Summary
Full Decision
The arbitrators Prof. Doctor Rui Duarte Morais (arbitrator-president), Doctor Tomás Cantista Tavares and Prof. Doctor Ana Maria Rodrigues (arbitrator-members), designated, respectively, by agreement of the arbitrators appointed by the parties, by the Claimant and by the Respondent to form the Arbitral Tribunal, agree as follows:
1. Report
A…, SA, NIPC…, with headquarters in …, …, …, Lisbon (hereinafter A… or Claimant) filed a request for constitution of the collective arbitral tribunal, pursuant to the combined provisions of articles 2, no. 1, al. a) and 6, no. 2, al. b) of Decree-Law no. 10/2011, of 20 January (Legal Regime of Arbitration in Tax Matters, hereinafter RJAT), in which the Tax and Customs Authority (hereinafter AT) is the Respondent, with a view to the declaration of illegality of the assessment of Corporate Income Tax and Compensatory Interest for 2012, in the amount of €769,869.87 (no. 2016…, compensation…).
The request for constitution of the arbitral tribunal was accepted by the President of CAAD and proceeded through normal channels.
The collective arbitral tribunal was constituted on 13/12/2016.
The AT responded, by way of defense, arguing that the request should be dismissed.
By mutual agreement and with the consent of the parties, the meeting provided for in article 18 of the RJAT was dispensed with. The parties presented oral arguments.
The arbitral tribunal was regularly constituted and is materially competent, as provided in articles 2, no. 1, al. a) and 4, both of the RJAT.
The parties have legal standing and capacity, are legitimate and are represented (articles 4 and 10, no. 2, of the same statute and articles 1 to 3 of Ordinance no. 112-A/2011, of 22 March).
The proceedings do not suffer from any nullities and there is no obstacle to the examination of the merits of the case.
2. Factual Matters
2.1. Proven Facts
The following facts relevant to the decision are considered proven:
a) The Claimant is engaged in the business of transport, specifically in road transport of goods for home delivery.
b) The Claimant was wholly owned by B…, SGPS, SA (NIPC…).
c) In December 2010, B… alienated 100% of the capital of the Claimant to the company C…, SA (NIPC…) – an entity controlled by the fund D… – constituted in September 2010, whose corporate purpose was the provision of administrative services and support to transport companies.
d) D… is a venture capital entity, engaging (generally, through companies controlled by it) in the acquisition of shareholdings and control of companies, with a view to capital appreciation, through improvement of management quality, and, consequently, of investor returns.
e) D… (venture capital fund) controlled the company E… SGPS, SA (NIPC…), which, in turn, was the sole shareholder of C…, SA, which acquired the entirety of the capital stock of the Claimant.
f) C…, SA financed the completion of the purchase of A… through: i) Shareholder advances from E…, SGPS, of €13.6 Million, at the rate of 15%/year; ii) Bank loans (from …) of €23 million, with tranche A, in the amount of €19.5 Million, intended for the purchase of the capital stock of the Claimant.
g) In September 2011 (with accounting effects as of 1/1/2011), C… (the absorbed company) merged into A… (the absorbing company), by means of global transfer of the assets of the absorbed into the absorbing – an operation usually referred to as reverse or inverted merger.
i) Following the merger, the Claimant (absorbing company) assumed (i) all of C…'s liabilities and (ii) the financial charges (interest) incurred by C… with the banks and the shareholder – which, in 2012, amounted to €3,345,790.05.
j) In the venture capital business (developed by fund D…) it is customary for the purchase of the shares of the company to be acquired to be effected by a special purpose vehicle established for that purpose (in this case, C…) and subsequently to carry out the merger with the operating entity (A…) – normal or inverted – in order to: (i) reduce administrative costs; (ii) comply with bank requirements (placing the debt in the same legal entity that owns the assets).
k) The AT did not accept the fiscal deduction of such charges (interest), and consequently initiated the assessment that is the subject of the present arbitral proceeding.
l) On 2 August 2016, the Claimant paid the amount set forth in the contested assessment (Corporate Income Tax and interest) and accrued interest, in the total amount of €773,709.83.
2.2. Unproven Facts
There are no facts relevant to the examination of the merits of the case that were not proven.
2.3. Reasoning for the Establishment of Factual Matters
The proven facts are based on the documents submitted by the parties, on their consent (also regarding the documents, amounts and payment dates), on official information and other documentation contained in the administrative file.
3. Legal Matters
3.1. Issue to be Decided
As accepted by the parties, the issue that arises in the present proceedings concerns only the tax treatment to be given to the interest and other charges borne, in 2012, by A…, relating to the loans (from shareholders and third parties) contracted for the purchase of the capital of A… itself and which the Claimant came to bear by virtue of and as a consequence of the merger with its shareholder C… (which originally contracted such obligations).
In the opinion of the AT, as expressed in the reasoning for the assessment in question, such interest and charges would not be fiscally deductible, pursuant to article 23 of the CIRC (as worded and numbered at the date of the facts), because they are not indispensable for the obtaining of income or the maintenance of the income source (and are not applied in operations).
For the Claimant, conversely, such interest and charges would be fiscally deductible, by meeting the requirements inherent in article 23 of the CIRC.
As emerges from the reasoning of the assessment (and other documents attached to the proceedings) and was clearly reaffirmed by the AT in its arguments, the issue to be decided does not concern, nor even incidentally, a possible transfer pricing adjustment regarding interest owed to the shareholder (article 63 of the CIRC), nor the application of the General Anti-Abuse Clause (article 38, no. 2, of the LGT) for any abusive arrangement of operations with exclusive or preponderant tax purposes, in abuse of legal forms (indebtedness [and resulting interest] for the purchase of capital followed by merger of companies, so that the profitable operating entity bears such charges and reduces its annual fiscal profit).
3.2. Applicable Law
Pursuant to article 23 of the CIRC (as worded and numbered at the date of the facts), the following are considered costs or expenses:
"1. […] those which are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the income source, in particular: (…)
c) Of a financial nature, such as interest on third-party capital applied in operations […], expenses with credit operations […]";
Furthermore, with the merger of companies "the absorbed companies are extinguished […], transmitting their rights and obligations to the absorbing company" (article 112, al. a), of the Commercial Companies Code).
3.3. The Arguments of the Parties
The reasoning of the assessment (and response of the Respondent and other pronouncements of the AT throughout the proceedings) invokes, in summary, that the interest borne by A… following the consummation of the merger (and as a consequence of this operation) relating to the financing originally contracted by C…, SA directly for the acquisition of the capital of A… do not merit the qualification of "indispensable" for the obtaining of income or maintenance of the income source: following the merger they no longer finance the acquisition of shareholdings (and are not applied in operations); in each year in which the interest is recorded, there would have to be a balancing between the financial charges borne and the income and existence of the asset; such interest would not be linked to the normal activity of the claimant and the associated asset does not exist and would not contribute to taxable income in the future.
The Claimant argues, to the contrary, that the interest borne in 2012 by A… is indispensable for the obtaining of income or maintenance of the income source, and therefore qualifies as a fiscal expense, pursuant to article 23 of the CIRC. The interest is borne by A… in the exercise of its activity; the loans (and, consequently, the interest resulting from them), when originally incurred (by C…, SA), were applied in operations and were indispensable to income and maintenance of the income source – and if they were at the initial moment, they must be forever, whatever subsequent modifications (even with the merger); the merger, among its normal effects, leads to the economic and tax result of the proceedings; the merger is an operation permitted by commercial and tax law and the AT, in the reasoning of the act, does not invoke the alleged abuse of the merger operation, followed by the acquisition, pursuant to article 38, no. 2, of the LGT.
3.4. Decision
The arbitrators analyzed all the arguments presented by the parties (in their written submissions, documents and arguments), as well as the reasoning and consideration of previous arbitral decisions on the matter – explained, moreover, by the parties – but always bearing in mind the (minor) particularities of the case ("each case is a case").
In fact, various arbitral decisions (for example, in proceedings 14/2011-T and 87/2014-T) refused the fiscal deduction of interest borne by the absorbing company post-merger, relating to financing contracted by the absorbed pre-merger with a view to the acquisition of the capital stock of the future absorbing company. Conversely, arbitral decisions 101/2013-T, 42/2015-T (here in a non-inverted merger, but the considerations are the same), 92/2015-T and 93/2015-T, 108/2015-T pronounce themselves in the opposite sense, accepting the deduction of such financial charges, by considering them manifestly indispensable for the obtaining of income or for the maintenance of the income source.
The arbitrators weighed all the arguments of the parties and the content of all the aforementioned decisions and decided in the sense of annulling the contested assessment. They considered that this interest and charges borne by the Claimant meet the requirements inherent in article 23 of the CIRC to justify their fiscal deductibility, based on the arguments set forth below.
Let us begin with FOUR clarifying notes, entirely uncontroversial, which help to frame the decision of the case.
First, and as already mentioned, the subject matter of the proceedings is limited solely to the application of article 23 of the CIRC to the interest borne in 2012 by A…, relating to the loans (from shareholder and third parties) contracted for the purchase of the capital of A… itself and which the Claimant bears by virtue of and as a consequence of the merger with its shareholder C…, which originally contracted such debts.
As a second note – relevant to the decision – it is necessary to bear in mind the tenor of the Judgment of the STA (Supreme Administrative Court) of 2/12/2011, case 0865/11 (in a case of division-merger).
That judgment established that the tax notion of merger (capable of tax neutrality) is broader than the legal definition in the CIRC which required, at the time, the legal formality of attribution to the respective shareholders of securities representing the capital of the other entity. There is tax neutrality in the merger operation governed by commercial law, even if it does not involve the attribution to shareholders of securities representing capital – as happens, symptomatically - among other cases -, in the situation of inverted merger. That is: the STA treated in tax terms the inverted and non-inverted merger equally, recognizing the tax neutrality of both operations, even if they do not involve the attribution of shares to shareholders.
This jurisprudence illuminates the decision of the proceedings: it is settled that mergers, inverted or non-inverted, possess the same legal regime, whether within the scope of commercial law or in tax matters, namely regarding the tax regime of tax neutrality described in articles 73 et seq. of the CIRC. That is, the merger operation described in commercial law – whether inverted or not – merits the same treatment and regime for tax law: both as regards tax neutrality (deferral of taxation of returns associated with these merger operations); and, in general, as regards the tax consequences, direct or indirect, arising from them.
There is not, so to speak, a first-class merger – non-inverted – with tax neutrality and, in general, tax acceptance of the provisions imposed by commercial law; and a second-class merger – the inverted one – in which such provisions would not obtain or would obtain in a more occasional and exceptional manner.
Nothing of the sort: there exists only the merger operation, encompassing the inverted and non-inverted, exactly with the same tax legal regime, and with the same and exact reasons for the various tax consequences that are associated with it.
This means, looking at the case of the proceedings, that the legal answer is the same, whether or not there is an inverted merger. The regime of tax acceptance of the interest in question has the same framework, considerations and solution, whether the merger was non-inverted (with the absorption of A… into C…), or in the case of the inverted merger chosen by the parties. Nor does there have to be an additional justification by the claimants to explain why they chose one and not the other. That falls within the total freedom of the parties, which it is incumbent upon the interpreter to respect, on the presumption, evidently, that there occurs a true and real merger – and that is settled, since no one disputes it.
The third note relates to the regime of merger from the legal and commercial law perspective. A merger (inverted or not) does not resemble, in economic terms, a liquidation of companies. Here, the legal and economic disappearance of a company occurs, because it has exhausted its purpose or corporate interest.
In merger, by contrast, the legal disappearance is not associated with the economic death of the enterprise, which continues, although restructured, in the company resulting from the merger, both from the perspective of the company (continuation of activity), and from the point of view of the shareholders (equal involvement in those activities). The absorbed company is extinguished, without doubt; but all rights and obligations are transferred to the Absorbing Company, which continues the activity of the "deceased" (article 112, al. a), of the CSC). There is a legal modification, with economic continuity (Judgment of the STA of 13-04-2005, delivered in case 01265/04 and Judgment of the TCA-South of 17-04-2012, delivered in case 04172/10, available at www.dgsi.pt).
The fourth note – accepted by the parties – relates to the peaceable acceptance of the deduction of such financial charges if the merger had not occurred, or attributable to the year 2011 (if they existed or would have existed), by compliance with the requirements of article 23 of the CIRC. Here, a company (C…) to acquire an asset (capital stock of A…), as a form of exercise of its activity and profit-seeking perspective, must finance itself with third parties (banks and shareholders), bearing the inherent financial charges associated with the financing. No one disputed – and we believe rightly – that prior to the merger, from the perspective of C…, we were in the presence of interest on third-party capital applied in operations (article 23, no. 1, al. c), of the CIRC).
Well then:
The issue of the proceedings is thus to know whether the merger – inverted or not – alters this state of affairs; whether the interest, once accepted in tax terms (in a peaceful manner), cease to be so after the merger, due to subsequent non-compliance with the requirements of article 23 of the CIRC (general requirement of indispensability and special requirement of application in operations).
The answer, as we have stated, goes in the direction of the fiscal deduction of such interest, even after the merger, now in the sphere of the Claimant, based on three main arguments, set forth below – and bearing in mind the previous considerations.
The FIRST relates to the analysis of the literal content of article 23, no. 1 of the CIRC: the deduction of financial charges requires that "interest on third-party capital be applied in operations". And everyone agrees that, at the initial moment, the credit obtained (from banks and shareholders) was applied in operations, with the acquisition of a shareholding in the Claimant, by C…, SA – subsuming it in the exercise of its activity and pursuit of profit.
Then a merger occurs, according to the rules of commercial law – whether inverted or not (as we have seen, the standard for the concrete case is the same). With this operation, one cannot say that the third-party capital ceased to be applied (the financing continued) and remain assigned to operations, now restructured by legal effects of the merger (transfer of rights and obligations to the absorbing company). That is: there is no diversion of financing, in an abusive intent, in the sense that it now serves the advancement of extra-corporate interests, e.g., to the benefit of a shareholder. Nothing of the sort: what occurs is merely the production of the normal economic effects of the merger, consented to and imposed by commercial law, and it is impossible to conclude that the effects of that operation, following the strict dictates of commercial law, result in the protection of interests alien to the corporate interest, merely to abusively benefit third parties to the merger operation. This interpretive result would be a veritable contradiction in its terms, because it would be equivalent to admitting that commercial law, in regulating the merger (inverted or not) would permit results that would violate the protection of interests safeguarded by that legal discipline.
In sum: if the interest was fiscally accepted prior to the merger (because the third-party capital was applied in operations), then it will also be after the merger (inverted or not), which merely followed the rules of commercial law, of transfer of all rights and obligations of the absorbed, because after the merger, they continue to be considered interest on third-party capital applied in operations.
The SECOND argument considers the similar situation (identical to the proceedings) in which, whether or not there is a subsequent merger, the Company decided to abandon the object of the investment (because it is not profitable), but obviously had to maintain the financing that provided the financial means for the investment.
Suppose a company X buys a high-value machine to pursue a new activity – and finances itself with the Bank to buy it and will pay €100,000 in interest over 10 years (and at the end will have to amortize the capital). Now imagine that the company concludes, at the end of the 4th year, that this activity is not profitable, because there is no market for the products produced by the machine, so it decides to abandon production and the machine is shut down and "abandoned". Of course it will have to continue to pay the annual interest of €100,000. But will such interest, from the 5th year on, not be deductible from fiscal income, by arguing that they are not applied in operations or that they are not indispensable for income or maintenance of the income source?
Well, those charges will remain deductible, notwithstanding the disappearance – by way of a business decision – of the object in which the third-party capital that remunerate them was applied. The third-party capital was applied in operations at the initial moment – giving rise to the productive investment. And that is sufficient and adequate to justify the fiscal deduction of the interest arising therefrom, regardless of the vicissitudes of that investment in the future. The financial charges continue to be deductible, even though the investment has failed or proved to be a bad investment or an unfruitful business decision – for, and this is what matters, the third-party capital was linked to an investment that at the initial moment was applied in operations.
And if this is the case, regardless of the occurrence of any merger (but in economic disinvestment), it will be all the more so in case of merger, in which, as we have seen, there is no subjective decision of any disinvestment, but merely the objective transfer of rights and obligations, by legal effect of that institute of commercial law.
Of course, the previous considerations could be confronted – in tax terms – and this is the THIRD argument, with the existence of an arrangement of operations purposely designed to provide an undesired tax result, of abusive tax saving, embodied in an acquisition of shares with the use of financing, immediately followed by merger (inverted or not) with the purpose of abusively reducing the taxes to be paid in subsequent years by the operating and profitable company (by effect of the financial charges that had been borne for its acquisition). We are not saying that such abuse occurred in the case of the proceedings. What is important to emphasize is that the AT, in the reasoning of the tax act, did not invoke such argumentative arsenal to justify the assessment, in substitution or cumulatively with article 23 of the CIRC. Despite suspecting the temporal and chronological arrangement of the operations and the "tax saving" assured with the deduction of the interest on the financing of the acquisition of A… from the operational income of A… (post-merger), it did not sustain the tax correction under article 38, no. 2, of the LGT or under article 73, no. 10, of the CIRC or even under article 63 of the CIRC (invoking an excessive quantification of interest between related entities). And the judge, in tax proceedings, must focus on the object of the case, as delimited by the reasoning, under penalty of illegal reasoning a posteriori and usurpation of the power-duty of executive power.
And, to conclude, article 23 of the CIRC is not reducible to an anti-abuse rule, which could be used in substitution for article 38, no. 2, of the LGT, article 73, no. 10 of the CIRC or article 63 of the CIRC. Each rule has a different prescriptive content – and article 23 of the CIRC does not function as an anti-abuse rule substitutive of those other provisions. Article 23 of the CIRC limits its scope of action to the non-deduction of expenses thus accounted for, but which, when incurred (or investments made) do not fall within the economic interest of the Company, but serve extra-corporate interests, of directors or third parties. Suppose that a Company bears the interest of financing contracted by it to make an investment solely for the private benefit of a shareholder or director (and that is not recharacterized as income in kind of the individual). Or that it finances with a bank to hand over that financial amount to a third party, without any consideration or outside its corporate purpose. In those cases, the interest that it comes to bear with those funds is not fiscally deductible because they were not ( ab initio and forever) applied in the operations of the Company.
The case of the proceedings is entirely different. The third-party capital was applied in operations; and should it be intended to invoke that all the operations would be recharacterized as an abusive arrangement of an arrangement of operations, albeit lawful from the civil law perspective, to obtain a tax gain – which at some steps of the inspection is what is subtly implied – then the reasoning would not have to resort to the institute of article 23 of the CIRC but, as already explained, to other institutes at the disposal of tax law to attempt to achieve such corrective result.
*
The argumentation presented is sufficient for the annulment of the contested assessment. It is therefore not necessary to explore the other arguments presented by the claimant (repercussion of the tax neutrality of the merger operation on the deduction of financial charges resulting from loans transmitted by way of neutral merger) and which arise from the other judicial proceedings (financial assistance) but whose argumentation was not invoked in these proceedings.
*
The Claimant requested, in addition to the annulment of the contested assessment, that the AT be ordered to refund the tax paid plus compensatory interest under law.
Article 43, no. 1, of the LGT provides that compensatory interest is due in favor of the taxpayer when it is determined in judicial proceedings (and arbitral action is included in that legal provision, for coherence and unity of the legal system) that there was error attributable to the services that resulted in payment of tax debt superior to that owed.
Well, that is what occurs in the proceedings. The AT, in producing the additional Corporate Income Tax assessment – now annulled – resulted in a payment of tax by the taxpayer, ultimately unwarranted and required only by error attributable to the services of the AT (which made an illegal tax assessment).
Therefore, meeting the requirements of article 43 of the LGT, the AT must proceed to pay compensatory interest, at the legal rate, from the moment of payment by the taxpayer until full refund to the taxpayer of the tax paid by it.
5. Decision
In accordance with the foregoing, this Arbitral Tribunal agrees to:
Declare the request for declaration of illegality of the contested assessment of Corporate Income Tax and Compensatory Interest for 2012, in the amount of €769,869.87 (no. 2016…, compensation 2016 … . GRANTED.
And, consequently:
Order the refund to the claimant of the Corporate Income Tax for 2012 paid by it in relation to the subject matter of these proceedings, in the amount of €769,869.87;
Condemn the AT to pay compensatory interest to the Claimant, on the amount referred to in the preceding point, from 2 August 2016 until full reimbursement.
6. Value of the Proceedings
In accordance with the provisions of article 97-A, no. 1, paragraph a), of the Tax Procedure and Process Code (CPPT) and article 3, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the proceedings are valued at €769,869.87;
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Lisbon, 19 May 2017
The Arbitrators
Rui Duarte Morais (Arbitrator President)
Tomás Cantista Tavares (Arbitrator Member)
Ana Maria Rodrigues
(Text prepared by computer, pursuant to article 131, no. 5 of the Code of Civil Procedure, made applicable by reference of article 29, no. 1, al. e) of the Legal Regime of Tax Arbitration)
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