CAAD Case 514/2018-T: Deductibility of Financial Charges on Supplementary Capital Contributions & Double Taxation in IRC

ARBITRAL DECISION (consult complete version in PDF)

The arbitrators Dr. Jorge Manuel Lopes de Sousa (arbitrator-president), Dr. António Lobato das Neves and Dr. André Festas da Silva, designated by the Deontological Council of the Centre for Administrative Arbitration to form the Arbitral Court, constituted on 27-12-2018, agree as follows:

1. Report

A..., S.A., taxpayer no. ..., with registered office in ... ..., ..., in Lisbon, (hereinafter designated as "Claimant"), came, under the terms set out in subparagraph a), number 1, of article 2 and number 3, of article 24, both of the Legal Regime of Tax Arbitration ("RJAT"), approved by Decree-Law no. 10/2011, of 20 January, to submit a request for arbitral pronouncement with a view to the annulment of the decision rejecting the Gracious Complaint no. ...2017..., which ruled on the legality of the additional taxation of Corporate Income Tax ("IRC") number 2016..., for the fiscal year 2012, which determined a total amount payable of € 6,183.80 (six thousand, one hundred and eighty-three euros and eighty cents), including default interest and compensatory interest, and a corrected tax result of € 964,078.25 (nine hundred and sixty-four thousand and seventy-eight euros and twenty-five cents), to which corresponds the collection document no. 2016....

The Claimant further requests the condemnation of the Tax and Customs Authority to refund the amount of € 5,513.70 (five thousand, five hundred and thirteen euros and seventy cents), plus the payment of the respective indemnity interest.

The request for constitution of the arbitral court was accepted by the President of CAAD and notified to the TAX AND CUSTOMS AUTHORITY on 16-10-2018.

In accordance with the terms set out in subparagraph a) of no. 2 of article 6 and subparagraph b) of no. 1 of article 11 of the RJAT, the Deontological Council designated as arbitrators the signatories, who communicated acceptance of the appointment within the applicable period.

On 06-12-2018, the Parties were notified of this designation and did not manifest any intention to refuse the designation of the arbitrators, in accordance with the combined provisions of article 11, no. 1, subparagraphs a) and b) of the RJAT and of articles 6 and 7 of the Deontological Code.

Thus, in compliance with the provision of subparagraph c) of no. 1 of article 11 of the RJAT, the collective arbitral court was constituted on 27-12-2018.

The Tax and Customs Authority submitted its response, raising the exception of untimeliness and expiration of the right of action and defending the lack of merit of the request for arbitral pronouncement.

By ruling of 08-10-2018 it was decided to waive the holding of the meeting provided for in article 18 of the RJAT and arguments, and for the case to proceed with response to the exception.

The Claimant made submissions on the exception, defending its lack of merit.

The arbitral court was duly constituted and is competent.

The parties have standing and legal capacity, are legitimate (articles 4 and 10, no. 2, of the same legislation and article 1 of Ordinance no. 112-A/2011, of 22 March) and are duly represented.

The case does not suffer from nullities.

It is necessary to decide.

2. Factual Matters

2.1. Proven Facts

The following facts are considered proven:

1. A. The Claimant is a Portuguese company established in 1989, whose corporate purpose is, in addition to the management and promotion of real estate, construction, purchase, sale, resale and administration of real estate, the acquisition of other companies and their financing, as well as participation in complementary business associations, consortiums or other forms of association.

2. In terms of IRC, the Claimant is part of a group in a special taxation regime for company groups (RETGS), with B... SGPS, S.A. as the parent company, with tax number ... (page 2 of the Tax Inspection Report contained in the administrative file, the contents of which are deemed reproduced).

3. By ruling of the Deputy Director-General of the Tax and Customs Authority of 02-12-2013, the cessation of application of RETGS to the aforementioned group was declared, with effect from 31-12-2008 (article 25 of the Response and document no. 9 attached by the Claimant).

4. By judgment handed down by the Lisbon Tax Court, the aforementioned ruling was annulled and the maintenance of RETGS was decided, with effect from 01-01-2009 (document no. 9 attached with the request for arbitral pronouncement, the contents of which are deemed reproduced).

5. The Claimant was subject to a general inspection action for the fiscal years 2012, 2013 and 2014.

6. From the inspection action on the Claimant, concerning the fiscal year 2012, a corrected tax result of - € 964,078.25 was determined, which corresponds to the tax result declared by the Claimant, in the amount of - € 1,829,583.07 (negative value, duly marked with the symbol "-"), minus the corrections proposed to the taxable matter (fiscal year 2012) in the amount of € 865,504.82.

7. The Claimant was notified of the additional IRC taxation no. 2016... (collection document no. 2016...), concerning the fiscal year 2012, in which is indicated: (i) the total amount payable of € 6,183.80, including default interest and compensatory interest (corresponding to autonomous taxation), and (ii) the corrected tax result of € 964,078.25.

8. The Claimant filed a gracious complaint of the taxation, which was numbered ...2017... and was rejected by Ruling of the Assistant Director of the Finance Directorate, dated 31-08-2017 and notified to the Claimant on 06-09-2017.

9. The decision on the Gracious Complaint manifests agreement with information, which is contained in document no. 3 attached with the request for arbitral pronouncement, the contents of which are deemed reproduced, in which is referred, among other things, the following:

V - ALLEGATIONS OF THE CLAIMANT

The claimant, in its petition, presents a document (cf. pages 2 to 229 appended to the present case), which includes 20 pages with the specification of 197 points and 15 attached documents.

In its petition the claimant alleges, in summary, based on the following grounds:

• The amount determined in the additional taxation, as autonomous taxation, in the total of €5,513.70, is not due, as it had already been paid by B... S.G.P.S., S.A., under the Special Taxation Regime for Company Groups (RETGS), being thus, illegal, due to duplication of levy (§4) to (§31);

• "(...) even though RETGS ceases ... with effects dated to 2012, the truth is that the self-assessment of the autonomous taxation now under analysis was not omitted, it is only corrected in accordance" (§ 23);

• "(...) the effects of fiscal consolidation are currently under contentious litigation (...)" (§42);

• Regarding the total correction of € 865,504.82, based on financial charges not accepted for tax purposes, it states:

• "(...) being one of the corporate purposes of the claimant the acquisition of other companies and their financing, whether as a contribution or as accessory payments, it is quite obvious ... that the interest paid for financing its participations is covered by the corporate purpose, since the acquisition of other companies aims at profit (...)." (§ 136);

• No correction should have been made, the financial charges incurred being classifiable under subparagraph c) of no. 2 of art. 23 of the IRC Code.

Indemnity Interest (§ 188 to § 197)

• The amount unduly paid should be reimbursed and its right to indemnity interest should be recognized, on that amount, calculated at the rate of 4%.

In these terms, it requests the annulment of the IRC taxation act, being reimbursed of the amount unduly paid in the total of € 5,513.70, and that its right to indemnity interest be recognized.

VI - OVERALL ANALYSIS AND OPINION

The claimant is a publicly held company that has been assessed for IRC and VAT purposes since 1989-04-17, for carrying out the activity of "Real Estate Promotion (Building Project Development)", CAE 41100 (cf. pages 292 to 294 appended).

The claimant states that it is covered by the Special Taxation Regime for Company Groups (RETGS), under the terms of art. 69 of the CIRC, in relation to the year under analysis, 2012, with the group being dominated by the company B... S.G.P.S., S.A. (parent company), currently C... (S.G.P.S.), S.A., tax number.... However, consultation of the computer system of the Tax Authority does not confirm this (cf. pages 290-291 and 308-309).

Furthermore, according to Information no. 1213/13 of the DSIRC, with ruling of the Deputy Director-General dated 2013-12-02, the cessation of RETGS application to the B... group, SGPS, SA is verified, with effect from 2008-12-31, and may opt for the regime again in 2013, by requesting such option (cf. pages 314 to 316 of the case).

Thus, the claimant's argument is without merit, the determination in the additional taxation of the total of € 5,513.70, as autonomous taxation, being correct.

As already mentioned, in the context of an inspection action for the year 2012, conducted at the Finance Directorate of Porto, corrections were determined in the total of € 865,504.82, based on financial charges not accepted for tax purposes.

The Inspection Report states (cf. page 274 of the case):

"(...) A... is bearing financial charges arising from loans that are financing the activity of its associated companies without the totality of these charges incurred being passed on to the actual beneficiaries of these funds.

Thus, the costs associated with financing that is being used by other companies, not A..., should be disregarded for tax purposes, regarding the differential existing between the costs and the income derived from the financing obtained and granted. (...)".

In this way, corrections were made, resulting from the non-recognition of the tax deductibility of financial charges incurred in the interest of other companies that are its associated companies, as determined in the table that follows:

Having analyzed the situation, the following should be noted:

• Considering that the claimant contests corrections made by the tax inspection services of the Porto Finance Directorate, with reference to the taxation period of 2012 (012015...), we requested adequate information on the factual matters underlying the case in question (cf. page 232 appended to the case).

From the response obtained (cf. pages 285 to 288 appended to the present case) the following pages 287 and 288 are transcribed:

"(...) A... stated that in order to meet the financial shortfalls of its participations it made loans to them with the character of contributions, and that B..., in turn, does the same in relation to the financial shortfalls of A....

We do not question these statements, what is questioned is the tax deductibility of the financial charges that A... is bearing to make those same contributions, since, unlike A..., B... debits interest to A... when it makes contributions to it to meet its financial shortfalls, and with those funds A... will meet the financial shortfalls of its participations for free, assuming in their entirety the financial charges of the funds that do not remain in its sphere but are transferred to the sphere of its participations.

Whatever the financing method used, whether we are faced with bank loans or loans with the character of contributions, we have financial charges associated with them, provided for in subparagraph c) of no. 2 of article 23 of the IRC Code, whereby, the tax deductibility of those same financial charges must be analyzed, in light of the provisions of the aforementioned article, there being no different framework depending on the nature of the financial charges, that is, whether they derive from bank loans or contributions.

Contrary to what the taxpayer states, the AT has never questioned the non-onerous character of the loans made, much less the freedom of decision in the form of financing of the companies, it only questions the tax deductibility of the financial charges that A... is bearing and then, with the funds obtained which have associated charges incurred, finance its participations, with A... bearing the charges of those same funds that are transferred to other companies and not used in the sphere of A... itself.

A... alleges that the jurisprudence invoked by the AT concerns bank loans and therefore is not applicable to the present case, since here we are faced with contributions and not bank loans.

However, what we are analyzing, as well as in all the legislation and jurisprudence mentioned, is the deductibility of financial charges, and not the source of such charges, since, regardless of whether they originate from contributions or bank loans, we are faced with expenses of a financial nature, classifiable under subparagraph c) of no. 2 of article 23 of the IRC Code.

Now, all charges of the same nature, in this case financial nature, will have the same legal framework, whether they derive from bank loans or other types of loans, the question is the assessment of their tax deductibility in light of the provisions of the aforementioned article 23 of the IRC Code.

We do not thus see why the jurisprudence invoked would not apply, since all of it relates to financial charges, contrary to the case of the jurisprudence now invoked by A..., which appeals to the Judgment of the Supreme Administrative Court of 29/02/2006, when this Judgment has at its origin the assessment of the deduction of charges with meal allowance and food expenses.

Here, yes, we are faced with situations that cannot be comparable, since the Judgment now brought to bear is relative to the tax deductibility of charges relating to meals, when the case we are analyzing concerns the tax deductibility of financial charges.

The taxpayer also invokes a decision of the Tax Section of the Centre for Administrative Arbitration (CAAD) (Decision handed down in P. no. 12/2013-T).

We must state that the decision now invoked by the taxpayer concerns the reality of a company managing social participations, an entity that has, as its sole contractual purpose, the management of social participations in other companies.

Now A... does not have as its sole activity the management of social participations, so we are faced with different realities that cannot be evaluated in the same way.

In this judgment the tax deductibility of the charges incurred by a SGPS, whose activity and operation is based exclusively on the management of its participations and subsidiaries, was under discussion. The case in question is manifestly different, and the same consequences cannot be drawn from completely different realities.

It is not by the mere fact that the company includes, in a completely accessory manner, in its CAE the acquisition of shares or stakes in other companies, financing of these, through contributions and or accessory payments, that it can be equated to a company managing social participations that has as its exclusive activity the management of its participations and subsidiaries.

The specialty of legal entities must be considered. Thus, the expenses provided for in article 23 of the IRC Code must relate from the outset to the company taxpayer itself, that is, for a given amount to be considered an expense of that company it is necessary that the respective activity be carried out by it itself, not by other companies.

As per jurisprudence previously invoked, the Supreme Administrative Court has already defined that the expenses listed in article 23 of the IRC Code must relate to the company itself in question, since for an amount to be considered an expense of that company it is necessary that the respective activity be carried out by it itself, not by other companies even if it maintains special relations with them, since, otherwise, how could the exercise of the activity of one company with which it had some relationship be imputed to another company, making it an essential requirement of the tax deductibility of expenses the individualized consideration of each company or institution.

Thus, it is in relation to the entity whose expenses are under consideration, taking into account the business activity it develops, that the tax deductibility of financial charges should be assessed and not in the sphere of any other entity with which it is related, that is, the connection of causality between the incurrence of financial charges and the development of the activity of the company owing them.

Consequently, the interest borne by a company in relation to loans in which it is manifestly proven that the funds obtained are diverted from its own operation to that of other entities with which it is related cannot be accepted as deductible.

This is what occurs in the situation in question, since A... is bearing financial charges arising from loans which in turn are channeled to other companies, without any amount being charged for the provision of such financial means, whereby the costs associated with financing that is being used by other companies, not A..., should be disregarded for tax purposes.

What is not in question here is the assessment or interference in the company's management decisions, but rather the assessment of the tax deductibility of costs incurred, in light of the requirements established by article 23 of the IRC Code.

In this sequence, the Supreme Administrative Court, as per jurisprudence already stated, has duly clarified that the costs provided for in this article must relate to the company taxpayer itself, whereby, for a given amount to be considered a cost of that company, it is necessary that the respective activity be carried out by it itself, not by other companies even if in a relationship of domination, that is, the costs must relate from the outset to the company taxpayer itself, that is, for a given amount to be considered an expense of that company it is necessary that the respective activity be carried out by it itself, not by other companies, even when it comes to associated companies, as occurs in the case here in question.

The mere possibility that in the future there may be gains resulting from the application of these capital in its associated companies does not alone determine that such investments can fall within the concept of tax expenses, because for that it was necessary that such charges were indispensable for the realization of the income or gains subject to tax or for the maintenance of the source of income.

The law does not prohibit A... from assuming commitments according to the group of companies, if it so chooses, depending on its management options, however, the usefulness of these decisions for the group does not eliminate the individualized interest of each of the entities involved.

A... also alleges that, if the proposed corrections were to be made, at the level of financing costs, these should equally be produced by the AT, in the opposite sense, in the sphere of B..., that is, the non-recognition of the income in the sphere of the company that charges these expenses to A....

Now, it is not our role to evaluate the situation of B..., since the inspection procedure carried out is on A... and not B..., whereby, not knowing the reality of B..., we will not be able to evaluate the income charged by this, accounted for and declared, as well as the charges that will, in turn, also be associated with obtaining such income, as well as with the development of its own activity.

Regarding the invoked matters relating to the accounting of the corrections, we present the following understanding:

In order to assess the weight that the loans granted represent in the totality of loans obtained, this cannot be done through the balance that exists at a given moment in the fiscal year, but rather through the totality of the funds that were made available to A... by B... and the funds that A..., in turn, transferred throughout the year to its associated companies.

That is, if we were to carry out this analysis through the year-end balances, this reality would be completely distorted, at the limit we could have a situation in which A..., by mere hypothesis, transferred throughout the year to its associated companies all the funds it obtained from B... and at the end of the year its associated companies returned all these amounts, with the balance consequently standing at zero.

Following the understanding now invoked by the taxpayer, we would obtain that the weight that the loans granted represented in the loans obtained was nil, which would completely depart from the existing reality.

As for the year 2014, the year in which A... charged interest to ..., for purposes of calculating financing costs not accepted for tax purposes, these were deducted from the interest which, in turn, A... incurred in the financing obtained, to the extent that these actually originated income in the sphere of A....

NOTE - We emphasize the fact that in inspection action, carried out for the fiscal year 2011, authorized by Service Order no. OI2014..., for the same taxpayer, corrections to the financing costs incurred in that fiscal year were equally promoted, in the proportion of the loans which it in turn grants to its associated companies, in a total of 468,922.49€.

These corrections were subject to voluntary settlement by A..., SA, which proceeded to send the substitute tax return form 22 for the fiscal year 2011, adding the amount of 468,922.49€.

Conclusion:

In light of what has been explained above, we understand that the elements and or arguments presented in no way alter the position initially assumed. (...)."

It is concluded, therefore, that in light of the above and with which we agree, the claimant does not have grounds with regard to the arguments put forth in defense of the annulment of the taxation act.

Thus, having regard to what has been described above and after analysis of what is set out in the Information from the Finance Directorate of Porto, it appears that the present complaint should be rejected.

INDEMNITY INTEREST

In addition to what has been set out, it is also convenient to analyze the request for payment of indemnity interest deducted, which is manifestly unsustainable in the case under analysis, because under the terms of art. 43 of the LGT, indemnity interest is due when it is determined, in a gracious complaint or judicial appeal, that there was an error attributable to the services from which resulted payment of the tax debt in an amount greater than legally due. Now in the case under analysis if there is an error, the same is not attributable to the services, but rather to the claimant.

1. The Claimant submitted a Request for Arbitral Pronouncement for the assessment of the legality of the decision rejecting the Gracious Complaint with no. ...2017..., as well as, consequently, for the assessment of the legality of the IRC taxation no. 2016..., requesting the condemnation of the Respondent in the annulment of the act rejecting the Gracious Complaint identified with no. ...2017..., as well as, consequently, the annulment of the additional IRC taxation no. 2016..., concerning the fiscal year 2012, which determined a total amount payable of € 6,183.80, including default interest and compensatory interest, and a corrected tax result of € 964,078.25, which was the subject of arbitral process no. 636/2017-T (document no. 2, attached with the request for arbitral pronouncement, the contents of which are deemed reproduced).

2. In that arbitral process no. 636/2017-T, a decision was handed down on 13-07-2018 in which the Singular Arbitral Court considered the value of the case to be the amount of € 871,688.62 and declared itself "incompetent ratione valoris, without prejudice to the provisions of no. 3 of article 24 of the RJAT" (document no. 2 attached with the request for arbitral pronouncement, the contents of which are deemed reproduced).

3. Following the above additional taxation, on 20-12-2016, the Claimant proceeded to payment of the amount of tax determined under the Special Program for Reduction of Debt to the State ("PERES"), in the amount of € 5,513.70 (five thousand, five hundred and thirteen euros and seventy cents) (Document no. 14, attached with the request for arbitral pronouncement, the contents of which are deemed reproduced).

4. B... SGPS, SA, tax number..., the parent company of the group, filed a self-assessment relating to the group concerning the fiscal year 2012, in which it included the autonomous taxation of € 5,513.70 relating to the Claimant (pages 310-312, on pages 160-164, of part 3 of the computer file and document no. 5 attached with the request for arbitral pronouncement, the contents of which are deemed reproduced).

5. On 15-10-2018, the Claimant submitted the request for arbitral pronouncement which gave rise to the present case.

2.2. Non-Proven Facts and Reasoning of the Factual Matters Decision

2.2.1. It was not proved what the form of notification of the arbitral decision handed down in process no. 636/2017-T was, but it is not necessary to ascertain this form to decide the question of untimeliness raised by the Tax and Customs Authority.

2.2.2. With regard to the payment of autonomous taxation by the group B... SGPS, SA, it can be inferred from the statements of the Claimant and from the fact that the cessation of application of RETGS was only decided on 02-12-2013, after the self-assessment and payment, which occurred on 31-05-2013, as can be seen from the documents included in document no. 5, attached by the Claimant, whose correspondence to reality is not questioned, and from the self-assessment of the group which is contained in the administrative file (pages 310-312, on pages 160-164, of part 3 of the computer file).

The Tax and Customs Authority does not say that the payment was not made, stating, in the decision on the gracious complaint and in the present case, that the computer system does not confirm it and that the application of RETGS would have lapsed.

But the fact is that, since the cessation was not declared on the date on which the self-assessment should have been presented, it had to be presented, as it was on 29-05-2013, as can be seen from the administrative file.

Being in this self-assessment included the amount of € 183,156.07 of autonomous taxation (field 365) it is to be presumed that it includes the value of autonomous taxation relating to the Claimant.

2.2.3. The remaining facts were given as proven based on the documents attached with the request for arbitral pronouncement and those contained in the administrative file.

3. Question of Untimeliness of the Submission of the Request for Constitution of the Arbitral Court (Expiration of the Right of Action)

The Tax and Customs Authority raised the question of untimeliness of the submission of the request for constitution of the arbitral court, made on 15-10-2018, following a decision of incompetence handed down on 13-07-2018 by a Singular Arbitral Court in process no. 636/2017-T.

In the arbitral decision referred to, the Singular Arbitral Court declared itself "incompetent ratione valoris, without prejudice to the provisions of no. 3 of article 24 of the RJAT".

In this no. 3 of article 24 of the RJAT it is established that:

3 - When the arbitral decision terminates the process without ruling on the merits of the claim due to a fact not attributable to the taxpayer, the periods for complaint, appeal, revision, promotion of official revision, revision of the taxable matter or to raise a new arbitral pronouncement of the acts which were the subject of the arbitral claim are counted from the notification of the arbitral decision.

Having the aforementioned decision become final, it must be considered established that the Claimant can use the "provisions of no. 3 of article 24 of the RJAT".

Thus, as results from the literal wording of this norm, the Claimant could "raise a new arbitral pronouncement" of the acts which were the subject of that process 636/2017-T, and the period for doing so is counted "from the notification of the arbitral decision".

This is a special norm for this situation, whereby the period of 90 days for requesting the constitution of an arbitral court, provided for in subparagraph a) of no. 1 of article 10 of the RJAT, is counted "from the notification of the arbitral decision".

In the case in question, as the arbitral decision was handed down on 13-07-2018 (a Friday), it cannot be considered notified before 16-07-2018.

Therefore, the period of 90 days counting from that date would end on 14-10-2018, which is Sunday, whereby its termination is considered transferred to 15-10-2018, the first working day thereafter, in accordance with article 279, subparagraph e), of the Civil Code, applicable by force of the provisions of article 20, no. 1, of the CPPT and article 29, no. 1, subparagraph c), of the RJAT.

Thus, as the request for constitution of the arbitral court was submitted on 15-10-2018, it must be considered timely.

For the foregoing, the exception of untimeliness (expiration of the right of action) invoked by the Tax and Customs Authority is without merit.

4. Matters of Law

4.1. Question of Duplication of Levy of Autonomous Taxation

The Claimant questions in the present case the taxation of autonomous taxation in the amount of € 5,513.70, defending that it was already paid under the RETGS, by the parent company of the group in which it was included, B... SGPS, SA.

As results from the factual matters, it should be considered proven that this payment was made.

The Claimant invokes that duplication of levy occurred.

In accordance with the provisions of article 205, no. 1, of the CPPT, duplication of levy occurs "when, with a tax being paid in full, another of the same nature is demanded from the same or a different person, relating to the same tax fact and the same period of time".

In the case in question, with the aforementioned amount having been paid on 31-05-2013, under the self-assessment carried out by B... SGPS, SA, it is concluded that the requirements for duplication of levy are met, since, upon taxing the same autonomous taxation to the Claimant, the same tax of a like nature is demanded from a different person, relating to the same tax fact and the same period of time.

Thus, with all the requirements provided for in article 205, no. 1, of the CPPT being met, and it not even being alleged that we are faced with a situation provided for in no. 2 of the same article, it must be concluded that the taxation challenged is flawed with duplication of levy, which justifies its annulment in the corresponding part, in accordance with article 163, no. 1, of the Code of Administrative Procedure, subsidiarily applicable, by force of the provisions of article 2, subparagraph c), of the LGT.

The taxation of compensatory interest, included in the taxation challenged, became void following the payment made by the Claimant under the Special Program for Reduction of Debt to the State ("PERES"), whereby only the annulment of the autonomous taxation is justified.

4.2. Question of Deductibility of Expenses for Remunerated Financings

The Tax and Customs Authority made a correction to the taxable matter of the Claimant for having incurred financing costs in the fiscal year 2012 (remunerated loans made by B... SGPS, S.A. to the Claimant) and in that fiscal year having made interest-free loans to companies in which it held interests.

The Tax and Customs Authority understood that in the proportion of the amount of such loans to the participations of the Claimant (in the amount of € 15,524,903.41) in relation to the total of the financings that generated financial charges (€ 29,354,107.41), the interest charged by B... to the Claimant is not deductible for purposes of determining the taxable matter, as it does not satisfy the requirements set out in article 23, no. 1, of the CIRC.

In the thesis adopted by the Tax and Customs Authority, "the expenses provided for in article 23 of the IRC Code must relate from the outset to the company taxpayer itself, that is, for a given amount to be considered an expense of that company it is necessary that the respective activity be carried out by it itself, not by other companies".

4.2.1. Concept of Indispensability of Expenses

Under the terms of article 23 of the IRC Code (in the version of Decree-Law no. 159/2009, of 13 July, in force in 2012), "expenses are those which are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the source of income".

The concept of indispensability has been repeatedly assessed by arbitral jurisprudence, in particular regarding the reinforcement of investment by a company in its participations, whereby the jurisprudence of the judgment of 13-02-2015, handed down in process no. 585/2014-T, will be adopted in general lines.

"The legal notion of indispensability is outlined (...) over an economic-business perspective, by fulfilling, directly or indirectly, the ultimate motivation for obtaining profit. Indispensable costs are equivalent to expenses incurred in the interest of the company or, in other words, in all acts abstractly subsumed in a profit-making profile." (...) "Indispensability encompasses any and all acts carried out in the interest of the company (...) The legal notion of indispensability thus represses acts inconsistent with the company's purpose, not inserted in the corporate interest, especially because they do not aim for profit".

"Indispensability thus does not mean an obligatory nexus of causality with income/gains, nor that, after the fact, the economic lucrative effects resulting from such expenses must necessarily be verified or proven. Provided that the expenses result from management acts which, based on the information known at the time of their execution, could have aimed at the expected obtaining of income or the maintenance of the source of production (physical, intangible, financial or other) this should lead to the acceptance of their deductibility".

It is referred to in the judgment handed down in process no. 585/2014-T as follows:

"Indispensability emerges as a determining factor for the admissibility of costs. Its delimitation is therefore fundamental to assess whether the charges were incurred in the interest of the participating company.

It should not always be excluded the possibility of deduction of investment costs of companies in their participations.

The concept of indispensability contained in article 23 of the CIRC should correspond to the costs incurred in the interest of the company, the expenses incurred in the scope of the activities covered by its statutory purpose, in the case of a company.

It is not therefore necessary a link to income, a mandatory nexus of causality between expenses and income. On the other hand, judgments by the Tax Administration on the appropriateness of management decisions are not relevant for that purpose, it being sufficient that they are taken within the scope of the company's interest.

The Central Administrative Court South, in proc. no. 06754/13 CT- 2nd Court of 16.10.2014 points to the following solution "It is the understanding of jurisprudence and doctrine that the Tax Authority cannot assess 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, with only those costs being external to the company's activity being only those in which it is not possible to discern any causal link with the income or gains (or with the income, in the current code expression - cf. art. 23, no. 1, of the C.I.R.C.), explained in terms of normality, necessity, congruence and economic rationality (cf. Judgment S.T.A. -2nd Section, of 21.04.2010, rec. no. 774/09; Judgment S.T.A. -2nd Section, of 13.02.2008, rec. no. 798/07; Judgment T.C.A. South -2nd Section, of 17.11.2009, proc.3253/09).

Now, an "asset is a resource controlled by the entity as a result of past events and from which it is expected that economic benefits will flow to the entity" - point 49 (a) of the Conceptual Framework of the Accounting Normalization System approved by the ruling published in Notice no. 15 652/2009, Official Gazette, II Series, of 7 September.

Thus, the "activity" of a company is not exhausted in the set of productive or operational operations. "Activity" is also the set of operations that aim at the realization of investments or the disposal of assets, the acquisition of financial interests and their subsequent disposal, the application of liquidity in investments or short-term securities and their management, the receipts and payments resulting from operational or non-operational income and expenses, and many others. Both the management of a physical asset, such as that of an intangible asset, such as that of a non-current asset held for sale, and that of a financial asset, will be activity.

The business activity that generates deductible costs must be that which translates into operations that have a purpose, an intent to obtain income or the purpose of maintaining the potential of an income-producing source.

In cases of investment of a company in one of its participations, financing from the parent will be done in the interest of this if it is to result in an expectation of future income directly resulting from it.

The deductibility of interest borne by the parent will depend on whether the financings contribute to, according to normal management rules, increase the expectation of future benefits or maintain the source of production (financial asset).

The fact that decisions taken in the sphere of the parent influence the assets of the participation does not mean that they are realized in the interest of third parties. They are taken from the perspective of the parent's interest in ensuring the operation and profitability of its investment in the participation.

The participation uses funds that are provided to it, but that provision of funds is made in the interest of the parent, that is, in the context of normal management acts that can be encompassed within its scope or profit-making purpose.

In situations where the parent holds all the capital of the participation and, therefore, has full ability to intervene in the management of the participation and ensure that the investment is used in its interest, the investment in the participation is reduced to management of the interest and constitutes the exercise by the parent of the economic activity that the participation carries out, whose positive or negative effects end up being reflected entirely in the legal sphere of the parent through the appreciation or depreciation of its interest, whereby the charges necessary to ensure the investment that enhances the obtaining of future benefits fall within the concept of economic indispensability, with the aforementioned sense of expenses entirely incurred in the interest of the company."

It is also in this sense the recent jurisprudence of the Supreme Administrative Court, as can be seen from the judgment of the Plenary of 27-06-2018, handed down in process no. 01402/17, drawn by unanimity, in which it was understood that

"The concept of indispensability of costs, to which article 23 of the CIRC refers, relates to costs incurred in the interest of the company or supported in the scope of activities deriving from its corporate purpose. Only when costs result from decisions that do not meet such requirements, namely when they do not present any affinity with the company's activity, should they be disregarded".

In the case in question, we are faced with interest-free financing by the Claimant to its participations through accessory contributions, a matter which was the subject of the judgment of the Supreme Administrative Court of 21-02-2018, handed down in process no. 0473/13, in which it was summarized:

V - Upon deciding to make accessory capital contributions to some of the companies in which it held interests without receiving any interest from them and, to make these financings contracted onerous loans from financial institutions, the financial charges borne by these loans are connected with the realization of the income or gains subject to tax or for the maintenance of the source of production of the participating company that contracted the loans and paid the corresponding financial charges.

VI - The management of social interests occurs through the influence that the voting rights that A'……… holds in the participated company, to be exercised at the general assembly, influencing the management decisions of the participated company, through the acquisition of more shares in the participated company, through the deliberation of the increase of its capital with the inherent increase in investment capacity, or through the strengthening of the capital of the participated company, increase in cash availability, among others. It being certain that A'……….is a shareholder of the participated company and may make accessory contributions to it, if it meets the legal requirements, the decision to make the accessory contribution is an exercise of its business activity of management of social interests. VII - It is not, at the level of the realization of the accessory contribution – by definition from the shareholder to the company – an activity of management of the participated company. The management act in question here is not an act of management of the participated company, which merely suffers the respective consequences in its legal sphere.

In the reasoning of this judgment of the Supreme Administrative Court, it is also stated:

Despite the accessory contributions having been granted by A'…….. for the companies in which it held interests to acquire financial interests in other companies – for this purpose, the purpose to which that capital was destined in the participated company is irrelevant - the interest borne by the first to obtain external financing, subsequently delivered to the participation, was done in the interest of the parent, as a direct consequence of its activity of management of financial assets – shares in the participation - which is, at least potentially, income-producing for the parent, indirectly through the success/failure that may result from the acquisitions of social interests that the participation has made with that money. In fact, it is an act of management intrinsically identical to another in which A'…….. contracted a loan to buy a machine for its industrial activity and from which it was bearing the inherent interest.

It is not a question here of knowing whether or not it is legitimate from the perspective of business management for such a loan. Tax law cannot disregard a cost because it understands that its assumption was a bad management act, nor can it consider a cost only because it understands that it was a good management act. Tax law has nothing to do with business management and regarding it must maintain only a conduct of neutrality.

(...)

"doctrine has noted that with accessory contributions there is an increase in the value of the financial investment made by the shareholder; This financial asset, thus reinforced or increased with the contributions, is a source of income production whereby, in terms of investment decision, the comparison between an initial outlay and the flows that it may originate is identical in investments in operational physical assets, in the acquisition of a capital interest or other type of financial investment".

Thus, "if the economic logic of the decision and the forms of financing are identical, if, furthermore, in all these cases the obtaining of income was enhanced, there is no reason why the financial charges should be deductible in some cases and not in others".

(...)

It is not overlooked that company A'……., SA holds social interests in various companies that confer on it total domination in some cases and in others partial domination varying between 0.04% and 99.99% and its corporate purpose encompasses real estate activities and the holding and management of social interests, understood as involving operations of financing of the companies in which it held interests so that they could better manage their portfolio of securities with a view to strengthening their business position either through the increase in market value of their own shares, either avoiding depreciation of its value, either carrying out financial and commercial operations that may generate profits, or at least be capable of generating them.

When it decided to make accessory capital contributions to some of the companies in which it held interests without receiving any interest from them and, to make these financings contracted onerous loans from financial institutions, the financial charges borne by these loans in the company A'……., SA are connected with the realization of the income or gains subject to tax or for the maintenance of the source of production of the participating company that contracted the loans and paid the corresponding financial charges.

The business and group of companies logic will frequently advise that loans be contracted by the parent company, likely the one that, by its size and prestige, is better positioned to obtain them from banking institutions on more favorable terms. Nothing in commercial law prevents this, it being incumbent on the companies in the group themselves to analyze such procedures, without the Tax Administration being able to interfere in such business option, as tax law does not impose different conduct.

As results from the factual matters established, the Claimant includes in its corporate purpose the acquisition of other companies and their financing, whereby, regardless of the form these financings assume (in this case, through accessory contributions), it must be concluded that they are intended for the maintenance of the source of production that are the participations and, therefore, fall within no. 1 of article 23 of the CIRC.

"The participation is not any entity foreign to the activity and interests of the parent. There is no expense in the sphere of the latter that has nothing to do with its corporate interest. The expense with interest incurred with capital obtained and subsequently contributed to the participation is done in the interest of the parent, as a direct consequence of its activity of management of an asset that emerges from a participation, which is real or potentially income-producing".

From the foregoing it follows that the corrections made relating to the deductibility of financial charges borne by the Claimant in 2012, partially used to finance its participations, violate article 23, no. 1, of the CIRC, which constitutes a violation of law flaw, which justifies the annulment of the correction made.

5. Restitution of Amount Paid Relating to Autonomous Taxation and Indemnity Interest

The Claimant paid on 20-12-2016 the amount of € 5,513.70 relating to autonomous taxation and requests the restitution of that amount, plus indemnity interest.

In accordance with the provisions of subparagraph b) of article 24 of the RJAT, the arbitral decision on the merits of the claim from which no appeal or challenge is possible binds the Tax Administration from the end of the period set for appeal or challenge, the latter having to, in the exact terms of the merit of the arbitral decision in favor of the taxpayer and until the end of the period set for the voluntary execution of judgments of the tax courts, "reestablish the situation that would exist if the tax act subject to the arbitral decision had not been made, adopting the acts and operations necessary for that purpose", which is in line with the provisions of article 100 of the LGT [applicable by force of the provisions of subparagraph a) of no. 1 of article 29 of the RJAT] which establishes that "the tax administration is obliged, in case of total or partial merit of a complaint, judicial appeal or challenge in favor of the taxpayer, to the immediate and full reestablishment of the legality of the act or situation subject to litigation, including the payment of indemnity interest, if applicable, from the end of the period of execution of the decision".

Although article 2, no. 1, subparagraphs a) and b), of the RJAT uses the expression "declaration of illegality" to define the competence of the arbitral courts operating in CAAD, making no reference to condemnatory decisions, it should be understood that it encompasses in its competences the powers which, in judicial challenge proceedings, are attributed to the tax courts, this being the interpretation that is in line with the meaning of the legislative authorization on which the Government based itself to approve the RJAT, in which it proclaims, as first guideline, that "the tax arbitral process should constitute a procedural means alternative to the judicial challenge process and to the action for recognition of a right or legitimate interest in tax matters".

The judicial challenge process, despite being essentially a process of annulment of tax acts, admits the condemnation of the Tax Administration in the payment of indemnity interest, as is inferred from article 43, no. 1, of the LGT, in which it is established that "indemnity interest is due when it is determined, in a gracious complaint or judicial challenge, that there was an error attributable to the services from which resulted payment of the tax debt in an amount greater than legally due" and from article 61, no. 4 of the CPPT (in the version given by Law no. 55-A/2010, of 31 December, to which corresponds no. 2 in the initial version), which "if the decision recognizing the right to indemnity interest is judicial, the period for payment is counted from the start of the period of its voluntary execution".

Thus, no. 5 of article 24 of the RJAT, when it says that "payment of interest is due, regardless of its nature, in accordance with the terms provided in the general tax law and in the Code of Tax Procedure and Process", should be understood as allowing the recognition of the right to indemnity interest in the arbitral process.

As the payment of indemnity interest depends on there being an amount to be reimbursed, it is within the competence of the arbitral courts operating in CAAD to assess whether there is a right to reimbursement and to what extent.

It is therefore necessary to assess the requests for reimbursement of the amount paid unduly plus indemnity interest.

As a consequence of the illegality of the taxation, the Claimant is entitled to be reimbursed the amount of € 5,513.70, which it paid unduly, by force of the aforementioned articles 24, no. 1, subparagraph b), of the RJAT and 100 of the LGT, as such is essential to "reestablish the situation that would exist if the tax act subject to the arbitral decision had not been made".

Regarding the right to indemnity interest, it is regulated in article 43 of the LGT, which establishes, insofar as is relevant here, the following:

Article 43

Payment of Undue Tax Debt

1 – Indemnity interest is due when it is determined, in a gracious complaint or judicial challenge, that there was an error attributable to the services from which resulted payment of the tax debt in an amount greater than legally due.

(...)

1. The rate of indemnity interest equals the rate of compensatory interest.

Regarding indemnity interest, article 43, nos 1 and 2, of the LGT establishes that "indemnity interest is due when it is determined, in a gracious complaint or judicial challenge, that there was an error attributable to the services from which resulted payment of the tax debt in an amount greater than legally due".

In the case in question, it was the Tax and Customs Authority which made the taxation challenged, on its own initiative, whereby the illegalities which affect them are attributable to it.

Thus, the Claimant is entitled to indemnity interest at the legal default rate counted from 20-12-2016, until full reimbursement, in accordance with articles 43, nos 1 and 4, and 35, no. 10, of the LGT, 61, nos 2, 3, 4 and 5, of the CPPT, and art. 559 of the Civil Code and Ordinance no. 291/2003, of 8 April.

6. Decision

In accordance with the foregoing, the arbitrators of this Arbitral Court agree to

a) Judge the exception raised by the Tax and Customs Authority to be without merit.

b) Judge the request for arbitral pronouncement to have merit.

c) Annul the correction to the taxable matter of the Claimant in the amount of € 865,594.82 and the acts applying it, which are the IRC taxation no. 2016 ... and the decision of the gracious complaint no. ...2017....

d) Condemn the Tax and Customs Authority to pay and refund the Claimant the amount of € 5,513.70, plus indemnity interest, in accordance with point 5 of this judgment.

7. Value of the Case

In accordance with the provisions of article 306, no. 2, of the CPC and 97-A, no. 1, subparagraph a), of the CPPT and 3, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of the case is set at € 871,688.62.

8. Costs

In accordance with article 22, no. 4, of the RJAT, the amount of costs is set at € 12,240.00, in accordance with Table I annexed to the Regulation of Costs in Tax Arbitration Proceedings, charged to the Tax and Customs Authority.

Lisbon, 04-03-2019

The Arbitrators

(Jorge Lopes de Sousa)

(António Lobato das Neves)

(André Festas da Silva)