IRS Withholding Tax on Distribution of Advance Profits: CAAD Case 507/2018-T Ruling

TAX ARBITRATION DECISION

Process no. 507/2018-T

Date of Decision: 2019-08-28
IRS
Value of Claim: € 60,903.21

Subject: IRS – Withholding at source; Distribution on account of profits

ARBITRAL DECISION (consult full version in PDF)

I – REPORT

1. On 11 October 2018, A... LDA (hereinafter referred to as the Claimant), NIPC ..., with registered office at Rua ..., no. ..., ...-... ..., submitted a request for constitution of an arbitral tribunal, under the combined provisions of articles 2 and 10 of Decree-Law no. 10/2011, of 20 January, which approved the Legal Regime of Arbitration in Tax Matters, as amended by article 228 of Law no. 66-B/2012, of 31 December (hereinafter, abbreviated as RJAT), seeking the declaration of illegality of the act of assessment of IRS and compensatory interest no. 2018..., of 9 July 2018, relating to the fiscal year 2014, in the total amount of € 60,903.21.

2. To substantiate its request, the Claimant alleges, in summary, that the basis of the legal presumption applied by the Tax and Customs Authority (hereinafter referred to as the Respondent or TA) as the grounds for the contested assessment does not exist in this case, and therefore there is no basis whatsoever to consider that there was an advance on account of profits and, consequently, to determine the withholding at source of IRS on the amount in question.

3. On 12-10-2018, the request for constitution of the arbitral tribunal was accepted and automatically notified to the TA.

4. The Claimant did not appoint an arbitrator, and therefore, pursuant to the provisions of subparagraph a) of n. 2 of article 6 and subparagraph a) of n. 1 of article 11 of the RJAT, the President of the CAAD Deontological Council designated the undersigned as arbitrators of the collective arbitral tribunal, who communicated acceptance of the office within the applicable time limit.

5. On 30-11-2018, the parties were notified of these designations and expressed no intention to refuse any of them.

6. In accordance with the provisions of subparagraph c) of n. 1 of article 11 of the RJAT, the Collective Arbitral Tribunal was constituted on 20-12-2018.

7. On 04-02-2019, the Respondent, duly notified for this purpose, submitted its reply defending itself by means of a counter-argument.

8. Pursuant to the provisions of subparagraphs c) and e) of article 16 and n. 2 of article 29, both of the RJAT, the holding of the meeting referred to in article 18 of the RJAT was dispensed with.

9. A deadline having been granted for the submission of written submissions, these were submitted by the parties, commenting on the evidence produced and reiterating and developing their respective legal positions.

10. On 04-03-2019, the Claimant, in accordance with the principle of due process, commented on the allegations of the Respondent.

11. The parties were informed that the final decision would be notified by the deadline provided for in article 21, n. 1 of the RJAT, which deadline was extended in accordance with n. 2 of the same article.

12. The Arbitral Tribunal is materially competent and is regularly constituted, in accordance with articles 2, n. 1, subparagraph a), 5 and 6, n. 2, subparagraph a), of the RJAT.

The parties have legal personality and capacity, are legitimately interested and are legally represented, in accordance with articles 4 and 10 of the RJAT and article 1 of Ordinance no. 112-A/2011, of 22 March.

The proceedings are not affected by any nullities.

Thus, there is no obstacle to the examination of the case.

Having reviewed all matters, the tribunal hereby pronounces:

II. DECISION

A. MATTERS OF FACT

A.1. Facts Established as Proven

1. The Claimant is a limited liability commercial company engaged in the provision of medical services in the field of ophthalmology, with its share capital distributed among shareholders B... and C..., who are married to each other.

2. In compliance with Service Order no. OI2017..., an external inspection action was initiated for the fiscal year 2014 of the Claimant, initially in respect of VAT and withholdings at source for IRS purposes, and subsequently extended to IRC.

3. Following the aforementioned inspection action, the Claimant was notified, on 2 May 2018, of the draft Tax Inspection Report, in which the Tax Administration proposed corrections in respect of IRC and IRS, the latter resulting from the alleged failure to withhold at source on the amount of € 191,000.00.

4. On 17 May 2018, the Claimant submitted its observations in prior hearing, arguing – in respect of the IRS matter – that the amount of € 191,000.00 did not correspond to an advance on account of profits but rather to a loan granted to the shareholders, as recorded in its accounting.

5. On 2 July 2018, the Claimant was notified of the Final Inspection Report, with the Tax Administration maintaining the understanding set forth in the draft report notified.

6. The Final Inspection Report contains, inter alia, the following:

"Through the consultation of the elements previously identified, it was verified that the activity developed in this fiscal year was based on the provision of medical services in the field of ophthalmology, namely consultations, examinations and surgeries, the aforementioned services having been performed on the premises of D... (hereinafter designated as "D..."), on a subcontracting basis.

D... is a private institution located at ..., ..., no. ..., Rua ..., in Lisbon, which provides medical and surgical care in ophthalmology, through the subcontracting of service providers, which includes the taxpayer, and providing its own resources (such as facilities, personnel and equipment). (...)

It is important to note that D..., the purchaser of services, has special relationships with the taxpayer, under the terms of n. 4 of article 63 of the CIRC, effected by the attribution of functions of administration, management or direction to the same person, the managing shareholder of the taxpayer, B... (hereinafter designated as "Dr. B..."), and therefore the operations carried out between both entities will be subject to more detailed analysis in order to ascertain whether the terms and conditions agreed were those which would normally be accepted or practiced between independent entities.

In terms of expenses, the item with the greatest weight was "supplies and external services", strongly increased by the acquisition of medical services, recorded in account # 6221141 – Provision of Medical Services, whose recorded value was approximately 46% of the revenues obtained by the taxpayer.

Inspection Procedure

The inspection procedure began with a meeting held at the place where the taxpayer conducts its activity, located at ..., ..., Rua ..., in Lisbon (D... facilities), at which the managing shareholder, Dr. B... and the certified accountant of the company, Dr. E... were present.

At this meeting, in addition to general aspects concerning the activity developed, detailed clarifications were requested about the procedure adopted in the operations carried out with D..., both in terms of invoicing and payment, given the relevance they assume in the revenues recorded by the taxpayer.

The agreement provided for the invoicing of services rendered on the basis of a percentage of the value which D... had already invoiced to the final customer, for examinations (50%) and for consultations (70%), plus the portion stipulated in the case of surgeries (which varied depending on the type of intervention and the insurance/agreement existing). Payment was made partially, with one part being paid at the time of performance of the services, in cash, and the remainder being settled subsequently by cheque.

The services rendered, although being provided and invoiced by the taxpayer, were paid by D... directly to the shareholder, Dr. B..., either by delivery of cash amounts or by issuance of cheques in his name.

The remaining clarifications provided considered relevant, on this and other matters, were reduced to writing in a signed declaration by the managing shareholder and supplemented with copies of other accounting elements, in particular:

• Analytical ledgers as at 31/12/2014;

• Accounting extracts (fiscal year 2014);

• Bank statements for the account ..., of F...;

• Supporting documents for loans made to shareholders;

The preliminary analysis of the collected elements immediately highlighted some atypical situations, in particular relating to the pronounced divergence between the accounting record of banking operations and the information in the bank statements:

[Comparative table demonstrating divergences between accounting records and bank statements]

This comparative table demonstrates that the accounting record of banking operations did not reflect the truth of the facts that can be ascertained from the bank statements.

Among the identified divergences, the following stand out:

• Customer receipts that, from an accounting perspective, were recorded as deposits in the company's account but did not enter the company's bank account, violating article 63-C of the LGT which requires, for all IRC taxpayers, that receipts and payments relating to the business activity conducted be handled through a bank account in its name;

• Payments of company expenses which, according to the accounting records, all expenses and charges were paid against the bank account, but objectively only part of the recorded amounts were identified in the bank statement;

• Operations omitted from the accounting: there are operations identified in the statements, in particular cash outflows, that were not identified in the accounting.

The identified irregularities constitute evidence of possible violations of tax norms in respect of IRC and withholding at source, whose substantiation is set out in the following chapter.

III. DESCRIPTION OF FACTS AND GROUNDS FOR PURELY ARITHMETIC CORRECTIONS

III.1. – VERIFICATIONS PERFORMED

In respect of IRC, an analysis was performed of current accounts and documents supporting accounting records, in some cases by sampling, specifically those of materially significant value, others in their entirety, depending on the nature of the operations in question. However, the approach to these matters, throughout the report, will only address accounts susceptible to correction or whose analysis contributes to clarifying any situation.

1. Revenues

The information extracted from the elements consulted (namely from the e-invoice system, SAFT files, accounting folders and data sent by third parties) made it possible to identify the revenues obtained by the taxpayer and compare them with the values recorded in the accounting.

In the case of invoices issued to D..., given that they presented a generic description ("provision of medical services" and/or "consultations and examinations" and not always with the indication of the period to which they related), support schedules for invoicing were requested. This request was made simultaneously with the taxpayer and the customer, in order to identify and validate the items contributing to the invoiced values and the respective payment methods used.

The support schedules presented identified the nature of the services rendered, namely consultations, examinations and surgeries (performed for individuals and with agreements/insurance), the amounts due and amounts paid (...)

As already mentioned, the taxpayer was entitled to 70% of the value of consultations, 50% of the value of examinations and the total identified in the case of surgeries (...)

Comparing the values obtained with those shown in the accounting (account # 7.2.1.1.3.1 - Service Provisions – D...: € 655,048.97) and in e-invoice (invoices issued by D... to the taxpayer: € 655,048.97), a divergence of € 73,070.27 was found.

The representative of the taxpayer acknowledged the divergence but stated that it was resolved in the following fiscal year (2015) with the issuance of the missing invoicing and, to prove it, presented the support schedules for invoicing of 2015, the payment methods and the extracts from the accounting.

Considering that the amount of invoicing in arrears, which should have been issued in 2014 was, in fact, invoiced in excess (compared to the values determined in the 2015 support schedules for invoicing) and that there was no prejudice to the State, despite the procedure not being correct, no correction will be proposed in terms of taxation of revenues but the appropriate infringement proceedings will be instituted for failure to issue invoices within the legally provided deadlines.

2. Payments

According to the accounting records, the only financial account held by the taxpayer in this fiscal year was the bank account - # 123 – F..., and therefore this would have to reflect the entries relating to all payments and receipts of the company.

However, as already mentioned, the mere analysis of the current account statement (account # 123 – F...) and the bank statements revealed reconciliation divergences that were difficult to reconcile, as evidenced in the following examples:

• Opening balance of 2014

• Total debits and credits

With regard to receipts, it was immediately found that the amounts paid by customers were recorded as debits to the bank account (account # 123 – F...) but without corresponding to the truth of the facts (evidenced in the bank statements).

Even excluding the services that were invoiced in the following fiscal year, referred to in the previous section, the divergences between actual receipts and the operations recorded in bank account # 123 – "F..." and in the bank statements are significant and materially relevant.

To ascertain the aforementioned divergences, a survey was made of the amounts actually paid by customers in 2014, the amounts recorded as debits in account # 123 – "F..." and the amounts credited to the company's bank account, identified through the bank statements.

Given the invoicing deferral recorded for services rendered in December 2014, the amount paid by the principal customer (D...) in 2014 was ascertained:

[Schedule of payments by D...]

To the payments made by D..., were added the amounts paid by the remaining customers:

[Schedule of payments by other customers]

Comparing the total payments made with the deposits recorded in the bank statements, the following divergences were ascertained:

[Table of divergences]

The justification presented by the representative of the taxpayer for the lack of evidence of payments in the bank statements ("As mentioned, in the year in question the managing shareholder received payments in the name and on account of the Company, with cheques drawn by D..., LDA. to the order of the managing shareholder") does not legitimise the procedures adopted and demonstrates a clear and unequivocal irregularity in terms of administrative infringement law, for the failure to use the bank account of the taxpayer for the handling of all payments and receipts relating to the business activity developed, as provided for in article 63-C of the LGT, as well as in terms of taxation of revenues which is explained as follows.

Indeed, considering that the revenues paid by customers were recorded in account # 123 – F... but did not enter, in their entirety, into the company's sphere, we are faced with a disbursement liable to taxation in respect of income tax, with its tax classification depending on how the disbursements were evidenced in the accounting.

Through the elements collected, the following was verified:

• Amount paid by customers in 2014: € 686,522.42

• Amount recorded in account # 123 - F...: € 690,689.89;

• Total amount credited in bank statements in 2014: € 143,705.80;

• Amount recorded in the accounting in shareholder accounts:

• Loans to shareholders: € 191,000.00:

• Account # 268211 - B... - € 95,000.00;

• Account # 268212 – C... - € 96,000.00;

i. Income from Capital

The CIRS provides in n. 1 of article 5 that "income from capital means the fruits and other economic advantages, whatever their nature or designation, whether pecuniary or in kind, proceeding, directly or indirectly, from patrimonial elements, goods, rights or legal situations, of a moveable nature, as well as from their respective modification, transmission or cessation, with the exception of gains and other income taxed in other categories" and subparagraph h) of n. 2 of the same article adds: "the fruits and economic advantages referred to in the preceding number include, in particular: h) The profits of entities subject to IRC made available to the respective shareholders or proprietors, including advances on account of profits".

In the present situation, although the appropriation of amounts is assumed by the shareholder and declared in writing, the accounting did not reflect the alleged situation and only evidenced, as debits, in shareholder accounts, loans in the total amount of € 191,000.00.

The recorded loans are supported only by mere loan receipts (with no correspondence in the evidence of financial flows from the taxpayer in favour of the shareholders), without the characteristic elements of loans, such as repayment terms, interest to compensate for the unavailability of money and the associated risk or even Stamp Duty as provided for in the respective Code. The taxpayer itself, through its representative, acknowledged that "no loan contracts were executed. The amounts owing by shareholders on 31.12.2014 relate to amounts loaned during bank reconciliation regularised in 2015. Therefore no stamp duty was paid" (Annex III).

Accordingly, it is important to consider the provision of n. 4 of article 6 of the CIRS which states "entries in any current accounts of shareholders, written in commercial or civil companies in commercial form, when not resulting from loans, the provision of work or the exercise of social offices, are presumed to be made by way of profits or advance on profits" (emphasis ours).

Given the elements collected and what was stated by the shareholder, it is considered that the requirements for the legal basis of the presumption provided for in subparagraph h) of n. 2 of article 5 and in n. 4 of article 6 of the CIRS are met, and therefore the withholding of amounts from the company by the shareholders in their personal sphere, written in shareholder current accounts [# 268211 - B... (€ 95,000.00) and # 268212 – C... (€ 96,000.00), totalling € 191,000.00, are presumed to have occurred by way of distribution of profits or advance on account of profits.

Accordingly, in terms of taxation, the inspected company was obliged to carry out the withholding of IRS, in accordance with article 101, n. 2, subparagraph a) of the CIRS, and therefore it is necessary to determine the moment in which the tax became due.

Moment of Taxation and Allocation of Income from Capital to be Taxed by Period:

Article 7, n. 1 of the CIRS provides that "the income referred to in article 5 becomes subject to taxation from the moment it is due, its due date is presumed, it is made available to its holder, it is settled or from the date of determination of its quantitative amount, as the case may be".

In the present situation, having regard to all the evidence previously exposed, it is considered that the distribution of profits or advance on account of profits occurred at the moment in which it was recognised accounting the placing it at the disposal of the shareholders, that is, at the moment in which the deliveries should have been recognised in the accounting in specific shareholder creditor accounts.

It should be noted that the distribution of profits and advances on account of profits are subject to withholding at source, as a final matter, at the liberatory rate of 28%, in respect of IRS, as provided for in article 71, n. 1, subparagraph c) of the CIRS, which, in accordance with the indication in n. 3 of article 98 of the same act, should be paid to the State Treasury by the 20th day of the month following that to which it relates.

In summary, for the reasons set out above and in accordance with subparagraph h) of n. 2 of article 5 and n. 4 of article 6 of the CIRS, the € 191,000.00 recorded in shareholder accounts constituted a distribution of profits or advance on account of profits and, consequently, in accordance with article 71, n. 1, subparagraph c) of the CIRS, subject to withholding at source at the rate of 28%, in the following periods:

[Schedule of withholding by period]

The withholding at source owed for income from capital, considered as made available to the shareholders, in the fiscal year 2014, totals € 53,480.00. (...)

IX. RIGHT TO BE HEARD

To comply with the provisions of article 60 of the LGT and article 60 of the RCPITA, the taxpayer was made aware of the "Draft Report Conclusions" (letter No. ..., of 02-05-2018) by personal notification, served on the managing shareholder B..., on 02-05-2018, as attested by the notification certificate attached.

The right to be heard was exercised within the time limit granted and was received by these Tax Inspection Services on 18-05-2018 (Receipt no. 2018...).

The petition submitted contested the corrections proposed in the draft report, basing its allegations on the following assumptions:

a) The value considered as income from capital (presumption of advance on account of profits), in the amount of € 191,000.00 refers to shareholder loans (point 15);

b) The value proposed as undocumented expenses (€ 368,545.08) should be considered as "pending restitution or, at best, as corresponding to a value that became fully integrated into the shareholder's legal sphere by way of advance on account of profits" (point 23);

a) Presumption of Advance on Account of Profits – € 191,000.00

The amount in question was classified as capital income using the presumption of advance on account of profits, provided for in n. 4 of article 6 of the CIRS, because it relates to amounts that left the taxpayer's sphere, not under a loan contract or by way of consideration for the provision of work or the exercise of social offices and which, from an accounting perspective, were evidenced in shareholder accounts [€ 191,000.00 = € 96,000.00 (account # 268211) - € 95,000.00 (account # 268212)].

In the observations submitted, the petitioner alleges that this amount did not represent advances on account of profits but rather loans granted to the shareholders and that the global amount owed would even have been repaid to the company in 2017 (point 14).

However, this inspection action concerns the fiscal year 2014.

In that fiscal year, the taxpayer received € 686,522.42 from customers, through payments made to the managing shareholder, Dr. B..., but in the company's bank account, the only financial account identified in the accounting, only € 143,705.80 was credited (fact confirmed in point 10).

Of the remaining amount not returned to the company (€ 542,816.62), € 191,000.00 were presumed to have been paid by way of advances on account of profits, in accordance with the provisions of article 6, n. 4 of the CIRS, because they met the requirements set out in the aforementioned norm.

On the presumption applied, there is abundant case law of the higher courts of the tax jurisdiction that is relevant and, indeed, mandatory, in light of the procedure adopted, and therefore only one example is cited: "The presumption that the aforementioned amounts received by the company should be considered "advance of profits" to the administrators is a legal presumption (established expressly and directly in the law), and not a simple presumption, only natural or judicial, based on the data of common experience - which, as is known, is admitted only in the cases and circumstances in which the admission of testimonial evidence is admitted in accordance with the provisions of article 351 of the C.C.

Therefore, the rule provided for in n. 2 of article 350 of the C.C. applies, specific to legal presumptions - which, in order to be destroyed (in cases where the law permits), must be rebutted by means of contrary proof (emphasis ours).

(...)

In view of the literal, logical and systematic elements of the norms governing the taxation of category E income, more specifically the cases in which such income may be presumed, the only situations in which presumptions are allowed with respect to such income are those typified in article 7 [now article 6], specifically and insofar as the case is concerned, nos. 4. Entries in any current accounts of shareholders, written in commercial or civil companies in commercial form, when not resulting from loans, the provision of work or the exercise of social offices, are presumed to be made by way of profits or advances on profits (emphasis ours).

The presumptions established in this article may be rebutted on the basis of a judicial decision, administrative act, declaration of the Bank of Portugal or acknowledgement by the General Directorate of Contributions and Taxes." – Process 0 3221/09 TCA South.

The fact that the petitioner now alleges that, in the course of the third fiscal year following the occurrence of the tax facts, and already with the present inspection acts in progress, the managing shareholder will have made a transfer in favour of the taxpayer in the amount owed, in no way alters what was referred to.

Objectively, at the end of the fiscal year 2014, there existed € 191,000.00 that left the company's sphere, without being supported by any loan contract or by way of consideration for the provision of work or remuneration of social offices, recorded in accounts of other debtors in the names of the shareholders (accounts # 268211 and 268212) and supported only by mere receipts of advances.

And, as already mentioned, the CIRS determines that entries made in the current account of shareholders that do not result from loans, the provision of work or the exercise of social offices, must be considered, presumptively, as made by way of profits or advances on profits (n. 4 of article 6).

Even if it were the intention of the petitioner to assume the existence of a loan contract, on the basis of a possible obligation to repay on the part of the shareholder, this could also not be accepted by the failure to comply with the requirements provided for this type of contract in the Civil Code (CC).

Indeed, loan contracts are regulated in article 1143 of the CC, which requires, for loans of value exceeding € 25,000.00 (twenty-five thousand euros), a contract in the form of a public deed or authenticated private document.

And, if the contract must be celebrated in such form and is not, the same is rendered null and void.

In the present situation, as already mentioned, only mere receipts of advances were presented, without any contract attached or identifiable in the folders and proof of payment of the stamp duty owed was not made.

The managing shareholder himself, in terms of the attached declarations, expressly denied the existence of loan contracts as well as the payment of any stamp duty.

Thus, in view of the facts invoked, the € 191,000.00 in question fully meet the following requirements:

• These are amounts that belonged to the taxpayer but left the company's sphere;

• They were written in accounts of other creditors in the names of the shareholders;

• They were not supported by loan contract(s) in accordance with article 1143 of the CC;

• They were not paid by way of consideration for the provision of work or the exercise of social offices;

Therefore, in accordance with article 6, n. 4 of the CIRS, as already referred to in the draft report, they are presumed to have been delivered to the shareholders by way of profits or advances on account of profits and, consequently, subject to withholding at source, as a final matter, at the liberatory rate of 28%, in respect of IRS, as provided for in article 71, n. 1, subparagraph c) of the CIRS."

1. Following the Final Tax Inspection Report, an additional assessment of IRS and compensatory interest no. 2018..., of 9 July 2018, was issued, in the total amount of € 60,903.21, of which € 7,423.21 corresponded to compensatory interest.

2. On 16 July 2018, the Claimant made payment of the assessed amounts.

3. From the declarations of the Claimant relating to Simplified Business Information (IES), the following is noted:

a. From the fiscal year 2014, submitted on 2015-06-30 (...), that the € 191,000.00 were recorded as other current assets (field A5124), other accounts receivable (field A5985) and other debtors (field A8037);

b. From the fiscal year 2016, submitted on 2017-06-28 (...), that the Balance Sheet notes the insertion of the value of € 24,829.52 in the cash and bank deposits account (A5125), and the final balance in bank deposits of € 24,829.52 (A...);

c. From the fiscal year 2017, submitted on 2018-06-29 (...), that the Balance Sheet notes the entry of the value of € 342,136.69 in the cash and bank deposits account (A...), and the final balance in demand deposits of € 332,221.29 (A...), being written as debits (value entries) for € 862,992.92 and as credits (value exits) for € 555,601.15.

A.2. Facts Established as Not Proven

With relevance to the decision, there are no facts that should be considered as not proven.

A.3. Substantiation of Matters of Fact Proven and Not Proven

With respect to matters of fact, the Tribunal does not have to pronounce on all that was alleged by the parties; rather, it has the duty to select the facts that matter for the decision and distinguish between proven and unproven matters (see article 123, n. 2 of the CPPT and article 607, n. 3 of the CPC, applicable by virtue of article 29, n. 1, subparagraphs a) and e), of the RJAT).

In this manner, the facts relevant for judgment in the case are selected and delimited according to their legal relevance, which is established in light of the various plausible solutions to the question(s) of Law (see former article 511, n. 1 of the CPC, corresponding to the current article 596, applicable by virtue of article 29, n. 1, subparagraph e), of the RJAT).

Accordingly, having regard to the positions assumed by the parties, in light of article 110, n. 7 of the CPPT, the documentary evidence and the case file, the facts listed above were considered proven, with relevance to the decision, taking into account that, as written in the Decision of the TCA-South of 26-06-2014, handed down in case 07148/13, "the probative value of the tax inspection report (...) may have probative force if the assertions contained therein are not contested".

Allegations made by the parties and presented as facts, consisting of strictly conclusive statements incapable of proof and whose veracity is to be ascertained in relation to the concrete matter of fact above established, were neither given as proven nor as not proven.

B. MATTERS OF LAW

The present arbitral action concerns the assessment of the legality of the application of the presumption in article 6, n. 4 of the CIRS which provides that entries in the current account of the shareholder, when not resulting from loans, the provision of work or the exercise of social offices, are presumed to be made by way of profits or advances on account of profits.

For the purposes of deciding the case, article 6 of the applicable CIRS provides:

"4 - Entries in any current accounts of shareholders, written in commercial or civil companies in commercial form, when not resulting from loans, the provision of work or the exercise of social offices, are presumed to be made by way of profits or advances on account of profits.

5 - The presumptions established in this article may be rebutted on the basis of a judicial decision, administrative act, declaration of the Bank of Portugal or acknowledgement by the General Directorate of Taxes."

With relevance also to the situation under examination, article 5 of the same Code provides:

"1 - Income from capital means the fruits and other economic advantages, whatever their nature or designation, whether pecuniary or in kind, proceeding, directly or indirectly, from patrimonial elements, goods, rights or legal situations, of a moveable nature, as well as from their respective modification, transmission or cessation, with the exception of gains and other income taxed in other categories.

2 - The fruits and economic advantages referred to in the preceding number include, in particular: (...)

h) The profits of entities subject to IRC made available to the respective shareholders or proprietors, including advances on account of profits, with the exception of those referred to in article 20."

Also relevant is article 7 of the same Code, which provides:

"1 - Income referred to in article 5 becomes subject to taxation from the moment it is due, its due date is presumed, it is made available to its holder, it is settled or from the date of determination of its quantitative amount, as the case may be. (...)

3 - For the purposes of the foregoing, account is taken of: (...)

1. The making available, for income referred to in subparagraphs h), i), j), l) and r), as well as for certificates of consignment;"

*

Abundant case law has already been handed down on the matter now at issue by the higher courts of the tax jurisdiction, examples of which are:

• Decision of TCA-South of 25-11-2008, handed down in case 02544/08, and of 13-10-2009, handed down in case 03221/09;

• Decision of TCA-South of 11-01-2011, handed down in case 04357/10;

• Decision of TCA-South of 22-02-2011, handed down in case 04487/11 (cited by the Respondent);

• Decision of TCA-South of 18-02-2016, handed down in case 08760/15;

• Decision of TCA-South of 05-02-2015, handed down in case 08216/14;

• Decision of TCA-South of 04-06-2015, handed down in case 07453/14;

• Decision of TCA-South of 15-12-2016, handed down in case 09929/16;

Of particular interest to the specific question to be resolved in the file, the following decisions are highlighted:

• Decision of the STA of 15-12-2004, handed down in case 01187/04, where it can be read:

"A judicial decision, handed down in the course of judicial review, according to which the taxpayer did not receive interest in a loan contract in which he was the lender constitutes a sufficient basis for rebutting the presumption contained in article 7, n. 5 of the CIRS."

And, further:

"Article 7, n. 2 of the CIRS provides that it is presumed that loans bear interest.

In turn, n. 5 of this legal provision establishes that this presumption may be rebutted on the basis of a judicial decision, administrative act, declaration of the Bank of Portugal or acknowledgement of the General Directorate of Taxes.

This legal provision finds its parallel in the former article 14 of the Capital Income Code which, in addition to establishing an identical presumption, prescribed that the same could only be rebutted "by judicial decision handed down in proceedings instituted by the taxpayer against the State, in which it is declared to have been proven that interest was not received in advance, nor was or is owed or, if owed, is at a different rate, or by declaration issued by the Bank of Portugal confirming the interest rate actually practised or its absence".

From the comparison of these legal provisions, it immediately follows that it is no longer necessary, as it was, a judicial decision handed down in civil proceedings instituted by the taxpayer against the State, with a view to rebutting such presumption.

Thus, nothing prevents the judicial decision to which article 7, n. 5 of the CIRS now refers from being handed down, as it was in the case, in judicial review proceedings.

On the other hand, from such comparison it also follows that, since the former regime did not provide for any limitation as to the means of proof available to the interested party for this purpose, it is not clear, in light of the current legal framework, how the process of forming the said judicial decision could not be supported, contrary to what is affirmed by the Revenue Authorities, by testimonial and/or documentary evidence.

Moreover, as André Salgado de Matos states (CIRS, annotated, 1999, pp. 148/149) this presumption is rebuttable, under pain of unconstitutionality, and the proof that it does not correspond to reality may be provided by the taxpayer through any legally admissible means, in accordance with the general rules of Law, including those which the Revenue Authorities, in the appeal, understands are not admissible.

In short, returning to the case at hand, the appealed decision raises no concerns in this point, being an adequate basis for rebutting the said presumption, as it is, obviously, a judicial decision, having been handed down in judicial review which is an appropriate means for this purpose, based on means of proof admitted in accordance with the general rules of Law.";

• Decision of TCA-South of 13-04-2010, handed down in case 03461/09, where it can be read:

"1. Income in category E of the IRS consists of income recorded in any current accounts of shareholders, written in commercial or civil companies in commercial form, which, in principle, are presumed to be made by way of profits or advances on account of profits;

1. For such presumption of tax incidence to operate, it is necessary to show that the basis of the presumption is proven, on pain of the same being unable to operate and the case having to be decided against the party burdened with that burden of proof;

2. The TA having failed to prove the basis of that presumption (the entries in the shareholder's current account written in that company) the same cannot found the assessment on the presumption resulting therefrom, which is thus illegal, by reason of the absence of a tax fact."

And, further:

"In the case, the TA undertook to tax the now appellant on the basis of the unknown fact – that such amount deposited by the company in his favour resulted from profits or advances on account of profits of that same company – which it subsumed to the norm of n. 4 of article 7 of the CIRS, but without taking care to demonstrate and prove the basis of the presumption, that is, that such amount had been written as an entry in its current account as shareholder and that it did not result from a loan, the provision of work or the exercise of social offices, having indeed even determined that this amount was not recorded in this shareholder's account (see report at page 11 of the PAT attached), and therefore the basis of the presumption is not fulfilled, the same being unable to conclude for the attribution of this amount to such title, as the result of that, which as was seen did not exist, and therefore the assessment, in light of this factuality, could not have been made under this norm, which thus proves to be improper by reason of the absence of this tax fact.

In accordance with articles 74, n. 1 of the LGT and 342, n. 1 of the CC, the basis of the legal presumption must be necessarily proven with the corresponding facts integrating it, on pain of the case being decided unfavourably to the party burdened with this burden, that is, to the TA, and, in light of such failure, the result that the legal presumption was intended to obtain cannot be said to have been achieved"

• Decision of TCA-North of 07-07-2016, handed down in case 00446/11.9BEBRG, where it can be read:

"I - Article 6, n. 4 of the CIRS enshrines a presumption concerning capital income, namely that amounts recorded in any shareholder accounts of commercial or civil companies in commercial form, amounts which do not result from loans, the provision of work or the exercise of social offices, are presumed to be made by way of profits or advances on account of profits.

III - Only entries made in a shareholder account (and which are not proven to relate to alleged loans) are presumed, in light of the provision of n. 4 of article 6 of the CIRS, to be made by way of profits or advances on account of profits.

IV - The Tax Administration did not make use of the presumption contained in this norm, because the amount in question was not recorded in a shareholder account of the company.

V - It was incumbent on the Tax Administration to prove the prerequisites of its action (see article 74, n. 1 of the LGT), and in the present case this did not occur, given that the facts indicating that would allow the Tax Administration to make the classification of amounts recorded in accounting as income in category E, made available to the shareholders, in accordance with the provisions of article 5, nos. 1 and 2, subparagraph h) of the CIRS, are not gathered, thus the contested assessment suffers from the defect of violation of law."

*

Having established this, it falls to be examined, in light of the understandings settled above, the substance of the case.

The matter sub iudice raises, firstly, a question arising from the settled and reiterated understanding in the case law cited above, that it is incumbent on "the Tax Administration to prove the prerequisites of its action".

Being in question the norm of article 6, n. 4 of the CIRS, it is incumbent on the TA, in this case, to prove the respective prerequisites.

It happens that the wording of such norm is ambiguous in accordance with its wording, it not being clear therefrom whether for the TA to make use of the presumption it is necessary only to demonstrate the existence of entries in shareholder current accounts, or whether, in addition, it must also bear the burden of demonstrating that such entries do not result from loans, the provision of work or the exercise of social offices (negative proof).

This question not having been the subject of direct treatment in the case law analysed, it is possible to detect divergent understandings in this respect.

Thus, if the cited Decision of TCA-South of 11-01-2011, handed down in case 04357/10, appears to be satisfied with proof of the existence of movements in shareholder accounts, already the cited Decision of TCA-South of 13-04-2010, handed down in case 03461/09, seems to consider that the basis of the presumption encompasses the demonstration that "such amount had been written as an entry in his current account as shareholder and that it did not result from a loan, the provision of work or the exercise of social offices".

Having regard to the literal tenor of the norm in question, preference is inclined towards this latter understanding, that is, that the TA should demonstrate that the amounts it seeks to presume as attributed by way of profits or advances on account of profits:

a) have been recorded in any shareholder current accounts; and

b) do not result from loans, the provision of work or the exercise of social offices.

Indeed, by virtue of these circumstances being stated in the norm of article 6, n. 4 of the CIRS, prior to the enactment of the presumption, it is indicated that the legislative intent was that only when all of them are verified can the presumption enshrined operate.

Despite the option taken being questionable, having regard to the increased difficulty typical of proving negative facts, it is believed that this was the one enshrined in the legal text in question.

Now, and firstly, having regard to the facts ascertained in the RIT and its respective substantiation, it cannot be considered that proof has been made that the amounts in question in the file did not result from loans.

Indeed, the TA, in the substantiation now under scrutiny, merely limits itself to rebutting the proof presented by the Claimant, in particular the accounting record as loans to shareholders, the existence of receipts (whose genuineness it does not question), and the "repayment" carried out in 2017, without itself making any probative effort in the matter relating to the (non)existence of any loan, apart from the indication that there is no "correspondence in the evidence of financial flows from the taxpayer in favour of the shareholders", operating, in practice, an (not legally supported) reversal of the burden of proof with respect to the contested circumstance of the (non)existence of any loan.

Therefore, in light of such a deficit in proof, it must be concluded, with the aforementioned Decision of TCA-South of 13-04-2010, handed down in case 03461/09, that "the TA having failed to prove the basis of that presumption (...) the same cannot found the assessment on the presumption resulting therefrom, which is thus illegal by reason of the absence of a tax fact."

In any event, and even if it were understood, as appears to result from some other case law cited, that it is incumbent on the TA merely to demonstrate the existence of entries in shareholder current accounts, with the burden then falling on the taxpayer to demonstrate that such entries result from loans, the provision of work or the exercise of social offices, the conclusion would still have to be the same.

Indeed, and as already indicated, the Claimant demonstrated that the amounts in question were subject to accounting record as loans to shareholders (which is acknowledged by the TA itself), the existence of receipts (whose genuineness the TA did not question), as well as the "repayment" of those amounts carried out in 2017 (also acknowledged by the TA).

Having regard to the circumstance invoked by the TA in this matter, namely that there is no "correspondence in the evidence of financial flows from the taxpayer in favour of the shareholders", it is naturally clear that the same will not assume, of itself alone, any determinative relevance in the matter, since the existence of a loan contract does not in any way presuppose the existence of direct financial flows between lender and borrower.

On the other hand, the argument advanced by the TA in respect of the earlier hearing exercised by the Claimant, and reiterated in the arbitral proceedings, regarding the nullity of the loan, should be judged incapable of acceptance.

Thus, and as is well-known, the invalidity of a legal transaction is not to be confused with its non-existence, and from the norm of article 6, n. 4 of the CIRS it is not possible to extract the interpretation that the same is restricted, insofar as the case is concerned, to validly executed loans.

On the other hand, it is equally certain that legal transactions, even if invalid (voidable or void), are capable of producing legal effects, in particular, and also insofar as the case is concerned, the obligation to restore the benefits received by virtue of the invalid transaction.

This circumstance cannot, naturally, fail to be relevant to the matter under analysis, in that it concerns the taxation of an amount (presumably) deferred by a company to one of its shareholders as income.

Now, if that amount has been deferred in the context of a legal transaction, even if void, from which emerges the obligation to restore it, the same will not constitute, formally and substantively, income for the one who received it.

Thus, and as was written in the arbitral decision handed down in case no. 165/2013-T of the CAAD, in terms that are subscribed to:

"The Respondent understands that the Loan Contract does not meet the formal requirements required by article 1143 of the Civil Code, for which reason it is not valid. Accordingly, it considers that we are faced with advances on account of profits, which should have been taxed under the IRS.

It is certainly true that, under the provisions of article 1143 of the Civil Code, a loan of value exceeding €25,000 is only valid if it is made by public deed and a loan of value exceeding €2,500 if it is by a document signed by the borrower. It follows from article 294 of the Civil Code that legal transactions celebrated in violation of provisions of an imperative character, as in this case, are void.

The nullity, under the provisions of article 286 of the Civil Code, is invocable at any time by any interested party and may be declared ex officio by the court. The declaration of nullity has retroactive effect, under the provisions of n. 1 of article 289 of the Civil Code, with all that was provided to be restored.

Indeed, as the Respondent also argues, we are faced with a matter of civil law, and therefore, under the provisions of n. 2 of article 11 of the LGT, the tax norms under analysis must be interpreted using the terms proper to this area of law. On the other hand, the tax law, or the application made of it, cannot create different normative provisions from those existing in the appropriate diplomas.

Put another way: the Civil Code provides that loan contracts which do not comply with the formal requirements legally established are void and cannot produce any effects, with all that was provided to be restored (the borrower must return the amount received and the lender must return any interest received). This is the sanction legally provided for failure to comply with the formal requirements associated with the loan contract. In essence, the law determines that it is as if the loan contract never existed, with both the contract and its effects disappearing from the legal order.

This is the only consequence of failure to comply with the formal requirements provided for in the law. It does not follow, however, from the law, that other consequences may result from the void loan contract. And, accordingly, it cannot apply the tax law in the sense of deriving consequences different from those legally provided from this non-compliance. That is, if the loan contract is void due to lack of form, the restoration of what was provided may be determined, but it cannot be considered that the invalidity has as a consequence that the contract did not exist and, therefore, we are faced with a different reality – in the case, an advance on account of profits.

Accordingly, it must be concluded that the fact that formalities were omitted in the execution of the loan contract cannot have as a consequence that the contract did not exist and, therefore, we are faced with a different reality – and if, in light of the nullity of the contract, the parties are bound to restore what they received, it could, in the extreme, be understood that the same should occur in this case, with the managing shareholder having to restore the amounts recorded in the current account previously identified, but it cannot be considered that, by failure to comply with the formalities associated with the execution of this type of contract, the operation substantially practised (a loan) should be qualified differently.

It is certain that, under the provisions of n. 4 of article 36 of the LGT, "The qualification of a legal transaction made by the parties, even in an authentic document, does not bind the tax administration." On the other hand, it is also necessary to refer to n. 1 of article 74 of the LGT, under the terms of which the burden of proof of facts constituting rights falls on the one who invokes them, as well as to n. 1 of article 75 of the same act, under the terms of which the accounting records of taxpayers are presumed to be true and in good faith, when carried out in accordance with tax and commercial legislation. This presumption does not apply when one of the circumstances provided for in n. 2 of article 75 of the LGT occurs – which is not the case.

Additionally, under the provisions of article 293 of the Civil Code, "An invalid or voidable transaction may be converted into a transaction of a different type or content, if it contains the requirements of substance and form, when the purpose pursued by the parties permits the assumption that they would have wanted it, had they foreseen the invalidity." Accordingly, in the extreme, one could consider that we are faced with a loan contract promise, which would not have to comply with the requirements of form, as provided for in n. 1 of article 410 of the Civil Code. Accordingly, payments would be made on account of a definitive loan contract, to be executed on a date to be indicated.

It should also be noted that the accounting record of the amounts paid to the shareholder was made in account 268, which is a Shareholders/Partners – Other Operations account. Customarily, operations with shareholders that are not advances on account of profits, allocated results or available profits, among others, are recorded in this account. The debit record reflects a payment made by the company, and therefore the record made for accounting purposes is consistent with the classification given to the operation.

Therefore, it is verified that the accounting record of the movements associated with this operation, in the various fiscal years in question, is carried out in a manner similar to that of the loan contract. Also here should be referred to n. 1 of article 75 of the LGT, that is, as the accounting of the Claimant was not called into question, it should be considered that it reflects the reality of the facts – and, accordingly, that a loan contract was indeed executed between the Claimant and the managing shareholder.

In summary, it is found that the assessments issued have as their sole basis the failure by the Claimant to comply with the formalities associated with the execution of the loan contract. However, this basis is merely formal. N. 4 of article 6 of the IRS Code established a presumption under the terms of which "entries in any shareholder current accounts, written in commercial or civil companies in commercial form, when not resulting from loans, the provision of work or the exercise of social offices, are presumed to be made by way of profits or advances on account of profits." Presumptions may be rebutted, under the provisions of n. 2 of article 351 of the Civil Code, which was verified in this case – the Claimant presented the Loan Contract executed with the managing shareholder, having recorded the operation in the accounting in conformity, which permits rebuttal of the presumption that the operation would configure an advance on account of profits.

In this context, the burden of proof that the contract did not in fact correspond to a loan contract was returned to the Tax Administration and Customs Authority. It happens that no proof was made in this respect – it was merely alleged that, by virtue of the contract not having been executed by public deed, the same was not valid and therefore should be qualified as an advance on account of profits. Accordingly, and because the Tax Administration failed to prove the fact alleged (that the amounts in question were delivered by way of an advance on account of profits), it should be considered that the operation exists in the legal order in the terms in which it was defined by the Claimant. We are, accordingly, faced with a loan contract, with the payments made to the managing shareholder being deliveries of loaned values.

The making available of amounts in the context of a loan contract do not constitute income of the managing shareholder, and are accordingly not subject to taxation, neither through withholding at source, nor finally. Accordingly, the correction should not proceed."

"entries in any shareholder current accounts, written in commercial or civil companies in commercial form, when not resulting from loans, the provision of work or the exercise of social offices."

In this manner, even in the case of understanding, as appears to result from some other case law cited, that it is incumbent on the TA merely to demonstrate the existence of entries in shareholder current accounts, with the burden accordingly falling on the taxpayer to demonstrate that such entries result from loans, the provision of work or the exercise of social offices, the conclusion would still always be, at the limit, that there is a well-founded doubt as to the existence of the tax fact, under the terms presupposed by article 100 of the CPPT, determining the annulment of the tax act, as was judged in the Decision of TCA-South of 06-03-2001, handed down in case 1703/99.

The annulment of the tax assessment accordingly entails the annulment of the assessment of interest on that tax.

*

As to the request for indemnificatory interest formulated by the Claimant, article 43, n. 1 of the LGT establishes that indemnificatory interest is owed when it is determined that there was error attributable to the services which results in payment of the tax debt in an amount higher than that legally owed.

In the case, the error affecting the annulled assessment is attributable to the Respondent, which issued it without the necessary legal support.

The Claimant is accordingly entitled to be reimbursed with the amount it paid (under the terms of the provisions of articles 100 of the LGT and 24, n. 1 of the RJAT) by virtue of the annulled act and, further, to be indemnified for the improper payment through the payment of indemnificatory interest by the Respondent, from the date of that payment, until its reimbursement, at the legal suppletive rate, under the terms of articles 43, n. 1 and 4, and 35, n. 10 of the LGT, article 559 of the Civil Code and Ordinance no. 291/2003, of 8 April.

C. DECISION

In these terms, this Arbitral Tribunal decides to adjudge the arbitral claim formulated to be entirely well-founded and, in consequence,

a) Annul the act of assessment of IRS and compensatory interest no. 2018..., of 9 July 2018, in the total amount of € 60,903.21;

b) Condemn the Respondent in payment of indemnificatory interest, in the terms determined above;

c) Condemn the Respondent in the costs of the proceedings, in the amount fixed below.

D. Value of the Proceedings

The value of the proceedings is set at € 60,903.21, in accordance with article 97-A, n. 1, a) of the CPPT, applicable by virtue of subparagraphs a) and b) of n. 1 of article 29 of the RJAT and n. 3 of article 3 of the Regulation of Costs in Tax Arbitration Proceedings.

E. Costs

The amount of the arbitration fee is set at € 2,448.00, in accordance with Table I of the Regulation of Costs in Tax Arbitration Proceedings, to be paid by the Respondent, given that the claim was entirely well-founded, in accordance with articles 12, n. 2 and 22, n. 4, both of the RJAT, and article 4, n. 5 of the aforementioned Regulation.

Let notification be made.

Lisbon, 28 August 2019

The Arbitrating President

(José Pedro Carvalho)

The Arbitrating Arbitrator

(Francisco Melo)

The Arbitrating Arbitrator

(Olívio Mota Amador)