IRC Fair Value Adjustments on Financial Instruments – CAAD Arbitration 563/2015-T

ARBITRAL DECISION

I. REPORT

1. On 31 August 2015, the commercial company A… –…, Lda., NIPC …, with registered office at … (Building …, ..., (hereinafter, Claimant), filed a petition for the constitution of an arbitral tribunal, under the combined provisions of Articles 2, paragraph 1, subparagraph a), and 10, paragraphs 1, subparagraph a), and 2, of Decree-Law No. 10/2011, of 20 January, which approved the Legal Framework for Arbitration in Tax Matters, as amended by Article 228 of Law No. 66-B/2012, of 31 December (hereinafter, referred to in abbreviated form as RJAT), following the rejection of the gracious complaint No. …2014… – IRC 2011 (…/2014), seeking the declaration of illegality of the self-assessment of corporate income tax (IRC) for the fiscal year 2011.

The Claimant attached 9 (nine) documents and did not request the production of any other evidence.

The Respondent is AT – Portuguese Tax and Customs Authority (hereinafter, Respondent or AT).

1.1. In essence and in brief summary, the Claimant alleged as follows (which we mention mostly by transcription):

• A… is a commercial company, to which the Special Regime for Taxation of Groups of Companies, provided for in Articles 69 et seq. of the Corporate Income Tax Code (CIRC), was applicable in 2011 for taxation purposes, and the fiscal group of which the Claimant was part – in its capacity as the dominant company of the group – also consisted of companies B… and C…;

• Companies B… and C… proceeded, on 24 May 2012, to the electronic submission of periodic income statements (form 22), relating to the taxation period of 2011, resulting in taxable profit of € 1,431,996.48 and a tax loss of € 88,603.60;

• The Claimant also proceeded, on 28 May 2012, and within the scope of its declarative obligations as the dominant company of the fiscal group, to the electronic submission of the income statement of the said fiscal group, resulting in total taxable profit of € 4,669,173.00;

• The Claimant proceeded, on 4 July 2013, to the replacement of the corporate income tax income statement of the fiscal group A…, however the taxable profit initially calculated remained unchanged;

• The self-assessment of corporate income tax for the fiscal year 2011 contains errors that necessitate its revision, which result from errors in the tax treatment afforded to losses resulting from the application of the fair value model in financial instruments, which, although primarily affecting the individual sphere of companies B… and C…, are reflected in the self-assessment of corporate income tax of the Claimant;

• On 31 December 2009, B… and C…, were holders of financial interests in D…, respectively, in the percentages of 0.005% and 0.00003%, and until that year, the interests in question were accounted for in B… and C… at their acquisition cost, net of a provision for financial investments, calculated by the difference between the acquisition cost of the interest and the value of its market quotation at the end of the taxation period, as evidenced in the 2009 Financial Statements and Reports of B… and C…;

• With the approval of the Accounting Standardization System (SNC), B… and C… began to measure the financial interests held in D… at fair value through profit or loss, in accordance with the Accounting and Financial Reporting Standard ("NCRF") 27; in this sense, the balances reported on the balance sheet as of 1 January 2009 were reexpressed for SNC;

• The conversion from the Official Chart of Accounts (POC) to SNC was carried out through two transition adjustments which, together, had a nil impact on shareholders' equity; however, each of the transition adjustments must be analyzed autonomously, as follows: reversal of the accounting provision constituted under POC which resulted in a positive change in shareholders' equity; and negative fair value adjustment, which resulted in a negative change in shareholders' equity;

• On 31 December 2011, B… and C…, were holders of financial interests in D…, respectively, in the percentages of 0.004% and 0.00002%, and during the fiscal year 2011, such interests underwent a negative variation in quotation compared to their value on 31/12/2010, a decrease measured by the fair value method;

• The Claimant considered as fiscally deductible only 50% of the fair value adjustment occurring in the transition from POC to SNC as well as of the losses in 2011, this being the treatment afforded by the Claimant solely because it considered this to be the position of the AT, as expressed in the Doctrinal Record relating to case …/2011, with dispatch of 24/02/2011;

• Considering that the adjustments resulting from the application of fair value compete, in the Claimant's understanding, for the formation of taxable profit in its entirety – a situation that the Claimant did not take into account when presenting the periodic income statement (form 22) of corporate income tax – a gracious complaint was filed, on 22/05/2014, seeking the revision and correction of the corporate income tax assessment relating to the period 2011;

• The Claimant requested, within the scope of the gracious complaint presented, the correction of the corporate income tax assessment and the consequent reduction of taxable profit, in the following terms: (i) Deduction in field 705 of section 7 of the periodic income statement (form 22) "Positive patrimonial variations ("Transitional regime provided for in Article 5, paragraphs 1, 5 and 6 of Decree-Law 159/2009, of 13/7"), of the following amounts: B… – amount initially declared: € 57,246.84, corrected amount: € 0.00; C… – amount initially declared: € 387.53, corrected amount: € 0.00; (ii) Annulment in field 738 of section 7 of the periodic income statement (form 22) ("Capital gains resulting from changes in valuation method (Article 46, paragraph 5, subparagraph b))"), of the following amounts: B… – amount initially declared: € 61,170.73, corrected amount: € 122,341.46; C… – amount initially declared: € 120.82, corrected amount: € 241.65;

• Which corresponds to a reduction of taxable profit in the consolidated sphere of A… in the amount of € 118,916.91, totaling € 4,550,256.09 of taxable profit;

• The AT did not take into account the arguments raised by the Claimant, having rejected the gracious complaint petition duly presented, a rejection with which the Claimant cannot agree, insofar as it is tainted by a defect of violation of law;

• The question at issue in the present case, the solution of which is intended to be achieved, is to determine what tax treatment should be afforded to losses resulting from the application of the fair value model in financial instruments that have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a participation in capital exceeding 5% of the respective share capital;

• There are here two contrary interpretations: the first thesis, which is defended by the AT, considers that losses resulting from the fair value model in financial instruments should be treated under Article 45, paragraph 3 of CIRC, and thus are only deductible in 50%; the contrary thesis, defended by the Claimant, argues that these losses should be viewed in light of Article 18, paragraph 9, subparagraph a) and Article 23, paragraph 1, subparagraph i), both of CIRC, with no application of said Article 45, paragraph 3, and thus the fair value adjustments should be deductible in their entirety;

• Paragraph 3 of Article 45 may only be applicable to situations that are considered "losses" or "negative patrimonial variations," and by losses should be understood the facts qualified as such under CIRC and negative patrimonial variations must be understood as those that are not reflected in the net results of the fiscal year, as defined in Article 24;

• If a strict interpretation were not applied to the concepts of Article 45, paragraph 3, we would be giving this subparagraph enormous scope of application, which cannot have been the legislator's intention;

• Situations that fall within the scope of "expenses" under CIRC can never be within the scope of the provision in question, since the legislator was very clear in framing this situation within the concept of "expenses" and not "losses," leaving no doubt that subparagraph i) of Article 23 does not refer to the amounts in question as "losses," but as "expenses," and therefore the situation under analysis falls within Article 23 and can never be framed within Article 45;

• "Expenses" and "losses" are two concepts that are not equivalent, as is evident from the fact that, with Law No. 2/2014, of 16 January, which reformed CIRC, Article 23 changed its heading once again to "expenses and losses";

• With the reform of the Corporate Income Tax Code effected by Law No. 2/2014, the legislator further clarified any doubt that might subsist by changing subparagraph i) of Article 23 from "expenses resulting from the application of fair value in financial instruments" to "losses from fair value reductions in financial instruments"; it should be recalled that Article 45, paragraph 3, was repealed by Law No. 2/2014, that is, the legislator changed the description of subparagraph i) of Article 23 from "expenses" in financial instruments to "losses" in financial instruments precisely at the same time it repeals Article 45, paragraph 3, such that the alteration of subparagraph i) of Article 23 has no practical effect because this alteration does not result in those realities only competing for taxable profit by 50% (with Article 45, paragraph 3, repealed, the change from "expense" to "loss" in this case no longer implies the deduction of this item in only 50%);

• Had the legislator wished, it had several years to change subparagraph i) of Article 23 from "expenses" to "losses" in such a way that these realities would only compete for taxable profit by 50%, but it chose not to make this change during the validity of Article 45, paragraph 3, resulting from this fact that the legislator never intended to provide that expenses resulting from fair value adjustments in financial instruments would only compete for taxable profit by 50%, and the legislative intention was always to ensure that these adjustments compete for the formation of taxable profit in their entirety;

• Given the rationale for the establishment of the provision fixed in Article 45, paragraph 3 of CIRC (previous Article 42), in the wording given at the time of the facts – namely, the fight against fraud and tax evasion – it must be concluded that the reasons that led to the adoption of said provision find no justification in the specific case;

• The content of the provision established in Article 45, paragraph 3, becomes, entirely, devoid of any useful effect when, as is the case, we are dealing with financial instruments that have a price formed in a regulated market and in relation to which the taxpayer does not hold, directly or indirectly, a participation in capital equal to or exceeding 5% of the respective share capital.

The Claimant concludes its initial pleading by requesting the following:

"Wherefore it is respectfully requested of Your Excellency that you be pleased to uphold this petition for the constitution of an arbitral tribunal and for an arbitral decision on the corporate income tax assessment relating to the fiscal year 2011 and, as a consequence, declare the illegality of the act of rejection contested, correcting, as a consequence, the said corporate income tax assessment, recognizing that the taxable profit determined by the fiscal group A… in the taxation period 2011, amounts only to € 4,550,256.09, with all other legal consequences."

1. The petition for the constitution of an arbitral tribunal was accepted and automatically notified to the AT on 18 September 2015.

2. The Claimant did not proceed to appoint an arbitrator, such that, under the provisions of paragraph 1 of Article 6 and subparagraph a) of paragraph 1 of Article 11 of RJAT, the President of the CAAD Ethics Council appointed the undersigned as arbitrator of the Singular Arbitral Tribunal, who communicated acceptance of the office within the applicable period.

3. On 2 November 2015, the parties were duly notified of this appointment and did not express any intention to refuse the appointment of the arbitrator, in accordance with the combined provisions of Article 11, paragraph 1, subparagraphs b) and c) of RJAT and Articles 6 and 7 of the CAAD Code of Ethics.

4. Thus, in accordance with the provisions of subparagraph c) of paragraph 1 of Article 11 of RJAT, the Singular Arbitral Tribunal was constituted on 17 November 2015.

5. On 5 January 2016, the Respondent, duly notified for this purpose, presented its Response in which it specifically challenged the arguments raised by the Claimant and concluded for the lack of merit of the present action, with its consequent dismissal of the claim.

On the same occasion, the Respondent proceeded to attach to the proceedings its respective administrative file (hereinafter, referred to in abbreviated form as AF).

6.1. In essence and also briefly, it is important to extract the most relevant arguments on which the Respondent based its Response (which we mention mostly by transcription):

• Without prejudice to the fact that the systematic application of Articles 18, paragraph 9, subparagraph a) and 45, paragraph 3, both of CIRC, is at issue, it is important first to consider the ratio legis of these two legal provisions;

• By virtue of the aforementioned Article 18, paragraph 9 of CIRC, adjustments occurring through the application of fair value compete for the formation of taxable profit whenever they respect financial instruments recognized at fair value through profit or loss, i) have a price formed in a regulated market and, ii) the taxpayer does not hold, directly or indirectly, a capital participation exceeding 5% of the respective share capital;

• While maintaining the realization principle, which determines that fiscal relevance only occurs at the moment of disposal, when the aforementioned conditions are not met;

• Notwithstanding the option to adopt the fair value model, albeit in very restricted situations compared to what is provided for in the accounting standards, the legislator understood the need to create transitional mechanisms that would safeguard the impact that the change in the measurement system would have on the companies' shareholders' equity;

• Neither the temporal allocation regime associated with the adoption of fair value as a measurement criterion emerged, in the context of corporate income tax, with the creation of Article 18, paragraph 9, subparagraph a), such that this provision cannot be considered an innovation in any way;

• The characterization of the provision of Article 18, paragraph 9, subparagraph a) as an exceptional rule would be inappropriate, since for that type of assets with quotations in regulated markets, CIRC does not contemplate a general rule and a special rule for temporal allocation of income and expenses;

• Thus, Article 18, paragraph 9, subparagraph a) provides the only rule applicable to the situations provided therein, and therefore, at most, could be considered as a particular regime for temporal allocation of income/gains and expenses/losses resulting from measurement by the fair value criterion in certain specific situations;

• The attempt to argue that Article 18, paragraph 9, subparagraph a) and Article 45, paragraph 3 of the Corporate Income Tax Code mutually exclude each other is completely devoid of sense, on the grounds that facts qualifiable as expenses do not fall within the scope of Article 45, and that paragraph 3 of Article 45 may only apply to situations that are considered losses or negative patrimonial variations;

• The assertions supporting that claim seem to forget that the deduction by half of the negative difference between realized gains and realized losses and of other losses and negative patrimonial variations relating to capital interests covered by Article 45, paragraph 3, has always been applied both to cases where such losses, as well as other losses and negative patrimonial variations, resulted from operations carried out in regulated markets (stock exchanges) and outside these markets;

• The non-application of Article 45, paragraph 3 of CIRC to the particular situations provided for in Article 18, paragraph 9, subparagraph a) of CIRC would result in a situation of injustice, inasmuch as it would confer a more unfavorable treatment to situations where such rule did not apply, even if these were capital interests measured at fair value in accordance with the respective accounting standards, in that the capital loss verified in that actual disposal would be recognized for taxation purposes in only half, whereas the loss verified in capital interests measured at fair value but contemplated in the provision of Article 18, paragraph 9, subparagraph a) of CIRC, according to the Claimant's thesis, would not suffer any limitation, being fully considered for the purposes of determining the taxable base;

• Which, moreover, would equally occur, specifically, when there is a situation of accounting reclassification or changes in the assumptions of subparagraph a) of paragraph 9 of Article 18 of CIRC (situations which, for tax purposes, are assimilated to onerous dispositions), that is, independently of the value transacted continuing to be that of the market (fair value);

• Thus, if the legislator did not establish any difference between operations carried out in regulated markets or in unregulated markets, it is not possible to construct an interpretation of Article 45, paragraph 3 that excludes from its scope capital losses, as well as other losses and negative patrimonial variations determined in operations with capital instruments, carried out in regulated markets;

• It is true that this provision has underlying the purpose of mitigating the effects of tax base erosion practices, but the legislator, in giving it a comprehensive and generic wording, chose not to include in its provision any weighting of particular circumstances of the specific operations that give rise to capital losses, as well as other losses or negative patrimonial variations;

• The emphasis given by the Claimant to semantic questions around "costs," "losses," "expenses," results in a decontextualized reading of the provision of Article 45, paragraph 3, which inevitably leads to a reductive interpretation of the scope of the rule;

• The concept "losses" inherent in Article 45, paragraph 3 of CIRC assumes an open formulation, within which fall all types of losses relating to capital interests, including potential losses, that is, the legislator, when referring to "other losses relating or negative patrimonial variations relating to capital interests," did not define them, leaving a door open for all losses, including expenses/losses resulting from fair value measurement, to be subsumed here, thus ensuring that both accounting and fiscally the adjustments resulting from the application of fair value would be considered gains from fair value increases or losses from fair value reductions;

• The financial interests at issue here thus fall within Article 18, paragraph 9, subparagraph a) of CIRC, with changes in their fair value competing for the formation of taxable profit, as expenses, by virtue of the provision also of Article 23, paragraph 1, subparagraph i) of CIRC, similarly to what occurs at the accounting level;

• However, in accordance with the provision in the final part of paragraph 3 of Article 45 of CIRC, the losses determined, relating to capital interests, compete for the formation of taxable profit in only half of their value;

• The legislator made a clear choice with regard to losses verified in capital interests provided for in subparagraph a) of paragraph 9 of Article 18 of CIRC, which consisted in the attribution of fiscal relevance, independently of their actual realization, substantiating such choice, as far as this matter is concerned, a clear departure from the realization principle;

• As for the fact that the subsumption to the partial deduction regime provided for in Article 45, paragraph 3 of expenses/losses determined in accordance with and subject to the conditions referred to in Article 18, paragraph 9, subparagraph a) of CIRC, is not accompanied by a symmetric treatment for income/gains, and of the potential injustice that may result therefrom, in fact, there is no legal provision that permits the consideration of only half of its value in the calculation of taxable profit;

• And if the legislator, neither before nor after 2010, introduced any provision establishing a symmetric solution for income/gains and expenses/losses resulting from the application of fair value, in the terms and conditions referred to in Article 18, paragraph 9, subparagraph a), then neither can the interpreter, whether the AT or the taxpayer, substitute itself in that task;

• Given the provision of paragraph 1 of Article 5 of Decree-Law No. 159/2009, according to which only effects on shareholders' equity (…) that are considered fiscally relevant in accordance with the Corporate Income Tax Code and its complementary legislation enter into the formation of taxable profit, the deductible value of negative adjustments in each of the five years corresponds to half of 1/5 of the total value determined, since its provision is subsumed to the regime of that provision of the Corporate Income Tax Code (i.e., to Article 45, paragraph 3);

• The provision contained in Article 45, paragraph 3 of CIRC defines the applicable regime in generic terms regarding the deduction of negative differences between realized gains, as well as other losses and negative patrimonial variations relating to capital interests, being excluded therefrom only cases where the law established particular treatment, namely in Articles 23, paragraphs 3, 4 and 5 of CIRC and in paragraph 2 of Article 32 of EBF;

• The provision of Article 18, paragraph 9, subparagraph a) aims solely to establish a rule for temporal allocation of income/gains and expenses/losses resulting from the application of fair value to capital instruments that contribute to the formation of taxable profit, in implementation of the principle of specialization of fiscal periods or accrual, not establishing, therefore, the applicable regime regarding the deductibility of those expenses/losses;

• Consequently, the deduction of expenses/losses resulting from the application of fair value to capital instruments, in accordance with Article 18, paragraph 9, subparagraph a), is governed by the provision of Article 23, paragraph 1, subparagraph i) and Article 45, paragraph 3 of CIRC, that is, they are only deductible by half of their value;

• Article 45, paragraph 3, although created with the general purpose of limiting the erosion of the tax base, is of automatic application to the situations provided therein and independently of weighing the concrete conditions of the operations that give rise to capital losses, or other losses or negative patrimonial variations relating to capital interests, with no distinction being made regarding the manner or place where the operations were carried out and whether prices are formed or not in regulated markets;

• If the legislator understood that it should not create a symmetric solution to that applied to expenses/losses resulting from the adoption of fair value to capital instruments, in the terms and conditions referred to in Article 18, paragraph 9, subparagraph a), for income/gains, these should enter into the calculation of taxable profit, as provided in Article 20, paragraph 1, subparagraph f) of CIRC, with the AT not being able, by virtue of the principle of legality, to fill this omission;

• The tax act impugned does not violate the constitutionally established principle according to which taxation should be based on actual income, since such principle established in paragraph 2 of Article 104 of the Constitution is the general regime, which admits exceptions, such as, among many others, the limitations on the deductibility of expenses, for tax purposes, provided for in Article 45 of CIRC;

• The AT's interpretation is not infirmed in the proceedings and, before the amendments introduced to the Corporate Income Tax Code by Law No. 2/2014, of 16 January, paragraph 3 of Article 45 was applicable to adjustments resulting from the measurement at fair value of financial instruments with the requirements defined in subparagraph a) of paragraph 9 of Article 18, such that the Respondent should have considered, in the fiscal years at issue in the proceedings, that the loss reflected in results in the accounts could only be deducted for tax purposes by half of its value.

The Respondent concludes thus its pleading:

"In these terms, and in such other respects as Your Excellency shall duly supply, the present petition for an arbitral decision should be judged to lack merit, maintaining in the legal order the tax acts now impugned and accordingly absolving the respondent entity from the claim, all with the due and legal consequences."

1. On 6 January 2016, a ruling was issued dispensing with the holding of the meeting referred to in Article 18 of RJAT and granting a period for the Parties, in succession, to present, if they so wish, written arguments.

2. Both Parties presented arguments, in which they reiterated the positions previously assumed in their respective pleadings.

II. PRELIMINARY FINDINGS

The Arbitral Tribunal was regularly constituted and has competence.

The proceedings do not suffer from any nullities.

The parties have personality and judicial capacity, are duly represented and are legitimate.

There are no exceptions or preliminary matters that prevent knowledge of the merits and which must be addressed.

III. REASONING

III.1. ON THE FACTS

§1. PROVEN FACTS

With regard to the matter of fact, it is important, first of all, to note that the Tribunal is not required to pronounce on everything alleged by the parties; rather, it has the duty to select the facts that matter for the decision and to distinguish proven facts from unproven facts (cf. Article 123, paragraph 2 of CPPT and Article 607, paragraphs 3 and 4 of CPC, applicable ex vi Article 29, paragraph 1, subparagraphs a) and e) of RJAT). In this way, the facts relevant to the judgment of the case are chosen and defined based on their legal relevance, which is established in view of the various plausible solutions to the question(s) of law.

Within this framework, the following facts with relevance to the decision are considered proven:

a) The Claimant is a commercial company, to which the Special Regime for Taxation of Groups of Companies, provided for in Articles 69 et seq. of the Corporate Income Tax Code, was applicable in 2011 for taxation purposes.

b) The fiscal group of which the Claimant was part – in its capacity as dominant company of the group – also consisted of companies "B… – …, S.A.", NIPC … and "C… – …, S.A.", NIPC ….

c) Companies "B…" and "C…" proceeded, on 24 May 2012, to the electronic submission of periodic income statements (form 22), relating to the taxation period 2011, resulting in taxable profit of € 1,431,996.48 and a tax loss of € 88,603.60, respectively. [cf. documents nos. 2 and 3 attached to the initial pleading.]

d) In the income statement (form 22), relating to the fiscal year 2011 of company "B…", the following values were entered [cf. document no. 2 attached to the initial pleading.]:

• in field 705 [Negative patrimonial variations (transitional regime provided for in Article 5, paragraphs 1, 5 and 6 of Decree-Law 159/2009, of 13/7)] of section 07: € 62,181.17;

• in field 738 [Capital gains resulting from changes in valuation method (Article 46, paragraph 5, subparagraph b)] of section 07: € 57,246.84.

e) In the income statement (form 22), relating to the fiscal year 2011 of company "C…", the following values were entered [cf. document no. 3 attached to the initial pleading.]:

• in field 705 [Negative patrimonial variations (transitional regime provided for in Article 5, paragraphs 1, 5 and 6 of Decree-Law 159/2009, of 13/7)] of section 07: € 120.82;

• in field 738 [Capital gains resulting from changes in valuation method (Article 46, paragraph 5, subparagraph b)] of section 07: € 378.53.

f) The Claimant proceeded, on 28 May 2012, as the dominant company, to the electronic submission of the income statement (form 22), relating to the fiscal year 2011, of the aforementioned fiscal group, resulting in total taxable profit of € 4,669,173.00. [cf. document no. 4 attached to the initial pleading.]

g) The Claimant proceeded, on 4 July 2013, to the replacement of the corporate income tax income statement of the said fiscal group, relating to the fiscal year 2011, however the taxable profit initially calculated remained unchanged.

h) On 31 December 2009, "B…" and "C…" were holders of financial interests in D…, in the following percentages:

i) Until 2009, the interests in question were accounted for in "B…" and "C…" at their acquisition cost, net of a provision for financial investments, as provided for in the Official Chart of Accounts ("POC"), calculated by the difference between the acquisition cost of the interest and the value of its market quotation at the end of the taxation period. [cf. documents nos. 5 and 6 with the initial pleading.]

j) With the approval of the Accounting Standardization System (SNC), "B…" and "C…" began to measure the aforesaid financial interests held in D… at fair value through profit or loss, in accordance with the Accounting and Financial Reporting Standard ("NCRF") 27, such that the balances reported on the balance sheet, as of 1 January 2009, were reexpressed for SNC.

k) The conversion from POC to SNC was carried out through two transition adjustments which, together, had a nil impact on shareholders' equity, namely: (i) reversal of the accounting provision constituted under POC which resulted in a positive movement in shareholders' equity; and (ii) negative fair value adjustment, which resulted in a negative movement in shareholders' equity. [cf. documents nos. 5 and 6 with the initial pleading.]

l) The movements referred to in the previous subparagraph are thus summarized:

m) In addition to the negative fair value adjustment occurring in the transition from POC to SNC, during the fiscal year 2011, the interests held by "B…" and "C…" in D… underwent a negative variation in quotation compared to their value on 31/12/2010, a decrease measured by the fair value method. [cf. documents nos. 8 and 9 attached to the initial pleading.]

n) On 31 December 2011, "B…" and "C…" were holders of financial interests in D…, in the following percentages:

o) The Claimant considered as fiscally deductible only 50% of the fair value adjustment occurring in the transition from POC to SNC, as well as of the aforementioned losses in 2011, because it considered that this was the position of the AT, as expressed in the Doctrinal Record relating to Case No. …/2011, with dispatch of 24/02/2011 by the Director-General of Taxes.

p) On 22 May 2014, the Claimant filed a gracious complaint – the initial petition of which is here given as fully reproduced – seeking the revision and correction of the self-assessment of corporate income tax relating to the fiscal year 2011, on the grounds that it suffered from an error in the tax treatment afforded to losses resulting from the application of the fair value model (transition adjustment and loss in 2011), which, although primarily affecting the individual spheres of "B…" and "C…", were reflected in the self-assessment of corporate income tax of the Claimant. [cf. document no. 7 with the initial pleading.]

q) The Claimant requested, within the scope of the gracious complaint presented, the correction of the self-assessment of corporate income tax and the consequent reduction of taxable profit, in the following terms [cf. document no. 7 with the initial pleading.]:

(i) Deduction in field 705 of section 7 of the periodic income statement (form 22) "Positive patrimonial variations ("Transitional regime provided for in Article 5, paragraphs 1, 5 and 6 of Decree-Law 159/2009, of 13/7")", of the following amounts:

(ii) Annulment in field 738 of section 7 of the periodic income statement (form 22) "Capital gains resulting from changes in valuation method (Article 46, paragraph 5, subparagraph b))", of the following amounts:

r) This corresponds to a reduction of taxable profit in the consolidated sphere of the Claimant in the amount of € 118,916.91, totaling taxable profit of € 4,550,256.09. [cf. document no. 7 with the initial pleading.]

s) The said gracious complaint was registered under number …2014… at the Tax Office of the ... – …, and the following draft decision was made in respect thereof [cf. pages 259 verso to 263 verso of the AF]:

[Draft decision content]

t) The Claimant was notified, through official letter no. …/…, dated 01.04.2015, from the Division of Administrative and Contentious Justice of the Tax Justice Area of the Finance Directorate of …, sent by registered mail (RM…PT), of that draft decision and to exercise, if it so wished, its right to a hearing. [cf. pages 264 to 265 verso of the AF]

u) The Claimant did not exercise its right to a hearing, such that the aforementioned draft decision was converted into a final decision and, consequently, the gracious complaint was rejected by dispatch dated 25 May 2015, issued by the Head of the Division of Administrative and Contentious Justice of the Tax Justice Area of the Finance Directorate of …, by subdelegation from the Director of Finance of …, with the reasoning above referred to in subparagraph s). [cf. pages 266 and 266 verso of the AF]

v) The Claimant was notified, through official letter no. …/…, dated 27.05.2015, from the Division of Administrative and Contentious Justice of the Tax Justice Area of the Finance Directorate of …, sent by registered mail with acknowledgment of receipt (RF…PT), of the dispatch rejecting the gracious complaint. [cf. pages 267 to 269 of the AF]

w) On 31 August 2015, the Claimant presented the petition for the constitution of an arbitral tribunal that gave rise to the present proceedings. [cf. processing management information system of CAAD]

§2. UNPROVEN FACTS

With relevance to the assessment and decision of the case, there are no facts that have not been proven.

§3. REASONING ON THE MATTER OF FACT

With regard to the proven facts, the Tribunal's conviction was based on the facts pleaded by the parties, whose correspondence to reality was not called into question, the documents attached to the proceedings and the respective administrative file.

III.2. ON THE LAW

§1. THE ISSUE TO BE DECIDED

The question placed before the Tribunal amounts to determining what tax treatment should be afforded to losses resulting from the application of the fair value model in financial instruments, whose counterpart is recognized through profit or loss, which are capital instruments and which have a price formed in a regulated market, with the taxpayer not holding, directly or indirectly, a participation in capital exceeding 5% of the respective share capital.

Specifically, accepted as established by both the Claimant and the Respondent that the financial interests in question should be accounted for in accordance with the fair value criterion and that the same were recognized through profit or loss, it is important then to elucidate whether the accounting loss resulting from the application of the fair value method and the accounting loss verified in the year 2011, resulting from the depreciation of the quotation of the shares of "BCP," properly measured by the fair value method and recognized in profit or loss, should be taken into account in their entirety or only by 50%.

In this regard, the Parties advocate two diametrically opposed positions, namely:

a) The Respondent believes that those losses should be treated in accordance with the terms provided in Article 45, paragraph 3 of the Corporate Income Tax Code and, therefore, are only deductible by 50%;

b) The Claimant considers that those same losses should be treated in accordance with the terms provided in Articles 18, paragraph 9, subparagraph a) and 23, paragraph 1, subparagraph i), both of the Corporate Income Tax Code, with no application of Article 45, paragraph 3 of the same legal code, such that the fair value adjustments are deductible in their entirety.

§2. THE LEGAL FRAMEWORK

The legal and tax assessment of the situation sub judice must necessarily begin with the delimitation of the applicable legal block, for which it is necessary to invoke the legal rules that appear concretely relevant, which must be considered in the version applicable ratione temporis.

Thus, from the Corporate Income Tax Code it is necessary to consider the following rules:

"Article 17

Determination of Taxable Profit

1. The taxable profit of legal persons and other entities mentioned in subparagraph a) of paragraph 1 of Article 3 is constituted by the algebraic sum of the net result of the period and of the positive and negative patrimonial variations verified in the same period and not reflected in that result, determined based on the accounts and possibly corrected in accordance with this Code.

(…)"

"Article 18

Periodization of Taxable Profit

1. Income and expenses, as well as the other positive or negative components of taxable profit, are attributable to the taxation period in which they are obtained or incurred, independently of their receipt or payment, in accordance with the economic periodization regime.

(…)

1. Adjustments resulting from the application of fair value do not compete for the formation of taxable profit, being allocated as income or expenses in the taxation period in which the elements or rights giving rise to them are disposed of, exercised, extinguished or liquidated, except when:

a) They respect financial instruments recognized at fair value through profit or loss, provided that, where they are capital instruments, they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a participation in capital exceeding 5% of the respective share capital;

(…)"

"Article 20

Income

1. Income is understood as that resulting from operations of any kind, as a result of a normal or occasional action, basic or merely accessory, in particular:

(…)

f) Income resulting from the application of fair value in financial instruments;

(…)"

"Article 21

Positive Patrimonial Variations

1. Furthermore, positive patrimonial variations not reflected in the net result of the taxation period compete for the formation of taxable profit, except:

(…)

b) Potential or latent capital gains, albeit expressed in the accounts, including revaluation reserves under fiscal legislation;

(…)"

"Article 23

Expenses

1. Expenses are understood as those that are proven to be indispensable for the realization of income subject to tax or for the maintenance of the income-producing source, in particular:

(…)

i) Expenses resulting from the application of fair value in financial instruments;

(…)

1. Expenses incurred with the onerous transfer of capital interests, irrespective of the basis therefor, to entities with which there are related party relationships, in accordance with paragraph 4 of Article 58, or to entities resident in Portuguese territory subject to a special taxation regime, are not equally accepted as expenses of the taxation period, as well as capital losses resulting from changes in the valuation method relevant for tax purposes, in accordance with paragraph 9 of Article 18, which result, in particular, from accounting reclassification or changes in the assumptions referred to in subparagraph a) of paragraph 9 of this article."

"Article 24

Negative Patrimonial Variations

Under the same conditions referred to for expenses, negative patrimonial variations not reflected in the net result of the taxation period furthermore compete for the formation of taxable profit, except:

(…)

b) Potential or latent capital losses, albeit expressed in the accounts;

(…)"

"Article 45

Expenses Not Deductible for Tax Purposes

(…)

1. The negative difference between realized gains and realized losses through the onerous transfer of capital interests, including their redemption and amortization with capital reduction, as well as other losses or negative patrimonial variations relating to capital interests or other components of shareholders' equity, namely additional contributions, compete for the formation of taxable profit in only half of their value.

(…)"

"Article 46

Concept of Capital Gains and Capital Losses

1. Capital gains or capital losses realized are understood as gains obtained or losses suffered through onerous transfer, irrespective of the basis therefor, and as well as those resulting from casualties or those resulting from the permanent appropriation for purposes other than the activity carried on, concerning:

(…)

b) Financial instruments, with the exception of those recognized at fair value in accordance with subparagraphs a) and b) of paragraph 9 of Article 18.

(…)

1. The following are assimilated to onerous transfers:

(…)

c) Changes in the valuation method relevant for tax purposes, in accordance with paragraph 9 of Article 18, which result, in particular, from accounting reclassification or changes in the assumptions referred to in subparagraph a) of paragraph 9 of this same article.

(…)"

§3. THE CASE SUB JUDICE: SUBSUMPTION TO THE APPLICABLE LEGAL BLOCK

From the normative perspective, the epicenter of the disagreement between the Parties lies in the interpretive and applicative parameterization of the provision of paragraph 3 of Article 45 of the Corporate Income Tax Code.

The Respondent argues that the segment of that provision which provides that "other losses or negative patrimonial variations relating to capital interests or other components of shareholders' equity (…) compete for the formation of taxable profit in only half of their value," encompasses situations such as those in the case, thereby requiring that the losses in question, determined through the application of fair value, compete for the formation of taxable profit in only half of their value.

In support of its position, the Respondent invokes the doctrinal opinions of André A. Vasconcelos, A. C. Pires Caiado, Luís C. Viana and Luís P. Ramos, Luísa Anacoreta Correia and Helena Martins, authors who, in summary, argue that, given the comprehensive formulation of that legal provision, it encompasses losses resulting from adjustments arising from the application of fair value, in cases provided for in subparagraph a) of paragraph 9 of Article 18 of the Corporate Income Tax Code.

The Respondent further relies on the decision rendered on 24.09.2015, in case no. 25/2015-T of CAAD, in which the following conclusion is reached:

[Decision excerpt discussing the application of Article 45.3]

Finally, the Respondent invokes the judgment no. 85/2010 of 03.03.2010 of the Constitutional Court, which ruled on the constitutionality of the aforementioned legal rule.

With due respect, we consider that the position advocated by the Respondent does not align with what we believe to be the correct interpretation of the aforementioned legal rules – namely, Articles 18, paragraph 9, subparagraph a) and 45, paragraph 3, both of the Corporate Income Tax Code – and its consequent application to the situation sub judice.

As set forth in subparagraph a) of paragraph 9 of Article 18 of the Corporate Income Tax Code, fair value, both positive and negative, competes for the formation of taxable profit when it respects "financial instruments recognized at fair value through profit or loss, provided that, where they are capital instruments, they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a participation in capital exceeding 5% of the respective share capital."

The respective legal presuppositions are therefore as follows:

a) Capital instruments with a price formed in a regulated market;

b) Such financial instruments being accounted for at fair value through profit or loss; and

c) The taxpayer not holding, directly or indirectly, a participation exceeding 5% of the respective share capital.

Once these presuppositions are met, the taxable fact ceases to be associated with the realization of the securities, becoming centered on the fluctuation of the respective official quotation between the beginning and the end of the taxation period. That is, what is taxed is the mere holding of the asset and not its sale.

Being that, through that legal rule, fair value is taxed in exceptional situations and of undisputed reliability, since it only affects financial instruments transacted in a regulated market and the respective official quotation functions as a reliable valuation of fair value measurement.

This said. The fiscal rule applicable to fair value appreciation must be equal to that for depreciation of the asset, lest, failing this, a fiscal asymmetry of fair value is created, flagrantly violating the principles of equality and taxpaying capacity. Thus, if positive fair value is fully taxed (the regime of gains and losses is never applied to it), then negative fair value must be afforded equal treatment, assuming it as a full expense of the fiscal year.

The justificatory reasoning for the exclusion of partial fiscal deduction of realized expenses cannot, in fact, be extended to the taxation of negative fair value of Article 18, paragraph 9, subparagraph a) of the Corporate Income Tax Code, since, first and foremost, the taxable fact disassociates itself from the decision to sell and, therefore, the will of the taxpayer never shapes the taxable fact based on fair value. Moreover, negative fair value never underlies a motivation of tax evasion, for the simple reason that fair value taxation is limited to assets transacted in a regulated market, where the quotation of the asset and, therefore, its appreciation and depreciation, is entirely beyond the tax will of the taxpayer. Furthermore, as already stated, if the proceeds from fair value are fully taxed, expenses should also be fully accepted.

There are, in fact, no compelling fiscal or extrafiscal reasons that justify the disparity in the taxation of positive and negative components of fair value. A differentiated treatment, embodied in the non-acceptance, total or partial, of fair value losses, contrary to the full taxation of positive fair value, generates a tax regime more unjust than the realization model, which is therefore unconstitutional, since such disparity has no underlying reasons of fiscal, economic or legal basis, resting solely on the need to preserve fiscal revenue.

Within this framework, we here embrace the position upheld in the judgment rendered on 25.11.2013, in case no. 108/2013-T of CAAD, as we completely agree with it – thereby seeking to obtain uniform interpretation and application of the law (cf. Article 8, paragraph 3 of the Civil Code) – and we accordingly reproduce the essential features of its reasoning:

"The adoption of fair value as an accounting valuation criterion with fiscal relevance corresponds to a Copernican change in the regime of taxation of income or expenses resulting from the acquisition of financial instruments.

In effect, prior to the adoption of fair value, patrimonial variations relating to financial instruments were irrelevant from the standpoint of the formation of taxable profit of each period, by virtue of the provision of Article 21, paragraph 1, subparagraph b) of CIRC. Only at the moment of realization of the gain or loss did the patrimonial variation verified assume fiscal relevance.

This fiscal framework had (as it has in the part in which it is maintained) three well-marked characteristics, namely:

· It was a one-time taxation, that is, which occurred only once throughout the entire period of holding the financial instruments;

· It was dependent on a voluntary action of the taxpayer, insofar as the transaction of the instruments generating the patrimonial variation, the condition of its fiscal relevance, would only occur if and when the taxpayer so wished;

· The valuation of the patrimonial variation was fixed in function of the specific transaction that triggered its fiscal relevance.

The combination of these three characteristics just pointed out, forthwith provided fertile ground for accounting and tax manipulations, since the taxpayer could choose to trigger the fiscal relevance at the moment and terms most fiscally advantageous.

On the other hand, given the relevance of the taxpayer's will in the mechanism of fiscal relevance of patrimonial variation, the system established adapted itself to the adoption of mechanisms for conditioning that will, in the sense of conforming it to economically more desirable behaviors, which, in this case, passes for the preference for realization of gains, to the detriment of realization of losses.

It is in this context that the emergence of the provision of the former Article 42, paragraph 3 of CIRC, which precedes the current Article 45, paragraph 3 of the same, is explained.

Such provision, whether in its original wording, resulting from Law 32-B/2002 of 30 December, or in that given to it by Law 60-A/2005 of 30 December, is explained objectively and subjectively (that is, in light of the motivation expressed by the legislator) by needs linked to the fight against fraud and tax evasion and to the broadening of the tax base, directed to the desired consolidation of the budgetary accounts of public finances.

The acceptance of the application of the fair value model in financial instruments, operated by Decree-Law 159/2009 of 13 July, introduced, in the part covered, a radically different model, both of valuation and of fiscal relevance of patrimonial variations relating to the holding of those instruments.

In effect, the legislator's intention when adopting the fair value model, duly evidenced, was, assumed and expressly, to maintain "the application of the realization principle with respect to financial instruments measured at fair value whose counterpart is recognized in shareholders' equity, as well as capital interests that correspond to more than 5% of share capital, albeit recognized at fair value through profit or loss."

As for "financial instruments" corresponding to less than "5% of share capital," "whose counterpart is recognized through profit or loss, (...) in cases where the reliability of the determination of fair value is in principle assured," the legislative intention was to accept "the application of the fair value model," excluding the realization principle.

In keeping with this, Article 18, paragraph 9 of CIRC applicable, came to provide that, as a rule, "Adjustments resulting from the application of fair value do not compete for the formation of taxable profit, being allocated as income or expenses in the taxation period in which the elements or rights giving rise to them are disposed of, exercised, extinguished or liquidated." This is a clear and deliberate manifestation of the assumed realization principle.

However, the same provision, in its subparagraph a), establishes the exception to this regime, as follows: "except when: a) They respect financial instruments recognized at fair value through profit or loss, provided that, where they are capital instruments, they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a participation in capital exceeding 5% of the respective share capital."

That is, and equally as assumed by the legislative entity, when "income or expenses (...) respect financial instruments recognized at fair value," "compete for the formation of taxable profit" "provided that":

a. They are recognized "through profit or loss";

b. They concern "capital instruments";

c. "have a price formed in a regulated market"; and

d. "the taxpayer does not hold, directly or indirectly, a participation in capital exceeding 5% of the respective share capital."

Once these conditions are fulfilled:

a. Income resulting from the application of fair value in financial instruments are considered (Article 20, paragraph 1, subparagraph f) of CIRC); and

b. Expenses resulting from the application of fair value in financial instruments are considered (Article 23, paragraph 1, subparagraph i) of CIRC).

In this manner, where previously we had a one-time fiscal relevance, at the time of transaction of those instruments, we now have continued fiscal relevance. That is, in light of the new provisions of the regime of fiscal relevance of accounting at fair value of financial instruments, income or expenses resulting from the application of fair value to these now directly bear on the formation of taxable profit (Articles 20, paragraph 1, subparagraph f) and 23, paragraph 1, subparagraph i) of CIRC) of the very year in which they occur, provided that certain conditions are met (Article 18, paragraph 9 of CIRC), which include price formation in a regulated market, and the patrimonial variations verified as gains or losses are not taxed (Article 46, paragraph 1, subparagraph b) of CIRC).

In this context, there cease manifestly to be any needs related to the fight against fraud and tax evasion, not only because the fiscal relevance of patrimonial variations ceases to be conditioned by an act of will of the taxpayer, but also because valuation is objectively fixed.

On the other hand, and for the same reasons, equally lacking in sense is any measure for conditioning the will of the taxpayer, in the sense of favoring "more desirable" economically behaviors and, as such, in conformity with the interests of broadening the tax base and budgetary consolidation.

Notwithstanding all the amendments introduced by Decree-Law 159/2009 of 13 July, the former Article 42, paragraph 3 of CIRC, renumbered to Article 45, paragraph 3, maintained its validity, with its wording unchanged.

Hence the question, as occurs in the case, whether such rule will apply, or not, to depreciations relating to financial instruments, which compete for the formation of taxable profit, in accordance with Article 18, paragraph 9, subparagraph a) of CIRC.

Prima facie, the answer to such a question would be affirmative, as the AT argues, given the comprehensiveness of the provision in question, already pointed out by the Author cited by the latter in its response.

A careful and coordinated reading of the relevant provisions for the analysis of the case, which we have already indicated, will, however, allow a different conclusion.

Let us see then.

Article 45, paragraph 3 of CIRC, already transcribed, provides that:

"The negative difference between realized gains and realized losses through the onerous transfer of capital interests, including their redemption and amortization with capital reduction, as well as other losses or negative patrimonial variations relating to capital interests or other components of shareholders' equity, namely additional contributions, compete for the formation of taxable profit in only half of their value."

An analysis of the regulatory text reveals with clarity that the legislator chose, to include therein, three types of situations that should be considered, in function of the presumption of good legislative technique, as distinct, namely:

a. "The negative difference between realized gains and realized losses through the onerous transfer of capital interests";

b. "other losses (…) relating to capital interests or other components of shareholders' equity";

c. "other (…) negative patrimonial variations relating to capital interests or other components of shareholders' equity."

Let us then see whether the situation in the case falls within any of the situations enumerated.

The situation alluded to under subparagraph a) above will be manifestly inapplicable, not only because there was no realization operated through onerous transfer, but also because Article 46, paragraph 1, subparagraph b) excludes the situations described in Article 18, paragraph 9, subparagraph a) from the concept of realized gains. In this manner, any difficulty that may exist in the case can only fall within one of the situations enumerated in subparagraphs b) and c) above.

The apparent indiscriminate comprehensiveness of the provisions in question can, however, be reasonably mitigated if one considers that "losses" and "other negative patrimonial variations" are concepts, not redundant, but possessed of their own distinct sense.

To understand such a fact, it will be necessary to go back to Articles 23 and 24 of the same Code, attending to the terminological evolution operated by Article 159/2009 of 13 December.

In effect, before the entry into force of the latter diploma, the articles referred to in CIRC provided, respectively, that:

· "Expenses or losses are understood as those proven to be indispensable for the realization of income or gains subject to tax or for the maintenance of the income-producing source, in particular the following: (...)";

· "Under the same conditions referred to for expenses or losses, negative patrimonial variations not reflected in the net result of the fiscal year furthermore compete for the formation of taxable profit, except: (...)."

It is thus verified that when the current wording of Article 45, paragraph 3 of CIRC was established, this Code expressly distinguished, for what is relevant here, three types of situations, namely:

a. Expenses;

b. Losses;

c. Negative patrimonial variations not reflected in the net result of the fiscal year.

The provision of Article 42, paragraph 3 (predecessor of the current 45, paragraph 3) should thus be considered as reported to these concepts, defined in Articles 23 and 24. In this manner, and for obvious reasons, from the provision of that rule there should be excluded expenses relating to "capital interests or other components of shareholders' equity," including therein only losses (as defined in Article 23) and negative patrimonial variations (as defined in Article 24) relating to those interests.

And that this is so, that is, that the expression "other losses or negative patrimonial variations" used in the current Article 45, paragraph 3 of CIRC does not have an indiscriminately comprehensive sense, but rather a precise sense, defined in Articles 23 and 24, emerges from the fact that the legislator employed the same distinction.

Moreover, the inclusion within the scope of the provision in question, not only of losses (as defined in Article 23) and negative patrimonial variations (as defined in Article 24), but also of expenses (as defined in Article 23), would result in, for example, the acquisition cost of capital interests only competing by half of the respective value toward the determination of taxable profit, which would be, obviously, inconceivable in a minimally reasonable legislator.

The normative amendment implemented by Decree-Law 159/2009 of 13 July will not have altered anything of relevance in the matter in question. In effect, notwithstanding the body of Article 23 having come to refer only to expenses, the fact is that CIRC continues to employ the expression "losses," including in Article 23 itself (cf. paragraph 1, subparagraph h)). This occurs in coherence, moreover, with SNC, which in accordance with point 2.1.3.e) of the annex to Decree-Law 158/2009 of 12 July, maintains the distinction between "expenses" and "losses."

In this manner, it is concluded that Article 45, paragraph 3 of CIRC applicable will report to:

a. Negative differences between realized gains and realized losses through the onerous transfer of capital interests;

b. Other losses relating to capital interests or other components of shareholders' equity; and

c. Other negative patrimonial variations relating to capital interests or other components of shareholders' equity;

whereby "losses" should be understood as facts qualifiable as such under CIRC, and "negative patrimonial variations" should be understood as negative patrimonial variations not reflected in the net result of the fiscal year, as defined in Article 24.

There will not thus be included within the scope of the provision in question facts qualifiable as "expenses" under CIRC, albeit relating to capital interests or other components of shareholders' equity.

The AT itself seems to recognize this, since in the "Instruction Manual for Completion of Section 07, Form 22," regarding field 737, it states that "In this field are entered, by 50%, the amounts relating to other losses (which are not capital losses, since these follow the 'mechanism' of gains and losses) relating to capital interests or other components of shareholders' equity. For example, amounts corresponding to 50% of losses from fair value reductions are added to this field 737, when these fall within the scope of Article 23, paragraph 1, subparagraph i), by virtue of the provision of Article 18, paragraph 9, subparagraph a)." It happens that Article 23, paragraph 1, subparagraph i) of CIRC does not refer to the amounts in question as "losses," but as "expenses," such that their entry in the field in question would be incorrect.

Furthermore, and if there were any doubt, if the legislator, when the Decree-Law 159/2009 of 13 December came into force, intended to encompass the situations listed in Article 18, paragraph 9, subparagraph a) of CIRC within the scope of Article 45, paragraph 3 of the same, it would have:

· Included "Expenses resulting from the application of fair value in financial instruments," not in Article 23, but in Article 24 of CIRC; or

· Referred to such situations as "losses resulting from the application of fair value in financial instruments" and not as "expenses."

Within the framework just set out, one should thus consider that Decree-Law 159/2009 of 13 July introduced, as far as the part covered by the acceptance of the application of the fair value model in financial instruments is concerned, a special regime of relevance for the computation of taxable profit, justified both by its own objectivity and by the confessed intention of approximation of accounting to taxation.

This circumstance is, given the current wording of CIRC, capable of generating any type of doubt, as is verified, particularly, by the wording of Articles 20, paragraph 1, subparagraphs f) and h), 23, paragraph 1, subparagraphs i) and l), and, in particular, Article 46, paragraph 1, subparagraph b), in light of which it is clearly evidenced the legislator's intention to distance the adjustments resulting from the application of the fair value criterion in financial instruments, in accordance with what is recognized by CIRC, from the regime of gains and losses.

Already the regime resulting from the combination of Articles 45, paragraph 3 and 46 of CIRC only makes sense from the perspective of the admissibility of patrimonial variations in question under the prism of the aforementioned realization principle.

For, being in question, in light of such principle, the assessment of patrimonial variation based on a transaction, there will always be a voluntary factor in relation to it.

That is, in the regime for which the provision of Article 45, paragraph 3 was thought and instituted, the realization of losses, and other situations enumerated was dependent on a voluntary action corresponding to the realization thereof. Now, in this context, it will be understandable that the legislator institutes mechanisms of disincentive to an action susceptible of being considered as undesirable, in the case the realization of losses or other negative patrimonial variations. By providing that such situations will only bear on 50% of the amount accounted, the tax legislator is, objectively, conditioning the actions encompassed by the legal provision, imposing a negative incentive on the same.

On the other hand, and being in question financial instruments of a value not objectively quantifiable, the disregard of 50% of the negative patrimonial variations verified would also have a function of "compensating" the natural tendency of economic operators, at the tax level, to inflate losses.

However, those aspects will not already verify in the situations encompassed by Article 18, paragraph 9, subparagraph a). Here, being involved adjustments resulting from accounting at fair value, determined by objective criteria (with "a price formed in a regulated market"), there is no doubt or intervention of the will of the taxpayer in the verification of the negative or positive patrimonial adjustment. That is, these will occur or not, independently of the action and will of the taxpayer.

Now, to penalize, in these cases, the taxpayer with a disregard of 50% of the expense incurred, would be entirely unjustified, whether from an economic or a legal standpoint.

For, recall that this situation of contingent (indeed, random) unjustified penalization would only occur by virtue of the exception to the realization principle regime of situations encompassed by Article 18, paragraph 9, subparagraph a) of the applicable CIRC. That is, if with respect to those situations the general regime of the body of Article 18, paragraph 9 were applied, according to which the same would not compete "for the formation of taxable profit, being allocated as income or expenses in the taxation period in which the elements or rights giving rise to them are disposed of, exercised, extinguished or liquidated," the pointed-out incoherence would not verify, since the fact that would trigger the competition for the formation of taxable profit would only occur by the will of the taxpayer, such that it would be the latter's to choose to realize the negative patrimonial variation, with the consequent tax penalization, or to defer this to a moment when it would be less voluminous or, even positive, diminishing or eliminating the penalization resulting from the operation to itself and to the Treasury. It is the exception of subparagraph a), by removing the situations provided therein from the scope of the realization principle, that justifies the new regime of relevance for taxable profit, instituted.

Evidence of all that has been said presents itself in the table elaborated below, which demonstrates the unreasonableness of the application of the provision of Article 45, paragraph 3 to situations encompassed by Article 18, paragraph 9, subparagraph a)):

The non-application of the provision of Article 45, paragraph 3 of CIRC to expenses, and concretely to "Expenses resulting from the application of fair value in financial instruments," with full consideration of the patrimonial repercussions verified, whether positive or negative, leads to a coherence of taxation whatever the moment at which disposal of the financial instrument occurs. That is, at whatever moment one chooses to dispose of the financial instrument, positive and negative patrimonial changes offset each other, such that, ultimately, the taxpayer only adds to or subtracts from its taxable profit the difference between the acquisition value and the sale value.

If, on the other hand, the provision of Article 45, paragraph 3 of CIRC were applied, as the AT seeks, from the moment at which a negative patrimonial change occurs, there will be a discrepancy between the fiscal relevance of negative and positive patrimonial variations, without any justification, as said, since those variations occur objectively and independently of the action or will of the taxpayer. Thus, if at the end of the second year the taxpayer in the example above proceeded to realize the financial instrument in question, notwithstanding having realized a gain of only 20 (which would be taxed as such under the realization principle), they would, in fact, have paid tax on 30 (40-10). In the same manner, if they proceeded to that realization at the end of the third year, they would have paid tax on 20, notwithstanding not having had any patrimonial increase with the operation. And if they proceeded to the same realization at the end of the sixth year, they would have paid tax as if they had had a patrimonial increase of 30 (80-50), notwithstanding having had an actual patrimonial variation of -20, which, under the realization principle enshrined in CIRC, would be admissible, albeit in only 50% of the respective value (-10)!

It seems clear that such results, merely random and without any substantive justification supporting them, could not have been intended by a minimally reasonable legislator.

It is true that the alternative solution, which excludes the application of Article 45, paragraph 3, leads to the fact that, should there ultimately be a loss, it ends up having been considered at 100%, and not at 50%, as would occur under the realization principle. This would be the case, in the example of the table above, of realization occurring in years 4 or 6. However, this positive discrimination (or rather, non-negative discrimination) by the choice of the fair value criterion could be justified, first and foremost, because in the regime of Article 18, paragraph 9, subparagraph a), it no longer makes sense for any disincentive to the realization of losses, since they will bear fiscally independently of their actual realization. One should equally not disregard that, on the one hand, accounting at fair value is considered more in conformity with the approximation between accounting and taxation, a purpose confessedly pursued by the legislator of Decree-Law No. 159/2009 of 13 July, and, on the other, the circumstance that we are dealing with realities objectively evaluated, without significant room for manipulation fiscally convenient. That is, as had been advanced already, the reasons for fighting fraud and tax evasion do not verify, nor the reasons for budgetary consolidation, which demonstrably were at the genesis of the provision of Article 45, paragraph 3 of CIRC.

In this manner, and in sum, in obedience to the hermeneutic requirements of Article 9 of the Civil Code, according to which "Interpretation should not be limited to the letter of the law, but should reconstitute from the texts the legislative thinking, taking especially into account the unity of the legal system, the circumstances in which the law was elaborated and the specific conditions of the time in which it is applied" (paragraph 1), and "In fixing the sense and scope of law, the interpreter shall presume that the legislator established the most correct solutions and knew how to express its thinking in adequate terms." (paragraph 3), it is understood that Article 45, paragraph 3 of CIRC should be interpreted to mean that its provision does not encompass expenses resulting from the application of fair value in financial instruments, which bear on the formation of taxable profit in accordance with subparagraph a) of paragraph 9 of Article 18."

In these terms, not being the situation sub judice under the normative purview of paragraph 3 of Article 45 of the Corporate Income Tax Code, the petition for an arbitral decision deserves full merit, since the controversial act of self-assessment of corporate income tax, relating to the fiscal year 2011, suffers from an error concerning the legal presuppositions, due to misinterpretation and misapplication of the provision of that legal rule, which constitutes a defect of violation of law.

Given the reasoning on which it is based (cf. proven fact s)), the act of rejection of the gracious complaint presented by the Claimant and which had as its object the aforementioned act of self-assessment of corporate income tax is struck down by the same defect of violation of law.

IV. DECISION

In the terms set forth above, this Arbitral Tribunal decides:

a) To judge procedent the petition for declaration of illegality of the self-assessment of corporate income tax, relating to the fiscal year 2011, impugned in these proceedings, with the taxable profit of the fiscal group "A…" in the fiscal year 2011 to be reduced by € 118,916.91 and, as a consequence:

· In field 705 of section 07 of the income statements (Form 22) of companies "B…" and "C…" the amounts € 122,341.46 and € 241.65 should respectively be entered;

· The amounts entered in field 738 of section 07 of the income statements (Form 22) of companies "B…" and "C…" are annulled in their entirety;

· In field 778 of section 07 of the income statement (Form 22) of company "B…" the amount € 1,343,578.92 should appear;

· In field 777 of section 07 of the income statement (Form 22) of company "C…" the amount € 89,102.95 should appear;

· In field 380 of section 09 of the income statement (Form 22) of the fiscal group "A…", presented by the Claimant, the amount € 4,550,256.09 should appear.

b) To judge procedent the petition for declaration of illegality of the act of rejection of the gracious complaint...

[Document continues but text is truncated in original]