rather a precise sense, defined in articles 23 and 24, follows from the fact that the legislator employed the same distinction.

Furthermore, the inclusion in the scope of the rule in question not only of losses (as defined in article 23) and negative equity variations (as defined in article 24), but also of costs (as defined in article 23 in the version prior to Decree-Law no. 159/2009), would lead to the fact that, for example, the acquisition cost of equity components would only contribute half of their respective value to the ascertainment of taxable income, which would, obviously, be inconceivable in a minimally reasonable legislator.

The normative alteration implemented by Decree-Law no. 159/2009, of 13 July, will not have altered anything of relevance in the matter in question. Indeed, notwithstanding the body of article 23 having come to refer only to expenses, the fact is that the CIRC continues to use the expression "losses", including in article 23 itself (see no. 1, paragraph h)). This occurs in coherence, moreover, with the ASS, which pursuant to point 2.1.3.e) of the annex to Decree-Law no. 158/2009 of 12 July, maintains the distinction between "expenses" and "losses".

In this way, it is concluded that article 45, no. 3, of the CIRC will be reported to:

a) Negative differences between capital gains and capital losses realized through paid transfer of equity components;

b) Other losses relating to equity components or other components of own capital; and

c) Other negative equity variations relating to equity components or other components of own capital.

With the understanding that by "losses" should be understood facts qualifiable as such in light of the CIRC, and by "negative equity variations" should be understood negative equity variations not reflected in the net result of the fiscal year, as defined in article 24.

Facts qualifiable as "expenses" in light of the CIRC will thus not be included within the scope of the rule in question, even if relating to equity components or other components of own capital.

The Tax and Customs Authority itself appears to recognize this, since in the "Manual for Completing Table 07, Model 22", with respect to field 737, it states that "In this field are entered, at 50%, the amounts relating to other losses (other than capital losses, given that these follow the 'mechanism' of capital gains and losses) relating to equity components or other components of own capital. For example, the amounts are added to this field 737 corresponding to 50% of losses from fair value reductions, when these fall within the scope of article 23, no. 1, paragraph i), by virtue of the provision of article 18, no. 9, paragraph a)".

It occurs that article 23, no. 1, paragraph i), of the CIRC does not refer to the amounts in question as "losses", but as "expenses", whereby their entry in the field in question will be incorrect.

Moreover, and should there be any doubt, if the legislator, upon entry into force of Decree-Law no. 159/2009 of 13 December, intended to cover the situations listed in article 18, no. 9, paragraph a), of the CIRC, within the scope of article 45, no. 3, of the same, it would have:

• Included "Expenses resulting from the application of fair value in financial instruments", not in article 23, but in article 24 of the CIRC; or

• Referred to such situations as "losses resulting from the application of fair value in financial instruments" and not as "expenses".

In the context just set out, it should then be considered that Decree-Law no. 159/2009, of 13 July, came to introduce, with respect to the part covered by the acceptance of the application of the fair value model in financial instruments, a special regime of relevance for the calculation of taxable income, justified both by its own objectivity and by the confessed intention of approximating accounting to taxation.

This circumstance is, in light of the wording of the CIRC after Decree-Law 159/2009, not susceptible to generating any type of doubts, as is verified, in particular, by the wording of articles 20, no. 1, paragraphs f) and h), 23, no. 1, paragraphs i) and l), and, in particular 46, no. 1, paragraph b), in light of which it is evident in a clear manner the legislator's intention to remove adjustments arising from the application of the fair value criterion in financial instruments, in terms recognized by the CIRC, from the regime of capital gains and losses.

The regime resulting from the combination of articles 45, no. 3, and 46 of the CIRC only makes sense in the perspective of the admissibility of the equity variations in question under the prism of the aforementioned principle of realization.

For, being at stake, in light of such principle, the measurement of equity variation as a function of a transaction, there will always be a voluntary factor in relation to that.

That is, in the regime for which the rule of article 45, no. 3 was thought and instituted, the realization of capital losses, and other situations listed was dependent on a voluntary action corresponding to the realization of the same. Now, in this context, it will be understandable that the legislator institutes mechanisms of disincentive to an action susceptible of being considered as undesirable, in this case the realization of capital losses or other negative equity variations. By providing that such situations will only be relevant at 50% of the accounted amount, the tax legislator is, objectively, conditioning the actions covered by the legal provision, imposing a negative incentive to the same.

On the other hand, and being in question financial instruments of value not objectively quantifiable, the disregard at 50% of negative equity variations verified would also have a function of "compensating" the natural tendency of economic operators to, at the tax level, inflate losses.

However, those aspects will not verify themselves already in the situations covered by article 18, no. 9, paragraph a). Here, being in the face of adjustments arising from the accounting of fair value, determined by objective criteria (with "a price formed in a regulated market"), there is no doubt or intervention of the will of the taxpayer in the verification of the negative or positive equity adjustment. That is, these will occur or not, independently of the action and will of the taxpayer.

Now, to penalize, in these cases, the taxpayer with a disregard of 50% of the expense incurred, would be entirely unjustified, both from an economic point of view and from a legal point of view.

For, recall, this situation of contingent (random, even) unjustified penalization would only occur by virtue of the exception of the situations covered by article 18, no. 9, paragraph a), of the CIRC to the regime of the principle of realization. That is, if with respect to those situations the general regime of the body of article 18, no. 9 were applied, according to which the same would not contribute "to the formation of taxable income, being attributed as revenues or expenses in the tax period in which the elements or rights that gave rise to them are alienated, exercised, extinguished or settled", the pointed inconsistency would not verify itself, since the fact that would trigger the contribution to the formation of taxable income would only occur by will of the taxpayer, whereby it would be up to the latter to choose to realize the negative equity variation, with the consequent tax penalty, or defer this to a moment in which it was less voluminous or, even positive, decreasing or eliminating the penalty arising from the operation for itself and for the Public Treasury. It is the exception of paragraph a), by removing the situations provided for there from the scope of the principle of realization, that justifies the new regime of relevance for taxable income, which was instituted.

Evidence of all that has just been said is presented in the framework elaborated below, which demonstrates the unreasonableness of the application of the rule of article 45, no. 3, to the situations covered by article 18, no. 9, paragraph a):

The non-application of the rule of article 45, no. 3, of the CIRC to expenses, and specifically to "Expenses resulting from the application of fair value in financial instruments", with the full consideration of the equity repercussions verified, whether positive or negative, leads to a coherence of taxation whatever time the alienation of the financial instrument occurs. That is, at whatever time one chooses to proceed with the alienation of the financial instrument, the positive and negative equity changes offset one another, so that, ultimately, the taxpayer has only added to or diminished its taxable income by the difference between the acquisition value and the sale value.

Already if the rule of article 45, no. 3, of the CIRC were applied, as the Tax and Customs Authority intends, from the moment a negative equity change occurs, there will be a discrepancy between the tax relevance of negative and positive equity variations, without any justification, as has been said, since those variations occur objectively and independently of the action or will of the taxpayer. Thus, if at the end of the second year the taxpayer of the above example proceeded with the realization of the financial instrument in question, notwithstanding having realized a capital gain of only 20 (which would be taxed as such under the principle of realization), would have, ultimately, paid tax on 30 (40-10). In the same way, if it proceeded to that realization at the end of the third year, it would have paid tax on 20, notwithstanding not having had any equity increase with the operation. And if it proceeded to the same realization at the end of the sixth year, it would have paid tax as if it had had an equity increase of 30 (80-50), notwithstanding having had an actual equity variation of -20, which, under the principle of realization enshrined in the CIRC, would be admissible, even if only at 50% of the respective value (-10)!

It appears clear that such results, merely random and without any substantive justification supporting them, could not have been intended by a reasonable legislator, which, by imperative of article 104, no. 2, of the CRP, must base the taxation of enterprises fundamentally on their real income.

It is true that the alternative solution, which excludes the application of article 45, no. 3, leads to the fact that, should a capital loss ultimately occur, it ends up having been considered at 100%, and not at 50%, as would occur under the principle of realization. This would be the case, in the example in the table above, if realization occurred in years 4 or 6. However, this positive discrimination (or rather, no negative discrimination) for the choice of the fair value criterion may be justified, first of all, because in the regime of article 18, no. 9, paragraph a), it no longer makes sense any disincentive to the realization of capital losses, since the same will be tax-relevant independently of their effective realization. One should not fail to consider that, on one hand, accounting at fair value is considered more consistent with the approximation between accounting and taxation, an end confessedly pursued by the legislator of Decree-Law no. 159/2009, of 13 July, and, on the other, the circumstance that we are dealing with objectively evaluated realities, without there being significant room for fiscally convenient manipulations.

That is, as has already been advanced, the reasons for combating tax fraud and evasion do not verify themselves, nor the reasons for budget consolidation, which demonstrably were in the origin of the rule of article 45, no. 3, of the CIRC.

Thus, it must be concluded that the situations in which its raison d'être does not apply must be removed from the scope of this article 45, no. 3, in harmony with the old maxim "cessante ratione legis cessat eius dispositio (where the raison d'être of the law ends, its scope also ends)". "The teleological method has been moving increasingly to the foreground in relation to literal interpretation. According to the principle long known: cessante ratione legis, cessat lex ipsa, the end and the raison d'être should matter more than the literal sense. The raison d'être should prevail, not only within the limits of a literal wording often equivocal, but also by breaking the bonds of that literal wording or by restricting a legal formula with excessively broad scope".

In this way, and in summary, in obedience to the hermeneutic imperatives of article 9 of the Civil Code, according to which "The interpretation should not limit itself to the letter of the law, but should reconstitute from the texts the legislative thought, taking above all into account the unity of the legal system, the circumstances in which the law was elaborated and the specific conditions of the time in which it is applied" (no. 1), and "In fixing the sense and scope of the law, the interpreter will presume that the legislator adopted the most correct solutions and knew how to express its thought in adequate terms." (no. 3), it is understood that article 45, no. 3, of the CIRC should be interpreted in the sense that its provision does not include expenses resulting from the application of fair value in financial instruments, which are relevant for the formation of taxable income pursuant to paragraph a) of no. 9 of article 18.

In these terms, with evident textual support in article 5, no. 1, of Decree-Law 159/2009, of 13 July, it should be understood that "the effects in own capital arising from the first-time adoption of international accounting standards" "arising from the recognition or non-recognition of assets or liabilities, or from changes in their measurement, contribute, in equal parts, to the formation of taxable income of the first tax period in which those standards apply and of the four following tax periods", without reservations or limitations, with article 45, no. 3, of the said Code not applying in these cases, to the extent that these negative effects are not covered by its provision.

Consequently, the corrections made by the Tax and Customs Authority which underlie the taxation subject to challenge suffer from the defect of violating the law, due to erroneous interpretation of article 45, no. 3, of the CIRC, whereby the declaration of their illegality is justified.

4. Reimbursement of Amounts Improperly Paid and Compensatory Interest

The Claimant requests the condemnation of the Tax and Customs Authority to reimburse to it the amounts illegally self-assessed and to pay it compensatory interest, calculated from 01-09-2013, regarding the 2012 self-assessment, and from 01-09-2014, regarding the 2013 self-assessment.

4.1. Admissibility of Recognition of the Right and Condemnation to Pay Compensatory Interest in Arbitral Proceedings

In accordance with the provision of paragraph b) of article 24 of the LFATM, the arbitral decision on the merits of the claim to which no appeal or challenge is possible binds the tax administration from the end of the period provided for appeal or challenge, and this administration should, in the exact terms of the procedural success of the arbitral decision in favor of the taxpayer and until the end of the period provided for the voluntary execution of the decisions of tax courts, "restore the situation that would exist if the tax act subject of the arbitral decision had not been performed, adopting the acts and operations necessary for this purpose", which is in harmony with the provision of article 100 of the LGT [applicable by virtue of the provision of paragraph a) of no. 1 of article 29 of the LFATM] which establishes that "the tax administration is obliged, in case of total or partial procedural success of a claim, judicial challenge or appeal in favor of the taxpayer, to the immediate and full restoration of the legality of the act or situation subject of the litigation, including the payment of compensatory interest, if applicable, from the end of the period for execution of the decision".

Although article 2, no. 1, paragraphs a) and b), of the LFATM uses the expression "declaration of illegality" to define the competence of the arbitral tribunals functioning in the CAAD, making no reference to condemnatory decisions, it should be understood that their competencies include the powers which in judicial challenge proceedings are attributed to tax courts, this being the interpretation that is in harmony with the sense of the legislative authorization on which the Government based its approval of the LFATM, in which it proclaims, as the first guideline, that "the tax arbitral process should constitute an alternative procedural means to the judicial challenge process and to the action for recognition of a right or legitimate interest in tax matters".

The judicial challenge process, despite being essentially an annulment process of tax acts, admits the condemnation of the Tax Administration to the payment of compensatory interest, as follows from article 43, no. 1, of the LGT, in which it is established that "compensatory interest is due when it is determined, in an administrative claim or judicial challenge, that there was error attributable to the services of which results payment of the tax debt in an amount greater than that legally due" and article 61, no. 4 of the CCPT (in the wording given by Law no. 55-A/2010, of 31 December, which corresponds to no. 2 in the original wording), that "if the decision that recognized the right to compensatory interest was judicial, the payment period is counted from the beginning of the voluntary execution period".

Thus, no. 5 of article 24 of the LFATM, in saying that "payment of interest is due, regardless of its nature, in the terms provided in general tax law and in the Code of Tax Procedure and Process", should be understood as permitting the recognition of the right to compensatory interest in the arbitral process.

Moreover, since compensatory interest is calculated on the basis of the amount to be reimbursed and has as its final limit the date of processing of the respective credit note (article 61, no. 5, of the CCPT), the possibility of condemnation in compensatory interest inherently includes condemnation to reimburse the amount that serves as the basis for its calculation.

4.2. Right to Compensatory Interest in Cases of Self-Assessment

The substantive regime of the right to compensatory interest is regulated in article 43 of the LGT, which establishes the following:

Article 43

Improper Payment of the Tax Obligation

"1 – Compensatory interest is due when it is determined, in an administrative claim or judicial challenge, that there was error attributable to the services of which results payment of the tax debt in an amount greater than that legally due.

2 – It is also considered that there was error attributable to the services in cases in which, despite the taxation being effected on the basis of the taxpayer's declaration, the latter followed, in its completion, the generic guidance of the tax administration, duly published.

3 – Compensatory interest is also due in the following circumstances:

a) When the legal deadline for voluntary restitution of taxes is not met;

b) In case of annulment of the tax act by initiative of the tax administration, from the 30th day following the decision, without the credit note having been processed;

c) When the revision of the tax act by initiative of the taxpayer is effected more than one year after the latter's request, unless the delay is not attributable to the tax administration.

4 – The rate of compensatory interest is equal to the rate of default interest.

5 – In the period that elapses between the date of the end of the deadline for voluntary execution of judicial decision with final judgment and the date of issuance of the credit note, regarding the tax that should have been reimbursed by judicial decision with final judgment, default interest is due at a rate equivalent to double the rate of default interest defined in general law for debts to the State and other public entities."

In the proceedings at hand there is improper payment of tax regarding the parts of the self-assessments in which the request for arbitral pronouncement succeeds.

From the various situations in which compensatory interest is due indicated in article 43 of the LGT, there will be a place for the same if it is understood that there was error attributable to the services.

In the case in question, the improperly paid taxes were self-assessed, so the Tax and Customs Authority had no intervention in the performance of the act on which the payment was based, with the performance of the act itself being attributable to the Claimant.

Therefore, as to the acts of self-assessment, error attributable to the services did not occur, there being, consequently, no right to compensatory interest derived from their performance.

However, the same does not apply to the decision on the administrative claim, for the Claimant's claim regarding the illegality of the self-assessment should have been accepted and the non-acceptance of the claims is attributable to the Tax and Customs Authority.

This case of the Tax and Customs Authority maintaining an illegal situation, when it should have restored it, should be framed, by mere declarative interpretation, in no. 1 of article 43 of the LGT, for it is a situation in which there is an adequate nexus of causality between an error attributable to the services and the maintenance of improper payment and the omission of restoration of legality when the action that would restore it should be performed should be equated with the action.

In the case in question, the administrative claim was submitted on 19-03-2015, so the period for decision ended on 19-07-2015 (article 57, no. 1, of the LGT).

From what has been stated, it should be understood that, from the moment the deadline for decision on the administrative claim was completed, compensatory interest begins to accrue.

In these terms, the request for reimbursement of the amounts improperly paid, in the total of € 1,960,955.07, being € 640,922.55 relating to the year 2012 and € 1,320,032.52 relating to the year 2013, is well-founded.

As to compensatory interest, the request is partially well-founded, with compensatory interest to be calculated on the amount of 1,960,955.07, from 20-07-2015 until complete reimbursement of the amounts improperly paid.

Compensatory interest is calculated on the basis of the supplementary legal rate and paid in accordance with articles 43, nos. 1, and 35, no. 10 of the LGT, article 24, no. 1, of the LFATM, article 61, nos. 3 and 4, of the CCPT, article 559 of the Civil Code and Regulation no. 291/2003, of 8 April (or any other or others that alter the legal rate).

5. Decision

In accordance with the foregoing, this Arbitral Tribunal agrees

a) To find that the request for a declaration of partial illegality of the self-assessments of CIT of Fiscal Group B…, referring to the fiscal years 2012 and 2013, with respect to the amounts of € 640,922.55 (2012) and € 1,320,032.52 (2013), respectively, in a total of € 1,960,955.07, which resulted from the illegal application of article 45, no. 3, of the CIRC, is well-founded;

b) To annul the aforementioned self-assessments, in those parts;

c) To find that the request for a declaration of illegality of the order of 28-05-2015, of the Director of Finance of …, which rejected the administrative claim submitted by the Claimant regarding those self-assessments, is well-founded;

d) To annul the aforementioned order of rejection;

e) To find that the request for reimbursement of the amounts improperly paid in the total amount of € 1,960,955.07 is well-founded and to condemn the Tax and Customs Authority to effect it;

f) To find that the request for payment of compensatory interest is partially well-founded and to condemn the Tax and Customs Authority to pay it calculated on the amount of € 1,960,955.07, from 20-07-2015 until complete reimbursement of the amounts improperly paid, at the supplementary legal rate.

6. Value of the Case

In accordance with the provision of article 306, no. 2, of the Code of Civil Procedure and 97-A, no. 1, paragraph a), of the Code of Tax Procedure and Process and 3, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the case is valued at € 1,960,955.07.

Lisbon, 17 December 2015

The Arbitrators

(Jorge Manuel Lopes de Sousa)

(Ricardo da Palma Borges)

(Ana Maria Rodrigues)

[1] Available at http://info.portaldasfinancas.gov.pt/NR/rdonlyres/BAFFC60A-E1B8-4217-89E1-17440629A6BA/0/ManualQ07201104052V.pdf, p. 31.

[2] To be precise, this would be inconsistent, in that article 18, no. 9, paragraph a) refers to "financial instruments recognized at fair value through results", and article 24 refers, as has been seen, to "negative equity variations not reflected in the net result of the fiscal year".

[3] BAPTISTA MACHADO, Introduction to Law and to Legitimizing Discourse, page 186.

[4] KARL ENGISCH, Introduction to Legal Thought, page 120.

[5] ANTUNES VARELA, Of Obligations in General, 10th edition, page 528: "The omission, as a purely negative attitude, cannot generate physically or materially the damage suffered by the injured party; but it is understood that the omission is the cause of the damage, whenever there is a special legal duty to perform an act which, surely or very probably, would have prevented the consummation of that damage."