Reverse Merger Financing Costs Under Article 23 CIRC – CAAD Arbitration 491/2016-T

ARBITRATION DECISION

The arbitrators Judge Councillor José Baeta de Queiroz (arbitrator-president), Prof. Doctor Tomás Cantista Tavares and Prof. Doctor Américo Brás Carlos (arbitrators-members), designated respectively by the CAAD (in the absence of agreement by the arbitrators appointed by the parties), by the Claimant and by the Respondent to form the Arbitration Tribunal, agree as follows:

1. Report

A..., SA, NIPC ..., with registered office in ..., ..., Lisbon (hereinafter A... or Claimant), filed a request for constitution of the collective arbitration tribunal, pursuant to the combined provisions of Articles 2, no. 1, lit. a), and 6, no. 2, lit. b) of Decree-Law no. 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter RJAT), in which the Tax and Customs Authority (hereinafter TA) is the Respondent, with a view to the declaration of illegality of the IRC assessments and compensatory interest for 2012 and 2013, detailed below:

Regarding 2012: IRC Assessment no. 2016 ... and compensatory interest no. 2016 ... to 2016..., according to account reconciliation statement 2016..., in the total amount to be paid of 1,174,509.39€.

Regarding 2013: IRC Assessment no. 2016 ... and compensatory interest no. 2016 ... and 2016 ..., according to account reconciliation statement 2016 ..., in the total amount to be paid of 1,047,214.83€.

The request for constitution of the arbitration tribunal was accepted by the President of the CAAD and followed its normal procedure, namely with notification to the TA. All arbitrators communicated their acceptance within the applicable period. The parties did not express any intention to refuse the designation of the arbitrators.

The collective arbitration tribunal was constituted on 17/11/2016.

The TA responded, arguing that the request should be judged ungrounded.

On 16/2/2017, the meeting provided for in Article 18 of the RJAT was held; this was followed by the examination of witnesses indicated by the Claimant; which was followed, also on the same day, by oral arguments by the parties, where they maintained, in essence, the defence of their initial positions, already set out in the Statement of Claim and in the TA's response.

The arbitration tribunal was regularly constituted and is materially competent, as provided in Article 2, no. 1, lit. a) and 4, both of the RJAT.

The parties have legal personality and capacity, are legitimate and are represented (Articles 4 and 10, no. 2, of the same statute and Articles 1 to 3 of Ordinance no. 112-A/2011, of 22 March).

The proceedings are not affected by any nullities and there is no impediment to the examination of the merits of the case.

2. Facts

2.1. Established Facts

The following facts relevant to the decision are considered established:

a) The Claimant is engaged in the distribution of piped gas, as well as in the installation, assembly and technical assistance of the respective networks;

b) The B... fund (and its subsidiaries) is a venture capital entity for qualified investors, whose assets are intended to be invested in the acquisition of equity interests in entities with high growth and appreciation potential.

c) The B... fund established the C... company, held by it at 100%, to lead investments in the activities of production, distribution and marketing of gas, fuels and their derivatives.

d) On 13/5/2009, C... established the D... company, held by it at 100%, whose corporate purpose was, in essence, the development of activities in the production, distribution and marketing of gases and other fuels.

e) Also in 2009, D... acquired the capital stock of A... (a mature entity already engaged in this piped gas distribution business, with assets and customer portfolio).

f) To consummate that acquisition (and, to a much lesser extent, to develop operational activity), D... became indebted to banks (in the amount of 28 million euros) and to its shareholders in the amount of 15,240,000.00€.

g) Also in 2009, with effect from 1/7/2009, D... merged with A..., in a reverse merger operation, justified by the following reasons: 1) requirement of the financing banks (see financing agreement, cl. 2, no. 10 and 14, no. 3 – doc. no. 5, attached with the Statement of Claim); 2) cost rationalization; 3) the merger is reversed because A... had licenses and permits (for the exercise of the activity), name, brand and market reputation – and if the merger were not reversed, the permits and licenses would be revoked and there was commercial risk with customers.

h) Following the merger, the Claimant (surviving company) assumed (i) all of D...'s liabilities and (ii) bore the costs (interest) incurred by D... with the banks and shareholders.

i) In venture capital activity (as developed by the E... group) it is customary for the purchase of shares of the company to be acquired to be carried out by a vehicle company established for that purpose (D...) and subsequently a merger to be promoted with the operating entity (A...) – ordinary or reverse – in order to (i) reduce administrative costs and (ii) due to bank requirements (place the debt in the same legal entity that owns the assets).

j) The TA does not accept that A... may deduct, in 2012 and 2013, for tax purposes the costs (interest) relating to financing originally contracted by D... for the acquisition of A... and assumed by the latter as a result of the merger. It bases its claim on Article 23 of the Personal and Corporate Income Tax Code (CIRC), considering that such financial charges are allegedly not indispensable for obtaining income or for maintaining the source of production and consequently promotes the IRC assessments subject to the present arbitration proceedings.

k) The Claimant paid the assessments contested in this proceeding: that of 2012 (tax and interest) in the amount of 1,174,509.39€, on 19 July 2016; that of 2013 (tax and interest), in the amount of 1,047,214.83€, on 25 July 2016 (docs. no. 8 and 9 of the Statement of Claim).

2.2. Unestablished Facts

There are no facts with relevance for the examination of the merits of the case that have not been established.

2.3. Justification for the Determination of Facts

The established facts are based on documents presented by the parties (which are, essentially, documents issued by the tax authorities, the merger and financing documents), on the agreement of the parties (also regarding the documents and values and dates of payments), on the testimony of the witnesses (who showed themselves to be knowledgeable of the facts, impartial and credible) and on official information attached to the proceedings.

3. Points of Law

3.1. Question to be Decided

As accepted by the parties, the question that arises in the present proceedings concerns only the tax treatment to be given to the interest and other costs incurred, in 2012 and 2013, by A... relating to loans (from shareholders and third parties) for the purchase of A...'s own capital and which the claimant bears by virtue and as a result of the merger with its shareholder D..., which originally contracted these liabilities.

In the opinion of the TA, these interest and costs would not be tax-deductible, under Article 23 of the CIRC - in the wording and numbering at the date of the facts - because they are not indispensable for obtaining income or maintaining the source of production. For the Claimant, on the other hand, these interest and costs would be tax-deductible, by satisfying the requirements inherent in Article 23 of the CIRC.

3.2. Applicable Laws

According to Article 23 of the CIRC (in the wording and numbering at the date of the facts), are considered costs or expenses:

"1. [...] those that are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the source of production, namely:

(...)

c) Of a financial nature, such as interest on borrowed capital applied in the operation [...], costs with credit operations [...]";

On the other hand, with the merger of companies "the incorporated companies are dissolved [...], transmitting their rights and obligations to the surviving company" (Article 112, lit. a), of the Commercial Companies Code).

3.3. The Arguments of the Parties

The justification of the assessments (and the Respondent's response and other statements by the TA throughout the proceedings) invokes, in summary, that the interest borne by A... after the consummation of the merger (and as a result of this operation) relating to financing originally contracted by D... directly for the acquisition of A...'s capital does not merit the nature of indispensable for the profits or maintenance of the source of production: after the merger it no longer finances the acquisition of equity interests; there would have to be, in each year in which interest is recorded, a balancing between the financial costs incurred and the profits and existence of the asset; these interest payments would not be linked to the Claimant's normal activity and the associated asset does not exist and would not contribute in the future to taxable income.

The Claimant argues, on the other hand, that the interest borne in 2012 and 2013 by A... is indispensable for the profits or maintenance of the source of production, and is therefore qualified as a tax cost under Article 23 of the CIRC. The interest is borne by A... in the course of its activity; the interest, when originally incurred (by D...), was indispensable for profits and maintenance of the source of production – and if it was so at the initial moment, it must be so forever, whatever subsequent modifications (even with the merger); the merger, among its normal effects, leads to the result in the proceedings; the merger is an operation permitted by commercial and tax law and the TA, in the justification of the act, does not invoke the alleged abuse of the merger operation, under Article 38, no. 2, of the General Tax Law (LGT).

3.4. Decision

The arbitrators analyzed all the arguments put forward by the parties (in their written pleadings, documents and oral arguments), as well as the argumentation and consideration of previous arbitral awards on the subject, but always keeping in mind the subtle differences of the case ("each case is a case").

Indeed, several arbitral awards (for example, in cases 14/2011-T and 87/2014-T) refused the tax deduction of interest borne by the surviving company post-merger, relating to financing contracted by the incorporated company pre-merger for the acquisition of the surviving company's capital stock. On the contrary, arbitral awards 101/2013-T, 42/2015-T (here in an ordinary merger, but the considerations are the same), 92/2015-T and 93/2015-T pronounce themselves in the opposite sense, accepting the deduction of these financial charges, considering them manifestly indispensable for obtaining profits or maintaining the source of production.

Furthermore: the arbitrators have already ruled in another case on the same subject matter (case 88/2016-T), composed of the same exact panel – and decided, by majority, in the sense of accepting the tax deduction of these financial charges, even after the merger. In this case, they again considered all the factual and legal arguments contained in this case and the content of the previous arbitral awards – also in case 88/2016-T, to confirm whether they maintained or not the direction of their decision.

After all that consideration, they decide, by majority, in the sense of annulling the assessments challenged and consider that these interest and costs borne by the Claimant are indispensable for profits and maintenance of A...'s source of production, based on the consideration and decision of the arbitral award in case 93/2015-T, to which they adhere and the operative part of which follows, reproduced in this case (which was also done in case 88/2016-T).

(Beginning of citation from the arbitral award in case 93/2015-T)

"[...] exclusively at stake are interest on borrowed capital, it is considered that the starting point of the decision-making process in the dispute that must now be settled is situated within the framework of Article 23, no. 1, c) of the CIRC.

Such rule provides, among other things, and to the extent that what now matters, that 'Expenses are considered (...) namely: c) interest on borrowed capital applied in the operation.'

Thus, and before proceeding in the direction of ascertaining whether from the aforementioned rule results, or not, a limitation of the deductibility of interest on borrowed capital to its application in the operation, or whether, as concluded in Award 42/2015T, interest on borrowed capital applied for other purposes will be within its scope deductible, it is necessary to assess whether, in this case, that is or is not the situation that obtains.

In such assessment, and unless better advised, it should be taken into account, as decision-making parameters, in addition to what has been already duly addressed, four aspects that are considered fundamental, namely:

• The first [...] is the circumstance that the equity interests of the surviving company, which formed part of the assets of the incorporated company, do not exist in the patrimony of the company resulting from the merger process;

• The second, which is deemed to be no less unavoidable than the foregoing, is that the 'borrowed capital' to which the interest borne and whose deductibility is questioned is attributable, in a moment prior to the merger, was already fully applied;

• The third, far less evident, but equally unavoidable and relevant, is that the company resulting from the merger process is not materially identical (from the perspective of economic reality) with the company benefiting from the merger, as it was configured previously to it;

• The fourth, which is deemed to be, likewise, not contestable, is that the shares allotted in the merger process to the shareholders of the incorporated company will be consideration, not for the capital obtained by the latter, through the financing whose interest has its deductibility at issue, but, as has already been seen, for the shares of that same incorporated company and which, by virtue of the merger process, are extinguished.

In light of these parameters, it is considered that, effectively, in this case the prerequisites of the aforementioned letter c) of no. 1 of Article 23 of the CIRC are fulfilled, because the expenses with interest in question correspond to borrowed capital that was applied in the operation of the entity that bears them.

This statement, which at first sight might appear counter-intuitive, will be understandable if the third of the fundamental decision-making criteria listed above is properly borne in mind.

Indeed, and as was written in the Award of the Superior Court of Administrative Justice of 13-04-2005, handed down in case 01265/04[1]:

'A merger by incorporation, even though it implies that only the company into which the others are incorporated survives with its own legal personality, does not have the consequence, in the field of economic and business realities, of the disappearance of the merged companies. Some commercial law doctrine – see PINTO FURTADO, PINTO COELHO and PUPO CORREIA in the places cited in the appealed judgment – points out that the merged company, losing its legal personality, nevertheless persists, modified, forming one unit with others, in conditions different from those that occurred before the merger. But it does not cease to continue to exist the same economic reality, the same set (now integrated in another broader one) of means dedicated to a productive activity, which the partners, moreover, wanted to enhance with the merger.

That is, with a merger by incorporation there occurs a transformation of the company, but not an extinction, with the integration not resulting in its disappearance, but in its alteration, even though it implies the loss of legal personality.'

Also in the Award of the Southern Administrative Court of Appeals of 17-04-2012, handed down in case 04172/10[2], it was written that 'the merger of companies is the act by which two or more companies combine their economic forces to form, with the partners of all of them, a single collective personality, a new economic and legal subject.

Hence it can be stated, as A. appears to have done, that the merger is, as a general rule, and the situation under analysis does not constitute an exception, recommended by interests common to the companies involved in it, and not only to one of them.'

And further: 'It is true that it could be argued that the merged company, losing its legal personality, nevertheless persists, modified, forming one unit with others, in conditions different from those that occurred before the merger; however, it is also true that the same economic reality does not cease to exist, the same set (now integrated in another broader one) of means dedicated to a productive activity, which the partners, moreover, wanted to enhance with the merger.

In another formulation, it can be stated that with a merger by incorporation there occurs a transformation of the company, but not an extinction, with the integration not resulting in its disappearance, but in its alteration, even though it implies the loss of legal personality.'

Understanding this, it will then be comprehensible the statement that the expenses with interest in question correspond to borrowed capital that was applied in the operation of the entity that bears them. Indeed, properly understanding the economic reality post-merger (not fraudulent), one should accept that the entity resulting therefrom, although contained in the legal 'shell' of the surviving company, no longer corresponds to this as it was configured before the aforementioned process of corporate reorganization, but rather is a synthesis between the incorporated company and the surviving company.

Citing the preceding case law, it continues 'the same economic reality exists', the 'same set (now integrated in another broader one) of means dedicated to a productive activity', in the operation of which the borrowed capital whose interest expenses come to have their deductibility questioned were applied, since the integration did not result in their disappearance, but in their alteration, even though with the loss of legal personality.

Thus, in light of this understanding of the effects of merger by incorporation – including the reverse – one cannot conclude otherwise than by the fulfillment of the prerequisites of the aforementioned lit. c) of no. 1 of Article 23 of the CIRC.

It thus becomes comprehensible the passage from Award 42/2015T cited above, according to which 'the merger maintains in the Claimant the financing for which it paid interest, and had as patrimonial consequence the joining, in the same balance sheet, of the assets that such debt financed and continued to finance. Not mere financial assets, but their real translation into assets and liabilities of an operational character'. Indeed, the perspective of the aforementioned award, which would be unquestionable in cases of ordinary merger by incorporation (not reverse or upstream), where it is evident that the surviving company exchanges the equity interests it holds for the economic reality that the investee company represents, should be considered equally valid in cases of reverse merger, since the material post-merger reality (the 'economic reality', the 'set (...) of means dedicated to a productive activity'), would be, at least as far as they constitute relevant aspects for the problematic under discussion, precisely the same[3].

This conclusion is not invalidated, it should be said, by the fact that, as stated in Arbitral Award 87/2014T, 'the tax deduction of financial costs incurred (...) must be assessed in the context of the Claimant's own business activity, in consideration of the normative criteria resulting from no. 1 of Article 23 of the CIRC', and that 'to proceed with the application to the present case of the requirement of indispensability of costs, it is decisive to ascertain (...) the effective and concrete allocation of the financing of which the interest borne is the remuneration or, in other words, it is important to verify the destination or use of the funds obtained in relation to which the taxpayer intends to tax-deduct, for purposes of computing its taxable profit, the interest and other associated charges it incurred'.

Rather the contrary. Understanding that the Claimant, as it presents itself post-merger, is no longer the same center of interests that existed before that process, but another different one that synthesized itself with the incorporated company and that, therefore, the business context of the Claimant incorporates, also, the economic reality previously embodied autonomously by the company incorporated in it, one would then be – truly – assessing the 'normative criteria resulting from no. 1 of Article 23 of the CIRC' 'in the context of the Claimant's own business'.

On the other hand, and as has already been mentioned, nor is it verified that there has been any alteration in the '(...) the effective and concrete allocation of the financing of which the interest borne is the remuneration', or deviation in the 'destination or use of the funds obtained in relation to which the taxpayer intends to tax-deduct, for purposes of computing its taxable profit, the interest and other associated charges it incurred', because, on the one hand and as was seen, the financing was fully applied in a moment prior to the merger, and, on the other and as has equally been seen, the proceeds of that application were not even diverted to a third party, notably to the shareholder (before the incorporated company and, after, the surviving company), insofar as the shares of the surviving company of which it became holder derive, not from the financing whose interest is at issue, but from the shares of the incorporated company that it held, and which were extinguished by the merger process.

The position adopted is equally compatible with the assertion that can be read in the same award just referred to, according to which 'the fact that certain financial charges were previously tax-deductible within the scope of the determination of the taxable matter of a certain company does not mean, of itself, that they are necessarily so in the same terms within the scope of the company that, by merger, incorporated the latter'.

Indeed, and as Professor Teixeira Ribeiro already referred to, in light of the Industrial Contribution Code (CCI)[4], the subparagraphs of no. 1 of Article 23 of the CIRC cannot be understood in any other way than that when costs or losses are specifically listed in Article 23, their essentiality is presumed, and consequently the taxpayer is relieved of the corresponding proof, and that is precisely the purpose of the enumeration (derived, among other things, from the use of the expression 'namely').

It does not mean the fulfillment, in this case, of lit. c) of no. of Article 23 of the CIRC, that the TA cannot question the general requirement of deductibility of expenses, contained in the body of the article, demonstrating that, despite fulfilling a subparagraph thereof (in this case lit. c)), the merger was carried out for interests other than those of the companies party to it[5].

Similarly, the TA could demonstrate that, despite fulfilling a subparagraph of no. 1 of Article 23, and that the merger was determined by interests of the companies party to it, the same was carried out in a fraudulent context, so as not to produce tax effects, as prescribed by Article 38, no. 2 of the General Tax Law (LGT)[6].

It so happens that, in this case, neither one nor the other of the ways was pursued by the TA, so it will not be the responsibility of the Tribunal to assess its merit.

It is not considered, finally, that the circumstance, also identified above, is relevant, namely that at the moment when the interest is incurred, the assets in which the borrowed capital was applied do not already form part of the legal sphere of the company resulting from the merger.

Indeed, with the borrowed capital applied in the operation (a situation different from the 'diversion' of part of the capital for applications foreign to business interest, which, as has been seen, does not obtain in the present case), it is considered that it would, nonetheless, be possible to refuse the tax deductibility of the corresponding financial charges, demonstrating (and thus, eliminating the presumption of deductibility resulting from lit. c) of no. 1 of Article 23 of the CIRC, detected in the wake of Professor Teixeira Ribeiro), that the proceeds of that application – and no longer the borrowed capital - would have been diverted for extra-business purposes.

What has just been stated will be easily comprehensible using the example of a company that, using borrowed capital, acquires a vehicle, which it dedicates, from the outset, to the operation within the scope of its activity, but which, from a given moment, comes to allow its use exclusively in the interest of third parties (e.g.: partners; other companies).

In this situation, it is deemed that the presumption of indispensability of the financial charges incurred with the acquisition of the vehicle, arising from the application of the borrowed capital in the operation of the company in question, will be set aside[7], so the deductibility of those charges should be refused. It is not, however, once more, that the situation in the present case.

Rather, what happens in the situation before us is that, by way of the merger operation carried out, there was a disappearance of the object of the application of the borrowed capital. That is: such object, which existed, ceased to exist (which is different and, again, is not what happens in the situation sub iudice, of continuing to exist in the sphere of third parties).

Returning to the example of the vehicle, the situation would be the same as would occur in the case where, by way of a business decision, it became unusable before the end of the payment period of the financial charges related to its acquisition (e.g.: the use of the same in an advertising campaign that destroys it). Still, it is believed, those charges will remain deductible, despite the disappearance – by way of a business decision – of the object in which the borrowed capital that remunerated them was applied. This would only not happen, following what has just been said, if it were demonstrated that the decision that caused the disappearance of such object was motivated by interests foreign to the company or, then, that it was abusive. What – once more – is not what is at stake in the present proceedings.

It should finally be said that it is considered that the regime relating to the prohibition of financial assistance in the acquisition of own equity interests, essentially regulated in Articles 322, no. 1 of the Commercial Companies Code (CSC), and 23 of the Second Directive 77/91/EEC of the Council, of 13 December 1976, will not invalidate either the decision-making parameters from which one started, or the conclusions that have been drawn.

Notwithstanding such question not having been either a basis for the tax act subject to the present arbitration action[8], nor raised by the parties themselves[9], it will always be said, in favor of the integrity of the decision, that it is not apparent that any act has been concretely carried out that can be pointed to as having occurred in violation of the aforementioned prohibition.

Indeed, the very no. 1 of Article 23 of the Second Directive 77/91/EEC of the Council, of 13 December 1976, in force at the date of the tax fact[10], and in light of which the norm of Article 322, no. 1 of the Commercial Companies Code (CSC)[11] must be read, considers financial assistance the advance of funds, the granting of loans or the provision of guarantees, it being certain that, in this case, it is not ascertained that any of these situations has occurred.

Indeed, the funds used for the acquisition of the Claimant's equity interests were provided by banking entities, and not advanced or granted on credit by the Claimant, and this, as far as can be ascertained, did not provide any guarantee in favor of the creditors of the financing used for the acquisition of the aforementioned equity interests, so that, barring the occurrence of fraud, it cannot be considered that, in this case, the Claimant provided financial assistance, proscribed by the aforementioned norms.

That is, in summary: there is no doubt that funds were not advanced, credits granted or guarantees provided by the Claimant, with a view to the acquisition of own equity interests. If – and in this case, it is deemed that this is a discussion that will not be appropriate to continue, so will not be of interest whether such is questionable or unquestionable – the same results were obtained by other non-prohibited ways, we would then be faced with a fraudulent action, to be treated as such.

For any violation of the prohibition of financial assistance to be considered verified, it would always have to be withdrawn from the combination of all legal acts practiced by the Claimant, and the intention – in that case, fraudulent - to, by that means, obtain a result that the law prohibits.

Indeed, a conclusion of violation of the prohibition of financial assistance by the Claimant will – it is believed – always have to be based on the combination of the complex of acts practiced, from the institution of the group's corporate organization initially established, to the realization of the reverse merger by incorporation, passing through the financing operation carried out, it being certain that all these acts, in themselves considered, will present themselves as lawful and proper to the various business entities involved in them, and only a fraudulent purpose and result actually demonstrated will be capable of removing the mantle of legality that covers them.

Now, unless better advised, being thus each one of the various legal acts practiced by the different participants in the complex action at stake in the present proceedings, lawful and business-oriented, the proper means of carrying out the aforementioned demonstration, and drawing its own effects in tax matters, will be by way of the anti-abuse clause[12].

This conclusion will not, it is believed, be susceptible to being affected by the consideration – moreover not made by the TA itself – of the prohibition of financial assistance in the densification of the general criterion of indispensability of Article 23, no. 1 of the CIRC, not least because it is understood that not only would it be necessary, previously, that an effective (and not merely generic or potential) violation of the aforementioned prohibition be demonstrated, but that, being at issue – in the present case, as has been said – an overall action of evasion of the law, the use of the general clause of indispensability would constitute – with all due respect and, may the expression – itself an 'evasion of the law', insofar as it would be an expedient means of removing the guarantees that the law intended to confer on the taxpayer, in cases where the TA understands that the legal forms used by the latter do not have correspondence in the economic reality pursued.

In any event, it is further noted that, with no doubt remaining that in the case a so-called 'leveraged merger' ('merger leveraged buy-out', mLBO) took place, no less certain will it be that such a figure is known, for a date that can be considered already long, to the legislator, which – to date – has understood not to draw from that knowledge either its illegalization in general (nor is there knowledge, moreover, that such has occurred in any EU legal system), nor any other effects in the tax field.

Moreover, in regimes, such as the Italian one, where mLBO operations have already been regulated, the regulation established insists especially on the obligations of communication and audit, thus making clear that the operation in itself is not intrinsically illicit and/or fraudulent, but that, solely, it contains within itself a potential of illicitness/fraud, superior to normal. Thus being, it is considered that the mere occurrence of a leveraged merger operation will not, of itself, be susceptible to being considered fraudulent and, still less, anti-business.

Finally, it will always be said that the application to the case, by way of the general criterion of the indispensability of expenses, of the prohibition of financial assistance in the acquisition of own equity interests, under the argument that all the acts and contracts carried out were characterized by the purpose that it be the Claimant's patrimony that bore the cost of the acquisition of its own equity interests, will equally run up against the finding that this same result would be obtained if the merger by incorporation had taken place in the opposite direction.

Concluding, and as Professor Saldanha Sanches referred to[13], if 'Operations of demerger and merger are an area where attempts to obtain tax savings by means of abusive practices are very frequently verified, which motivates the legitimate concerns of the legislator', it cannot be a matter of starting from an 'insurmountable distrust (...) with respect to the reverse merger, as if this operation could only be carried out to circumvent tax law or were, in itself, an abusive operation'.

Thus, considering that, in the case, the prerequisites of Article 23, no. 1, c) are fulfilled, in particular, that the borrowed capital to which the financial charges whose deductibility is questioned by the TA refers was effectively applied in the operation of the Claimant, as it presented itself on the date it incurred those charges (post-merger), at issue in the present proceedings, and that it is not demonstrated (nor did such fact constitute, even, a basis of the tax acts subject to the present arbitration proceedings) that the merger operation, from which resulted the disappearance of the equity interests in which the aforementioned borrowed capital had been applied, was exclusively or mainly motivated by interests foreign to business, or fraudulent, should the arbitration requests for annulment wholly proceed.

(End of citation from Arbitral Award)

For the sake of truth, it should be noted that the matter of financial assistance is not properly a subject to be decided, as it was never invoked by the TA during the proceedings (nor in a subsidiary form). It is addressed only as a mere notation suggested by the subject matter, as also happened in case 93/2015-T.

With the operative content of the essential question – in the sense of annulling the assessments challenged, as they do not violate Article 23 of the CIRC – the pronouncement on the other defects pointed out by the claimant (alleged insufficiency of the justification of the assessment acts, omission of essential legal formality [failure to notify for the exercise of prior hearing], lack of justification [incongruity and lack of clarity] of the tax inspection report itself) becomes moot.

The Claimant also requested that, in addition to the annulment of the assessment challenged, the TA be condemned to return the tax paid plus compensatory interest at the statutory rate.

Article 43, no. 1, of the LGT provides that compensatory interest is due in favor of the taxpayer when it is determined in judicial challenge (and the arbitration action is included in this legal provision, by coherence and unity of the legal system) that there was an error attributable to the services as a result of which payment of a tax debt superior to that which was due occurred.

Now, that is what happens in the present case. The TA, by introducing additional IRC assessments – now annulled – implied a tax payment by the taxpayer that was ultimately undue and required only, by error attributable to the TA's services (which illegally required assessed tax).

Whence, the requirements of Article 43 of the LGT being satisfied, the TA must proceed with the payment of compensatory interest, at the statutory rate, from the moment of payment by the taxpayer until complete reimbursement to the taxpayer of the tax paid by it.

4. Decision

In accordance with the foregoing, this Arbitration Tribunal agrees on:

To judge well-founded the request for declaration of illegality of the assessments challenged for IRC and compensatory interest for 2012 and 2013, namely:

For 2012: IRC Assessment no. 2016 ... and compensatory interest no. 2016 ... to 2016..., according to account reconciliation statement 2016..., in the total amount to be paid of 1,174,509.39€;

For 2013: IRC Assessment no. 2016... and compensatory interest no. 2016 ... and 2016..., according to account reconciliation statement 2016..., in the total amount to be paid of 1,047,214.83€.

And in consequence:

1. To order the reimbursement to the claimant of the IRC and compensatory interest for 2012 paid by it, in the amount of 1,174,509.39€;

2. To order the reimbursement to the claimant of the IRC and compensatory interest for 2013 paid by it, in the amount of 1,047,214.83€.

3. And to condemn the TA to pay compensatory interest to the Claimant, as follows discriminated: on 1,174,509.39€ (IRC 2012), from 19/7/2016 until full reimbursement; on 1,047,214.83€ (IRC 2013), from 25/7/2016 until full reimbursement.

5. Value of the Proceedings

In accordance with the provision of Article 97-A, no. 1, lit. a), of the Code of Tax Procedure and Process (CPPT) and 3, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of the proceedings is set at € 2,221,174.22€.

Notification required.

Lisbon, 5 April 2017

The Arbitrators

José Baeta de Queiroz (Arbitrator President)

Tomás Cantista Tavares (Arbitrator Member)

Américo Brás Carlos (Arbitrator Member – dissenting as per declaration attached, which forms an integral part of this decision)

DISSENTING OPINION

I voted against the decision contained in the award, essentially because:

1. Not adhering to the case law of the Superior Court of Administrative Justice and the Administrative Courts of Appeal – rather basing its argument on decisions of the Tax Arbitration Tribunal – disregards the conforming role of the case law of those superior courts and is susceptible to appeal under no. 2 of Article 25 of the RJAT.

2. The assessment of the 'proven indispensability of expenses for the realization of income subject to tax or for the maintenance of the source of production' referred to in no. 1 of Article 23 of the CIRC can only be made in relation to the entity that accounts for and bears them, as is moreover admitted at p. 12 of the Award[14] and results from repeated case law of the Superior Court of Administrative Justice[15] of which an example is its Award of 30.05.2012, case no. 171/11, which concluded: 'costs cannot fail to respect the taxpayer company itself'. Taxpayer company which is in the case sub judice, the Claimant, undeniably the only person – the only center of attribution of rights and duties - that after the merger survived in the legal order[16], including the part thereof that respects taxation.

3. In the case of payment of charges with loans, I understand that it is the use of the assets acquired with the funds thus obtained that determines the characterization and regime that falls – indispensability and tax deductibility, or not – to the concomitant interest[17].

4. The assessment of proven indispensability of expenses, although it should not involve prior value judgments on the correctness or incorrectness of the company's management decisions, should be anchored in the idea of proven 'necessity'[18] thereof, 'in view of the corporate object of the commercial entity in question'[19].

5. Furthermore, the exercise of assessing proven indispensability or proven necessity of expenses cannot also fail to be grounded in an assessment based on a vision of normality or verisimilitude (as is moreover common in any assessment for purposes of legal judgment) in the face of the expense itself, but also in the face of all the circumstances that determined that the same was incurred in the circumstances in which it was. As was decided in the Award of the Southern Administrative Court of Appeals of 16.10.2014, case no. 6754/13, an expense is indispensable when there is 'a causal nexus with profits or gains explained in terms of normality, necessity, congruence and economic rationality'.

6. Now in the case of the present proceedings, the factual progression of the entire operation was:

• On 12.05.2009, a Venture Capital Investment Fund (B...) establishes a company C... (C...) holding 100% of the capital;

• On 13.05.2009, the company C... establishes the company D... (D...) holding 100%, the latter having the same administrators as C..., which were also the senior responsible officers of the Venture Capital Investment Fund. The company D... was established with a corporate purpose similar to that of the company A... (A...) already pre-existing and at the time legally independent of Companies C... and D..., as well as of the Investment Fund.

• On 18.05.2009, three banks made available to company D... a loan of 28 million euros intended to permit the acquisition of the shares of company A..., the credit institutions having imposed the obligation that company A... incorporate by merger company D..., within a maximum period of one year. It should be noted that company D... never had operational activity, did not acquire the permits and licenses necessary for its exercise and did not have assets to satisfy the guarantee requirements imposed by bank creditors (see p. 4 of the award)[20].

• On 30/12/2009, the total merger of D... (parent company) into the Claimant A... (surviving company) was consummated, with effects retroactive to 30/6/2009.

1. As is crystal clear, the entire operational sequence is subordinated to the following objective: acquisition of the entire capital stock of the Claimant by the E... group (as is the nature of Venture Capital Funds) and placement of the debt resulting from the respective financing in the acquired company itself - the Claimant - the only entity with relevant operational activity and with income which, as has been said, makes possible the tax deduction of the charges incurred as a result of the debts contracted by a third party for the acquisition of its own equity interests.

2. All steps of the operation are inserted in the same 'unity of intention and action' and are, from the beginning, solely directed to the business purpose referred to in the previous number. An objective foreign to the business interest of the Claimant, with the financing and payment of the concomitant charges not being necessary to its activity, nor indispensable for the pursuit of its specific business interest embodied in the production of its income subject to tax or in the maintenance of its source of generation. The obligation to pay the charges in analysis was never, from the first hour, contracted in the business interest of the Claimant, and could not, after the merger, come to be considered such financings as indispensable for purposes of no. 1 of Article 23 of the CIRC.

3. And the noted 'unity of intention and action' in which the facts referred to above are inserted makes all the difference with respect to the situation of continuation of payment and deduction of interest beyond the existence of an asset whose acquisition generated charges, which the Award used to, by exemplifying, support its decision. In the example used in the Award, the subsequent circumstance that determines the disappearance of the asset – a vehicle that is removed from the assets – is not inserted in the 'line of intention and action' that determined its acquisition with recourse to credit[21]. The unity of action that results from the factuality contained in the present case, noted above, equally puts in question the cornerstone of the Award which is based on the idea of making relevant the fact that the purchase of the Claimant's shares occurred, in full, before the merger.

4. And not far removed from this line of assessment of the indispensability of expenses in the face of the ultimate business objective (or commercial objective or business purpose) is the judicious doctrinal reference of Tomás Cantista Tavares 'the legal notion of indispensability cuts itself, therefore, over an economic-business perspective, by direct or indirect fulfillment of the ultimate motivation of the contribution to the obtaining of profit'[22].

5. An interpretative effort cannot, in my view, segment the acts of a chain of logically interrelated acts and ignore the whole which, in that their relationship, reveals the business purpose.

6. It should be said that it is also in the consideration of the business purpose that one can 'take into account the economic substance of the tax facts', as determined by no. 3 of Article 11 of the LGT.

7. In consequence, having regard to the above, the charges relating to those loans, borne by the Claimant, do not meet the requirement of indispensability referred to in no. 1 of Article 23 of the CIRC, because, in summary:

a) They do not respect the activity carried on by it (Award of Superior Court of Administrative Justice, case 171/11);

b) The expenses corresponding to the interest borne by a surviving company by virtue of the acquisition of borrowed capital by the incorporated company to acquire 100% of the shares of the first, are not indispensable for this company (surviving company), because they were not constituted in its business interest, and thus are not necessary for the pursuit of its corporate purpose (Awards of Superior Court of Administrative Justice, case 164/12 and Awards of Southern Administrative Court of Appeals, case no. 5327/12 and case no. 8137/14);

c) There is no causal nexus between those expenses and its profits or gains, explained in terms of normality, necessity, congruence and economic rationality (Award of Southern Administrative Court of Appeals, case no. 6754/13);

1. And these reasons alone would suffice for such charges not to be tax-deductible.

2. But the impossibility of tax deduction of such charges is further prescribed by lit. c) of no. 1 of Article 23 of the CIRC.

3. Such consequence is not prevented by the exemplary enumeration formed by the set of subparagraphs of the said number. As a whole, the subparagraphs of no. 1 form an exemplary enumeration by virtue of admitting the existence of other expenses in which a company may incur. However, this does not mean that within some of these subparagraphs the law has not included mandatory provisions, such as those resulting from part of its lit. c) and lit. j)[23].

4. The fact should be highlighted that in lit. c) of no. 1 of Article 23 of the CIRC the legislator has imposed for financial charges a limitation (and it also did so for expenses relating to some financial instruments, including in the rule some instruments and excluding others, according to its method of measurement) that it did not wish to repeat with respect to other expenses mentioned therein (discounts, premiums, transfers, exchange differences, etc.). The norm exists and the interpreter cannot act as if it did not exist, considering it useless (see no. 3 of Art. 9 of the Civil Code).

5. In the norm of lit. c) of no. 1 of Article 23 of the CIRC, the law, within the general scope of financial charges, establishes for interest the following rule: 'interest on borrowed capital applied in the operation is tax-deductible'. And, from its combination with the requirement of proven indispensability referred to in the said no. 1, in view of the criteria of normality, necessity, congruence and economic rationality, I adhere to the understandings of MARIA DOS PRAZERES LOUSA[24] and RUI MARQUES[25], to conclude that, dealing with borrowed capital, this must be applied in the operation by the company that bears the charges, so that the corresponding charges are tax-deductible. Which is not the case in the present proceedings.

6. The Award also brought to the fore the problematic of the 'prohibition of financial assistance', to conclude that it does not apply in the present case, because the Claimant did not proceed to 'advance funds, the granting of loans or the provision of guarantees'. Without prejudice to considering this subject matter relevant as it affects the principle of indispensability of costs, I also dissent here, because, unless better advised, it is the Claimant that through its payments of the debt contracted by the incorporated company is 'furnishing the funds' to a third party so that it holds the equity interests representing its capital. This directly contends with the provision of no. 1, Article 322 of the Commercial Companies Code (CSC)[26].

7. And these prohibited acts of financial assistance are sanctioned by no. 3 of the same Article 322, with the most forceful of the negative values reserved for illegal acts – nullity.

8. Combining the provision of nos. 1 and 3 of Article 322 of the CSC, with no. 1 of Article 23 of the CIRC, an act that the legal order 'sanctions' with nullity cannot be considered indispensable or necessary for tax purposes. This would be the denial of the principle of unity of the legal order.

For all these reasons, the tax act under analysis should have been upheld; and for that reason I hereby file this dissenting opinion.

Lisbon, 5 April 2017

Américo Brás Carlos