CAAD Case 519/2018-T: Deductibility of Costs and Indispensability of Expenses Under Article 23 of IRC Code

ARBITRAL DECISION (consult full version in PDF)

The arbitrators Judge José Poças Falcão (arbitrator-president), Prof. Doctor Nuno Cunha Rodrigues and Prof. Doctor Maria do Rosário Anjos (arbitrator members) designated by the Deontological Council of the Centre for Administrative Arbitration to form the Arbitral Tribunal, constituted on 02-01-2019, agree as follows:

I – REPORT

A) Of the Petition

1. On 18-10-2018 the company A..., LDA., a limited liability commercial company, registered under the single registration number at the Commercial Registry Office and legal entity identification number ..., with registered office at ..., ...-... ... (hereinafter referred to as Petitioner), filed a petition for constitution of an arbitral tribunal, pursuant to the provisions of paragraph a) of no. 1 of article 2 and articles 10 and following of Decree-Law no. 10/2011, of 20 January and of Ordinance no. 112-A/2011, of 22 March, for challenging and declaration of illegality of the act of assessment of Corporate Income Tax (IRC), with number 2018... and the consequent act of assessment of interest with numbers 2018... and 2018..., embodied in the statements of account reconciliation with number 2018..., referring to the fiscal year 2016, in the total amount of €160,731.99.

2. The petition for constitution of the Arbitral Tribunal presented by the Petitioner was accepted on 19-10-2019 by the Esteemed President of CAAD and automatically notified to AT, in accordance with the terms and for the purposes legally provided. The Petitioner opted not to nominate an arbitrator, so, pursuant to the provisions of paragraph a) of no. 2 of article 6 and paragraph b) of no. 1 of article 11 of RJAT, in the wording introduced by article 228 of Law no. 66-B/2012, of 31 December, the Deontological Council designated as arbitrators the undersigned, who communicated their acceptance of the appointment within the applicable deadline. The tribunal was constituted on 02-01-2019.

3. On 02-01-2019 an arbitral order was issued notifying the Tax and Customs Authority (AT) to present a response within the legal deadline, pursuant to the provisions of nos. 1 and 2 of article 17 of RJAT. The Respondent submitted its response to the case file on 06-02-2019, whose content is deemed to be fully reproduced herein.

4. On 25-02-2019, in light of the position of the parties evidenced in the case file, an arbitral order was issued regarding the meeting provided for in article 18 of RJAT, with the following content:

"The legal definition and function of evidence are established in art. 341 of the CC: '(...) Evidence serves to demonstrate the reality of facts (...)'.

According to the CPC, the right and/or conclusions of the parties, of fact or of law, cannot be the subject of evidence (Cfr., e.g., ALMEIDA, Francisco Manuel Lucas Ferreira de, Direito Processual, vol. II, Almedina, Coimbra, 2015, p. 225), without prejudice to the exceptional situation (which is not relevant here) provided for in article 348, CC, which includes in the object of evidence certain legal norms derived from customary, local or foreign law. That is: in cases of official knowledge (normal situation) the Judge must determine the content of the law and apply it (iura novit curia).

Evidence is produced or brought for analysis within the proceeding with the primary function of demonstrating the truth of the facts alleged by the parties for the conviction of the judge, as prescribed by the aforementioned art. 341 of the CC.

In the present case, there is no surprise at any controversy between the parties regarding the reality of the facts, namely those essential to the object and decision of the dispute.

In fact, with respect to the ruling requested by the Petitioner, AT itself recognizes, does not challenge or accepts that '(...) the facts are duly supported by the documentary evidence attached to the case file, thus being a matter, exclusively, of applying the law to those facts (...)' [cfr 120º of the Response].

Thus, having considered the, at least, apparent absence of subject matter and/or futility of the requested procedure of examining witnesses and having regard to the provisions of articles 16-c) of RJAT and 130 of CPC, applicable ex vi article 29-1/e) of RJAT, the petition for production of witness evidence filed by the Petitioner shall be dismissed, unless the specific facts with relevance regarding which the production of witness evidence is requested are indicated and the Tribunal subsequently recognizes, beyond relevance, the controversial nature thereof.

Deadline for the petitioner to indicate the specific facts among those alleged, regarding which it seeks the production of witness evidence: 5 (five) days. Notify. (...)"

1. On 04-03-2019, the Petitioner made submissions by way of a petition filed with the case. In summary, it states that "it considers that holding a hearing for examination of the witnesses listed could constitute an essential contribution to the provision of clarifications on the matter of fact contained in articles 11 to 13, 18 to 20, 24 to 28, 29 and 30, 35 to 42, 45 to 51, 59 to 65, 72, 75, 77 to 85 and 111 to 114 of the initial petition. (...) Indeed, attention should be paid to the fact that the additional assessment subject to the present challenge, determined by the Tax and Customs Authority, is based on a sequence of acts, regarding which some clarifications are necessary, capable of demonstration and contextualization only by means of witness testimony. In light of the foregoing, and in accordance with the principle of cooperation provided for in article 7 of CPC, the Petitioner requests that the procedure of examining the witnesses be promoted in order to provide clarifications that appear relevant on the matter of fact, thereby contributing to a complete clarification of the normality, reasonableness and non-censurability, in the legal-normative sphere, of the operations underlying the assessment act being challenged.

Without disregarding the foregoing, it is further noted that there is pending in this tribunal another case – case no. 464/2018-T – whose alleged facts coincide with those of the present dispute. In that other case the tribunal constituted found it pertinent to examine the listed witnesses, as it is envisaged with interest, in addition to or alternatively to the production of witness evidence within the present case file, the benefit thereof in this dispute, should, of course, the Esteemed Arbitrators see actual advantages therein."

1. Following the position of the petitioner, the Tribunal issued an arbitral order on 09-03-2019, in which it dispensed with the meeting provided for in article 18 of RJAT, considering: "a) that this is a case not capable of definition of specific procedural rules, different from those commonly followed by CAAD in the generality of arbitral proceedings and b) that there are no exceptions to be heard and decided before ruling on the petition nor any apparent need for correction of procedural documents. (...) The Tribunal continues to foresee no utility/necessity in the examination of witnesses. However and as requested by the claimant and absent express and substantiated opposition from the opposing party, this Tribunal will consider in the assessment and for the decision of the matter of fact, the statements given by the witnesses in case no. 464/2018-T, pending before CAAD between the same parties allegedly with discussion on the same matter of fact of the present case [cfr article 421 of CPC, applicable ex vi article 29-1/e) of RJAT]". In the same order a period of 20 days was set for final submissions by the parties and the date of 03-06-2019 was indicated as the probable date for issuance of the final decision.

2. Petitioner and Respondent presented written submissions, respectively, on 26-03-2019 and 04-04-2019. On 23-04-2019 the Tribunal requested that CAAD make available the recording of the witness examination evidence held in case no. 464/2018-T, as indicated by the petitioner. The recording was sent to the tribunal on 24-04-2019.

B) THE POSITION OF THE PARTIES AND THE ISSUE TO BE DECIDED

In summary, the Petitioner, in its arbitral petition, challenges the conclusion of the inspection procedure that took place during the year 2018, but already initiated in 2017, through which the Tax Inspection Service Directorate of the Tax and Customs Authority (hereinafter, AT) made corrections to the taxable profit declared by the Petitioner with reference to the fiscal years 2014, 2015 and 2016. These corrections gave rise to the additional tax assessments being challenged in this arbitral petition. Thus, it alleges that the corrections made consist in the fiscal disregard, in light of the provisions of no. 1 of article 23 of the IRC Code, of part of the financial charges borne in the fiscal year 2016 with external financing, which should also have been accepted as essential to the activity carried out by the Petitioner. It does not accept, therefore, the understanding contained in the Tax Inspection Report (RIT) and corroborated by the Finance Directorate, according to which the financing contracted by the Petitioner for the granting of accessory benefits, supplementary benefits and loans, on a gratuitous basis, to its subsidiaries "B...", "C..., S.A.", "D..., Lda.", "E..., Lda.", "F..., S.A.", "G..., Lda." and "H..., S.A.", "I..., S.A.", should not be considered as a deductible expense for the purposes of determining taxable profit for IRC purposes. In the case at hand only the fiscal year 2016 is relevant.

From the Petitioner's point of view, these financing arrangements were justified by the necessity of providing financial relief to its subsidiaries in years of crisis. It sets out a detailed set of situations reported to each of the subsidiaries to justify the objective necessity of the financing granted. The capital increase thus obtained should be viewed as an investment in the future of each of the subsidiaries, which is why it did not charge interest. It further concludes, alleging that charging interest in the situations described would have aggravated the financial situation of the subsidiary companies at risk of insolvency, which could have endangered the entire group, as well as the hundreds of jobs they provide. Finally, it considers that the corrections made are not sufficiently justified and violate the provisions of article 23 of CIRC, because the costs of the financing obtained should be considered as expenses essential to the formation of taxable profit, contrary to the conclusions contained in the RIT. The tax assessments being challenged, because they have as their basis the conclusions of the RIT suffer, according to the Petitioner, from the defect of violation of law due to error regarding the factual and legal premises underlying them, and should be annulled with all legal consequences.

The position of the Respondent AT is that which results from the Response filed with the case and which is hereby deemed fully reproduced, which, in essence, reproduces the content of the Tax Inspection Report (RIT) filed with the case. Thus, it alleges in defense of the sustenance of the considerations and conclusions contained in the RI, as had already been corroborated by the competent Finance Directorate. In conclusion, it considers that it is not proven that the expenses borne by the Petitioner with external financing obtained to finance, on a gratuitous basis, its subsidiaries are indispensable. Therefore, it understands that such expenses are not deductible because the requirement of "indispensability" provided for in article 23 of CIRC is not met. In conclusion, AT argues for the legality of the procedure that led to the corrections underlying the tax and interest assessments being challenged herein.

This, then, is the issue to be decided by this arbitral tribunal.

II - PROCEDURAL REQUIREMENTS

The Arbitral Tribunal is regularly constituted.

The Parties have legal personality and capacity, are legitimate and are legally represented (cfr. articles 4 and 10 no. 2 of RJAT and art. 1 of Ordinance no. 112/2011, of 22 March).

The proceeding does not suffer from defects that would invalidate it.

It is incumbent to decide.

III – DECISION ON THE MATTER OF FACT

With relevance for the decision to be rendered in the present case, the following facts are considered proven:

A) Proven Facts:

a. The Petitioner was established in October 1981 as a limited liability company, having commenced production in January 1983, and evolved into a holding company; it is a family business, established in 1981 by the founding shareholders, Dr. J... and Eng. K... (each with shareholdings of 30% of the capital stock), and messrs. L... (each with shareholdings of 5% of the capital stock).

b. These latter two shareholders sold their shareholdings to companies C..., SA and M... in 2007 and 2012, respectively.

c. The Petitioner focuses its activity on the production of hard metal, with which it manufactures precision parts and tools for a multiplicity of industries, namely, the automotive, metallurgical and metal-mechanic, pharmaceutical, chemical, ceramic, petroleum, gas and other industries.

d. As a complementary activity, A... manages various shareholdings, framing the exercise of this activity within article 2, no. 2 of its By-laws, which expressly state that "The company may participate in the capital stock of other companies, even with a different object from its own and in companies governed by special laws or complementary groups of companies".

e. With the expansion of its activity, A... evolved from a small family business into a large-scale organization, vertically integrating the areas of technology and engineering, manufacturing of specific equipment and tools, moulds and complementary materials.

f. At the date of the facts – 2014 to 2016, with emphasis on the latter year as it is the only one at issue in the present case, the A... Group was composed of the following companies: "B...", "C..., S.A.", "D..., Lda.", "E..., Lda.", "F..., S.A.", "G..., Lda." and "H..., S.A.", "I..., S.A."

g. The Petitioner held dominion over the group of companies and, therefore, exercised the functions of management and direction of all subsidiaries.

h. In the fiscal year 2016 the companies B... and N... SGPS Lda were created and I... was extinguished through merger and incorporation into A....

i. In the year 2016, which is at issue in the present case, A... made the decision to capitalize its subsidiaries C..., D..., E..., F..., G..., H..., S.A. and I..., S.A.

j. The financing contracted by the Petitioner was channeled to its subsidiaries through the granting of accessory benefits, supplementary benefits and loans, on a gratuitous basis, that is, without charging interest.

k. The funds contributed to its subsidiaries were as follows:

[Table referenced in original]

l. From the RIT it appears, with regard to the financial charges resulting from the financing to subsidiary companies, that "they are not applied in the exploitation activity of A... but rather exclusively for the benefit of the subsidiary companies and should therefore be considered expenses without tax relevance", as only "expenses incurred by the company are deductible, provided that these prove to be capable of generating income that contributes to the determination of the taxable profit of the company making the accessory benefits, supplementary benefits or accessory benefits, under the regime of supplementary benefits".

m. Contrary to the procedure of the Petitioner, which does not charge interest on the vast majority of loans to associated companies, the shareholders of the company charge interest to it when they make loans to it.

n. To effect such financing to its subsidiaries, the Petitioner resorted to external financing, incurring financial charges that it has been deducting in full from its taxable result, which in the view of article 23° of CIRC.

o. The Petitioner as of 31 December of the fiscal years 2014, 2015 and 2016 maintained in its assets accessory benefits/accessory benefits under the regime of supplementary benefits/supplementary benefits and loans to associated companies, not remunerated in the amounts identified in the table of section 111.1.1.3 of the RIT, which is deemed fully reproduced herein.

p. All financial charges borne by the petitioner and which were considered for the purposes of determining the taxable profit of the years 2014, 2015 and 2016 are connected with loans contracted to finance loans/accessory benefits/unremunerated loans, intended exclusively for subsidiary companies of the Petitioner, as detailed in the table below:

[Table referenced in original]

q. For the purposes of determining the taxable profit of the petitioner, the following amounts were added in each of the fiscal years:

[Table referenced in original]

r. The corrections were maintained following the exercise of the right to a hearing by the Petitioner.

s. As a result of the corrections made, the corresponding additional IRC assessments were issued, with nos. 2018... (additional IRC assessment) and 2018... and 2018... (compensatory interest assessments), and statement of account reconciliation no. 2018....

t. On 18-10-2018 the Petitioner filed the present arbitral petition.

B) FACTS NOT PROVEN

It was not proven:

• that the financing described or mentioned in j), k), l), n) and p) of the proven facts were intended or applied to the exploitation activity of the Petitioner.

C) REASONING OF THE PROVEN FACTS

The Tribunal does not have to rule on all the details of the matter of fact that was alleged by the parties, as it is incumbent upon it to select the facts that are relevant to the decision and to distinguish the matter that it considers proven and declare what it considers not proven (cfr. article 123, no. 2 of CPPT and article 607, no. 3 of CPC, applicable ex vi article 29, no. 1, paragraphs a) and e) of RJAT).

In the present case the matter of fact is supported in the documents filed with the case by the Petitioner and those contained in the inspection procedure carried out together with the Administrative Process (PA) filed by the Respondent.

The statements of witnesses produced in arbitral case 464/2018-T prove the proven and unproven facts listed above.

The matter of fact, in truth, does not appear to be controversial, but only the substantiation and interpretation of the applicable law to the concrete case.

Thus, having regard to the positions assumed by the parties, in light of article 110, no. 7 of CPPT, the documentary evidence filed with the case by the Petitioner and that which is contained in the Administrative Process itself and the recording of evidence provided and attached to these case files, the facts listed above were considered proven, with relevance to the decision.

IV – DECISION ON THE MATTER OF LAW

The question at issue in the present decision is whether the Respondent AT can proceed with the fiscal disregard, in light of the provisions of no. 1 of article 23 of the IRC Code, of part of the financial charges borne by the Petitioner in the fiscal year 2016 with external financing.

The possibility of deductibility of costs, in light of the aforementioned article 23, no. 1 of the IRC Code – whether in the wording resulting from Decree-Law no. 159/2009, of 13 July, or in the wording resulting from Law no. 2/2014, of 16 January – has been the subject of diverse jurisprudence issued both by CAAD and by administrative courts, which we shall analyze hereinafter.

i) On the interpretation of article 23 of CIRC and the question of the "indispensability" of expenses in tax jurisprudence:

Article 23 of CIRC provided, at the time to which the controversial facts refer, as follows, in the part that is relevant to consider herein:

"Article 23

Expenses and losses

1 - For the determination of taxable profit, all expenses and losses incurred or borne by the taxable person to obtain or ensure income subject to IRC are deductible.

2 - The following expenses and losses are considered to be covered by the preceding number, in particular:

(...)

c) Of a financial nature, such as interest on third-party capital applied in exploitation, discounts, premiums, transfers, exchange differences, expenses with credit operations, collection of debts and issuance of bonds and other securities, redemption premiums and those resulting from the application of the effective interest method to financial instruments valued at amortized cost;

(...)

3 - The deductible expenses in accordance with the preceding numbers must be documented, regardless of the nature or support of the documents used for that purpose.

(...)"

The Petitioner states, in article 187 of the initial petition, that "in accordance with that legal provision [article 23 of CIRC], the tax deductibility of the financial charges in question was dependent, as it would be for any other expense, on a judgment regarding their indispensability for the realization of taxable gains or for the maintenance of the source of income of the Petitioner."

It is therefore incumbent to analyze this nuclear requirement in the admissibility of expenses for tax purposes: their indispensability. Here we follow very closely what was stated in decision no. 79/2017-T of CAAD.

Let us see.

As a rule, obtaining external financing to use in the context of activity and considering as expenses the financial charges borne with such obtaining does not raise any tax issue. However, making available to other entities financial available resources, whether own or external, without charging interest, does not generate any taxable income, meaning that the balancing rule that should exist from a tax perspective between expenses and income is broken.

According to the understanding of the Central Administrative Court South "...the legal notion of indispensability is therefore delineated from an economic-business perspective, through direct or indirect fulfillment of the ultimate motivation of contribution to the obtainment of profit" (Decision of TCA South, of 27 March 2012, Case no. 053120/12).

The aforementioned decision further adds that "...the deductibility of the cost depends only on a causal and justified relationship with the activity of the company. And outside the concept of indispensability will remain only the acts inconsistent with the social purpose, those that do not fit within the interest of the company, especially because they do not aim at profit".

In this sense, once it is proven that the orientation of expenses is toward the pursuit of the company's activity and, consequently, toward the obtainment of profit, it is understood that the criterion of indispensability is met, and it is outside the scope of the Tax Authority to make value judgments about the quality of business management.

This understanding is, moreover, what has been followed by the arbitral tribunals of CAAD. In fact, according to the decision handed down in case 444/2015-T, "from a general point of view, the essential features of the path established by national doctrine and jurisprudence on the matter of indispensability of expenses can be synthesized as follows":

• the judgment on the indispensability of expenses borne implies that their contribution to the obtainment of profits or gains subject to tax or to the maintenance of the source of income be verified, whereby "The legal notion of indispensability is therefore delineated from an economic-business perspective, through direct or indirect fulfillment of the ultimate motivation of contribution to the obtainment of profit" and "the tax deductibility of the cost depends only on a causal and justified relationship with the activity of the company" (Decision of STA, handed down on 30-11-2011, in case no. 0107/11);

• the costs (...) cannot fail to relate, from the outset, to the contributing company itself. That is, for a certain amount to be considered a cost of that company it is necessary that the respective activity be carried out by it itself, and not by other companies." (Decision of STA, handed down on 30-05-2012, in case no. 0171/11);

• "a concept of indispensability which, definitively moving away from the idea of causality between expenses and income, places the emphasis on the relationship of expenses with the activity pursued by the taxable person, that is, considering that the aforementioned concept of indispensability is met whenever expenses are incurred in the interest of the company in the pursuit of its respective activities." (Decision of STA, handed down on 04-09-2013, in case no. 0164/12);

• the concept of indispensability is to be determined on a case-by-case basis and the nexus of economic causality cannot be disconnected from the factual reality of the specific case, such that "the Tax Authority cannot evaluate the indispensability of costs in light of criteria affecting the opportunity and merit of the expense. A cost is indispensable when it relates to the company's activity, such that costs foreign to the company's activity will be only those in which it is not possible to discern any causal nexus with the profits or gains (or with the income, in the current expression of the code - cfr. art. 23, no. 1 of C.I.R.C.), explained in terms of normality, necessity, congruity and economic rationality." (Decision of TCA-South, handed down on 16-10-2014, case no. 06754/13);

"The indispensability of the cost must result simply from its link to business activity. If the cost is not foreign to the company's activity, that is, if it relates to the normal activity of the company (regardless of whether the degree of intensity or proximity is greater or lesser), and if its existence is accepted (one is not faced with an apparent or simulated cost), the cost is indispensable." (Decision of TCA-North, handed down on 20-12-2011, case no. 01747/06.3BEVIS);

"...from the legal notion of cost provided by article 23° of CIRC does not result that AT may question the principle of freedom of management, scrutinizing the quality and opportunity of the economic decisions of the company's management and considering that only those from which directly profit for the company flows or which are revealed to be convenient for the company can be fiscally assumed. The indispensability to which article 23° of CIRC refers as a condition for a cost to be deductible does not refer to necessity (the expense as a sine qua non condition of profits), nor even to convenience (the expense as convenient for business organization), under pain of intolerable intrusion by AT into the autonomy and freedom of management of the taxpayer, but requires only an economic causal relationship, in the sense that it is sufficient that the cost be incurred in the interest of the company, in order, directly or indirectly, to obtain profits.

The legal notion of indispensability is therefore delineated from an economic-business perspective, through direct or indirect fulfillment of the ultimate motivation of contribution to the obtainment of profit. Indispensable costs are equivalent to expenses incurred in the interest of the company or, in other words, in all acts abstractly subsumable in a profitable profile. This aim deliberately brings the economic and tax categories closer together, through an interpretation that is primarily logical and economic of legal causality.

The essential expense is equivalent to every cost incurred in order to obtain income and which represents an economic loss for the company. As a rule, therefore, the tax deductibility of the cost depends only on a causal and justified relationship with the company's activity. And "outside the concept of indispensability will remain only the acts inconsistent with the social purpose, those that do not fit within the interest of the company, especially because they do not aim at profit." (Decision of STA, handed down on 30-11-2011, case no. 0107/11);

"The rule is that expenses correctly accounted for are tax costs; the criterion of indispensability was created by the legislator, not to permit the Administration to intrude into company management, dictating how it should apply its means, but to prevent the fiscal consideration of expenses which, although accounted for as costs, do not fall within the scope of the company's activity, were incurred not for its pursuit but for other interests alien to it. Strictly speaking, these are not true costs of the company, but expenses which, having in view their object, were abusively accounted for as such. Without the Administration being able to evaluate the indispensability of costs in light of criteria affecting 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 rest on a judgment about the convenience of the expense, made necessarily a posteriori. For example, expenses incurred with an advertising campaign that proved fruitless cannot, solely on account of that result, be stated to be dispensable.

The judgment on the opportunity and convenience of expenses is the exclusive prerogative of the entrepreneur. If he decides to make expenses with a view to pursuing the object of the company but is unsuccessful and those expenses prove, ultimately, to be unproductive, they do not cease to be tax costs. But any expense that he accounts for as a cost and is shown to be foreign to the purpose of the company is not a tax cost because it is not indispensable.

We understand (...) that, under pain of violation of the principle of taxpaying capacity, the Administration can only exclude expenses not directly ruled out by law under strong motivation that convinces that they were incurred beyond the social objective, that is, in the pursuit of another interest other than the business one or, at least, with clear excess, deviant from the objective needs and capacities of the company." (Decision of STA, handed down on 29-03-2006, case no. 01236/05).

Similarly, it was affirmed in case no. 648/2017-T of CAAD that the assessment of proven indispensability of expenses for the realization of income subject to tax or for the maintenance of the source of income, to which no. 1 of article 23 of CIRC refers, begins by only being able to be made in relation to the entity that accounts for and bears them, as results from reiterated jurisprudence of the STA, of which an example is its Decision of 30.05.2012, proc. no. 171/11, which concluded: "costs cannot fail to relate to the contributing company itself. That is, for a certain amount to be considered a cost of that company it is necessary that the respective activity be carried out by it itself, and not by other companies", as well as the decision of the STA of 10.7.2002, proc. no. 0246/02, which decided: "the costs provided for in that article 23 must relate to the contributing company itself", therefore "for a certain amount to be considered a cost of that company it is necessary that the respective activity be carried out by it itself, and not by other companies, even if in a dominion relationship".

It is therefore clear that, for the aforementioned requirement of indispensability to be met, the expense must relate to the contributing entity itself, considered in itself, and it is evident that the source of income whose maintenance is linked to the expenses in the "proven indispensability" relationship by force of no. 1 of article 23 of CIRC is that of the parent company that bears the charges and not that of the subsidiary company that benefits from them.

As affirmed by the decision of the TCA North of 14.3.2013, proc. no. 01393/06.1, "only costs that were proven to be indispensable for the realization of profits or gains or for the maintenance of the source of income but of the company itself and not of a third party should be considered costs of the fiscal year. That is, costs must be attributed to the activity carried out by the company in question and not by another company".

Having reached this point, it is incumbent to subsume the proven facts to the provisions of article 23 of CIRC.

ii) The deductibility of costs in the case sub judice:

As results from the facts given as proven, it was demonstrated that the Petitioner A... entered into various loan agreements with financial institutions with a view, in part, to granting accessory benefits, supplementary benefits and loans, on a gratuitous basis, to its subsidiaries "B..." (...), "C..., S.A." (C...), "D..., Lda." (D...), "E..., Lda." (E...), "F..., S.A." (F...), "G..., Lda." (G…) and "H…, S.A." (H…), "I…, S.A." (I...).

Thus, the requirement of proof of the cost is met.

With respect to the other requirements that result from article 23 of CIRC (indispensability of the expense and link to income subject to tax) the Respondent AT disregarded the expenses of a financial nature (interest) incurred by the Petitioner in the fiscal year 2016, because the taxable person used external capital to finance on a gratuitous basis the subsidiary companies.

In fact, it was proven that, to grant facilities to third parties, the Petitioner A... resorted to external financing, incurring financial charges that it deducted in full from its taxable result.

Thus, the Petitioner accounted for in account SNC 691 of the year 2016 financial charges (interest) relating to the financing loans contracted, part of which would have served to finance and maintain unremunerated loan or accessory benefits in subsidiary companies.

It is therefore necessary to assess whether the requirement of indispensability of the expense is met, which results from article 23 of CIRC, which implies a justified relationship with the company's activity, that is, that the financing obtained is applied to the company's activity and not to the financing of third parties' activity.

This requirement of indispensability of costs/expenses for the realization of profits/income subject to tax or for the maintenance of the source of income, established by article 23 of CIRC, has been duly treated in legal terms by the jurisprudence in order to resolve the specific cases it has had to face, therefore the solution to be given to the case sub judice is supported by previous judicial decisions, as results, moreover, from the principle contained in no. 3 of article 8 of the Civil Code.

The Supreme Administrative Court has stated on various occasions, regarding the meaning and functioning of the requirement of indispensability of costs for tax purposes, that "the requirement of indispensability of a cost must be interpreted as an indeterminate concept requiring case-by-case determination, as a result of an analysis from an economic business perspective, in the perception of an economic causality relationship between the assumption of a cost and its realization in the interest of the company, having regard to the business purpose of the commercial entity in question" (cfr., for example, the decisions of the STA of 15.6.2011, proc. no. 049/11, no. III and of 29.3.2006, proc. no. 01236/05, no. 3.4 and the decision of TCA South of 16.10.2014).

It is therefore a matter of knowing whether the interest subject to correction (resulting from loans contracted to realize supplementary, accessory benefits and loans) have, all of them, the potential to positively influence the obtainment of profits by the Petitioner.

To proceed with the application to the case at hand of the requirement of indispensability of costs, it is decisive to ascertain, on the basis of all relevant facts and circumstances, the actual and concrete allocation of the financing, of which the interest borne is the remuneration or, stated differently, it is necessary to verify the destination or use of the funds obtained in relation to which the taxable person intends to fiscally deduct, for the purposes of determining its taxable profit, the interest and other associated charges it bore.

Thus, it is strictly in relation to the entity whose costs are under consideration for the purposes of determining its respective taxable profit that it is important to assess, having regard to the business activity it carries on, the tax deductibility of the financial charges, and it is therefore necessary to ascertain the necessity, adequacy, normality or connection to a profitable business of the costs under consideration, i.e., the expense recorded by the Petitioner resulting from the financing operations.

In fact, in the economic causality relationship of the cost with the interest of the company, the business interest that is assessed is that of the company itself that deducts the cost fiscally. Thus, the Supreme Administrative Court stated, in the decision of 10.7.2002, proc. no. 0246/02, that "the costs provided for in that article 23 must relate to the contributing company itself", therefore "for a certain amount to be considered a cost of that company it is necessary that the respective activity be carried out by it itself and not by other companies, even if in a dominion relationship", reiterating in subsequent decisions of 7.2.2007, proc. no. 01046/05, no. III, of 20.5.2009, proc. no. 01077/08, of 30.11.2011, proc. no. 0107/11 and of 30.05.2012, proc. no. 0171/11, that "costs must relate from the outset to the contributing company itself, that is, for a certain amount to be considered a cost of that company it is necessary that the respective activity be carried out by it itself and not by other companies", because "[o]therwise, as could the exercise of the activity of one company be imputed to another company with which it had some relationship".

On another front, it is equally explicit in the jurisprudence that it is a requirement exigible of the application of article 23 of CIRC "the individualized consideration of each company or institution such that reasoning here cannot interfere with those in which appeal is made to "group" management criteria or even to the financing – albeit gratuitous – of its shareholders or even to their will which is irrelevant in that matter, as it is a legal criterion, being solely relevant the legal entity whose costs are under consideration" (vd. the decisions of the Central Administrative Court South of 16.10.2007, proc. no. 01276/06 and of 18.12.2008, proc. no. 02515/08).

Therefore, in compliance with the provisions of no. 1 of article 23 of CIRC, it has full relevance to verify whether the assumptions of tax deductibility of the costs with interest were satisfied having regard to the activity of the Petitioner and the taxation period in question.

As results from the factuality given as proven and set out above, in the case at hand, the economic and financial motivations that influenced the decision did not adhere to the interest of the Petitioner. Now, for the requirement of indispensability to be met, the expense must relate to the contributing entity itself, considered in itself, in which the source of income is that of the parent or controlling company, and not that of the subsidiaries.

In fact, the Petitioner is not an SGPS – contrary to what occurred in other CAAD decisions it invokes, such as decisions 12/2013-T; 113/2013-T and 264/2016-T – remaining as a taxable person for IRC purposes autonomously in relation to the companies associated with it.

The loans in question were not applied in the company itself but rather in the associated companies, through accessory benefits and supplementary benefits, with those commercial companies being independent, dedicating themselves to their own and autonomous activities and having distinct legal personality and tax capacity, with their accounts organized independently in relation to the others, which implies, on the one hand, that each has its own profits and costs and, as such, must account for them, and on the other hand, that these costs and profits cannot be integrated into the accounts of the others.

Now, in this regard, the STA understood in the decision of 19.04.2017, proc. no. 0925/16, the following:

"I - Not being the appellant an SGPS nor being covered by the regime of taxation of groups of companies the financial charges borne by it resulting from supressions and supplementary benefits made to associated companies on a gratuitous basis cannot be considered as costs fiscally deductible by not being indispensable for the realization of profits of the appellant subject to tax or for its maintenance as a source of producer of the same in accordance with article 23 of CIRC in the wording in force at the date of the facts.

II - The appellant remaining autonomously as a taxable person for IRC purposes and the companies associated with it equally autonomous and equally taxable persons for IRC purposes the financial charges borne by it resulting from supressions and supplementary benefits made in favor of the companies associated with it cannot be considered as an indispensable cost for the purposes of deductibility for IRC purposes under the provisions of article 23 of CIRC by being foreign to the exercise of its activity."

Similarly, the STA decided, in the decision of 12 July 2006 in case no. 186/06, that "the loans in question were not applied in the company itself but rather in (...) associated companies (...), and even in the case in which the entity that resorted to credit to lend to its subsidiaries held the totality of the capital stock of the subsidiaries, even so it would be an entity distinct from any of them, with distinct activities, with individualized accounts (...), that is "are independent commercial companies, dedicating themselves to their own and autonomous activities and having distinct legal personality and tax capacity (...) has its account organized independently in relation to the others, which implies, on the one hand, that each has its own profits and costs and, as such, must account for them, and on the other hand, that these costs and profits cannot be integrated into the accounts of the others".

The STA thus concluded that the loans "were not indispensable for the obtainment of its gains or profits or to maintain its source of income, therefore the interest resulting from them could not be accounted for as costs".

Also in the Arbitral Decision of 2017-01-26, handed down in case no. 273/2016-T of CAAD, issued regarding article 23 of CIRC, the following was decided:

"Moreover, the placing at the disposal of other entities of such financial available resources was carried out as was previously referred to, without there being any charging of interest or any other remuneration, situation which generated the establishment of an emphasis in the legal certification of accounts."

In fact, it is unequivocal that it is foreign to the social purpose of the company the placing at the disposal of other entities of financial available resources, if we have regard to, in particular, what is stated in article 6 of the Commercial Companies Code.

It is not, in truth, in the interest of the Petitioner to place financial available resources at the disposal of other entities, without charging interest, at the same time that there is a need, even if partial, to request external financing having, for that purpose, to bear the financial charges resulting therefrom. The amounts loaned, without any remuneration, could always avoid that part of the financial charges have to be borne.

In this context, it is considered that the position of AT in not considering as activity expenses the financial charges borne and directly related to the financial available resources that the Petitioner placed at the disposal of other group entities and that could have been used in the context of the activity, avoiding that part of the charges have to be borne, merits no judgment of censure.

(...)

What is said is that the granting of gratuitous loans to third parties, using the available resources of the Petitioner – which, naturally, result from the financing obtained and from the income from its activity – does not fulfill the aforementioned criterion of indispensability.

Moreover, AT, to reach the result to which it arrived, used an adequate criterion, described in point K) of the matter of fact, and it is certain that the Petitioner does not criticize it, nor proposes another, saying only that there is no direct allocation between the financing obtained and the loans granted – which is true and, it is repeated, AT did not affirm.

What there is is an economic reality that translates itself as follows: if the Petitioner had not granted the aforementioned gratuitous loans, it would not have needed to resort to credit to the extent it did. Therefore, the charges with that resort to credit are not, in their entirety, indispensable expenses.

One cannot, in this regard, invoke the social purpose of the Petitioner – which, in the concrete case, covers the "manufacturing and trading of hard metal tools and other similar items and machine tools. Manufacturing and machining of various metal products" – to justify the indispensability of the cost.

In fact, the use of the "object or social purpose of the entity" as a decision parameter to assess the indispensability of expenses for the purposes of article 23, no. 1 of CIRC remains very current in the jurisprudence of our superior courts in tax matters.

In line, for example, with the decision of the STA no. 01046/05, of 07.02.07, which considered not deductible the charges borne by a company to meet the realization of accessory benefits, because "they are not related to the social purpose and activity pursued by the company", which dedicated itself to "tile manufacturing and not to the management of shareholdings or financing of risk companies" and with the decision of the STA no. 0107/11, which in light of article 23 of CIRC decided not to be deductible the costs with interest and stamp duty on bank loans contracted by a company and applied to the financing of its associated companies, despite the relationship of total dominion, the STA, in Decision no. 01206/17, of 28.02.18, reiterated in clear form the connection between the concept of indispensability of expenses of a company and its "social purpose".

Having in mind that the Petitioner is not a Company Manager of Shareholdings (SGPS), the conclusions of this decision no. 01206/2017 are analyzed hereinafter.

It was a matter of knowing whether the financial charges borne by a company (which pursued real estate activity) with loans used in the realization of supplementary benefits in subsidiary companies were deductible under article 23, no. 1 of CIRC. It was decided in this decision the following:

"I - Being certain that the appealing party is a shareholder of the subsidiary company and can make supplementary benefits to it, should it meet the legal requirements, which is not shown to be in discussion here, in its legal sphere the decision to make the supplementary benefit is not the exercise of its business activity because it does not have, also, the management of shareholdings as its purpose.

II - The parasocial agreement it concluded and in compliance with which it came to realize the supplementary benefits does not alter/expand the social purpose of the appealing party and, by not obtaining legal framework in this, is not development of the social activity of the appealing party.

III - It is not a matter of assessing the quality of the management acts carried out by the appealing party but of verifying that, whatever financial operations it realizes, outside its social purpose, are not an act of management of its business activity, therefore it cannot contribute to this the costs that such financial operation produces.

IV - The strengthening of the capital of the subsidiary company through supplementary benefits made by the appealing party are not the exercise of the business activity of the appealing party, therefore the costs that are incurred with these or because of the realization of such benefits are not costs deductible for IRC purposes in light of art. 23 of CIRC."

This reasoning is adopted in the case sub judice. In fact, to be fiscally deductible, expenses must be imputed to "the activity of the entity itself delimited by its social purpose" (Decision TCA-South, of 16.10.2007, proc. no. 01276/06) or within the "scope of the social purpose" (cfr., e.g., decision 614/2015, otherwise cited by the Petitioner).

It is a requirement of the application of article 23 of CIRC "the individualized consideration of each company or institution such that reasoning here cannot interfere with those in which appeal is made to "group" management criteria or even to the financing – albeit gratuitous – of its shareholders or even to their will which is irrelevant in that matter, as it is a legal criterion, being solely relevant the legal entity whose costs are under consideration" (v. Decisions TCA-South of 16.10.2007, proc. no. 01276/06 and of 18.12.2008, proc. no. 02515/08).

And in fact, it is not apparent how one can dispense with the consideration of the social purpose of a company to judge the "proven indispensability" of costs incurred. Commercial companies are legal entities delimited in their activity by the social purpose. See article 11, no. 2 of the Commercial Companies Code (CSC): "As the purpose of the company the activities that the shareholders propose that the company come to exercise must be indicated in the contract" (art. 11, no. 2 of CSC). Commercial companies have as their purpose the practice of acts of commerce (art. 1, no. 2 of CSC) and their social purpose is a "certain economic activity" that the company will come to exercise (art. 980 of the Civil Code). That activity, previously determined and specified in sufficiently precise terms, under pain of nullity of the contract in accordance with article 42, no. 1, al. b) of CSC [4].

And by economic activity must be understood a series or habitual succession of acts of that nature and not the isolated practice of an act, such as the acquisition of a shareholding in another company. It results, moreover from the conjugation of nos. 4 to 6 of article 11 of CSC, that the simple statutory permission for acquisition of shareholdings in limited liability companies does not configure an extension of its social purpose.

A distinct situation will be that of companies charged with managing a portfolio of shareholdings, which is not the case of the Petitioner. Recall that the social purpose of the Petitioner covers the "manufacturing and trading of hard metal tools and other similar items and machine tools. Manufacturing and machining of various metal products".

In this context, it is understood that the realization of accessory benefits, supplementary benefits and loans in companies held by the Petitioner cannot be considered as operations potentially generating profits in the sphere of the Petitioner.

Consequently, the requirement of indispensability of the cost for the company specifically in question is not met.

In that, having regard to the object of the present case, it is important to stress the necessity, for the judgment of indispensability of costs, of the perception of an economic causality relationship between the assumption of a cost and its realization in the interest of the company to be concretized in relation to the commercial entity in question.

This means that the financial charges (interest) that the Petitioner accounted for in account SNC 691 of the year 2016 relating to the contracted financing loans, which would have served to finance/maintain loans/supressions/unremunerated accessory benefits do not find economic causality nexus with the interest and activity of the Petitioner itself, having no potential for generation of profits in its legal sphere.

In fact the tax deductibility of costs, by force of the principle of indispensability provided by article 23 of CIRC, presupposes an economic causality nexus between the costs in question and their realization in the interest of the company. See in this regard the decision of the Central Administrative Court North of 14.3.2013, proc. no. 01393/06.1BEBRG in which it was considered that "only costs that are proven to be indispensable for the realization of profits or gains or for the maintenance of the source of income but of the company itself and not of a third party should be considered costs of the fiscal year. That is, costs must be attributed to the activity carried out by the company in question and not by another company".

Finally, note that, contrary to what occurs in the acquisition of shareholdings, where there is the acquisition of a right to a greater percentage of dividends, greater capital gains or a greater value attributed in case of liquidation of the subsidiary company, there is in the provision of supplementary benefits a "proven indispensability" of the costs inherent thereto in accordance with no. 1 of article 23 of CIRC, since, in the most favorable scenario, what the providing company acquires is only the right to its reimbursement, in the circumstances provided for in the CSC.

Thus, because the requirements of no. 1 and its paragraph c) of article 23 of CIRC are not met, it is understood that the financial charges borne by the Petitioner for the realization of supplementary benefits, accessory benefits and loans in the subsidiary companies cannot be fiscally deductible, by the verification that there is no economic causality nexus of the same with its economic activity that permits the recognition that such expenses are proven to be indispensable for the obtainment of its income or for the maintenance of its source of income.

Therefore, the scrutiny that AT carried out of the destination of the financing and the allocation of the corresponding interest is congruent and sufficient for one to conclude that such financial costs are not potentially generative of profits for the Petitioner or relevant for the maintenance of the source of income.

Hence it must be concluded that, in the situation of the present case, there is no place for "the positive judgment of subsumption in corporate activity" by which "indispensable costs will be equivalent to costs incurred in the interest of the company" (cfr. decision of the STA of 30.11.2011, proc. no. 0107/11). In this manner, independent of the assumption of the loan in question by the Petitioner having resulted from the realization of accessory benefits; supplementary benefits or financing operations, it is necessary to declare that the costs accounted for by the Petitioner in the fiscal year in question with the financial charges relating to such loans do not satisfy the requirement of indispensability of costs/expenses imposed for tax purposes by article 23 of CIRC, given that there lacks the necessary allocation of costs to the business interest and productive activity proper to the Petitioner.

It is therefore legitimate the correction carried out by AT, object of the present case, since, as recognizes the Supreme Administrative Court in the decision handed down on 29-03-2006, process no. 01236/05, "the Administration can only exclude expenses not directly ruled out by law under strong motivation that convinces that they were incurred beyond the social objective, that is, in the pursuit of another interest other than the business one, or at least with clear excess, deviant from the objective needs and capacities of the company."

Similarly, RUI DUARTE MORAIS considers that "if the charge was determined by other motivations (personal interest of shareholders, administrators, creditors, other companies in the group, business partners, etc.), then such cost should not be held as indispensable." (emphasis ours).

And it should not be said, to the contrary, that, within the framework of assessing the indispensability of costs one should have present the objective of increasing profits and thereby give rise to taxable income which, in the case of supplementary benefits of accessory benefits or loans, would be embodied in dividends and potential capital gains.

This is because, within the scope of the regime of tax transparency, profits distributed by transparent companies to their shareholders are not treated fiscally as capital income (cfr. paragraph h) of no. 2 of article 5 of the IRC Code) and in the calculation of future capital gains resulting from alienation, to avoid the occurrence of double taxation, the profits imputed to shareholders and not yet distributed must be excluded, as is moreover provided for currently in no. 5 of article 20 of the PIT Code and in no. 5 of article 81 of the IRC Code.

Observe, finally, that the recognition or not of the relevance under company law, for the purposes of applying the Commercial Companies Code, of the realization of accessory benefits or supplementary benefits does not interfere with the judgment relating to the deductibility of costs that result from such operations, whose formulation follows different reasoning as it is based on the fulfillment of the requirements set out in no. 1 of article 23 of the IRC Code.

Finally, the Petitioner also refers that "subsidiarily, transfer pricing regime should have been applied". Now, when the Respondent AT intends to carry out any fiscal correction with a view to a corrective assessment it is it that, obviously, chooses the path that leads to that. Then it justifies it and subjects itself to the scrutiny that the taxpayers and the courts will make of that option and that journey.

It is therefore on the tax act practiced and not on what, in the understanding of the taxable persons, should have been practiced, that the judgment of the tribunal falls. And, having AT sustained the aforementioned fiscal correction in article 23, no. 1 of CIRC, in the terms referred to above, it does not merit the same, for that reason, any judgment of disapproval. In light of the case file, the Respondent AT is recognized as correct when in this regard it rules out the application of the regime of the so-called transfer pricing.

Finally, the Petitioner also alleges that the Respondent AT will have violated the constitutional principle of taxation based on actual profit, provided for in article 104, no. 2 of CRP, which requires that the taxation of taxable persons be carried out having regard to the totality of their profits and, as well, to the totality of their costs whose tax relevance should not be ruled out by law. However, as was decided, the costs in question invoked by the Petitioner should not, in light of the law, have tax relevance, therefore the invocation, by the Petitioner, of the constitutional principle of taxation based on actual profit, to the concrete case, does not proceed.

Consequently, having regard to the provisions of article 23 of CIRC, there is no defect of violation of law imputed to the additional IRC assessment of the Petitioner no. 2018... and the compensatory interest assessments no. 2018... and 2018..., in the part that results from the correction translated in the disregard of financial charges borne by the Petitioner. Reason why the principal petition must fail, as all consequent petitions formulated by the Petitioner relating to the principal petition equally fail.

V - DECISION

It is decided in this Arbitral Tribunal:

a) To judge the arbitral petition filed as wholly without merit and, in consequence,

b) To maintain in the legal order the act of assessment of Corporate Income Tax (IRC) with number 2018... and the consequent acts of assessment of interest with numbers 2018... and 2018..., embodied in the statement of account reconciliation with number 2018..., referring to the fiscal year 2016, in the total amount of €160,731.99 and

c) To order the Petitioner to pay the costs of the proceeding, fixed below.

VI. VALUE OF THE PROCEEDING

The value of the proceeding is fixed at 160,731.99€ (one hundred sixty thousand seven hundred thirty-one euros), in accordance with article 97-A, no. 1, a) of the Code of Tax Procedure and Proceedings, applicable by force of paragraphs a) and b) of no. 1 of article 29 of RJAT and of no. 2 of article 3 of the Regulations on Costs in Tax Arbitration Proceedings.

VII. COSTS

Under article 22, no. 4 of RJAT, and in accordance with Table I attached to the Regulations on Costs in Tax Arbitration Proceedings, the amount of costs is fixed at € 3,672.00 (three thousand six hundred seventy-two euros), to be borne by the Petitioner.

• Notify.

Lisbon, 23 May 2019

The Collective Arbitral Tribunal

José Poças Falcão

Nuno Cunha Rodrigues

Maria do Rosário Anjos