IRC Deductibility of Financing Costs After Merger by Incorporation – CAAD Case 508/2016-T

ARBITRAL DECISION

The Arbitrators José Pedro Carvalho (Presiding Arbitrator), Ana Maria Rodrigues and Eduardo Paz Ferreira, appointed as arbitrators at the Administrative Arbitration Centre, to form an Arbitral Court:

I – REPORT

On 18 August 2016, A…, LDA, legal entity no. …, with registered address at …, …, …, …-… …, filed 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 tax acts of additional assessment of Corporate Income Tax ("IRC"), relating to the period of 2012, identified with no. 2014…, of 06-03-2014, issued by the Tax and Customs Authority (hereinafter, "AT"), Income Tax, whose voluntary payment period ended on 07-05-2014, in the amount of €2,249,715.10 (two million, two hundred and forty-nine thousand, seven hundred and fifteen Euros and ten cents), of Statement of Interest Assessment, identified with no. 2014…, of 10-03-2014, and of Statement of Account Settlement, identified with no. 2014…, which gave rise to tax payable in the amount of €2,249,715.10, as well as the acts of dismissal of the administrative complaint no. …2014… and of the hierarchical appeal of that decision (no. …2015… / …/15), which had those acts as their subject.

To support its request, the Applicant alleges, in summary, that, by means of a merger by incorporation, the incorporating company (Applicant) assumed, by effect of law and immediately, the entirety of the assets of the incorporated company, including the financing expenses incurred by the incorporated company to acquire its social participation, whereby the deductibility of the expenses in the legal sphere of the Applicant cannot be questioned, unless there is proof of fraud or abuse.

On 19-08-2016, the request for constitution of the arbitral tribunal was accepted and automatically notified to the AT.

The Applicant did not proceed to appoint an arbitrator, whereby, under the provisions of paragraph a) of article 6(2) and paragraph a) of article 11(1) of the RJAT, the President of the Deontological Council of CAAD appointed the undersigned as arbitrators of the collective arbitral tribunal, who communicated acceptance of the assignment within the applicable period.

On 25-10-2016, the parties were notified of these appointments, and did not manifest any wish to challenge any of them.

In accordance with the provisions of paragraph c) of article 11(1) of the RJAT, the collective Arbitral Court was constituted on 10-11-2016.

On 15-12-2016, the Respondent, duly notified for this purpose, presented its response defending itself solely by way of challenge, alleging, in summary, that the deduction by the Applicant of charges of a financial nature related to its own acquisition, arising from the merger with the company of which it was the acquiring company, cannot be accepted fiscally, as they are not indispensable for the realization of profits or gains subject to tax or for the maintenance of the income-generating source, pursuant to article 23(1) of the IRC Code.

By decision of 25-01-2017, under the provisions of article 421 of the Code of Civil Procedure, applicable under article 29(1)(e) of the RJAT, it was determined that the testimony of witness B…, produced at a hearing in process no. 42/2015-T, should be used, and under paragraphs c) and e) of article 16 and article 29(2), both of the RJAT, the holding of the meeting referred to in article 18 of the RJAT was dispensed with.

Having been granted a period for submission of written arguments, these were submitted by the parties, commenting on the evidence produced and reiterating and developing their respective legal positions.

A period of 30 days was set, after submission of arguments by the Respondent, for rendering the final decision, which period was extended twice, under the legal terms, with notification to the parties, and a third time for 7 days. For the same reasons, the period referred to in article 21(1) of the RJAT was extended twice for 60 days.

The Arbitral Court is materially competent and regularly constituted, under articles 2(1)(a), 5 and 6(1) of the RJAT.

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

The proceedings do not suffer from any nullities.

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

All matters considered, it is appropriate to render

II. DECISION

A. FACTUAL MATTERS

A.1. Facts Taken as Proved

1. In 1964, in Sweden, C… founded the D… Group (abbreviation of "…").

2. Among the activities of the D… Group was the division dedicated to the diagnosis and treatment of kidney diseases, E….

3. This activity expanded throughout the world through the creation/acquisition of companies dedicated to the treatment of kidney diseases.

4. In Portugal, this expansion was carried out through various acquisitions that culminated in the creation of F… Lda. (TIN …, hereinafter also referred to as F…) and the transfer to its ownership of various local companies, all carrying out the same activity, identified above.

5. To realize these acquisitions, the D… Group lent to F… Lda., as well as to the companies participated by it, loans which, as of 2 December 2007, totaled €50,513,599.84, corresponding to the sum of the principal outstanding (€49,702,046.20) and accrued interest to that date (€811,553.64).

6. The company G… Lda. was, on 26 December 2006, subject to a division from which the company H…– SGPS Lda resulted, with the TIN….

7. In 2007, the company I…, wishing to enter this line of business, agreed with the D… Group on the acquisition of E…, including the acquisition of the various entities that, outside Portugal, were dedicated to the treatment of kidney diseases.

8. To realize this acquisition, I… established a company in Luxembourg, designated J… (hereinafter also referred to as J…), and this company, in turn, established/used companies in the different countries where E… had activities, including Portugal.

9. In the case of Portugal, the local company used was the Applicant, then designated K…, Lda (TIN …, hereinafter also referred to as K…), the original corporate name.

10. K… was initially based in the Free Trade Zone of Madeira, with activities of providing accounting and economic services, business consulting and management and other financial and economic activities.

11. Until 25 June 2007, K… was held by L… SGPS, S.A., with no social activity having been recorded.

12. On 26 June 2007, L… SGPS, S.A., transferred its quotas in K… to the company J…, with registered address in …, … …, Luxembourg, which had meanwhile changed its name to M….

13. Once holder of the entirety of the capital stock of the Applicant (at that time, €5,000.00), J… provided it, through a capital increase and bond issuance, with the necessary funds to realize the acquisition of the Portuguese companies that made up the E… division in Portugal.

14. Thus, on the day of acquisition, J… proceeded to increase the capital of K…, this increasing from €5,000.00 to €40,896,711.00, an increase which was recorded as having been realized in cash.

15. In the accounting of K… relating to the 2007 fiscal year, there is no evidence of movements in accounts of available funds, and in accounting terms, the capital increase was recorded as carried out, not as a counterpart of available funds, but through a third-party debt account.

16. On 27 June 2007, it was resolved in Minutes no. 14 of the company K… that, given the capitalization needs that the company would have to face the transactions it proposed to undertake and having the intention to proceed with payment of the price under the contract of transfer of quotas representing the entirety of the capital stock of the company F…, they would proceed with the issuance of a bond loan in the amount of €81,700,000.00, which would be fully subscribed by the sole shareholder (J…).

17. On 28 June 2007, the entity K… proceeded with the issuance of a bond loan, in the amount of €81,700,000.00, fully subscribed by the sole shareholder, J….

18. For the realization of the bond loan, the entity N…, S.A., intervened, which proceeded to pay interest to the subscribing company J…, and the entity O… SA, which proceeded to register this loan.

19. Within the framework of the said bond loan, the Applicant obligated itself to pay, on 29 June and 29 December of each year, interest on the bonds issued.

20. In the accounting of K…, the €81,700,000.00, corresponding to the sum of the capital increase and bond loan, were recorded as third-party debts, with a counterpart of loans, with none of the said operations resulting in the effective transfer of funds.

21. The acquisition of F… took place on 1 August 2007, through a contract of transfer of quotas, for the price of €122,611,711.00.

22. This acquisition involved the purchase of the quotas of F… Lda. (TIN …) and the acquisition of the loans (of €50,513,599.84) which had been acquired by its shareholders P… and Q…, both resident in Sweden.

23. Upon acquiring these credits, the Applicant became itself a creditor, in the amount referred to, of F… Lda. (TIN:…) and of the companies participated by it.

24. For each credit, the corresponding contracts were executed, and in the case of F… Lda. (TIN…), this contract was signed on 03-12-2007 – Inter-Company Proceeds Loan Agreement between the Applicant (lender) and F…, Lda. (borrower) for the amount of €37,359,426.00

25. The said acquisition was an integral part of an agreement (Share Sale and Purchase Agreement Regarding E…) executed between the companies that made up E… (in the case of Portugal, P… and Q…) and J…, with a view to the transfer of all participations held by E…, or its participated companies, in the capital of entities in any country of the world, including Portugal.

26. The transfer of participations held by E… included the purchase/transfer of credits held over the entities then participated by it.

27. At the moment of this global acquisition, J… proceeded to pay the full price (participations and credits) owed to E… and its participated companies, regardless of the contracts that would have to be executed at the level of each country.

28. The acquisition in question integrated the indirect acquisition of all companies then held by F….

29. This operation was recorded in the accounting of K… as a transfer of debtor balances – third-party debts (shareholders for the capital increase and for the bond loan) to financial investments, and not as a departure of available funds.

30. On 4 December 2007, F… changed its name to A… Lda..

31. On 03 December 2007, J… and K… executed an Inter-Company Proceeds Loan Agreement, in which the first entity appears as lender and the second as borrower, for the amount of €33,641,432.84.

32. On 10 December 2007, J… proceeded to a new capital increase of K…, this increasing from €40,896,711.00 to €57,773,878.00, an increase which was recorded in the accounting as having been realized in cash.

33. At this time, the situation relating to intra-group debt was as follows:

a. The Applicant had a debt to J…, its shareholder, of €81,700,000.00 relating to the bonds issued on 29.06.2007 intended to complete (together with own capital) the price of €122,612,071.00 corresponding to the acquisition of F… Lda (TIN:…);

b. The Applicant also had a debt to J…, its shareholder, of €33,641,432.84, intended to complete (together with own capital) the price of €50,513,599.84 for the acquisition of the credits held over F… Lda. and its participated companies, which J… had acquired from P… and Q…;

c. Resulting from the credits acquired as referred to in the previous point, relating to advances that had been provided to F… Lda. (TIN:…) by its previous shareholders P… and Q… (cf. articles 38° and 39° above), intended to allow F… Lda. to develop its activity in Portugal, it now had a debt to the Applicant of €37,359,426.00;

d. Also resulting from the same credits acquired, and for the same reasons, the companies held by F… Lda. (TIN:…) had debts to the Applicant that totaled, in aggregate, €13,154,173.84.

1. The payment of the debt referred to in a) of the preceding number was assured by the realization of the capital increase of €16,872,167.00 and the loan in the form of advances of €33,641,432.84, whereby none of the said operations (capital increase and loan) resulted in the effective transfer of funds.

2. On the total credits of €50,513,599.84 that the Applicant acquired from J…, over F… and companies participated by it, interest accrued, which totaled, in the period that elapsed until 31 December 2008, the overall amount of €7,506,346.12.

3. In July 2008, the Applicant changed its company name to S…, Lda., and its registered address, previously in the Free Trade Zone of Madeira, to its current registered address in….

4. On 1 August 2008, the Applicant obtained from J… a loan in the amount of €4,000,000.00, which it directed entirely to F…, Lda. (TIN:…), intended to support the treasury of this company and the other companies participated in Portugal.

5. On 29 September 2008, the Applicant obtained from J… a loan in the amount of €7,100,000.00, which it directed entirely to F…, Lda. (TIN:…), intended to allow it to acquire the entirety of the capital stock of Clinic Y….

6. The funds referred to were transferred directly from J… to F…, Lda. (TIN:…).

7. The interest on the above-mentioned bond loan was paid through N…, S.A., by F…, since K… had no operational activity that generated financial inflows.

8. This interest paid by F… to J… was recorded in the accounting of K… as a debt to third parties (F…).

9. Thus, F… paid interest on a bond loan whose participants were J… (creditor) and K… (debtor), constituting this interest a credit of F… over K….

10. The amount of said interest that F… paid to J… in the 2007 and 2008 fiscal years amounts to €11,664,656.99, divided between €3,874,826.75, relating to 2007 and €7,789,830.24, relating to 2008.

11. This same interest paid to entity J… was not subject to tax in Portugal, based on the provisions of Decree-Law no. 193/2005, of 7 November.

12. On 31 December 2008, F…, Lda. (TIN:…) and the other group companies in Portugal owed the Applicant a total of €69,119,945.96.

13. The payment of interest referred to above was made on account of this debt, as was the payment of a total of €59,844.95, paid to other entities (L…, …, O…, DGCI).

14. On 31 December 2008, the accounts between F…, Lda. (TIN:…) and the Applicant showed the following:

a. Debt of F…, Lda. (TIN:…) to the Applicant: €69,119,945.96;

b. Partial repayment of this debt by F…, Lda. (TIN:…), by means of payments made on account of the Applicant: €14,617,922.19 (€11,714,745.91 + €59,844.95 + €2,843,331.33 [of capitalized interest]);

c. Balance in favor of the Applicant: €54,502,023.77 (€69,119,945.96 - €14,617,922.19).

1. On the same date, the debt of the Applicant to its shareholder, in the part relating to the acquisition of the Advances, totaled €47,399,163.86, corresponding to the sum of the following loans made to the Applicant:

a. €33,641,432.84, relating to the acquisition of part of the credits which, on the date of purchase and sale of the E… division of the D… Group, P… held over the Portuguese Companies;

b. €2,628,218.23, relating to capitalization of interest accrued between 02-12-2007 and 31-12-2008, and not paid by the Applicant, corresponding to the loan of €33,641,432.84;

c. €4,000,000.00, remitted on 1 August 2008;

d. €7,100,000.00, remitted on 29 September 2008;

e. €29,512.19, relating to a withholding tax which the Applicant considered should be a cost supported by F…, Lda. (TIN…).

1. To this debt for advances was added the debt relating to the bond issuance.

2. On 31 December 2008, by merger, the Applicant incorporated a company in which it held a 100% interest, A…, Lda – TIN … (former F…), with effect from 1 January following, a participation acquired in August 2007, proceeding to adopt as its own the designation that was that of its participated company, also assuming the functions and corporate purpose of the incorporated company.

3. By the Applicant and by A…, Lda. (TIN:…) a merger by incorporation project was prepared jointly, and under article 98 of the Commercial Companies Code, which, in fiscal terms, was covered by the neutrality regime contained in articles 73 and following of the IRC Code.

4. By virtue of this merger, the Applicant became the direct owner of a series of companies in the healthcare sector, operating mainly in the area of dialysis.

5. With the said merger by incorporation, all assets and liabilities are combined in a single entity – the Applicant - which now bears the charges established with entity J…, when it was still designated K…, arising from the bond loan for the acquisition of company F….

6. With the merger, the amounts of debts between the merged companies were cancelled, maintaining the registration of the debt to the Luxembourg company (M…, S.A.R.L., former J…) in the amount of €47,399,162.66 relating to advances.

7. In 2007 and 2008, there were no relevant operational results in the accounting of K…, with the principal records thereof being losses arising from negative financial results arising from the bond loan, paid by F…, and losses arising from the administrative costs of its existence.

8. In December 2009, the Applicant proceeded to merge by incorporation the other group companies, commencing from that date to dedicate itself to the provision of medical services.

9. The merger by incorporation of the entities referred to in the preceding article and the Applicant was completed on 10-12-2009, with the effects hereof retroacting to 01-01-2009, having not resulted in any alteration to the articles of association of the Applicant.

10. Said merger was also submitted to the neutrality regime provided for in articles 73 and following of the CIRC, and within that framework, a request was submitted on 03-02-2010 for maintenance of the right to carry forward tax losses calculated in previous fiscal years, which includes, among other things:

• "The T… Group conducted an analysis of its business model in Portugal and concluded that there was a need to simplify and modernize its corporate structure, in order to strengthen its competitiveness and solidify its position in the dialysis market in our country, while mitigating inefficiencies that could represent an obstacle to the desired development".

• the merger operation "aimed to pursue, among others, the following objectives:

• Consolidate the Group's presence in the sector of dialysis medical services,

• Increase transparency of the Group to stakeholders,

• Increase administrative process efficiency,

• Increase treasury management efficiency,

• Increase operational efficiency,

• Promote training policy in A…,

• Improve the financing conditions of A… (in Portugal) with "I…."

1. For the said merger operation it was necessary to obtain acceptance from the Regional Health Administrations (ARS) of the change of ownership, without which it was not possible to continue the activity of providing dialysis care, a process that proved to be lengthy.

2. The amount of interest recorded and paid to the parent company (M…, S.A.R.L.) by the Applicant in 2012 was €8,545,010.58.

3. In order to verify whether the interest arising from the bond loan contracted by K… (TIN…) with J… would be fiscally deductible, on 06-11-2013, notification was sent to the Applicant for that verification.

4. On 15-11-2013, the Applicant provided the requested clarifications.

5. On 30-01-2014, the Applicant was notified of the Tax Inspection Report Project, and exercised its right to prior hearing, by means of a request sent on 14-02-2014.

6. The Applicant was notified on 27.02.2014, and through Office no. …, of the Tax Inspection Report.

7. The Applicant was, on the date of the tax event, classified, for IRC purposes, under the general regime for determining taxable profit, and commenced its activity on 30 January 2002.

8. On that same date, the Applicant was classified for the exercise of "Specialized clinical medical practice activities, on an outpatient basis - CAE 86220", having as secondary purpose "Accounting and auditing activities; tax consulting - CAE 69200".

9. From the Tax Inspection Report (RIT), the following is contained, among other things:

i. "With the incorporation of A…, Lda. (TIN…), in its parent company S…, Lda. (TIN…), all assets and liabilities were combined in a single entity, with the cash flows released by the activity and assets of the incorporated entity now bearing the charges arising from the bond loan executed between J… and K…, a loan that enabled the acquisition of company F….

Which is to say that, with the merger, the cash flows released by the activity of the incorporated company now bore the costs of its own acquisition."

ii. "In the specific case we have that the costs of acquiring company F… (subsequently A…, Lda.), which had been incurred by K… (subsequently S…, Lda.), through the merger, came to be borne by the cash flows generated by the acquired entity.

With the merger, the activity developed by the incorporating company came to correspond entirely to the activity that was already being carried out by the incorporated company, with the loan obtained by K… having as its sole objective obtaining capital for the acquisition of F….

S… (formerly K…) appeared only as a vehicle to realize the acquisition of A…, Lda. (formerly F…).

At the time of the Merger, S… (formerly K…) assumed the name of A…, Lda., which in practice translated, solely and only, to the cancellation of the registration of the tax subject with the TIN and registration no.….

Notwithstanding the cancellation of the tax subject registration …, it is A…, Lda. (formerly F…), the company that continues its previous activity, now under the TIN … and not S…, since this company added nothing to the purpose pursued by A…, Lda. (formerly F…), with its epilogue being the adoption of the name A…, Lda.

The costs subject to analysis served only to reduce the fiscal result of the company resulting from the mergers, without achieving any positive financial effect.

In conclusion, the use of the vehicle (K…) in the manner described allowed the financing cost that would be borne by the Luxembourg company (J..., now M...), in a direct acquisition, to come to be borne by the assets of the operational company (A…), being fully deducted from its result, after the incorporation of its assets into the vehicle company, with the respective impact at the fiscal level (EBITDA), as per the analysis conducted in section "II – 3.5.2 Balance Sheet and Statement of Results"."

iii. "In the case of A… the costs incurred with the bond loan are not related to its business activity, nor did they serve the maintenance of the income-generating source. Such costs, although recorded in its accounting, do not benefit its activity nor its respective business interest, but rather benefit a third party (M…, S.A.R.L., former J…), not being accepted for purposes of calculating the fiscal result, under paragraph c) of article 23(1) of the IRC Code.";

iv. "With respect to interest, as appears from the accounting of the tax subject for the years 2007 and 2008, these were paid through N…, S.A., by entity F…, the company acquired through that loan, because K… never had an operational activity, as previously described and as is evidenced by the operations recorded in the accounting of the entity and reflected in the trial balances of fiscal years 2007 and 2008 of K… (cf. annex 15, of 9 pages), where there are mere records in accounts of financial costs and revenues.

Now, in those same fiscal years (2007 and 2008), J…, in addition to the bond loan, made loans through advances to various group companies, with F… being the largest recipient of those advances, in the amount of €37,359,426.00 (annex 16, of 6 pages).

Thus, we have that F… received advances from J…, via K…, directing part of those advances received to the payment of interest on the bond loan of the parent company (K…), since the latter, as we mention in the preceding paragraphs, had no operational activity that generated financial inflows.

This interest paid by F… to J… was recorded in K… as a debt to third parties (F…), that is, F… paid interest on a bond loan whose participants were J… (creditor) and K… (debtor), constituting this interest a credit of F… over K…. We note that this credit over K… generated no revenue, and as a result of this F… is bearing a charge with advance interest to meet the payment of interest that should be an actual charge of the parent company K…."

v. "The amount of interest that F… paid to J… (responsibility of the participant K…) in the fiscal years 2007 and 2008 amounts to the sum of €11,664,656.99 (annex 11), divided between €3,874,826.75 relating to 2007 and €7,789,830.24 relating to 2008. This amount constituted a credit of K… over F… (advances), inasmuch as the latter did not have financial means to liquidate the interest on the bond loan.

With the merger, the amounts of debts between the Portuguese companies were cancelled, maintaining only the registration of the debt to the Luxembourg company in the amount of €47,399,162.66 relating to advances, an amount which is influenced by the amount referred to above (€11,664,656.99) relating to the payment of interest on the bond loan in the fiscal years 2007 and 2008 by F….

Thus, and under the provisions of paragraph c) of article 23(1) of the IRC Code, we will proceed to the correction of the interest supported relating to advances in the proportion of €11,664,656.99 against the value of the debt of advances (€47,399.656,99).

The amounts of interest supported in the years under analysis and recorded as period expenses in the account "691155 – Interest in group companies – payable" were of the following amount (annex 17, of 1 page):

[...]

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

[...]"

1. With respect to company G…– SGPS Lda., the RIT contains (p. 7 and following) the following:

"The tax subject identified above is currently ceased, this cessation having occurred due to the merger by incorporation with the company inspected here.

Until its incorporation, its activity consisted of consulting and provision of business services in the areas of administrative, financial and personnel management, accounting, computer science, scientific research, professional training and trade of apparatus, implements and products intended for the healthcare services sector.

More specifically, it functioned as a purchasing hub and manager of a series of other companies, whose principal object was the treatment of patients with kidney disease.

1. HISTORY OF THE COMPANY

This company commenced its activity on 19 October 1990 with the designation of G… – SGPS Lda having as its purpose, as its designation indicates, the management of social participations of other companies as an indirect form of carrying out economic activities. It commenced its activity with a capital stock of €1,047,475.58, divided into 3 quotas, having as shareholders the companies P… and Q…, with the first of these companies holding two quotas in the amounts of €948,713.60 and €98,637.28 and the third holding another in the symbolic amount of €124.70. On 22 December 2005 it proceeded to a capital increase of €100.00, with the participation of company Q… increasing to €224.70 and the capital stock to €1,047,575.58.

On 10 January of the following year it changed its designation to F… Lda (hereinafter F…), having on 26 December of the same year been subject to a division from which the company H…– SGPS Lda resulted, with the TIN….

On 1 August 2007, it is acquired by K… for the amount of €122,611,711.00 (annex 4, of 3 pages), changing its designation to A… Lda on 4 December of that same year.

All information relating to this company is contained in the registration of the Commercial Registry (annex 5, of 10 pages).

It in turn held the entirety of the capital of the following entities: 1.U…, S.A.

TIN: …

Address: Rua…, Number … -…-…LOURES

1. V… LDA

TIN: …

Address:…, …, …-…-… VILA DO CONDE

1. W… LDA

TIN: …

Address: …, Number …, Lisboa - …-… LISBOA

1. X… LDA

TIN: …

Address: …, …, …, Lisboa -…-… LISBOA

5.Y…, S.A.

TIN: …

Address: Rua…, …- …-… FIGUEIRA DA FOZ

6.Z…, S.A.

TIN: … Address: … (…) - …-… PORTO

1. AA… S.A

TIN: …

Address: Rua…, Number…, …- …-… MEM MARTINS

8.BB…, S.A.

TIN: …

Address: …, …-… AVEIRO

1. CC… LDA

TIN: …

Address:…, Number …, Lisboa - …-…. LISBOA

1. DD… LDA

TIN: …

Address:…, Number … - …-… ALMADA

1. EE… S.A.

TIN: …

Address: …, Number … -…-… ESTORIL

1. FF…, S.A

TIN: …

Address:…, …- …-… …

1. GG…, S.A.

TIN: …

Address: Rua …, Number …- …-… TORRES VEDRAS

1. HH… SA

TIN: …

Address: Rua …, Number … - …-… COIMBRA

It also partially held the capital of company II… LDA, with the TIN … and address: Rua …, …-….

In December 2008, A… Lda - TIN … is incorporated in its participant (S…, Lda - TIN:…) through a merger by incorporation process (annex 5, of 28 pages)."

1. As for company M..., with the former designation J..., holder of the TIN … and address in …, …, Luxembourg, the RIT contains (pages 9 and following) the following:

"With respect to this company, we know that it is held by a venture capital company called I… with registered address in England and which served as a vehicle for the acquisition of the E… group in the year 2007.

This information is even contained in a request made by I… to the Competition Authority of the European Commission within the context of the acquisition of the D… group (annex 7, of 1 page).

The former designation of this company was J… (hereinafter j…) and it was this entity that in 2007 proceeded with the acquisition of the company subject to this inspection (A… LDA, with the company name at the time of acquisition K…, Lda.) from company L…SGPS, S.A.".

1. The tax inspection procedure referred to resulted in the acts of additional IRC assessment, with no. 2014…, of 06.03.2014, whose voluntary payment period ended on 07-05-2014, in the amount of €2,249,715.10, of Statement of Interest Assessment, with no. 2014…, of 10-03-2014, and Statement of Account Settlement, with no. 2014…, with tax payable in the amount of €2,249,715.10

2. Following the notification of the acts referred to, the Applicant submitted, on 08-07-2014, an administrative complaint.

3. The Applicant was notified, through Office no. …, of 21-11-2014, of the draft dismissal of the complaint submitted and exercised its right to prior hearing, which was remitted on 09-12-2014.

4. The administrative complaint was dismissed by decision of 31-12-2014, by the Deputy Finance Director of the Finance Department of Lisbon, by delegation.

5. Against this decision was submitted, on 06-02-2015, by the Applicant here, a hierarchical appeal, as appears from the respective administrative file, which was dismissed by decision of the Deputy General Director, dated 06-04-2016, which was notified by registered office with acknowledgment of receipt no. …, of 31-05-2016, sent to the representative appointed by the now Applicant, signed on 02-06-2016.

6. The Applicant did not pay the amount that was assessed to it and in order to suspend the fiscal execution process no. …2014…, instituted for the execution thereof, provided a bank guarantee.

A.2. Facts Not Taken as Proved

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

A.3. Justification of Proved and Not Proved Factual Matters

With respect to factual matters, the Court does not have to pronounce on everything that was alleged by the parties, but rather has the duty to select the facts that matter for the decision and distinguish the proved from the not proved matters (cf. article 123(2) of the CPPT and article 607(3) of the CPC, applicable ex vi article 29(1)(a) and (e) of the RJAT).

Thus, the facts pertinent to the judgment of the case are chosen and delimited in function of their legal relevance, which is established in attention to the various plausible solutions of the legal question(s) (cf. former article 511(1) of the CPC, corresponding to the current article 596, applicable ex vi article 29(1)(e) of the RJAT).

Thus, taking into consideration the positions assumed by the parties, in light of article 110(7) of the CPPT, the documentary evidence and the administrative file joined to the case, the facts listed above were considered proved, with relevance to the decision, taking into account that, as was written in the Judgment of the TCA-South of 26-06-2014, rendered in process 07148/13[1], "the probative value of the tax inspection report (...) may have probative force if the assertions contained therein are not challenged".

Not taken as proved nor not proved were allegations made by the parties, and presented as facts, consisting of assertions that are strictly conclusive, incapable of proof and whose truthfulness must be assessed in relation to the concrete factual matters consolidated above.

B. ON THE LAW

The situation under examination in the present proceedings is of relatively simple configuration and may be, summarily and in its essential features, described as follows:

• The Applicant, in 2009, was the incorporating company in a merger by incorporation operation, in which a company incorporated was one in which it held 100% of the respective social participations;

• The Applicant held, in its liabilities, debts arising from financing and advance agreements, whose amounts had been applied in the acquisition of social participations and debts to the shareholders of the incorporated company and its participated companies, as well as in financing to them;

• By effect of the merger operation, the company resulting therefrom (now Applicant) had, in the fiscal year at issue (2012), to bear the said charges, and it is certain that, by effect of that same operation, the participations of the incorporated company (participated) that integrated the assets of the Applicant were extinguished.

The question that arises is, equally, of simple configuration, and concerns solely the determination of whether, as the AT contends, the charges corresponding to the expenses with financing and advances borne by the now Applicant meet the requirements of article 23(1) of the CIRC, relating to their indispensability for realization of profits or gains subject to tax or for the maintenance of the income-generating source, and, consequently whether they can be deducted in the determination of its taxable profit.

This is, fundamentally, what is presented to this Court for decision.

Let us see then.

From a general point of view, there is little controversy in that which has been the established path in national doctrine and case law on the matter of indispensability of expenses, the essential features of which may be summarized as follows:

• "The legal notion of indispensability is carved out, therefore, over an economic-business perspective, by direct or indirect fulfillment of the ultimate motivation of contributing to obtaining profit" and "the tax deductibility of the cost depends, solely, on a causal and justified relationship with the company's activity." (STA Judgment, rendered on 30-11-2011, in process no. 0107/11);

• "the costs (...) cannot but respect, from the outset, the taxpayer company itself. That is, for a certain sum to be considered a cost thereof, it is necessary that the respective activity be carried out by it itself, and not by other companies." (STA Judgment, rendered on 30-05-2012, in process no. 0171/11);

• "a concept of indispensability that, moving definitively away from the idea of causality between expenses and revenues, puts the emphasis on the relationship of expenses with the activity pursued by the tax subject, that is, considering that the said concept of indispensability occurs whenever expenses are incurred in the interest of the company, in pursuit of its respective activities." (STA Judgment, rendered on 04-09-2013, in process no. 0164/12);

• "the Tax Authority cannot evaluate the indispensability of costs in light of criteria relating to the opportunity and merit of the expense. A cost is indispensable when it relates to the company's activity, and costs foreign to the company's activity will only be those in which it is not possible to discern any causal nexus with the profits or gains (or with the revenue, in the current expression of the code - cf. article 23, no. 1, of the C.I.R.C.), explained in terms of normality, necessity, congruence and economic rationality." (TCA-South Judgment, rendered on 16-10-2014, process no. 06754/13);

• "The indispensability of the cost must result simply from its connection to business activity. If the cost is not foreign to the company's activity, that is, if it relates to the company's normal activity (regardless of whether the degree of intensity or proximity is greater or lesser), and if its existence is accepted (there is not a cost that appears to be or is simulated), the cost is indispensable." (TCA-North Judgment, rendered on 20-11-2011, process no. 01747/06.3BEVIS);

• "from the legal notion of cost provided by article 23 of the CIRC does not result that the AT may call into question the principle of freedom of management, scrutinizing the goodness and opportunity of the economic decisions of company management and considering that only those from which revenues directly accrue to the company or which prove convenient to the company may be fiscally assumed. The indispensability referred to in article 23 of the CIRC as a condition for a cost to be deductible does not refer to necessity (the expense as a sine qua non condition of revenues), nor even to convenience (the expense as convenient for business organization), under penalty of intolerable interference by the AT in the autonomy and freedom of management of the taxpayer, but requires, solely, a relationship of economic causality, in the sense that it is sufficient that the cost be incurred in the interest of the company, in order, direct or indirectly, to obtaining profits.

The legal notion of indispensability is carved out, therefore, over an economic-business perspective, by direct or indirect fulfillment of the ultimate motivation of contributing to obtaining profit. Indispensable costs are equivalent to expenses incurred in the interest of the company or, in other words, in all acts abstractly subsumible in a profit profile. This objective brings, purposely, the economic and fiscal categories close together, through a primarily logical and economic interpretation of legal causality. The indispensable expense is equivalent to every cost incurred in order to obtain revenues and which represents an economic decline for the company. In general, therefore, the tax deductibility of the cost depends, solely, on a causal and justified relationship with the company's activity. And outside the concept of indispensability will fall only acts that deviate from the corporate purpose, those that do not fit within the interest of the company, above all because they do not aim at profit." (STA Judgment, rendered on 30-11-2011, process no. 0107/11);

• "The rule is that correctly accounted expenses are fiscal costs; the criterion of indispensability was created by the legislator, not to allow the Administration to intrude in company management, dictating how it should apply its resources, but to prevent the fiscal consideration of expenses which, although accounted as costs, do not fall within the scope of the company's activity, were incurred not for its pursuit but for other interests alien thereto. Strictly speaking, these are not true costs of the company, but expenses which, in view of their object, were abusively accounted for as such. Without the Administration being able to evaluate the indispensability of costs in light of criteria relating to their opportunity and merit.

The concept of indispensability not only cannot be equated with a strict judgment of imperative necessity, as has been said, but also cannot be based on a judgment on the convenience of the expense, made, necessarily, a posteriori. For example, expenses made with an advertising campaign that proved unfruitful cannot, solely in function of that result, be stated to be dispensable.

The judgment on the opportunity and convenience of expenses is exclusive to the businessman. If he decides to make expenses in order to pursue the company's purpose but is unsuccessful and those expenses prove, ultimately, fruitless, they remain fiscal costs. But every expense that is accounted as a cost and shown to be foreign to the company's purpose is not a fiscal cost, because not indispensable.

We understand (...) that, under penalty of violation of the principle of tax capacity, the Administration can only exclude expenses not directly removed by law under strong motivation that convinces that they were incurred beyond the corporate objective, that is, in pursuit of another interest than the business one, or, at least, with evident excess, deviant, in light of the objective needs and capacities of the company." (STA Judgment, rendered on 29-03-2006, process no. 01236/05).

Being, thus, uncontroversial the decision criteria, there remains, solely, the operation of applying such criteria to the specific case.

This operation of applying the said criteria to situations similar or analogous to that under examination in the present case has already been attempted in the arbitral processes nos. 14/2011-T, 101/2013-T, 87/2014-T, no. 42/2015-T, 92/2015-T and 93/2015-T, all of the Administrative Arbitration Centre[2], with the two latter making a summary and assessment of the precedents, which is now subscribed to and, for brevity, dispensing with the transcription.

More recently, within the scope of arbitral processes nos. 337/2016T and 480/2016T, also of the CAAD, relating to the fiscal years 2009 and 2010 of the now Applicant, decisions were rendered in the sense of granting the request.

In the first of those processes was written, among other things, the following:

"The essential question to be decided therefore consists of knowing whether article 23 of the CIRC implies, as the AT alleges, that the financial charges paid by the Applicant to BB… (ex-X…) are not deductible, because they do not comply with the requirement of indispensability provided by that legal provision.

For the AT, the interest paid by the Applicant would not relate to its activity, but rather to the activity or interest of its participant, and could not contribute to the taxable result of the Applicant, because they depart from its corporate interest or its own activity.

As the AT states, in point 44 of its Arguments: "to accept the deductibility of financial charges associated with financing the acquisition of social participations of companies, whose activities generate revenues and gains that enable the deduction of those expenses, would be to deny the principle of balancing between expenses and revenues that is inherent in article 23(1) of the IRC Code".

Now the STA, within the scope of Process 0779/12, in a Judgment of 24-09-2014, rejects the interpretation of article 23 of the CIRC as having to imply an obligatory connection, a balancing, or a relationship between costs and revenues: (...)

Then the AT contends that (point 51 of its Arguments): "With respect to financial charges, that normative requires, just as for the generality of expenses, that the expenses and losses deductible for determining taxable profit be indispensable for obtaining revenues and gains subject to tax and for maintaining the income-generating source and concretizes, in its paragraph c) of article 23(1), the expenses of "a financial nature, such as interest on foreign capital applied in exploitation".

As for the question of the application of capital in exploitation: the AT's thesis has no support in law. The terms "namely" and "such as", used in the preamble of article 23(1) and in the respective paragraph c), make clear that financial charges of capital applied in exploitation are deductible but do not exhaust the universe of deductible financial charges. These will be, even when not applied in said exploitation; provided they pass the general test of indispensability, are substantiated and are not removed by another legal-fiscal norm. The concept of indispensability is consensually interpreted as implying that expenses relate to the company's activity or interest. Financial charges that fit here, even not being applied in activities considered operational or exploitation, may meet the conditions of indispensability.

And the financial charges here contended are related to the Applicant's activity, since they result from the financing of assets held by it and which even generate revenues of an operational nature.

The AT further advances, regarding the dismissal of financial charges, for not being inherent to the Applicant's own interest (articles 53, 56 and 73 of its Arguments):

'the costs borne with the loan are not related to its business activity, nor did they serve the maintenance of the income-generating source. Such costs, although recorded in its accounting, do not benefit its activity nor its respective business interest, but rather benefit a third party ((BB…., former X…) not being accepted for purposes of calculating the fiscal result, under paragraph c) of article 23(1) of the IRC Code.'

'The mergers within which company AA…, Lda (former F…, Lda) incorporated company A…, Lda (former D…, Lda), and the companies participated by it, despite being upstream mergers, in fact implied an entire transmutation of the incorporating company which legally was maintained but whose activity came to correspond entirely to the activities that had already been carried out by the incorporated companies.'

'What occurred with the merger operations was that, as a result of the extinction of the social participations held by company AA…, Lda. (ex.F…), the activity previously developed to which the bond loan was associated had no continuity, what subsisted was only operational activity developed by companies that had belonged to the B… Group, in the exploitation of which the funds obtained with that financing were not applied and, therefore, the financial charges borne did not contribute to the generation of revenues or income from dialysis treatment activities.'

The AT is not correct when it calls into question the deductibility of financial charges, at the level of the Applicant, on the ground that these are disconnected from its activity, its own interest, and that the funds obtained were not applied in exploitation. As a result of the merger operations, the same company (the Applicant) came to hold, as patrimonial elements recorded or recognized in its balance sheet, the assets and liabilities of the operative companies and continued to record, also in its balance sheet, the own capital and financial liabilities that supported the social participations that previously represented this set of patrimonial elements. There is a clear economic link between the debt that earns interest and the assets and liabilities that such debt supports.

When the AT refers to that "what subsisted was only operational activity developed by companies that had belonged to the B… Group, in the exploitation of which the funds obtained with that financing were not applied", it does not take into account that the ownership of the operational activity was only possible by paying the B… group an acquisition price that entailed the financing through bond loans and advances that generated the interest paid. Even from a strict perspective of nexus between revenues and expenses, it exists. The revenues derived from the business are related to the interest paid for its acquisition. From a patrimonial perspective, there is, even, a greater approximation between assets and the capital that finances them, now recorded in the same entity. Not putting into question the AT the economic purpose of the reorganization operations carried out, the disregard of the interest paid has no support in article 23 of the CIRC.

As for the matter of advances, and the amount of €11,664,656.99, the AT refers (article 30 of its Arguments) that: "As appears from the RIT, evidence was not found that unequivocally demonstrates that the amount of €11,664,656.99 is not included in the value of the advances, all the more so since company D… paid directly that interest on account of company F…, Lda, by virtue of this company not having financial means to proceed with the liquidation of the interest".

Now the arbitral request for decision presented by the Applicant puts into question the AT's thesis, without the latter, in the response or in the arguments, having rebuffed in a convincing manner the positions and explanations of the Applicant regarding the said €11,664,656.99.

The Court understands that there is no reason to disregard the interest on the bond loan and this conclusion also affects the correction made by the AT with respect to advances, whereby the correction is illegal and, consequently, the assessment should be annulled, by violation of law, namely article 23(1) of the CIRC, insofar as it is based thereupon."

In the second of the said judgments, one can read:

"The essential question to be decided therefore consists of knowing whether article 23 of the CIRC will imply, as the AT alleges, that the financial charges paid by the Applicant A… Lda (ex -J…) to G… SARL (ex -F…) are not deductible, because they do not comply with the requirement of indispensability provided by that legal provision.

This is because, for the AT, the interest paid by the Applicant would not relate to its activity, but rather to the activity or interest of its participant. As such, it could not contribute to the taxable result of the Applicant, because it departs from its corporate interest or its own activity.

As the AT states: "In other words, to accept the deductibility of financial charges associated with financing the acquisition of social participations of companies, whose activities generate revenues and gains that enable the deduction of those expenses, would be to deny the principle of balancing between expenses and revenues that is inherent in article 23 of the IRC Code".

Now the STA, in process 0779/12, in a Judgment rendered on 24.09-2014, rejects the interpretation of article 23 of the CIRC as having to imply an obligatory connection, a balancing, or a relationship between costs and revenues (...)

Therefore, it does not hold that the fiscal acceptance of an expense must respect a principle of balancing (or connection) with revenues.

Then the AT contends that: "With respect to financial charges, that normative requires, just as for the generality of expenses, that the expenses and losses deductible for determining taxable profit be indispensable for obtaining revenues and gains subject to tax and for maintaining the income-generating source and concretizes, in its paragraph c) of article 23(1), the expenses of "a financial nature, such as interest on foreign capital applied in exploitation". (emphasis of the AT).

This matter of the application of capital in exploitation, recurrent in the AT's arguments, merits analysis. Let us see. (...)

It is clear that the AT's thesis, according to which only financial charges arising from capital applied in exploitation would be deductible (and even then it would lack definition of what is understood by "exploitation") does not result from law. The terms "namely" and "such as", which we have underlined, make clear that financial charges of capital applied in exploitation are deductible, but do not exhaust the universe of deductible financial charges. These will be, even when not applied in said exploitation, provided they pass the general test of indispensability, are substantiated and are not removed by another legal-fiscal norm.

Now, the concept of indispensability, as has been seen, is consensually interpreted as implying that expenses relate to the company's activity or interest. Thus, financial charges that fit here, even not being applied in activities considered operational or "exploitation", may meet the conditions of indispensability.

And, as will be seen further on, the financial charges here contended are related to the Applicant's activity, since they result from the financing of assets held by it and which even generate revenues of an operational nature.

The AT further advances, regarding the dismissal of financial charges, for not being inherent to the Applicant's own interest, in summary (articles 69, 71 and 90 of the Response, underlines of the AT):

'In the case of K… Lda, the costs borne with the loan are not related to its business activity, nor did they serve the maintenance of the income-generating source. Such costs, although recorded in its accounting, do not benefit its activity nor its respective business interest, but rather benefit a third party G… S.A.R.L. (ex -F…) not being accepted for purposes of calculating the fiscal result, under paragraph c) of article 23(1) of the IRC Code.

Indeed, with the merger operations, within which company A… Lda (ex –B…) incorporated company K… Lda (ex-J…), and the companies participated by it, despite being upstream mergers, in fact implied an entire transmutation of the incorporating company which legally was maintained but whose activity came to correspond entirely to the activities that had already been carried out by the incorporated companies.

Indeed, what occurred with the merger operations was that, as a result of the extinction of the social participations held by company A… Lda (ex-B…), the activity previously developed to which the bond loan was associated had no continuity, what subsisted was only operational activity developed by companies that had belonged to the I… Group, in the exploitation of which the funds obtained with that financing were not applied and, therefore, the financial charges borne did not contribute to the generation of revenues or income from dialysis treatment activities."

The AT is not correct when it calls into question the deductibility of financial charges on the part of the Applicant, at the level of IRC, on the ground that these are disconnected from its activity, its own interest, and that the funds obtained were not applied in exploitation.

In fact, as a result of the merger operations, the same company (the Applicant) came to hold, as patrimonial elements recorded or recognized in its balance sheet, the assets and liabilities of the operative companies and continued to record, also in its balance sheet, the own capital and financial liabilities that supported the social participations that previously represented this set of patrimonial elements.

This means that, before the merger, K… Lda (ex -J…) held, on the right side of the balance sheet, sources of financing arising from A… (ex -B…[6]) paying interest on those sources which constituted debt; and, in its assets, social participations in operative entities. With the merger, the same entity (the Applicant) continues to hold the aforementioned liabilities (debts to the participant G…, SARL substituted the social participations - which were cancelled with the merger - now proceeding to recognize the assets and liabilities of operative companies whose acquisition, recall, constituted the essential cause of the indebtedness of A… (ex -B…) to G… SARL.

In sum, the merger maintains in the Applicant 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 already financial assets, but their real translation into assets and liabilities of an operational nature.

It is therefore clear that the Applicant's debt to the parent company - and the interest resulting therefrom - falls within the interest or activity of A… (ex -B…). There is a clear economic link between the debt that earns interest and the assets and liabilities that such debt supports.

Furthermore, such assets and liabilities (financial debt) now come to be recognized in the balance sheet of the same entity. Thus, the Court does not see how - in the AT's thesis - the fact that the debt originates from funds that G…, SARL ceded to the Applicant can lead, without more, to failure to comply with the requirement of indispensability then provided in article 23 of the CIRC.

When the AT refers that "what subsisted was only operational activity developed by companies that had belonged to the I… Group, in the exploitation of which the funds obtained with that financing were not applied", it does not take into account that the ownership of the operational activity referred to in entity A… (ex – B…) was only possible by paying the I… group an acquisition price that entailed the financing through bond loans and advances that generated the interest paid.

Even from a strict perspective of nexus between revenues and expenses, it exists. The revenues derived from the business are related to the interest paid for its acquisition. From a patrimonial perspective there is, even, a greater approximation between assets and the capital that finances them, now recorded in the same entity. Not putting into question the AT the economic purpose of the reorganization operations carried out, the disregard of the interest paid has no support in article 23 of the CIRC.

It may even be ventured that, being certain that in many reorganization operations the assets figure in a given entity and the debt that finances them may be in another, in the case in question the merger led to a joining of assets and liabilities whose management operations fall, certainly, within the interest or activity of the Applicant.

As for the matter of advances, and the amount of €11,664,656.99, the AT refers that:

"As appears from the RIT, evidence was not found that unequivocally demonstrates that the amount of €11,664,656.99 is not included in the value of the advances, all the more so since company K…, Lda (ex – J…) paid directly that interest on account of company A… (ex -B…) by virtue of this company not having financial means to proceed with the liquidation of the interest. Thus, in the absence of that demonstration, the basis of the correction reduces itself to that of the correction relating to the bond loan".

Moreover, the arbitral request for decision presented by the Applicant, put into question the AT's thesis, without the latter, in the Response, in arguments or by another means, having rebuffed in a convincing manner the positions and explanations of the Applicant regarding the said €11,664,656.99. It merely limited itself to referring that there is no evidence that such an amount is not included in the final balance of €47,399.656,99. Furthermore, the AT stating that "in the absence of that demonstration, the basis of the correction reduces itself to that of the correction relating to the bond loan" and the Court understanding that there is no reason to disregard the interest on the bond loan, then this conclusion also affects the correction made by the AT with respect to advances, whereby the correction is illegal and, consequently, the assessment should be annulled, by violation of law, namely article 23(1) of the CIRC, insofar as it is based thereupon."

Having in mind all that has been said, and not forgetting that – consensually and as appears from the factual matters – exclusively at issue is interest on foreign capital, there will be no doubts, then, that the starting point of the decision-making process of the dispute that now must be resolved is situated within the framework of article 23(1)(c) of the CIRC.

Such norm provides, among other things and in that which now matters, that "Expenses are considered (...) namely: c) interest on foreign capital applied in exploitation.".

Thus, it is appropriate to determine whether, in the case, this is, or not, the situation that exists.

In such determination, and unless better advised, one should take into account, as decisive referents, four aspects that are considered fundamental, namely:

• The first is the circumstance that the social participations of the incorporating company, which integrated the assets of the incorporated company, do not exist in the assets of the company resulting from the merger process;

• The second is that the "foreign capital" to which the interest borne relates and whose deductibility is questioned was, at a moment prior to the merger, already entirely applied;

• The third is that the company resulting from the merger process does not materially identify itself (from the perspective of economic reality) with the beneficial company of the merger, as it was configured prior thereto;

• The fourth is that, as a counterpart of its participations in the incorporated company, which by way of the merger were extinguished, all assets of the incorporated company came to integrate the assets of the incorporating company.

In light of these referents, it is held that, indeed, in the case the prerequisites of the above-mentioned paragraph c) of article 23(1) of the CIRC are met, because the expenses with interest at issue correspond to foreign capital that was applied in the exploitation of the entity that bears them.

Indeed, and as was written in the STA Judgment of 13-04-2005, rendered in process 01265/04[3]:

"The merger by incorporation, although it implies that only the company into which the others are incorporated survives with its own legal personality, does not have as a consequence, in the field of economic and business realities, 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 a whole with others, in conditions different from those that occurred before the merger. But the same economic reality does not cease to exist, the same set (now integrated in another, more enlarged) of resources dedicated to a productive activity, which the shareholders, incidentally, wanted to enhance with the merger.

That is, with the merger by incorporation there is a transformation of the company, but not an extinction, not resulting from the integration its disappearance, but its alteration, although it implies the loss of legal personality."

Also in the TCA-South Judgment of 17-04-2012, rendered in process 04172/10[4] it was written that "the merger of companies is the act by which two or more companies bring together their economic forces to form, with the shareholders of all of them, a single legal entity, a new economic and legal subject.

Hence it can be stated, as the A. seems to have done, that the merger is, in general rule, and the situation under analysis does not constitute an exception, recommended by interests common to the companies involved therein, 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 a whole 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, more enlarged) of resources dedicated to a productive activity, which the shareholders, incidentally, wanted to enhance with the merger.

In another formulation, it can be stated that with the merger by incorporation there is a transformation of the company, but not an extinction, not resulting from the integration its disappearance, but its alteration, although it implies the loss of legal personality.".

Understanding this, it will be understandable then the assertion that the expenses with interest at issue correspond to foreign capital, which was applied in the exploitation of the entity that bears them. Indeed, rightly understanding the post-merger reality (not fraudulent), one should accept that the entity resulting therefrom will constitute a synthesis between the incorporated and the incorporating company, in which both persist.

Continuing "to exist the same economic reality", the "same set (now integrated in another, more enlarged) of resources dedicated to a productive activity", in the exploitation of which the foreign capital whose interest expenses come to have their deductibility questioned were applied, since not resulting from the integration its disappearance, but its alteration, while maintaining its legal personality.

Thus, in light of this understanding of the effects of the merger by incorporation, one cannot conclude otherwise than by the fulfillment of the prerequisites of the above-mentioned paragraph c) of article 23(1) of the CIRC.

One subscribes thus to that which was written in Judgment 42/2015-T, according to which "the merger maintains in the Applicant 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 already financial assets, but their real translation into assets and liabilities of an operational nature". Indeed, the perspective of the judgment in question is, it is believed, unquestionable in cases of "ordinary" merger by incorporation, as is the case, where it is evident, as was there referred, that the incorporating company trades the participations it holds for the economic reality into which the participated company is translated.

Thus, the situation now at issue is, fundamentally, not different from any other in which an entity enters into financial charges, applies them to a given asset suited to the generation of revenues, and, still during the pendency of the said charges, exchanges that same asset for another, equally suited to the generation of revenues, although of distinct nature.

It is not therefore to be accepted, the allegation of the Respondent according to which "the activity previously developed to which the bond loan was associated had no continuity, what subsisted was only operational activity developed by companies that had belonged to the D… Group, in the exploitation of which the funds obtained with that financing were not applied and, therefore, the financial charges borne did not contribute to the generation of revenues or income from dialysis treatment activities."[5]. Indeed, if it is true that the initial activity – management and enjoyment of social participations – had no continuity in the post-merger period, it is no less true that that activity was replaced (initially, moreover, only in part, since participations in the entities previously participated by F… were maintained), by another, already of an operational nature, equally revenue-generating, exercised by the entity resulting from the merger which integrated, as a result of what was seen before, the entity that had entered into the charges, with the resources necessary for the exercise of this new activity – repeat, revenue-generating – being obtained only in function of the assumption of those same charges.

Also, in the same terms, the proposition of the Respondent is not to be accepted, according to which "with the merger, the assets of the incorporating company – social participations – that had been financed with the bond loan were extinguished, with only the liability subsisting"[6], since, as was seen, in addition to the liability, came to integrate the assets of the entity resulting from the merger, the assets of the merged company, and the circumstance that "the activity pursued" by the entity resulting from the merger, "came to become confused with the activity developed, before the merger, by the incorporated or absorbed companies" is translated into a normal effect of a non-abusive merger.

This conclusion is not invalidated by that which is affirmed in Arbitral Judgment 87/2014-T, that "the fiscal deduction of financial charges incurred (...) has to be evaluated in the context of business proper to the Applicant, in attention to the normative criteria resulting from article 23(1) of the CIRC", and that "in order to apply to the case in question 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 matters to verify the destination or use of the funds obtained in relation to which the tax subject intends to fiscally deduct, for purposes of calculating its taxable profit, the interest and other charges associated that it bore".

On the contrary. Understanding that the Applicant, as it presents itself post-merger, synthesized itself with the incorporated company and that, therefore, the business context of the Applicant incorporates, also, the economic reality previously corporized autonomously by the company incorporated therein, one will then be evaluating the "normative criteria resulting from article 23(1) of the CIRC" "in the business context proper to the Applicant".

On the other hand, it is also not verified that there has been any alteration in the "(…) effective and concrete allocation of the financing of which the interest borne is the remuneration", inasmuch as, on the one hand, the financing was entirely applied at a moment prior to the merger, and, on the other, was not, even, the product of that application diverted to a third party, particularly to the shareholder of the incorporating company, as the AT contends, inasmuch as there was no alteration in the shareholdings of the incorporating company, of which the respective shareholder remained the holder, the value of the shares of the incorporating company not even, so far as can be determined, having suffered any alteration by way of the merger or the financing whose interest is at issue.

Effectively, the foreign capital obtained by the incorporating company, by way of financing and advances, was entirely applied (exhausting itself) at the time of the acquisition of the social participations and provision of advances to the company that came to incorporate it. In the case it is that reality: the amounts obtained through financing and advances did not endure until a moment post-merger, being then redirected in their purpose, but, at the time thereof, were already entirely applied.

What will not stand in the way of the conclusion formulated – it is believed – is the finding that, at the moment in which interest is borne, the assets in which the foreign capital was applied do not already integrate the legal sphere of the company resulting from the merger.

Indeed, applied the foreign capital in exploitation (a situation different from the "diversion" of part of the capital for applications foreign to business interest, which, as was seen already, does not occur in the case), it is considered that it would, nonetheless, be possible to refuse the fiscal deductibility of the corresponding financial charges, demonstrating (and, thus, eliding the presumption of deductibility arising from paragraph c) of article 23(1) of the CIRC, detected in the wake of Prof. Teixeira Ribeiro), that the product of that application – and not the foreign capital - would have been diverted to extra-business purposes.

What has just been stated will be of easy understanding with recourse to the example of a company which, with recourse to foreign capital acquires a certain investment asset (vehicle, property, machine), which it affects, from the outset, to exploitation within the scope of its respective activity, but which, from a given moment onwards, comes to permit the use thereof exclusively in the interest of third parties (e.g. shareholders; other companies).

In this situation, it is considered, the presumption of indispensability of financial charges borne with the acquisition of the asset, resulting from the application of foreign capital in the exploitation of the company in question, will be set aside[14], whereby the deductibility of those charges should be refused.

It is not, however, once more, that the situation of the case.

Rather, what happens in the situation that concerns us, is that...

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