Deductibility of Financial Costs Under IRC: CAAD Arbitration Decision 480/2016-T

The arbitrators Counselor Maria Fernanda dos Santos Maçãs (President), Dr. Fernando de Jesus Amado dos Santos (Member) and Dr. Cristina Aragão Seia (Member), designated by the Deontological Council of the Administrative Arbitration Center (CAAD) to form the Collective Arbitral Tribunal, decided as follows:

1. Report

A…, Lda (hereinafter designated as the Claimant), legal entity no. …, with registered office in…, …, …, in…, came, under Article 2, no. 1, paragraph a) and Articles 10 et seq. of the Legal Framework for Tax Arbitration, provided for in Decree-Law no. 10/2011, of 20 January, as amended by Article 228 of Law no. 66-B/2012, of 31 December (hereinafter abbreviated as "LFTA") and Articles 1 and 2 of Regulation no. 112-A/2011, of 22 March, to file a request for arbitral determination with a view to:

- the assessment of the legality and annulment of the tax acts of Additional Levy of Corporate Income Tax (CIT) with number 2013…, in the amount of € 2,442,865.29 (doc. 1 attached to the arbitral request), of Statement of Interest Accrual with number 2013… and of Statement of Account Adjustment no. 2013…, which, after correction, resulted in tax payable in the amount of € 2,349,145.69, relating to the tax year 2011 (docs 2 and 3 attached to the arbitral request);

- the assessment of the legality and annulment of the decision denying the appeal made by them;

- the assessment of the legality and annulment of the decision denying the hierarchical review of the denial of the same appeal; and

- the condemnation of the Tax and Customs Authority to the payment of compensatory interest.

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

The request for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority on 01.08.2016.

The Claimant did not proceed to the appointment of an arbitrator, therefore, pursuant to the provisions of paragraph a) of no. 2 of Article 6 and paragraph b) of no. 1 of Article 11 of the LFTA, the President of the Deontological Council of CAAD designated Ms. Counselor Maria Fernanda dos Santos Maçãs, Dr. Fernando de Jesus Amado dos Santos and Professor Dr. Carlos Lobo as arbitrators of the collective arbitral tribunal, who communicated acceptance of the assignment within the applicable timeframe.

On 03.10.2016, the parties were duly notified of such designation and did not manifest any intention to refuse the appointment of the arbitrators, pursuant to the combined provisions of Article 11, no. 1, paragraphs a) and b) of the LFTA and Articles 6 and 7 of the Deontological Code.

Thus, in accordance with the provisions of paragraph c) of no. 1 of Article 11 of the LFTA, the Arbitral Tribunal was constituted on 04.11.2016.

Duly notified, the Tax and Customs Authority filed a response in which it defended the inadmissibility of the request, defending itself solely by contestation.

By order dated 11.01.2017 the meeting referred to in Article 18 of the LFTA was dispensed with and it was decided that the proceedings should continue with written submissions.

The date of 4 May was set for the pronouncement of the final decision.

On 26.01.2017, an order was issued by the President of the Deontological Council of CAAD substituting Professor Dr. Carlos Lobo, who resigned from the functions of assistant arbitrator, with Dr. Cristina Aragão Seia.

Pursuant to the provisions of no. 3 of Article 9 of the LFTA, it was understood that there was no justification for the repetition of any procedural acts, the proceedings continuing its other regular course.

The parties filed written submissions, commenting on the evidence offered, reiterating and developing their respective legal positions.

The arbitral tribunal was regularly constituted, in accordance with the provisions of Articles 2, no. 1, paragraph a), and 10, no. 1, of Decree-Law no. 10/2011, of 20 January, and is competent.

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

The proceedings are not affected by nullity and there are no exceptions or any obstacles to the assessment of the merits of the case.

2. Factual Matters

2.1. Proven Facts

Based on the evidence contained in the file and documents attached to the arbitral request, the following facts are considered proven:

a) The Claimant, A…, Lda (Tax ID No. ….), is a limited liability company which, according to the permanent certificate attached to the administrative file, has as its object "consulting and provision of business services in the areas of administrative, financial and personnel management, accounting, computing, scientific research, professional training, the commercialization of apparatus, utensils and products intended for the healthcare services sector and the preparation of studies and provision of medical care in all specialties, as well as the provision of related or similar services";

b) The Claimant had previous designations B…, Lda (until July 2008) and C…, Lda (until December 2008);

c) Until 25 June 2007, this company was owned by D…, SA and E…, SA, having had practically no activity since inception;

d) On 26 June 2007, these companies sold their shares in the Claimant, then B…, to the company F…, SARL;

e) F…, SARL (Tax ID No. ….), with registered office in Luxembourg, subsequently designated G…, SARL, is owned by a venture capital company named H…, with registered office in England, and served as a vehicle for the acquisition of the I… Group, in the year 2007, information which is contained in a request made by H… to the Competition Authority of the European Commission in connection with the acquisition of the I… group (annex 7 to the Tax Inspection Report).

f) On the date of said acquisition, F…, SARL proceeded to increase the capital of B…, changing it from € 5,000.00 to € 40,901,711.00, as shown in the permanent certificate of the Commercial Register and Minute no. 13 (doc. 6 attached to the Arbitral Request), said increase being made, according to said certificate, in cash;

g) On 28 June 2007, entity B… proceeded to issue a bond loan, in the amount of € 81,700,000.00, fully subscribed by the sole shareholder, F…, SARL (annex 9 to the Tax Inspection Report);

h) For this purpose it was resolved on 27 June 2007, as shown in Minute no. 14 of company B…(annex 10 to the Tax Inspection Report and document no. 7 attached to the Arbitral Request, whose content is hereby reproduced), that, given the capitalization needs that the company would have to meet the transactions it proposed to conduct and having the intention to proceed with the payment of the price under the share purchase agreement representing the totality of the capital stock of company J…, later designated K…, Lda (Tax ID No.), they would proceed to issue a bond loan in the amount of € 81,700,000.00, which would be fully subscribed by the sole shareholder (F…, SARL);

i) For the execution of the bond loan, L…, S.A. also intervened, which proceeded to pay interest to the subscribing company F…, SARL and M…, SA, which proceeded to register this loan;

j) Through an analysis of the accounting, the AT found that the € 81,700,000.00 never entered the accounts of the entity, appearing as third-party debts in counterpart to loans;

k) On 1 August 2007, k…, Lda (Tax ID No. ….), previously designated J…, is acquired by the Claimant for the amount of € 122,611,711.00 (annex 4 to the Tax Inspection Report).

l) This acquisition transaction was recorded in the accounting by a transfer of debtor balances — third-party debts (shareholders for the capital increase and for the bond loan) to financial investments rather than as a cash outflow, therefore the AT concluded that the monetary means relating to the capital increase as well as the bond loan never entered the accounts of B… (annex 11 to the Tax Inspection Report);

m) With regard to interest, as evidenced by the accounting for the years 2007 and 2008, it was paid through L…, S.A., by K…, the company acquired through said loan (annex 12 to the Tax Inspection Report) with B… having no operational activity, serving only as a vehicle for such acquisition;

n) This same interest paid to entity F… was not subject to tax in Portugal under Decree-Law no. 193/2005, of 7 November;

o) In the two years during which the analysis of the accounting of B… was conducted within the scope of Service Orders nos. OI2010…/…, the AT found that it had no relevant operational results, showing losses resulting from negative financial results derived from the bond loan, which were paid by A… (the entity acquired by B…);

p) On 10 December 2007, F…, SARL proceeded to increase the capital of B… again, changing it from € 40,901,711.00 to € 57,773,878.00, as shown in the permanent certificate of the Commercial Register and Minute no. 16 (doc. 12 attached to the Arbitral Request), said increase being made, according to said certificate, in cash;

q) In July 2008, company B…, Lda changes its name to C…, Lda. (hereinafter C…), also changing its registered office, previously in the Madeira Free Zone, establishing itself in Sintra, at its current address;

r) In December 2008, C…, through a merger, incorporates its subsidiary K…, Lda (Tax ID No. …), a participation acquired in August 2007, adopting the current designation, which was the designation of the subsidiary, assuming the functions and corporate objectives thereof (annex 6 to the Tax Inspection Report);

s) Through this merger, the Claimant became the direct owner of a series of companies in the healthcare sector (namely dialysis);

t) K…, Lda (Tax ID No. …), held the entire capital of the following entities:

1. N…, S.A., Tax ID No. …;

2. O…, Lda, Tax ID No. …;

3. P…, Lda, Tax ID No. …;

4. Q…, Lda, Tax ID No. …;

5. R…, S.A., Tax ID No. …;

6. S…, S.A., Tax ID No. …;

7. T…, S.A., Tax ID No. …;

8. U…, S.A. Tax ID No. …;

9. V…, Lda, Tax ID No. …;

10. W…, Lda, Tax ID No. …;

11. X…, S.A., Tax ID No. …;

12. Y…, S.A., Tax ID No. …;

13. Z…, S.A., Tax ID No. …;

14. AA…, S.A., Tax ID No. …;

u) It also held partial capital in company BB…, LDA, with Tax ID No. …;

v) In December 2009, the Claimant (already A…, Lda – Tax ID No. …) proceeded to merge, through incorporation, with the group companies, from that date on dedicating itself to the provision of medical services;

w) With the merger transaction, all assets of the incorporated company K… were transferred to its parent company C…;

x) And, with said incorporation, all assets and liabilities were combined in a single entity, with the incorporated entity, which generated the revenues or gains, beginning to support the charges arising from the bond loan entered into between company F… and company B…, resulting from the acquisition of company K… (J…);

y) K…, Lda (Tax ID No. …) ceased its activity due to the merger by incorporation with the Claimant (permanent certificate of the Commercial Register Conservation Office - annex 5 to the Tax Inspection Report);

z) An external inspection action was carried out on the Claimant under Service Orders nos. OI2013…, OI2013… and OI2013…, of 06/03/2013;

aa) Said inspection covered the tax years 2009, 2010 and 2011, being of general scope for the tax period of 2009 and, for the remainder, namely for the 2011 period subject to this request, of limited scope, focusing on CIT.

bb) The Claimant, in the tax years in question, exercised the activity of "Accounting and audit activities; tax consulting", CAE 69200 (until 27.01.2010) and from 28.01.2010 is registered for the activity of "Specialized medical practice activities, on an outpatient basis" - CAE 86220, having as secondary purpose "Accounting and audit activities: tax consulting" - CAE 69200.

cc) Within the scope of the inspection action, the AT found that in the years 2009, 2010 and 2011, the Claimant supported and recorded in its accounting costs (interest) with bond loan and advances, costs which the AT understood were not related to its business activity, nor served the maintenance of its profit-generating source, but rather benefited a third party (G…, SARL, former F…, SARL), therefore understood that such costs should not be accepted for the purpose of calculating the tax result, pursuant to paragraph c) of no. 1 of Article 23 of the CIT Code;

dd) The amount of interest recorded and paid to the parent company in the current company is approximately € 8.5 M, in all the tax years analyzed by the AT;

ee) On 10 October 2014, the Claimant was notified by the AT to prove the indispensability of the costs and/or expenses incurred with the interest supported with the bond loan for the generation of revenues (annex 13 to the Tax Inspection Report);

ff) The Claimant responded to the notification on 18 October 2014, stating, in summary, the following:

"• In 2007, H… agreed to the acquisition of part of the I… group's business dedicated to the provision of renal healthcare services in various jurisdictions;

• For this purpose, it established a company with registered office in Luxembourg (G… SARL) for the purpose of acquiring or establishing companies in each of the jurisdictions in which J… had activity with the purpose of executing the acquisition of I… group companies or, if possible, acquiring the assets and liabilities of those same entities.

• In Portugal, that transaction resulted in the acquisition of company J… by B…, as it was in this company that B… found its target (dialysis clinics).

• For this purpose G… SARL provided the Portuguese company with capital and debt for the purpose of proceeding with the acquisition of J….

• This route was chosen, among other reasons, for aligning with international best practices, for instilling financial discipline through the pressure it exerts on results, and debt exit of capital being simpler than dividend distribution.

• It was the intention of the A… group to acquire the clinics and not the companies, which in the Portuguese jurisdiction is not possible given the rules of the Regional Health Authorities.

• It was also the intention of the group to simplify the structure of the interests it held, which it did through a two-phase reorganization.

• This reorganization involved, first, the merger of J… into A… (formerly B…) and, secondly, the merger of the remaining entities into A…, which had to obtain the endorsement of the Regional Health Authorities.

• The two mergers, regardless of having taken place on different dates, were reportable to the date of 1 January 2009.

• From an economic-financial point of view the merger brought economic benefits to the Group and, consequently, to the National Economy.

• With respect to the deductibility of financial charges supported with the bond loan subscribed by the parent company:

"In summary, in order to certify the indispensability of a given expense for the generation of revenues or for the maintenance of the profit-generating source, the following should be verified:

• The framing of the expense within the scope of the activity of the taxable person and not of any other entity, even if related to it;

• A connection between the expense and the revenue subject to tax, even if indirectly;

• The expense should have, in its origin and cause, the specific interest of the company or, in other words, should comply with criteria of economic rationality in light of the statutory objectives and take into account the reasonableness and substantiation of management decisions at the moment and in the circumstances in which they are made."

• As for the deductibility of financial charges, prior to the merger, the loan was entered into for the acquisition of J…, which was not entirely unrelated to the corporate purpose of the company.

The financial charges "were incurred in strict pursuit of the activity of the Claimant... and in its sole and exclusive benefit" and without such financing would not have had the ability to execute the acquisition of J…, "an acquisition that, together with the subsequent management of the respective capital shares, constituted an important part of the Claimant's activity at a moment prior to the merger."

• Without that acquisition, "it would be potentially deprived of a set of revenues" and it did not enjoy the provisions of Article 32 of the Tax Benefits Statute with respect to gains and losses realized, therefore the financial charges supported complied with the conditions to be considered as indispensable for the generation of revenues.

• With regard to the period following the merger, one cannot question the indispensability of the expenses since (i) they are directly related to the activity of the taxable person, as well as to its corporate purpose, (ii) they contribute to the generation of revenue subject to tax and (iii) they are manifestly indispensable.

• The corporate purpose of A… became the following: "1 — Consulting and provision of business services in the areas of administrative, financial and personnel management, accounting, computing, scientific research, professional training, the commercialization of apparatus, utensils and products intended for the healthcare services sector and the preparation of studies and provision of medical care in all specialties, as well as the provision of related or similar services. 2 - The activities contained in the corporate purpose may be developed, in whole or in part, indirectly, through the holding of shares or participation in companies with identical or similar corporate purpose", maintaining to date;

• This change of activity aimed to accommodate the activities developed by the incorporated companies, with A… beginning to develop, through the merger, all activities developed by the incorporated companies.

• Thus, "the merger of J… into the Claimant did not result in the disappearance of any asset in the latter's sphere (namely capital shares) that gave rise to the bond loan that generated financial charges, but rather in the conversion of that asset into the set of assets and liabilities that those securities already represented."

• And as such the financial charges "necessarily fell within the Claimant's activity following the merger, i.e., were intended, in substance, to finance the acquisition of the assets sufficient and necessary for the development, in its sphere, of the activity of providing dialysis care previously developed by the subsidiaries, on an individual basis."

• With respect to the indispensability of the expenses, it states that "without the bond loan the Claimant would not have 'acquired' the assets and liabilities, namely the units of business care for healthcare services... which are, in fact, the source of revenue subject to tax - of prime importance to the Claimant at a moment following the merger."

• "The activity developed by the Claimant, following the merger, included the provision of healthcare services, using the human and material resources, as well as the assets and liabilities, of the incorporated entities, which falls fully within its corporate purpose;

Without the financing in question, the acquisition of J… would not have been possible and, without it, the subsequent merger, which enabled the then Claimant to develop its activity generating revenue subject to tax;

• In truth, the financing in question may be regarded as being intended, from the outset, for the acquisition of the assets and liabilities that make up the entirety of the assets of the incorporated companies...;

• Indeed, the merger should not be regarded as representing a change in the consolidated economic reality of the parent and incorporated companies, since it remained intact;

• There was no confusion, at any time, between the financial charges supported by the Claimant and the activity of third parties."

gg) The Claimant was notified on 11.11.2013 of the Draft Tax Inspection Report, having exercised its right to respond in prior hearing, by request submitted on 28.11.2013.

hh) On 09.12.2013 the Claimant was notified of the Tax Inspection Report.

ii) In accordance with the Tax Inspection Report, whose content is hereby reproduced, the AT made two corrections of a different nature, arguing as follows:

1. Costs supported with the bond loan:

"III. 1.4 - From the analysis of the transaction and proposed corrections

III.1.4.1 - Costs with bond loan

With the incorporation of K…, Lda. (Tax ID No. …), into its parent company C…, Lda. (Tax ID No. …), all assets and liabilities were combined in a single entity, with the cash flows released by the activity and assets of the incorporated entity beginning to support the charges resulting from the bond loan entered into between F… and B…, a loan that made possible the acquisition of company J….

That is to say that, with the merger, the [cash flows] released by the activity of the incorporated company began to support the costs of its own acquisition.

However, Article 23, no. 1 of the CIT Code provides that:

(...) In the concrete case, we have that the costs of the acquisition of company J… (subsequently K…, Lda.), which had been incurred by B… (subsequently C…, Lda.), through the merger, began to be supported by the cash flows generated by the acquired entity.

With the merger, the activity developed by the parent company began to correspond entirely to the activity already being carried out by the incorporated company, and the loan obtained by B… had as its sole objective the obtaining of capital for the acquisition of J….

C… (former B…) merely emerged as a vehicle to accomplish the acquisition of J… by K…, Lda. (former J…).

Upon the Merger, C… (former B…) assumed the name of A…, Lda, which in practice translated, only and solely, [into] the cancellation of the registration of the taxable person with Tax ID No. and registration no. ….

Notwithstanding the cancellation of the registration of the taxable person…, it is K…, Lda. (former J…), the company that continues its prior activity, now under Tax ID No. … and not C…, since this company added nothing to the purpose pursued by K…, Lda. (former J…), and which culminated in the adoption of the name A…, Lda.

The costs subject to analysis only served to reduce the tax result of the company resulting from the mergers, with no positive financial effect having been achieved.

In conclusion, the use of the vehicle (B…) as described, allowed the financing cost that would have been supported by the Luxembourg company (F… S.A.R.L., currently G…, S.A.R.L.), in a direct acquisition, [to be] supported by the assets of the operational company (A…), being fully deducted from the result thereof, after the incorporation of its assets in the vehicle company, with the respective impact at the tax level (EBITDA), as analyzed in the section "II - 3.5.2 Balance Sheet and Income Statement".

With regard to a business structure with contours comparable to the case under analysis, the Administrative Arbitration Center (created by Decree-Law no. 10/2011 of 20 January) already had the opportunity to rule, in Process no. 14/2011-T, which had as arbitrators Dr. João Menezes Leitão, Professor Ana Paula Dourado and Judge Counselor Domingos Brandão de Pinho, the latter as arbitrator-president.

(...)

In the case of A… the costs supported with the bond loan are not related to its business activity, nor served the maintenance of the profit-generating source. Such costs, although recorded in its accounting, do not benefit its activity or the respective business interest, but rather benefit a third party G…, S.A.R.L., former F… S.A.R.L.), not being accepted for the purpose of calculating the tax result, pursuant to paragraph c) of no. 1 of Article 23 of the CIT Code.

Thus, to the profit/loss for tax purposes declared by the taxable person, we will correct the amount of interest relating to the bond loan, pursuant to paragraph c) of no. 1 of Article 23 of the CIT Code and taking into account the jurisprudence that has ruled on this matter, as referred to above.

The amounts by tax year of these costs/financial expenses are as follows (according to documents attached in annex 15, of 2 pages):

Tax Years 2009 2010 2011

Financial Charges €8,119,618.34 €8,451,184.17 €8,498,138.97

Note: these values correspond to the costs/financial expenses actually incurred in each tax year, including the amounts of charges paid and relating to each tax year (account "691121 – interest expenses/interest paid"), added to the adjustments relating to the allocation of costs (account "691129 – interest payable")."

2. Charges with advances

"111.1.4.2 - Charges with Advances

Pursuant to paragraphs j), k) and l) of point III.1.2, we have that with respect to interest, as evidenced by the accounting of the taxable person for the years 2007 and 2008, the same were paid through L…, S.A., by entity J…, company acquired through said loan, because B… never had operational activity, as previously described and as evidenced by the transactions recorded in the accounting of the entity and reflected in the analytical trial balances for the tax years 2007 and 2008 of B… (cf. annex 16, of 9 pages), where there are mere entries in financial costs and revenues accounts.

Now, in those same years (2007 and 2008), F…, in addition to the bond loan, proceeded to make loans through advances to various group companies, with J… being the largest recipient of such advances, in the amount of € 37,359,426.00 (annex 17, of 6 pages).

Thus, we have that J… received advances from F…, via B…, allocating part of these received advances to the payment of interest on the bond loan of the parent company (B…), since the latter, as we mentioned in the previous paragraphs, had no operational activity that generated financial inflows.

This interest paid by J… to F… was recorded in B… as third-party debt (J…), that is, J… paid interest on a bond loan whose parties were F… (creditor) and B… (debtor), and this interest constituted a credit of J… against B….

We found that this credit against B… did not produce any revenue, regardless of the fact that, by way of this, J… was bearing a charge with advance interest in order to meet the payment of interest that should be the direct charge of the parent company B….

(…)

The amount of interest that J… paid to F… (liability of shareholder B…) in the years 2007 and 2008 amounts to the sum of € 11,664,656.99 (annex 12), divided between € 3,874,826.75 relating to 2007 and € 7,789,830.24 relating to 2008. This amount constituted a credit of B… against J… (advances), insofar as the latter did not have financial means to settle the interest on the bond loan.

With the merger, the amounts of debts between Portuguese companies were canceled, maintaining only the registration of the debt to the Luxembourg company in the amount of € 47,399,162.66 relating to advances, an amount which was influenced by the above-mentioned sum (€ 11,664,656.99) relating to the payment of bond loan interest in the years 2007 and 2008 by J….

Thus, and pursuant to the provisions of paragraph c) of no. 1 of Article 23 of the CIT Code, we will correct the interest supported relating to advances in proportion to the € 11,664,656.99 relative to the value of the advance debt (€ 47,399,656.99).

The amounts of interest supported in the tax years under analysis and recorded as period costs in the account "691155 - Interest related companies of the group – payable" were the following amount (annex 18, of 8 pages):

Tax Years 2009 2010 2011

Financial Charges

Advances €6,040,851.00 €4,552,041.00 €4,034,722.00

The percentage of correction will then be as follows:

Interest Paid = € 11,664,656.99

Advances € 47,339,656.99

This operation gives us a percentage of 24.61%, which applying to the amounts recorded in account 691155 gives us the following corrections:

Tax Years 2009 2010 2011

Correction Financial Charges

Advances €1,486,602.63 €1,112,836.26 €992,911.16"

jj) The Claimant commented on the Draft Tax Inspection Report but the AT maintained the position previously assumed;

kk) Following this, the AT issued the corresponding assessments for the periods 2009, 2010 and 2011.

ll) On 19.12.2013, the Claimant paid the sum of € 2,349,145.69, relating to the assessment challenged (document no. 4 attached to the arbitral request, whose content is hereby reproduced);

mm) The Claimant filed an appeal on 11.04.2014.

nn) On 10.09.2014 it was notified of the draft denial of the appeal filed, having exercised the right to respond, in prior hearing, which was submitted on 29.09.2014.

oo) By order dated 20.10.2014, issued by the Deputy Finance Director, in substitution capacity, of the Finance Directorate of Lisbon, the appeal was denied, expressing agreement with information contained in the Administrative File (document designated «PA11-pdf»), whose content is hereby reproduced, in which reference is made, among other things, to the following:

"2 - Costs with the bond loan:

2.1 - The appellant alleges that there was an economic motivation for the acquisition transactions of the operational assets of the I… Group in Portugal and that the bond loan was entered into with the purpose of financing such acquisition.

However, in the Tax Inspection Report that economic motivation or the purpose of the loan is not questioned, but it is concluded that those acquisition transactions did not benefit the appellant, which resulted from the merger with the acquired companies, but the holder of its capital.

2.2 - Also not justified is the argument that the appellant had an activity of managing capital interests and that the interest on the bond loan was recorded as costs within the scope of that activity.

Such type of activity is balanced by the costs of the financing it obtains, with revenues from interests in other companies, such as distributed profits or gains. However, in the present case, with respect to the holding of capital interests in J…/K…, Lda, such activity could no longer exist in the 2009 tax year, as the merger had already occurred.

2.3 - The result of the acquisition transactions of the companies that held the operational assets and activities of the I… Group in Portugal was the obtaining by G… SARL of the capital interest representing the entirety of the capital of the company resulting from the merger (the appellant), which incorporated those companies and assets.

2.4 - It is further noted in the appeal that the case dealt with in the Arbitral Judgment mentioned in the report (Process no. 14/2011-T) differs from the case here analyzed in that in the judgment there is a reverse merger and there the entity entering into the loan is not the one bearing the financial costs of the same.

However, it does not appear that the differences have relevance to the analysis of the case here in question, as in this one the merged companies were controlled directly or indirectly 100% by F…/G… (cf. points 6 and 8 of the merger project -fl. 331-verso and 332) and the conclusion in the judgment was not that the financial costs were incurred for the benefit of one or another of the companies that merged, but for the benefit of the company "D...", holder of the company resulting from the merger.

2.5 - Given the foregoing, it is to be concluded, as in the Tax Inspection Report, that the costs supported with the bond loan, although recorded in the accounting of the appellant, did not benefit the activity of the appellant or the respective business interest, but rather benefit a third party, G… SARL, and should therefore not be considered "indispensable for the realization of revenues or gains subject to tax or for the maintenance of the profit-generating source", for the purpose of applying no. 1 of Article 23 of the CIT Code.

So it is to be maintained that said correction.

3 - Charges with advances:

3.1 - Contrary to what is alleged in the appeal, the statement in the report that the amount of €47,399,162.66 was influenced by the sum of € 11,664,656.99 appears to be correct.

3.2 - Indeed, it appears in the report (cf. points ll-2.3-a and b above) that in the years 2007 and 2008 F…, in addition to the bond loan, proceeded to make loans through advances to various group companies, with J…, via B…, receiving the amount of € 37,359,426.00.

It also appears in the report (cf. points 11-2.3-c and e above) that the amount of interest on the bond loan paid by J… to F… in 2007 and 2008, € 11,664,656.99, gave rise to a credit of J… against B…(by reason of B… being the issuer) and a credit of B… against J…(by reason of the latter needing funds) and that these credits were canceled at the time of the merger, remaining the amount of € 47,399.162,66 due to F…/G….

The information provided in the appeal, although more detailed, do not appear to contradict that analysis.

3.3 - The value of € 11,664,656.99 influenced that of € 47,399.162,66 in the following sense: the financing of the expense relating to the interest on the bond loan (used in the acquisition, for the benefit of third parties, of the activities of J… in Portugal - cf. point 3.2), was reflected in the value of the financing needed by the appellant, therefore a part of the interest supported in 2009 by the appellant from financing of F…/G… (in the proportion of 11,664,656.99 / 47,399.162,66 = 24.61%) is not shown to be indispensable for the purpose of applying no. 1 of Article 23 of the CIRC.

Therefore, also in this case the correction should be maintained.

4 - As for the allegation of lack of substantiation, and given the foregoing, it is not concluded that the report lacks the reasons why the financial charges in question were not considered deductible in the calculation of the taxable profit for the tax year.

5 - Given that, as stated above in points 2 to 4, the appellant is not in the right, it is proposed that the request be denied, maintaining the additional assessment subject to appeal.

IV - PRIOR HEARING

1 - The appellant was notified of the draft decision of denial, as shown in pages 399 to 402 of the file, to exercise the right to prior hearing provided for in Article 60 of the General Tax Law. With the notification a photocopy of the draft decision was sent, the information of which was reproduced in the previous points.

2 - In prior hearing, the appellant comes to present a statement (pages 403 to 416) in which it reiterates what was previously alleged, not attaching any new documents.

3 - As for what is now alleged there is to say the following:

a) Costs with the bond loan:

As was made evident in the report, prior to the merger company B…/C… served as a vehicle in the plan to acquire the I… group in Portugal through the various transactions described in the report (without operational activity - cf. points ll-2.2-b and above).

Thus, in the 2009 tax year, after the merger that gave rise to the appellant company (which took place in December/2008), it was the cash flows released by the activity of the incorporated company that began to support the costs of its own acquisition (cf. point III.1.4.1 of the report -fl. 303).

It was for that reason, that is, because those acquisition transactions did not benefit the appellant, but the holder of its capital, that the costs of the bond loan were increased in the calculation of the appellant's taxable profit, and not because the economic motivation of the plan to acquire the I… group was questioned.

b) Charges with advances:

The appellant invokes the documents submitted with the appeal and intended to document this point (docs. nos. 9 to 14 - pages 254 to 274 - cf. points l-2-b and II-3 above), specifying the reasons for the debts between the various companies, especially those prior to the merger, and reiterating what was alleged.

It is further argued that the charges in question in no way differ from the remaining charges with advances. However, the correction did not result from the nature of the costs in question. As referred to, both in the report and in the draft decision, the correction concerns the interest on advances corresponding to the part of the advances needed for financing the costs of the bond loan, which, as stated in the previous point, did not benefit the appellant, but the holder of its capital.

4 - As for the request for provision of clarifications, by way of oral presentation, on the arguments and documentation (point 50 of the statement), it is to be said that it is a fundamental rule of the appeal procedure to limit the means of evidence to documentary form and to official elements available to the services, without prejudice to other measures, without the tax administration being subordinated to the initiative of the petitioner (Articles 69 paragraph e) of the Tax Procedure and Process Code and 58 of the General Tax Law).

5 - Given the foregoing in the previous points, and having regard to the facts and grounds invoked in the draft decision, it is proposed that the request be decided in the same sense of denial (cf. point 111-5 above)";

pp) On 30.10.2014 the Claimant was notified of the decision denying the appeal filed, having filed a hierarchical review thereof on 30.11.2014.

qq) The hierarchical review was denied by decision communicated to the Claimant on 31.05.2016.

rr) The Claimant filed a request for arbitral determination on 29.07.2016.

2.2. Unproven Facts

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

2.3. Substantiation of the Determination of the Factual Matters

The facts were established as proven based on the documents submitted by the parties and contained in the administrative file, as well as on the positions of the parties, it being noted that no actual disagreement emerges from the positions assumed by Claimant and Respondent with respect to the factual matters, with the disagreement being confined to matters of law.

3. Legal Matters

3.1. The Disputed Question

AT effected a tax correction to the interest supported and recorded, in 2011, by the objecting party, relating to two financial instruments of financing. One relating to a bond loan and another relating to advances from shareholders, both subscribed and executed by the parent company G… SARL (previously F…). Similar tax correction procedures had already been effected for the periods 2009 and 2010.

As grounds for such tax act which resulted in the disallowance of fiscally deductible costs, the AT invokes, in essence, non-compliance with the principle of indispensability of expenses. The corrections made to the financial expenses are as shown in Tax Inspection Report (TIR) and are those shown in Tables 1 and 2 below:

Table 1 - Correction of Accounting Costs

(1) Correction in the percentage of 11,664,656.99/47,399,656.99 = 24.61%

The procedure for correction of financial expenses resulted in an increase of taxable profit in the amount of € 9,491,050.13, as shown in Table 1 above. However, as a loss of € 1,022,201.15 had been declared, the Final Corrected Tax Profit was set at € 8,468,848.98 for 2011, as shown in Table 2 below.

Table 2 - Correction of Tax Profit/Loss

The central question to be decided consists of: i) knowing whether the interest recorded as expenses, as a result of financing made by the parent company (Luxembourg) to its subsidiary (Portuguese), which were applied in the acquisition of capital interests, comply or not with the principle of indispensability of expenses under Article 23 of the CIRC; ii) assessing any evidence that the amount of € 11,664,656.99, resulting from payments of interest made to G… SARL (formerly F…) and which were the responsibility of A… Lda (formerly B…) are included in the final balance, after the merger, of € 47,399,656.99.

3.2. Position of the Parties

3.2.1 Position of the Tax and Customs Authority (AT)

For the AT, the inspection action on the Claimant resulted from the need to control financial charges of a high amount and with a very significant weight relative to the recorded revenues, which would have their origin in a debt entered into for the acquisition of capital interests of companies subsequently incorporated by merger.

As explained in detail in paragraphs a) to r) of point 2.1 above, the Claimant, A… Lda, resulted from the merger in phases and of three types of entities. At a first level there were companies dedicated to the provision of healthcare services, in particular the diagnosis and treatment of kidney diseases (subsidiaries). At a second level, these companies were owned by company K… Lda (formerly J…, Lda), which held, in Portugal, the entities integrated in the I… Group, which acted worldwide in this area of healthcare service provision. At a third level is the A… group represented in Portugal by company A… Lda (formerly B…) owned by G…, SARL (Luxembourg).

In a 1st phase, the entity then designated C… (formerly B…), acquired the I… Group business in Portugal through the acquisition of capital interests of K…, Lda. To this end, the first company was provided with financial resources (equity and debt) by the parent company G… SARL (formerly F…).

The first merger occurs between C… (formerly B…) and K…Lda (parent company of subsidiary entities providing medical services). With this transaction, C… adopts the name of the incorporated company and begins to directly hold the financial interests in the various entities providing medical services.

The second merger occurred between the parent company, K…, and its subsidiaries, having in the assets of the parent company ceased to be financial investments to make way for assets and liabilities of another nature. That is, the accounting procedure of the merger transaction canceled the parent company's capital interests in counterpart to the assets and liabilities of its subsidiaries.

From the transactions described result, according to the AT, two relevant incidences to the case:

i) The incorporated entity, which generated the revenues or gains, began to support the charges resulting from the financing established between entity A…, Lda (here the objecting party) and G…, SARL. The amount of interest relating to the bond loan, recorded and paid to the parent company was approximately € 8,498 M, in 2011 (as shown in Table 1 above). That is, for the AT, with the merger, the revenues generated by the activity of the incorporated company began to support the costs of its own acquisition, considering, thus, that such funds were not used in the respective exploitation. As a corollary of this understanding it makes the inference or interpretation that such expenses are not deductible under the provisions of Article 23 of the CIRC.

ii) With the merger, it follows from the accounting procedure that the amounts of debts between merged Portuguese companies are eliminated, with only the registration of debt in the parent company A… Lda to the Luxembourg company remaining in the amount of € 47,399.162,66 relating to advances, an amount which is still influenced, according to the AT, by the sum of € 11,664,656.99 relating to the payment of interest on the bond loan in the years 2007 and 2008 by K… Lda (formerly J…).

In that conformity, the AT considers it appropriate to effect a specific correction to said amount resulting from advance interest corresponding to the part of the advances necessary to finance the costs of the bond loan, alleging they did not benefit the Claimant. That is, the advance interest is disallowed in the proportion of the impact of € 11,664.656,99 in the balance of € 47,399.162,66 or 24.61% (as shown in Table 1 above). To reinforce such argument it cites the Inspection Report, stating that no evidence was found that unequivocally demonstrated that the amount of € 11,664,656.99 was not included in the value of the advances. Thus, and for the AT, in the absence of such a demonstration, the ground of the correction is reduced to that of the correction relating to the bond loan.

Thus, the AT alleges that the tax correction relating to advance interest considered not deductible by the inspection services respects therefore the proportional part of advance interest incorporated in debt that served to pay the bond loan interest, since, in its thesis, they did not benefit the Claimant.

It further alleges that K… (formerly J…) itself, which paid to G…(formerly F…) interest on the bond loan that was the responsibility of C… (formerly B…), by not receiving payment immediately, was granting credit to the latter, without thereby obtaining any revenue (cf. no. 49 of the AT's Response).

As a result of this position, the AT defends (reporting in particular to the Inspection Report) that advance costs recorded in the 2011 period[1] should not be deductible in the proportion of the weight of € 11,664.656,99, which are included in the total advances in debt in the amount of € 47,399.656,99 to G…, SARL.

Regarding the issue of indispensability, the AT alleges that the financial charges supported will only be accepted as a tax expense if they meet the requirements of substantiation (justification), indispensability and correlation of expenses for the generation of revenues subject to tax.

Thus, the AT understands that, ultimately, such financial charges result from debt entered into for the acquisition of the capital interests of the company itself and such purpose does not "fit" within the requirement of indispensability.

In line with this assumption the AT understands that, to accept the deductibility of financial charges associated with the financing of the acquisition of the capital interests of companies whose activities generate the revenues and gains that enable the deduction of those expenses would be to deny the principle of balancing between expenses and revenues that is found in no. 1 of Article 23 of the CIT Code.

Accordingly, the AT defends the non-deductibility of the financial charges supported by A… Lda (formerly B…) with the bond loan subscribed by G…, SARL (formerly F…), intended to finance the acquisition of the shares of company K… Lda (formerly J…), in the tax periods of 2009, 2010 and 2011, having as legal grounds the non-fulfillment of the substantive conditions upon which no. 1 of Article 23 of the CIT Code makes the deductibility of expenses and losses dependent, in line with the interpretation made by the doctrine and jurisprudence.

Indeed, with respect to financial charges, that normative provision requires, according to the Respondent, as for the generality of expenses, that expenses and losses deductible for the determination of taxable profit are indispensable for the generation of revenues and gains subject to tax or are indispensable for the maintenance of the profit-generating source and sets forth, in paragraph c) of no. 1, expenses of "a financial nature, such as interest on borrowed capital applied in operations". Effectively, the merger transactions, within which company C… (hereinafter) incorporated company K…, Lda (formerly J…), and its subsidiary companies, despite being up stream mergers implied, in the AT's view, an integral transmutation of the parent company that legally remained but whose activity began to correspond entirely to the activities already being carried out by the incorporated companies.

It further alleges that the fact that the financial charges, at an earlier time, are deductible, in the sphere of company K… (formerly J…) or A… (formerly B…), does not enable concluding that such treatment remained guaranteed following the merger, as noted above, the analysis of the fulfillment of the requirement of indispensability is carried out in each tax period, that is, as the charges are supported and recorded. What occurred with the merger transactions was that, as a result of the extinction of the capital interests held by company A… (formerly B…), the activity previously developed to which the bond loan was associated no longer had continuity, remaining only the operational activity carried out by companies that had belonged to the I… Group, in whose exploitation the funds obtained through such financing were not applied and, therefore, the financial charges supported did not contribute to the generation of the revenues or revenues of the renal treatment activities.

3.2.2 Position of the Claimant

The Claimant, in turn, alleges that, on a global management plan, it did not make sense that the operations of the A… group in Portugal were scattered across 16 different companies.

Thus, the merger between the Claimant and K… Lda (formerly J…) and, subsequently, with the companies providing healthcare services its subsidiaries had justified economic objectives. It further alleges that the acquisition of the underlying business assets could not have been done differently, that is, directly, by virtue of regulatory reasons in effect in the healthcare sector.

Regarding the expenses supported with the bond loan, the Claimant refutes the AT's thesis, being its understanding that such charges are related, in a clear manner, to the activity or interest of the Claimant. It further adds that said financing was even more intense in equity, in the face of similar operations, since for every two euros of debt one euro of equity was realized.

In the Claimant's view, without the mergers and financing carried out, it could not exist today, within its scope of operations, an accounting and tax result identical to what it has generated. Without the charges it bears, states the Claimant, it could not have acquired K… Lda (formerly J…) and would not reach the dimension and economic structure it currently has. The Claimant synthesizes that, "the financial charges whose indispensability must be assessed were incurred in the pursuit of the activity of the Objecting party, since, without this financing, the Objecting party would not have had the ability to execute the acquisition of K… Lda (formerly J…), an acquisition that, together with the subsequent management of the respective capital interests, constituted an important part of its activity".

It further alleges that it was she, the Claimant, who entered into the bond loan and that the charges resulting therefrom were constituted in its sphere. With the merger, this reality did not change.

There occurred with the merger, in the Claimant's view, a true acquisition of assets and liabilities, distinct from capital interests, and generating operational results. Thus, the interest paid results from transactions which, after their execution, brought into the sphere of the Claimant the assets (means of obtaining revenues) and the debts (financial support of such means), all with a clear economic rationality.

That is, the assets and the capital that finances them (in this case, the debt) aggregated in the same entity, not making, according to the Claimant, sense the AT's thesis of separating such transactions or economic effects. The Claimant cites, in support of its thesis, arbitral decisions that would go in the direction it advocates.

Regarding the issue of charges with advances, the Claimant alleges that its debt to K… Lda (formerly J…) in no way was influenced by the € 11,664 M that the AT puts at issue in the Inspection Report. In the Arbitral Request a detailed explanation is made of the origin of such amount (Articles 278 et seq), concluding the Claimant that: "Contrary to what the AT states, that amount did not inflate, nor influence, the amount of the Objecting party's debt to its shareholder, nor had any impact on its calculation. Therefore the charges corresponding to it in no way differ from the charges (...) with the remaining advances from G… SARL (formerly F…) to the Objecting party".

3.3 Analysis and Decision

Following analysis of the positioning of the parties, we can say that the question to be decided focuses on the problem of knowing whether the financial charges, both of the bond loan and of the advances, not accepted for tax purposes and as such corrected by the AT for tax purposes, meet or not the requirements of indispensability. As a subsidiary question to this, it is also important to assess the grounds that allowed the AT to state that the amount of € 11,664 M is included in the final balance of advances (already following the accounting of merger transactions), whose owner is G… SARL. Let us analyze, then, the problem.

3.3.1 Legal Grounds: Interpretation of Article 23 of the CIRC and the Question of the "Indispensability" of Expenses

In the taxation of business income - in particular in entities subject to CIT - it is Article 17, no. 1 of the CIRC that defines the concept of taxable profit, determining there that "the taxable profit [...] is constituted by the algebraic sum of the net result of the fiscal year and the positive and negative changes in equity verified in the same period and not reflected in that result, determined on the basis of accounting and eventually corrected pursuant to this Code".

In a relationship of dependence, although partial, between tax result and result determined by accounting, the CIRC establishes as the basis for determining the taxable result the profit or loss determined by accounting. However, and in order to safeguard the public interest underlying taxation, it imposes certain requirements on the consideration of revenues and expenses for tax purposes.

It is in the context of costs that such requirements are more developed, with Article 23 being the provision that establishes the general principle of their acceptance. As of the date of the facts, Article 23 of the CIRC provided (of which part of no. 1 is transcribed below, underlined by the tribunal):

Article 23

Expenses or Losses

1 — Expenses or losses that are provably indispensable for the realization of revenues or gains subject to tax or for the maintenance of the profit-generating source are considered as such, in particular the following:

a) Those relating to the production or acquisition of any goods or services, such as materials used, labor, energy and other general costs of production, conservation and repair;

b) Distribution and sales charges, including transportation, advertising and product placement costs;

c) Financial charges, such as interest on borrowed capital applied in operations, discounts, premiums, transfers, exchange differences, expenses with credit operations, collection of debts and issuance of shares, bonds and other securities, redemption premiums;

(…)".

Thus, in this provision, emerges a nuclear requirement in the admissibility of expenses for tax purposes: its indispensability. What is to be understood by "indispensability"? Jurisprudence in this country has a well-settled analysis on how such a concept should be understood. Let us see.

In the Decision handed down in process 03022/09 on 6 October 2009, the Central Administrative Court of the South treats extensively the concept of indispensability and does so in the following terms:

"But how is the concept of indispensability to be assessed? Accepting that we are faced with a vague concept in need of specification and accepting that we are not, as regards such specification, faced with any power of discretion (in terms of technical discretion) on the part of the Tax Authority, it is then important to note the terms in which the law frames such a concept. (…)

Drawing on the study by TOMÁS TAVARES (…) we will say, as the author points out, that it appears evident that from the legal definition of expense provided by Article 23 of the CIRC does not result that the Tax Authority may call into question the principle of freedom of management, investigating the merits and convenience of the company's management economic decisions and considering that only those from which profits directly accrue to the company or which prove advantageous to the company may be fiscally assumed.

The indispensability to which Article 23 refers (…) requires, merely, a relationship of economic causality, in the sense that it is sufficient that the expense be made in the interest of the company, in order, directly or indirectly, to the obtaining of profits. (…) And outside the concept of indispensability will fall only those acts contrary to the social purpose, those that do not fall within the interest of the company, especially because they do not aim at profit".

Also on this subject, and with reference to a decision of the Central Administrative Court of the North, in the Decision of 12 January 2012, handed down in process 00624/05.0BEPRT, it is stated:

"In the consideration and fulfillment of this indeterminate concept – indispensability - it is essential that the analysis of a specific expense be made according to the corporate activity, that is, according to its objective within the scope of the company's activity; indispensable expenses will be equivalent to expenses incurred in the interest of the company. The criterion of indispensability was created by the legislator precisely to prevent the consideration at the tax level of expenses which, although recorded as costs, do not fall within the scope of the company's activity, which were incurred not for its pursuit but for other interests".

Finally, in a Decision of 29.03.2006, handed down in process no. 1236/05, the Supreme Administrative Court maintains that:

"The concept of indispensability, being indeterminate, has been fulfilled by case law on a case-by-case basis (…). The rule is that properly recorded expenses are tax expenses; the criterion of indispensability was created by the legislator, not to allow the Tax Authority to meddle in the management of the company, dictating how it should apply its assets, but to prevent the consideration for tax purposes of expenses which, although recorded as costs, do not fall within the scope of the company's activity, were incurred not for its pursuit but for other alien interests. Strictly speaking, these are not true company expenses, but expenses which, having regard to their purpose, were abusively recorded as such. Without the Tax Authority being able to evaluate the indispensability of expenses in light of criteria relating to their appropriateness and merit".

And, further on, this decision further states:

"that, under pain of violation of the principle of tax capacity, the Tax Authority may only exclude expenses not directly rejected by law under a strong motivation that convinces that they were incurred beyond the social purpose, or, at least, with clear excess, deviating, in the light of the objective needs and capabilities of the company".

The connection to the activity or interest of the company being the decisive element which jurisprudence has highlighted, let us look at some doctrine on the same question.

Thus, RUI MORAIS, maintains[2]:

"The invocation of the rule of indispensability of expenses can never be made to replace the judgment of convenience and appropriateness of charges assumed, as they resulted from the decision of the corporate organs, by another judgment, also of a business nature, made by the tax administration or by the courts".

And goes on to say that[3]:

"We cannot consider as good the direction of certain case law that denies the tax accreditation of certain expenses because it is not possible to establish a direct correlation with the obtaining of concrete revenues. Taken to the extreme, such understanding, we would have that expenses with research would only be fiscally deductible when such research had success, when, as a result thereof, the company began to sell new goods and services..."

To conclude in the following manner[4]:

"We argue that the question of whether a cost should or should not be had as indispensable should be resolved from the objective intent of the transaction, that is, the business purpose test… We think it is reasonably clear the purpose of the norm: to refuse tax participation in some of the expenses supported by the taxpayer… If the assumption of the expense was presided over by genuine business motivation… the cost is indispensable. When it should be concluded that the charge was determined by other motivations (personal interest of shareholders, administrators, creditors, other companies in the same group, business partners, etc) then such cost should not be had as indispensable."

For its part, J.L. SALDANHA SANCHES, states[5]:

"…knowing whether a certain cost corresponds, or not, to the most effective defense of the interests of the company is a question that cannot be resolved by assigning a power of State intervention…in order to make a judgment on a proper business management choice, just as it cannot validate the qualification of the expense as a cost by subjecting it to the condition of a posteriori verification of the actual generation of revenues".

The legal interpretation of the concept of "indispensability", as it existed at the time under Article 23 of the CIRC, has been, as doctrine and jurisprudence show, equated to expenses incurred in the interest of the company; to costs supported within the scope of activities arising from its corporate purpose. Only when the expenses result from decisions that do not meet such requirements should they be disallowed.

Now, as corporate entities have a corporate purpose or objective defined in their bylaws, with a view to realizing the purpose for which such collective entities are formed – the obtaining of an excess to be distributed to shareholders – then the management acts that contribute to such purpose shall constitute the activity of companies.

Productive activity should not be understood in a restrictive sense, but broadly, meaning activity related to a profit-generating source of the entity that bears the expenses. In seeking the meaning of the concept of company activity, it cannot be limited to mere or simple production of goods or services. To say that a cost must translate a relationship with activity can only mean that a relationship must be verified with the overall economic operations of exploitation or with the operations or management acts that fall within the pursuit of the entity's own interest that assumes such costs.

In that sense, the activity of a company will consist of the transactions resulting from the use of its assets, in particular, its assets and the management of its liabilities. That is, in the way its management will use the company's assets in the context of the various transactions (productive, commercial, investment and disinvestment, general financing, acquisition of financial interests and others) which, taken together, allow that entity to fulfill its economic purpose: the pursuit (immediate or long-term) of an economic surplus (profit).

The point this Tribunal wishes to underline is the following: the "activity" of a company is not exhausted, as often seems to emerge from some interpretations, in the set of operational acts. "Activity" is also the set of transactions that have as their purpose the realization of investments or the disposal of assets, the acquisition of financial interests and their subsequent disposal, the application of liquidity in short-term investments or securities and their management, the receipts and payments resulting from operational or non-operational revenues and expenses, and many others not expressly referred to here.

The management of companies has, in essence, as its purpose the obtaining of an excess from the use of the assets held by the economic-business entities. Such assets are, even through their normative-accounting classification, divided into different types: tangible fixed assets/fixed assets (e.g., machinery used in production), intangible assets (e.g., manufacturing patents), financial assets (e.g., capital interests), non-current assets held for sale (e.g., a machine that is no longer used in production and it is intended to sell in the short term), inventories/stock (e.g., raw materials) and so on.

Constituting this vast range of assets the means at management's disposal to generate revenues and surplus, it is natural that the purchase of physical assets for investments and their eventual disposal (disinvestment), the purchase and sale of financial interests, the application of liquidity, the receipts and payments of activity, all of it is part of what is considered normal or appropriate acts of the management of a company.

The significance and economic scope of such transactions depend on the economic-financial characteristics of the entities but, on a general level, they all fall under business management objectives and instruments, because they all fall within the scope or purpose of the activity conducted.

In concluding summary of this point, the business activity that generates deductible costs must be that which translates into transactions that have a purpose, an intent (and not an obligatory nexus of immediate causality) of generating revenue or the purpose of maintaining the potential of a profit-generating source.

3.3.2. The Application of the Concept of Indispensability to the Case at Hand

As results from the record, the Claimant, A…, Lda (Tax ID No. …) resulted from the merger of, essentially, three types of entities.

At a first level, there were companies dedicated to the provision of healthcare services, in particular the diagnosis and treatment of kidney diseases (subsidiaries). At a second level, these companies were owned by company K… Lda (formerly J…, Lda), which held, in Portugal, the entities integrated in the I… Group, which acted worldwide in this area of healthcare service provision. At a certain time, the entity then designated B…, acquired the I… Group business in Portugal (embodied in the entities referred to above). To this end, this company was provided with financial resources (equity and debt) by company G… SARL, with registered office in Luxembourg.

B… (later under the guise of the Claimant A…, Lda) thus became indebted to its capital holder, and thus proceeded to pay it financial charges resulting from the debt with which it had been financed to acquire the assets dedicated to the business that the I… group exploited in Portugal.

After several corporate reorganization transactions, J… in a first phase merged with B… (which, following the merger was renamed K… Lda), and, in a second phase, the various subsidiary companies of J… were also merged into K…, Lda (at that time its parent company). In summary, ultimately the Claimant incorporated both the former J… (1st merger) and the operating companies it held (2nd merger).

The essential question to be decided thus consists of whether Article 23 of the CIRC will imply, as the AT alleges, that the financial charges paid by the Claimant A… Lda (formerly J…) to G… SARL (formerly F…) are not deductible, by not meeting the requirement of indispensability as set forth in that legal provision.

This is because, for the AT, the interest paid by the Claimant would not relate to its activity, but rather to the activity or interest of its shareholder. As such, they could not contribute to the Claimant's taxable result, by departing from its social interest or its own activity.

As the AT states: "In other words, to accept the deductibility of financial charges associated with the financing of the acquisition of capital interests of companies whose activities generate the revenues and gains that enable the deduction of those expenses, would be to deny the principle of balancing between expenses and revenues that is inherent in no. 1 of Article 23 of the CIT Code".

Now, the SAC, in process 0779/12, in a Decision handed down on 24.09.2014, rejects the interpretation of Article 23 of the CIRC as implying an obligatory connection, a balancing or a relationship between costs and revenues. Let us see:

"I - In the understanding that doctrine and jurisprudence have been adopting for the purpose of investigating the indispensability of a cost (cf. Article 23 of the CIRC as worded in 2001), the AT may not investigate the merits and appropriateness of the company's economic management decisions, under pain of meddling in the freedom and autonomy of management of the company.

II - Thus, a cost will be accepted for tax purposes if, in a judgment related to the moment it was made, it is appropriate to the productive structure of the company and to the generation of profits, even if it turns out to be an unfruitful economic transaction or economically ruinous, and the AT may only disallow as tax costs those that do not fall within the scope of the taxpayer's activity and were incurred, not in the interest of the latter, but for the pursuit of alien objectives (when it is to be concluded, in the light of the rules of common experience, that it had no potential to generate profits).

III - If the taxpayer is a company dedicated to the construction of buildings, the AT cannot disallow costs relating to the acquisition of two properties on the ground of lack of demonstration of indispensability, even if that business turns out to be economically non-profitable due to its sale at a price six times lower than that at which they were acquired having generated a loss."

There is thus no merit to the position that the tax acceptance of an expense must respect a principle of balancing (or connection) with revenues.

Furthermore, the AT sustains that: "With respect to financial charges, that normative provision requires, as for the generality of expenses, that expenses and losses, deductible for the determination of taxable profit, are indispensable for the generation of revenues and gains subject to tax and for the maintenance of the profit-generating source and sets forth, in its paragraph c) of no. 1, expenses of "a financial nature, such as interest on borrowed capital applied in operations". (emphasis of the AT).

This question of the application of capital in operations, recurring in the AT's argument, merits analysis. Let us see.

Article 23 provided, at the time (underlined by the tribunal):

1 — Expenses or losses that are provably indispensable for the realization of revenues or gains subject to tax or for the maintenance of the profit-generating source are considered as such, in particular the following:

a) Those relating to the production or acquisition of any goods or services, such as materials used, labor, energy and other general costs of production, conservation and repair;

b) Distribution and sales charges, including transportation, advertising and product placement costs;

c) Financial charges, such as interest on borrowed capital applied in operations, discounts, premiums, transfers, exchange differences, expenses with credit operations, collection of debts and issuance of shares, bonds and other securities, redemption premiums;

It is judged to be clear that the AT's thesis, according to which only financial charges arising from capital applied in operations would be deductible (and even then it would be lacking to define what is meant by "operations") does not result from the law. The terms "in particular" and "such as", which we have underlined, establish that financial charges from capital applied in operations are deductible, but do not exhaust the universe of deductible financial charges. These will be so, even when not applied in said operations, as long as they pass the general test of indispensability, are substantiated and are not disallowed by another legal-tax provision.

Now, the concept of indispensability, as already seen, is consensually interpreted as implying that expenses relate to the activity or interest of the company. Thus, financial charges that fall within this framework, even if not being applied in activities considered operational or "operations", may meet conditions of indispensability.

And, as will be seen hereinafter, the financial charges here in dispute are related to the Claimant's activity, as they result from the financing of assets held by it and which even generate revenues of an operational nature.

The AT further advances, with respect to the disallowance of financial charges, for not being inherent to the Claimant's own interest, in summary (Articles 69, 71 and 90 of the Response, underlined by the AT):

«In the case of K… Lda, the costs supported with the loan are not related to its business activity, nor served the maintenance of the profit-generating source. Such costs, although recorded in its accounting, do not benefit its activity or the respective business interest, but rather benefit a third party G… S.A.R.L. (formerly F…), not being accepted for the purpose of calculating the tax result, pursuant to paragraph c) of no. 1 of Article 23 of the CIT Code.

Indeed, with the merger transactions, within which company A… Lda (formerly B…) incorporated company K… Lda (formerly J…), and its subsidiary companies, although they were up stream mergers, in fact implied an integral transmutation of the parent company that legally remained but whose activity began to correspond entirely to the activities already being carried out by the incorporated companies.

Indeed, what occurred with the merger transactions was that, as a result of the extinction of the capital interests held by company A… Lda (formerly B…), the activity previously developed to which the bond loan was associated no longer had continuity, what remained was only operational activity carried out by companies that had belonged to the I… Group, in whose operations the funds obtained through such financing were not applied and, therefore, the financial charges supported did not contribute to the generation of the revenues or incomes of the renal treatment activities."

The AT is not correct when it challenges the deductibility of financial charges supported by the Claimant, in the context of CIT, on the ground that they are disconnected from its activity, from its own interest, and that the funds obtained were not applied in operations.

Indeed, as a result of the merger transactions, the same company (the Claimant) began to hold, as patrimonial elements recorded or recognized in its balance sheet, the assets and liabilities of the operating companies and continued to record, also in its balance sheet, the equity and financial liabilities that supported the capital interests that previously represented this set of patrimonial elements.

This means that, prior to the merger, K… Lda (formerly J…) held, on the right side of the balance sheet, financing sources from A… (formerly B…[6]) paying interest on those sources which constituted debt; and, in its assets, capital interests in the operational entities. With the merger, the same entity (the Claimant) continues to hold the aforementioned liabilities (debts to the shareholder G…, SARL replaced the capital interests - which were canceled with the merger - now beginning to recognize the assets and liabilities of the operating companies whose acquisition, recall, constituted the essential cause of the indebtedness of A… (formerly B…) to G… SARL.

In summary, the merger maintains in the Claimant the financing for which it paid interest, and had as a patrimonial consequence the union, in the same balance sheet, of the assets that such debt financed and continued to finance. No longer financial assets, but their actual translation into assets and liabilities of an operational character.

It is thus clear that the Claimant's debt to the parent company - and the interest resulting therefrom - fall within the interest or activity of A… (formerly B…). There is a clear economic link between the debt that accrues interest and the assets and liabilities that such debt supports.

Furthermore, such assets and liabilities (financial debt) now come to be recognized in the balance sheet of the same entity. Thus, the Tribunal does not see how - in the AT's thesis - the fact that the debt is originative of funds that G…, SARL provided to the Claimant can lead, without more, to the failure to meet the requirement of indispensability then set forth in Article 23 of the CIRC.

When the AT refers to "what remained was only operational activity carried out by companies that had belonged to the I… Group, in whose operations the funds obtained through such financing were not applied", it does not take into account that the holding of the operational activity referred to in entity A… (formerly B…) was only made possible by having paid to the I… group a purchase price that implied the financing in bond loans and advances that generated the interest paid.

Even in a strict perspective of economic nexus between revenues and expenses, it exists. The revenues derived from the business are related to the interest paid for its acquisition. From an equity perspective, there is even greater approximation between the assets and the capital that finances them, now recorded in the same entity. Not challenging the AT the economic purpose of the corporate reorganization transactions carried out, the disallowance of the interest paid has no support in Article 23 of the CIRC.

It can even be ventured that, since it is certain that in many reorganization transactions the assets figure in a certain entity and the debt that finances them could be in another, in the case in question the merger led to a union of assets and liabilities whose management transactions fall, for certain, within the interest or activity of the Claimant.

As for the matter of advances, and the sum of € 11,664,656.99, the AT states that:

"As results from the TIR, no evidence was found that unequivocally demonstrated that the amount of € 11,664,656.99 was not included in the value of the advances, all the more so since company K…, Lda ("

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