Summary
Full Decision
ARBITRAL DECISION (see full version in PDF)
The arbitrators Counsel Jorge Lopes de Sousa (arbitrator-president), Professor Doctor Miguel Augusto Rodrigues Matos Torres and Dr. Ana Teixeira de Sousa (arbitrator members), designated by the Deontological Council of the Centre for Administrative Arbitration to form the Arbitral Tribunal, constituted on 11-12-2018, hereby agree as follows:
1. Report
A..., LDA. NIPC ..., with registered office at Rua ..., ..., ..., ...-... Coimbra (hereinafter referred to as the "Claimant"), has, pursuant to Decree-Law No. 10/2011, of 20 January (hereinafter "RJAT"), requested the constitution of an Arbitral Tribunal.
The Claimant seeks the annulment of the corporate income tax (IRC) assessment and compensatory interest No. 2018..., of 24-09-2018, to the extent it is based on autonomous taxation of "undocumented expenses" and corresponding compensatory interest.
The respondent is the TAX AND CUSTOMS AUTHORITY.
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 02-10-2018.
Pursuant to the provisions of article 6, paragraph 2, letter a), and article 11, paragraph 1, letter b) of the RJAT, in the wording introduced by article 228 of Law No. 66-B/2012, of 31 December, the Arbitrators initially designated by the Deontological Council communicated acceptance of the assignment within the applicable time limit.
On 21-11-2018 the parties were duly notified of this designation and did not express any intention to refuse the designation of the arbitrators, pursuant to the combined provisions of article 11, paragraph 1, letters a) and b) of the RJAT and articles 6 and 7 of the Deontological Code.
Thus, in compliance with the provision of article 11, paragraph 1, letter c) of the RJAT, in the wording introduced by article 228 of Law No. 66-B/2012, of 31 December, the collective arbitral tribunal was constituted on 11-12-2018.
The Tax Administration partially revoked the assessment "maintaining the correction relating to autonomous taxation on undocumented expenses, as well as the other corrections to the taxable base and autonomous taxation which were not contested".
The Tax and Customs Authority submitted a Response in which it argued that the request for arbitral pronouncement should be dismissed.
By order of 06-02-2019, the value of the case was fixed and the meeting provided for in article 18 of the RJAT as well as pleadings were dispensed with.
The arbitral tribunal was duly constituted, in accordance with the provisions of articles 2, paragraph 1, letter a), and 10, paragraph 1, of Decree-Law No. 10/2011, of 20 January, and is competent.
The Parties are duly represented, possess legal personality and capacity, are legitimately parties and are represented (articles 4 and 10, paragraph 2, of the same decree and article 1 of Ordinance No. 112-A/2011, of 22 March).
The proceedings do not suffer from any nullities.
2. FACTUAL MATTERS
2.1. Proven Facts
The following facts are considered proven:
A) The Tax and Customs Authority conducted a tax inspection of the Claimant, pursuant to Service Order No. OI2018...;
B) In that inspection, the Tax Inspection Report was prepared together with the request for arbitral pronouncement, the content of which is reproduced here, in which the following is stated, among other things:
III.2.1 Non-accepted Expenses – Undocumented Expenses
In accounting terms
A... uses the "Accounting Standard and Financial Reporting for Small Entities" (NCRF-PE) in the treatment of recognition, measurement, presentation and disclosure of the economic and financial realities of the entity.
In the preparation of financial statements, one of the most important characteristics to preserve is reliability. Financial information has the quality of reliability when it is free from material errors and biases.
In order to avoid errors, account reconciliations should be performed, and it is advisable to circularize account balances with external entities with which the company relates, namely with customers, suppliers, banking entities, the State (Tax and Social Security authorities) and other debtors and creditors.
Furthermore, physical counts of physical assets held by the company should be carried out, namely tangible fixed assets, inventories, cash, etc.
Another fundamental accounting procedure is the performance of bank reconciliations of demand deposit accounts, bank loans and other financial operations.
The objective of these procedures (circularization, physical counts, reconciliations) is to identify possible differences between accounting records and reality related to external entities or physical items held or leased, whereupon missing documents can be requested or clarifications can be sought regarding open transactions in doubt.
As a result of reconciliation of all accounts, with identification of all differences relating to errors, missing documents or other accounting omissions, it is possible to make the necessary adjustments for the purpose of presenting the Financial Statements of the company with a true and fair view of its financial position and performance, this being one of the main objectives to be taken into account in the preparation and presentation of that financial information.
A... did not demonstrate that it performs any circularization or account reconciliation.
The absence of supporting documents for expenses results in the failure to identify the recipients/beneficiaries, constituting undocumented expenses.
In commercial terms
Moreover, from a legal point of view, for shareholders to advance the receipt of profits, this is only possible if compliance with the requirements of article 297 of the Commercial Companies Code (CSC) is observed (a rule established for joint-stock companies, but applicable, with appropriate adaptations, to limited liability companies).
This article provides that the company agreement may authorize that, during the course of a financial year, advances on profits be made to shareholders, provided the following rules are observed:
• The board of directors or management, with the consent of the supervisory board or the general meeting, decides on the advance;
• The board of directors' or management's resolution is preceded by an interim balance sheet, prepared no more than 30 days in advance and certified by the statutory auditor, demonstrating the existence, at that time, of available funds for said advances, which shall observe, as applicable, the rules of articles 32 and 33, taking into account the results achieved during the part of the financial year in which the advance is made;
• Only one advance is made during each financial year and always in the second half thereof;
• The amounts to be attributed as advances do not exceed half of those that would be distributable, referred to in letter b).
In this context and in accordance with article 34 of the CSC, shareholders must return to the company the assets they have received in violation of the law, since, as this article also states, shareholders should not be ignorant of the law when profits are distributed, so knowing that it could not occur, they must thus return this amount to the company.
Now, consulting the minutes Nos. 15 to No. 30 of the years 2002 to 2017, respectively, which are attached as Annex 3, there is no deliberation in that sense, nor was any amount returned to the company by the shareholders.
Operation recorded in the accounting of A...
In December 2015 A... verified that the balances of the various banking entities recorded in the accounting were mostly higher than the actual values shown in the bank statements, so it proceeded to regularize the account balances (balance adjustment): 123 -...; 125-Montepio; 126-... and 129-..., through an "internal journal entry note", which is attached as Annex 4, by transfer to an account of other debtors (SNC 27 - Other accounts receivable and payable) creating a debit (indebtedness of third parties to the company) for the following amounts:
This entry reflects that there were, in fact, cash outflows associated with various payments in previous financial years, reflected in credit movements of the cash account (SNC 12 accounts), for which the taxpayer cannot identify either the origin of the expenses or the true beneficiaries.
In summary, the movement described above, influenced, in overall terms, negatively the accounting balance of the "SNC 12 - Demand Deposits" account, and "an artifice was used" by the taxpayer to place the available funds balance at real/normal values, appropriate to the reality of the company and in accordance with the bank statements as of 31 December 2015.
In this case, either by error or negligence, the entity will have prepared and presented the financial statements without reliability, as they did not faithfully represent the reality of the entity's financial position and economic performance, since a debit was recognized for a value that does not correspond to financial and economic reality.
Thus, the difference between the accounting balance and the actual balance in available funds of the "SNC 12 - Demand Deposits" account as of 31 December 2015 declared by the taxpayer of €158,753.99 will correspond to undocumented expenses.
According to article 123, paragraph 2, letter a) of the Corporate Income Tax Code, in the execution of accounts all entries must be supported by supporting documents, dated and capable of being presented whenever necessary.
On the other hand, if the taxpayer cannot prove who were the recipients that incurred the expenses, they will be considered as undocumented expenses and, in addition to having to be added in field 716 of table 07 of form 22, they will be subject to autonomous taxation.
Undocumented expenses are understood to mean all expenses incurred for which there is no document as proof of the operation, nor is it known where those expenses went and, therefore, the nature, purpose and origin of the expenses cannot be proven. Consequently, undocumented expenses:
• Do not comply with the provisions of articles 1, 3 and 4 of article 23 of the CIRC (Expenses and losses), as it cannot be proven that the expenses were incurred to obtain income.
• Are non-deductible charges under article 23-A, paragraph 1, letter b) of the CIRC (Charges not deductible for tax purposes);
• Are taxed autonomously, at the rate of 50% under article 88, paragraph 1 of the CIRC;
• Are added in field 716 of table 07 of form 22.
Thus, pursuant to articles 17, 23 and 23-A of the Corporate Income Tax Code, A... should add the amount of €158,753.99 in field 716 of table 07 of the IRC income tax return form 22 for the 2015 tax period, undocumented expenses for the 2015 period.
C) Following the inspection, the Tax and Customs Authority issued the IRC assessment No. 2018... in the amount of €128,568.46, together with the request for arbitral pronouncement, the content of which is reproduced here, which includes amounts of €81,647.98 in autonomous taxation and €10,579.22 in compensatory interest;
D) Notified for the purposes provided in article 13, paragraph 1 of the RJAT, the Tax and Customs Authority partially revoked "the additional IRC assessment No. 2018... of 2018-09-24, relating to the 2015 tax period, the taxable base determined by the tax inspection services having been reduced from €182,405.59 to the amount €23,651.60 (-€158,753.99) maintaining the correction relating to autonomous taxation on undocumented expenses" (clarification submitted by the Tax and Customs Authority on 26-11-2018);
E) In the grounds of the revocation decision, the content of which is reproduced here, the following is stated, among other things:
vi) Now, from the analysis of the elements contained in these proceedings, it is noted that that amount did not negatively affect the net result for the 2015 tax period, as stated in the tax inspection report (RIT), partially transcribed by the appellant in § 3 of the request for arbitral pronouncement, the underlying accounting entry only moves accounts in the company's assets (banks and other debtors) and does not move accounts for expenses and/or income and there is no evidence that, in 2015, that amount was recognized in the accounts as an expense for the purpose of determining the net result for 2015, so its disregard for the purpose of determining taxable income has no legal support and the additional assessment in question should be corrected accordingly, that is, by reducing the taxable base determined by the inspection services by 158,753.99 or, in other words, changing the taxable base from the amount of €182,405.59 to the amount €23,651.60 maintaining the correction relating to autonomous taxation on those undocumented expenses.
F) On 01-10-2018, the Claimant submitted the request for constitution of the arbitral tribunal that gave rise to the present proceedings.
2.2. Unproven Facts and Grounds for the Factual Decision
The facts were proved on the basis of the Tax Inspection Report and documents submitted by the Claimant and the Tax and Customs Authority.
There is no controversy regarding the proven facts.
3. LEGAL MATTERS
The Tax and Customs Authority, in the inspection it conducted of the Claimant, found that an operation had been recorded in the accounting described in the following terms:
"Operation recorded in the accounting of A...
In December 2015 A... verified that the balances of the various banking entities recorded in the accounting were mostly higher than the actual values shown in the bank statements, so it proceeded to regularize the account balances (balance adjustment): 123 -...; 125-...; 126-... and 129-..., through an "internal journal entry note", (...), by transfer to an account of other debtors (SNC 27 - Other accounts receivable and payable) creating a debit (indebtedness of third parties to the company)"
This debit is in the amount of €158,853.99.
The Tax and Customs Authority understood, in an initial phase, that "this entry reflects that there were, in fact, cash outflows associated with various payments in previous financial years, reflected in credit movements of the cash account (SNC 12 accounts), for which the taxpayer cannot identify either the origin of the expenses or the true beneficiaries" and that "the difference between the accounting balance and the actual balance in available funds of the "SNC 12 - Demand Deposits" account as of 31 December 2015 declared by the taxpayer of €158,753.99 will correspond to undocumented expenses".
It therefore concluded that the Tax and Customs Authority that "pursuant to articles 17, 23 and 23-A of the Corporate Income Tax Code, A... should add the amount of €158,753.99 in field 716 of table 07 of the IRC income tax return form 22 for the 2015 tax period, undocumented expenses for the 2015 period".
Pending the present proceedings, the Tax and Customs Authority partially revoked the assessment it made, considering that, after all, that amount of €158,753.99 should not be added to the taxable base because, in short, "the underlying accounting entry only moves accounts in the company's assets (banks and other debtors) and does not move accounts for expenses and/or income and there is no evidence that, in 2015, that amount was recognized in the accounts as an expense for the purpose of determining the net result for 2015".
And, consistently, in the correction document presented by the Tax and Customs Authority, the value "0.00" is listed in the said field 716 of table 7, relating to "undocumented expenses [art. 23-A, paragraph 1, letter b)]".
However, the Tax and Customs Authority understood that it would maintain the taxation of that amount as "undocumented expenses", with the application of the 50% rate provided for in article 88, paragraph 1 of the CIRC.
In the present proceedings, the Tax and Customs Authority argues that the Claimant "recognized a debit for an amount that does not correspond to financial and economic reality, without possessing any accounting support document whose probative value would make it possible to define the characteristics of the economic operation underlying that accounting entry, namely, what, why and to whom" and that, in line with the jurisprudence of the Supreme Administrative Court, these are undocumented expenses "expenses for which the documents required by law do not exist, regardless of whether their nature, origin and purpose are disclosed or concealed".
The Claimant, basing itself on jurisprudence of the Supreme Administrative Court and the Constitutional Court, argues, in short:
– that autonomous taxation relating to undocumented expenses relates to expenses borne by the taxpayer which, in accounting terms, affect the net result of the financial year, reducing it, translating into a penalty "associated with an anti-abuse purpose, such that abuse cannot be precluded (that is, it cannot be demonstrated that the beneficiary of the undocumented expenses declared this income for tax purposes);
– "the taxable fact giving rise to the tax is instantaneous: it is exhausted in the act of incurring a certain expense subject to taxation (although the calculation of the amount of tax, resulting from the application of the various tax rates to the various acts of incurring expenses considered, is to be carried out at the end of a certain tax period)";
– "the taxation of undocumented expenses is intended to compensate for the concealed payment of income to another identifiable taxpayer";
– it is "a taxation of the expense and not of the income, with a punitive purpose, anti-abuse and implying tax liability";
– "autonomous taxation is an exceptional regime within the constitutional legal framework of taxation of income increase and real income, and therefore should be subject to restrictive interpretation";
– "irregularities in the accounting of the taxpayer, including the existence of doubts resulting from those irregularities, cannot fall within the category of undocumented expenses, but are instead prerequisites for the application of indirect methods pursuant to art. 87 letter b) and 88 of the LGT";
– "what the AT cannot do is, under the guise of the presumption of veracity of taxpayers' declarations (which, as we have seen, is set aside in this case), "take advantage of" an accounting operation that it considers artificial and immaterial to extract from it the qualification and taxation that would apply to an actual and substantial operation";
– furthermore, IRC is due for each tax period which coincides with the calendar year (article 8, paragraph 1 of the CIRC) so that "the undocumented expenses which are taxed autonomously with reference to the 2015 financial year are those which were incurred in that year, those which, pursuant to article 88, paragraph 1, are not considered expenses of that tax period";
– the assessment suffers from an error as to the factual grounds, since "at least part of that amount related to undocumented expenses incurred in prior years";
– the TA failed to demonstrate and prove that the expenses it seeks to tax occurred.
3.1. Concept of "Undocumented Expenses"
The concept of "expenses" used in article 88, paragraph 1 of the CIRC is not defined in this Code and does not coincide with "expenses" as defined in article 23 of the CIRC (which includes, in particular, "losses" and "adjustments"), so the expression should be given the meaning it has in common language, namely the outflow of money from the assets of a company.
The Supreme Administrative Court understood, in the judgment of 7-7-2010, handed down in case No. 0204/10, cited by the Claimant, that these are "charges or expenses borne by the taxpayer which in accounting terms affect the net result of the financial year, reducing it": the assessment of whether or not the expense is duly documented and of the confidentiality of the expense is made with reference to the act through which the taxpayer bears the charge or expense which is likely to affect the net result of the financial year, for the purposes of determining the IRC taxable base. That is, the charge will not be duly documented when there is no documentary proof required by law demonstrating that it was actually borne by the taxpayer, and the expense will be confidential when it is not revealed who received the sum constituting the expense.
However, more recently, the jurisprudence of the Supreme Administrative Court does not make autonomous taxation based on undocumented expenses dependent on their relevance as expenses for determining taxable profit, as can be seen from the judgment of the STA of 31-3-2016, case No. 0505/15:
Article 81 of the CIRC, in the wording in force at the date of taxation, defined the various rates that would be used to tax the types of expenses listed there, without any legal provision determining that such taxation would only occur if these expenses had been treated as business tax costs for determining its taxable profit.
Accepting that the purpose of autonomous taxation pointed out by the appellant - reducing the tax expense while avoiding fraud and tax evasion - is one of the elements considered by the legislator in establishing this regulation, that purpose cannot allow, as it claims, that the interpretation of the normative rule in question be carried out in such a way as to insert a legal prerequisite into it with no support in the text of the law, which would be manifestly contrary to the provisions of article 9 of the Civil Code.
The expenses in question are taxed simply because they are incurred, and the taxpayer is indeed under an obligation to make them apparent in his tax return. If all or part of them could have been considered as business costs for determining its taxable profit, increasing the tax expense with the resulting decrease in taxable profit, and the company, by conscious decision or omission, did not consider them in that way in its tax return, they do not thereby lose their nature as expenses taxable under autonomous taxation, which, by definition, is a taxation separate from IRC taxation.
In arbitral jurisprudence, this understanding had already been advocated, namely in the dissenting opinion delivered by Professor Doctor Manuel Pires in case No. 7/2011-T:
expenses that are not documented, recorded in the accounting as expenses, should be included in the autonomous taxation in question, as well as those with the same characteristics, that is, undocumented, which should have been recognized in the accounting as expenses, although fiscally non-deductible, but were not and, therefore, did not affect the result, with no reason to exclude means that, although they may not be the most obvious, do not fail to imply undocumented expenses".
Thus, the undocumented expenses referred to in article 88, paragraph 1 of the CIRC are reduced to outflows of financial resources from the company's assets without a supporting document that allows the determination of the nature of the expense or its beneficiary.
However, for expenses to occur, it must be proven that these outflows of financial resources from the company occurred.
The recognition of "a debit for an amount that does not correspond to financial and economic reality, without possessing any accounting support document whose probative value would make it possible to define the characteristics of the economic operation underlying that accounting entry, namely, what, why and to whom", which the Tax and Customs Authority emphasizes in its Response as the relevant fact for autonomous taxation as undocumented expense, does not in itself constitute any expense, as, by itself, it does not alter the company's asset position.
As the Claimant states and the Tax and Customs Authority ends up agreeing in the act of partial revocation of the assessment, the mere movement of asset accounts (banks and other debtors) does not imply the performance of any "expense", not affecting, by itself, the company's assets.
However, in the Tax Inspection Report, the Tax and Customs Authority did not consider that this accounting operation constituted, in itself, an expense; rather, it considered it as demonstrative of the fact that "various payments in previous financial years will have occurred, reflected in credit movements of the cash account".
Thus, in light of the grounds of the disputed assessment, it will be "those various payments", those "credit movements of the cash account", that constitute the factual support for the autonomous taxation in question.
This understanding is reaffirmed in the decision on partial revocation of the assessment, in which it states:
"ii) That is, without any acceptable accounting support document by means of which it would be possible to define, without doubt, the essential characteristics of the economic operation underlying that accounting entry, namely elements such as what, why and to whom. The accounts of the appellant show that there was unquestionably an outflow of available funds from the company in a substantial amount (€158,753.99) but whose objective, operation(s) underlying it, destination and beneficiary(ies) of that amount are not identified, neither in the company's accounts nor did the appellant present any additional identifying element during the inspection procedure or in these proceedings".
However, this conclusion that there were "various payments in previous financial years", which are the basis for autonomous taxation in 2015, appears uncertain, in a situation where the Tax and Customs Authority indicates in the Tax Inspection Report deficiencies in the Claimant's accounting.
There, the Tax and Customs Authority expressed the view that, "in order to avoid errors, account reconciliations should be performed, and it is advisable to circularize account balances with external entities with which the company relates", "physical counts of physical assets held by the company should also be carried out" and "bank reconciliations of demand deposit accounts, bank loans and other financial operations" should be performed.
The Tax and Customs Authority noted in the inspection that "A... did not demonstrate that it performs any circularization or account reconciliation", and that "either by error or negligence, the entity will have prepared and presented the financial statements without reliability, as they do not faithfully represent the reality of the entity's financial position and economic performance, since a debit was recognized for an amount that does not correspond to financial and economic reality".
The unreliability of the accounting records does not permit the conclusion that accounting "errors" necessarily result in "various payments in previous financial years", as they may result from lapses or omissions.
In this case, the lack of credibility of the accounting is evident from the fact that the Tax and Customs Authority was unable to identify any of the "credit movements of the cash account" to which it refers, despite the fact that this is an account (Account 12 of the SNC) intended to record movements of funds deposited on demand in financial institutions, which could presumably be identified by examination of bank documentation, to which the Tax and Customs Authority can have access, pursuant to article 63-B of the LGT.
Now, the autonomous taxation of undocumented expenses presupposes the demonstration of the existence of the operations that are taxed, underlying those "credit movements of the cash account" from which, in the understanding of the Tax and Customs Authority, the difference between the balance of account 12 and the actual values of bank deposits resulted.
On the other hand, the conclusion drawn by the Tax and Customs Authority that "various payments in previous financial years, reflected in credit movements of the cash account" will have occurred, does not allow identification of which financial years in which those alleged payments may have occurred.
That reference to "various payments in previous financial years" literally expresses the conviction of the Tax and Customs Authority that the payments to which it refers will not have occurred in the 2015 financial year, but in previous ones.
If that is the case, as the Claimant argues, there will be no grounds for levying autonomous taxation with reference to the 2015 financial year, since, under the IRC, including with regard to autonomous taxation provided for in the CIRC, the principle of annuality stated in article 8 of the CIRC applies. In fact, autonomous taxation in IRC is, like the tax levied on taxable profit, determined in the annual periodic return, to which articles 117, paragraph 1, letter b), and 120 of the CIRC refer, so that in the 2015 financial year only expenses that occurred in that financial year can be taxed autonomously.
In any event, even if the Tax and Customs Authority, despite the literal wording of that expression, was also referring to the 2015 financial year, it is unequivocal that the conclusion drawn by the Tax and Customs Authority is that it was not only in the 2015 financial year that the alleged autonomous taxation will have occurred, but also in a plurality of unidentified prior financial years, so that at least that part relating to prior financial years (not determined) the assessment within the scope of the additional assessment relating to the 2015 financial year would be illegal.
Thus, since no outflow of financial resources from the company's assets in the 2015 financial year has been ascertained, nor in which "prior financial years" the alleged "various payments" may have occurred, one is left in a situation of doubt regarding the factual grounds on which the autonomous taxation assessment relating to the 2015 financial year is based, grounded in undocumented expenses. This doubt must be procedurally evaluated in favor of the Claimant, in light of the rule on burden of proof in article 74, paragraph 1 of the LGT.
Based on the foregoing, it is concluded that the disputed assessment suffers from a defect of error as to the factual and legal grounds, as the Claimant argues.
This defect justifies the annulment of the assessment, pursuant to article 163, paragraph 1 of the Code of Administrative Procedure, subsidiarily applicable pursuant to article 2, letter c) of the LGT.
3.2. Compensatory Interest
The assessment of compensatory interest is based on the assessment of autonomous taxation, so it suffers from the same defects.
4. DECISION
In accordance with the foregoing, this Arbitral Tribunal agrees on the following:
a) To partially uphold the request for arbitral pronouncement;
b) To partially annul the IRC assessment and compensatory interest No. 2018..., of 24-09-2018, to the extent it is based on autonomous taxation of "undocumented expenses" and respective compensatory interest, in the amount of €86,492.65 (€79,377.00 in autonomous taxation and €7,115.65, as stated in the order of 01-02-2019).
5. VALUE OF THE CASE
In accordance with the provisions of articles 296, paragraph 1 of the CPC and 97-A, paragraph 1, letter a) of the CPPT and 3, paragraph 2 of the Regulation of Costs in Tax Arbitration Proceedings, the value of the case is fixed at €86,492.65.
6. COSTS
Pursuant to article 22, paragraph 4 of the RJAT, the amount of costs is fixed at €2,754.00, in accordance with Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, to be borne by the Tax and Customs Authority.
Lisbon, 13-03-2019
The Arbitrators
(Jorge Lopes de Sousa)
(Miguel Matos Torres)
(Ana Teixeira de Sousa)
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