IRC Fair Value Adjustments: CAAD Arbitral Decision 58/2015-T on Corporate Tax Liquidations

ARBITRAL DECISION

The arbitrators Dr. Jorge Manuel Lopes de Sousa (President Arbitrator), Dr. Sérgio de Matos and Dr. Álvaro José da Silva (Member Arbitrators), appointed by the Ethics Council of the Administrative Arbitration Center to form the Arbitral Tribunal, constituted on 13-04-2015, agree as follows:

1. Report

A…, S.A., NIPC …, filed a petition for establishment of a collective arbitral tribunal, pursuant to article 2, no. 1, of Decree-Law no. 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter referred to only as LFATM), in which the Tax Authority and Customs Authority is the respondent, with a view to the declaration of illegality of the Corporate Income Tax assessments nos. 2014 … and 2014 …, relating to the fiscal years of 2010 and 2011.

The petition for establishment of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax Authority and Customs Authority on 04-02-2015.

Pursuant to the provisions of paragraph a) of no. 2 of article 6 and paragraph b) of no. 1 of article 11 of the LFATM, in the wording introduced by article 228 of Law no. 66-B/2012, of 31 December, the Ethics Council appointed as arbitrators of the collective arbitral tribunal the Honorable Counselor Jorge Lopes de Sousa, Dr. Sérgio de Matos and Dr. Álvaro José da Silva, who communicated their acceptance of the appointment within the applicable period.

On 26-03-2015 the parties were duly notified of this appointment and did not manifest any wish to refuse the appointment of the arbitrators, pursuant to the combined provisions of article 11, no. 1, paragraphs a) and b) of the LFATM and articles 6 and 7 of the Ethics Code.

Thus, in accordance with the provisions of paragraph c) of no. 1 of article 11 of the LFATM, in the wording introduced by article 228 of Law no. 66-B/2012, of 31 December, the collective arbitral tribunal was constituted on 13-04-2015.

The Tax Authority and Customs Authority filed a response, arguing that the petition should be judged to be without merit.

By order of 11-05-2015, it was decided to dispense with the meeting provided for in article 18 of the LFATM and for the proceedings to continue with written submissions.

The Parties filed written submissions.

The arbitral tribunal was regularly constituted and is materially competent, in light of the provisions of articles 2, no. 1, paragraph a), and 30, no. 1, of Decree-Law no. 10/2011, of 20 January.

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

The proceedings do not suffer from any defects and no exceptions were raised.

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

1. Matter of Fact

2.1. Established Facts

Based on the evidence contained in the file and the administrative proceeding attached to the record, the following facts are considered established:

a) The Claimant is a commercial company subject to Corporate Income Tax (CIRC);

b) The Claimant submitted, in 2011 and in 2012, its income declarations (Form 22) of CIRC relating, respectively, to the fiscal years of 2010 and 2011;

c) During these fiscal years (2010 and 2011), the Claimant held financial participations, consisting of shares representing the share capital of X..., S.A., Y..., W..., U..., Z... and T…, shares that represented less than 5% of the share capital of these companies, and such shares were admitted to trading on a regulated market;

d) The Claimant, in the aforementioned declarations, considered as negative equity variation and as transition adjustment from the regime of the Official Accounting Plan (POC) to the regime of the SNC, as provided for in article 5, nos. 1, 5 and 6 of Decree-Law 159/2009 of 13 July, the amount of 20% of the adjustment balance, in the amount of €14,401.79, which it entered in field 705 of Q07 of both Form 22 declarations of 2010 and 2011;

e) The amount considered by the Claimant is composed of transition adjustments made on 31-12-2009, relating to the balance between the increase and reduction of the fair value of shares of entities in which it holds a participation percentage of less than 5% and corresponds to 20% of that balance (specifically, €72,008.93 X 0.20= €14,401.79), in accordance with the table below:

(X..., U..., Y..., W..., Z... and T…)

f) In compliance with Service Orders nos. OI2013 … and OI2014 …, partial scope tax inspection actions were carried out on the Claimant – CIRC and relating to the fiscal years of 2010 and 2011;

g) The Tax Inspection understood that, following the adoption of the SNC, equity participations traded on a regulated market and representing less than 20% of the share capital of a particular entity – as is the case with the aforementioned shares, which represent a participation in capital of less than 5% – should be measured at fair value through profit or loss (IFRS 9) which requires the recognition for tax purposes of the reduction in fair value, in accordance with article 45, no. 3, of the CIRC (wording as of the facts);

h) The Tax Authority and Customs Authority, based on this rule, understood that negative adjustments to any component of equity – including therefore reductions in fair value relating to financial investments in shares – contribute to the formation of taxable profit only at half of their value, so the adjustments accepted for CIRC purposes of the aforementioned fiscal years shall be as follows:

(X..., U..., Y..., W..., Z... and T…)

i) With regard to "Losses from reductions in fair value of financial instruments" recorded in account 661, the Tax Inspection verified that the taxpayer recorded in the income statement, in the table relating to increases/reductions in fair value, in the year 2010 the amount of €179,672.00 and in the year 2011 the amount of €195,173.08;

j) These losses relate to shares representing less than 5% of the capital of X..., U..., Y..., W..., Z... and T…;

k) The Tax Inspection understood that these adjustments contribute to the formation of taxable profit in accordance with paragraph a) of no. 9 of article 18 of the CIRC and that, although such losses were considered deductible in accordance with (the then) paragraph i) of no. 1 of article 23 of the CIRC, their deductibility was (then) limited in accordance with the last part of no. 3 of the then article 45 of the same statute;

l) The Tax Inspection concluded, after analysis of the documents sent by the Claimant (Annexes VI, VII and XIII to the Tax Inspection Report), that it should have entered – in "field 737 – 50% of other losses relating to equity interests or other components of equity (article 45, no. 3, final part)" – 50% of the amounts of losses from fair value reduction that it had recorded in account "661 - Losses from reductions in fair value" in the years 2010 and 2011 in question;

m) That is, it should have entered in 2010 the amount of €89,836.00 and in 2011 the amount of €97,586.54, which correspond to 50% of the balance recorded, in those years, in "account 6610 – Losses from reduction in fair value of financial instruments", respectively (reiterated) of €179,672.00 and €195,173.08;

n) In view of this, considering the aforementioned non-deductible adjustments in 2010 and 2011, the Tax Inspection made the corresponding corrections to the tax losses that the Claimant had declared in those years, reducing them in accordance with the explanations in tables 3 to 6 of the Tax Inspection Report, whose contents are reproduced herein;

o) As a result of the aforementioned corrections, the Tax Authority and Customs Authority prepared the Corporate Income Tax assessments nos. 2014 … and 2014 …, relating to the fiscal years of 2010 and 2011, respectively (documents nos. 1 and 2, attached to the petition for arbitral determination, whose contents are reproduced herein);

p) On 03-02-2015, the Claimant filed the petition for establishment of the arbitral tribunal that gave rise to the present proceedings.

2.2. Unestablished Facts

There are no facts with relevance to the consideration of the merits of the case that have not been established.

2.3. Basis for the Establishment of the Matter of Fact

The established facts are based on the Tax Inspection Report, whose contents are reproduced herein, and on the agreement of the Parties, with no controversy regarding them.

1. Matter of Law

The corrections made by the Tax Authority and Customs Authority were based on the interpretation it made of the regime of article 45, no. 3, of the CIRC, in the wording in force in 2010-2011, which it understood to be applicable to the adjustments arising from the application of the fair value model in financial instruments, the counterpart of which is recognized through profit or loss.

It is accepted by the Parties that the financial participations in question should be accounted for in accordance with the fair value criterion and that the adjustments were recognized through profit or loss.

In this way, the issue to be resolved in the proceedings is properly delimited, which is, then, to know whether the accounting loss resulting from the retrospective application of the fair value method and the accounting losses verified in the fiscal years of 2010 and 2011, arising from the depreciation of the share price, properly accounted for in accordance with the applicable fair value criterion, and recognized in profit or loss, should be considered in full, or only at 50%.

3.1. Normative Framework

Article 45, no. 3, of the CIRC, in the wording given by Decree-Law 159/2009, of 13 July, establishes the following:

"3 – The negative difference between the capital gains and capital losses realized through the sale of equity interests, including their redemption and amortization with reduction of capital, as well as other losses or negative equity variations relating to equity interests or other components of equity, namely supplementary contributions, contribute to the formation of taxable profit only at half of their value."

The general rule on the determination of taxable profit of CIRC is article 17 of the CIRC which establishes that:

"1 – The taxable profit of legal persons and other entities mentioned in paragraph a) of no. 1 of article 3 is constituted by the algebraic sum of the net result of the period and of the positive and negative equity variations verified in the same period and not reflected in that result, determined on the basis of accounting and possibly corrected in accordance with this Code."

With regard to adjustments arising from the application of fair value, no. 9 of article 18 of the same Code provides that:

"9 – Adjustments arising from the application of fair value do not contribute to the formation of taxable profit, being recognized as income or expenses in the tax period in which the elements or rights that gave rise to them are disposed of, exercised, extinguished or liquidated, except when:

a) They relate to financial instruments recognized at fair value through profit or loss, provided that, in the case of equity 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; or

b) This is expressly provided for in this Code."

Article 20, no. 1, of the CIRC specifies the concept of income establishing, to the extent relevant here, the following:

"Income shall be deemed to include the results of operations of any nature, as a result of a normal or occasional action, basic or merely accessory, including in particular:

(...)

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

(...)

h) Realized capital gains;".

Article 23, no. 1, of the CIRC defines the concept of "expenses", establishing the following:

"1 – Expenses shall be deemed to include those that are demonstrably indispensable for the realization of income subject to taxation or for the maintenance of the source of income, including in particular:

(...)

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

(...)

l) Realized capital losses;".

With regard to positive equity variations, article 21, no. 1, of the CIRC provides that:

"Positive equity variations not reflected in the net result of the tax period also contribute to the formation of taxable profit, except:

(...)

b) Potential or latent capital gains, even if expressed in accounting, including revaluation reserves under legislation of a fiscal nature;"

With respect to negative equity variations, article 24, no. 1, of the CIRC states that:

"Under the same conditions referred to for expenses, negative equity variations not reflected in the net result of the tax period also contribute to the formation of taxable profit, except:

(...)

b) Potential or latent capital losses, even if expressed in accounting;".

With regard to capital gains and losses, article 46, no. 1 of the same Code provides that:

"1 – Capital gains or losses realized shall be deemed to be gains obtained or losses suffered through sale, whatever the title by which it is carried out, as well as those arising from losses or the result of permanent assignment for purposes unrelated to the activity carried on, relating to:

(...)

b) Financial instruments, with the exception of those recognized at fair value in accordance with paragraphs a) and b) of no. 9 of article 18;".

3.2. Analysis of the Issue

In analyzing this issue, the reasoning of the arbitral decision of 25-11-2013, handed down in proceedings no. 108/2013-T, shall be followed closely, which merits the agreement of the signatories.

The aforementioned article 45, no. 3, of the CIRC results from the renumbering of the previous article 42, no. 3, effected by Decree-Law 159/2009.

This no. 3 of article 42 in question, in turn, was introduced by Law 32-B/2002, of 30 December, with the following wording:

"The negative difference between capital gains and capital losses realized through the sale of equity interests, including their redemption and amortization with reduction of capital, contributes to the formation of taxable profit only at half of their value."

According to the Report of the Ministry of Finance for the 2003 State Budget (p. 33), the legislative intervention in the area in question (CIRC) was guided by "two priorities, namely the fight against tax fraud and evasion and the broadening of the tax base", the amendment of interest here being part of the "Broadening of the tax base and measures of moralization and neutrality" (p. 51).

The current wording of the rule under analysis resulted from the amendment implemented by Law 60-A/2005 of 30 December, and in accordance with the corresponding Report of the Ministry of Finance (p.31), the measure in question was part of the "FIGHT AGAINST TAX EVASION AND FRAUD AND OTHER MEASURES AIMED AT BUDGETARY CONSOLIDATION".

Meanwhile, no. 9 of article 18 of the applicable CIRC obtains its justification directly from the preamble of Decree-Law 159/2009, of 13 July, which introduced it into the aforementioned Code, where it can be read:

"Still in the field of approximation between accounting and taxation, the application of the fair value model in financial instruments is accepted, the counterpart of which is recognized through profit or loss, but only in cases where the reliability of the determination of fair value is in principle assured. Thus, equity instruments that do not have a price formed in a regulated market are excluded. Furthermore, the application of the realization principle was maintained with respect to financial instruments measured at fair value whose counterpart is recognized in equity, as well as equity interests corresponding to more than 5% of the share capital, even if recognized at fair value through profit or loss. (...)

In the same sense, the following are identified as assets covered by the regime of capital gains and losses: tangible fixed assets, intangible assets, investment properties, financial instruments, with the exception of those in which adjustments arising from the application of fair value contribute to the formation of taxable profit in the tax period.".

These expressed intentions have correspondence in that rule of no. 9 of article 18, as well as in the introduction, by the same legal instrument, of paragraphs f) and i) of no. 1 of articles 20 and 24 of the CIRC, as well as of paragraph b) of no. 1 of article 46.

Within the set of amendments introduced by the aforementioned Decree-Law 159/2009, of 13 July, it is also worth noting that where previously one spoke of profits and gains (article 20), one now speaks of income, and where previously one spoke of costs or losses (article 23), one now speaks of expenses.

Prior to the adoption of fair value, equity variations relating to financial instruments were irrelevant from the perspective of the formation of taxable profit for each period, by virtue of the rule of article 21, no. 1, paragraph b), of the CIRC, which established that "potential or latent capital gains, even if expressed in accounting, including revaluation reserves legally authorized" did not contribute to the formation of taxable profit. Only at the moment of realization of the capital gain or loss did the equity variation assume fiscal relevance.

This fiscal framework, which resulted in a single taxation (which occurred only once during the entire period of ownership of the financial instruments), dependent on a voluntary action of the taxpayer (in that the transaction of the instruments generating the equity variation, the condition for fiscal relevance thereof, would only occur if and when the taxpayer so chose) and in which the valuation of the equity variation was fixed as a function of the specific transaction that triggered its fiscal relevance provided fertile ground for accounting and fiscal manipulations, since the taxpayer could choose to trigger fiscal relevance at the moment and terms that were fiscally most advantageous to it.

On the other hand, and given the relevance of the taxpayer's will in the mechanism of fiscal relevance of equity variation, the system established was suitable for the adoption of mechanisms to condition that will, in order to conform it to economically more desirable behaviors, which, in this case, pass through the preference for realization of capital gains, to the detriment of realization of capital losses.

It is in this framework that the emergence of the rule of the previous article 42, no. 3, of the CIRC, which precedes the current article 45, no. 3, of the same, is explained.

Such rule, 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 legislature) by needs linked to the fight against tax fraud and evasion and the broadening of the tax base, aimed at the desired consolidation of public accounts.

The acceptance of the application of the fair value model in financial instruments, effected 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 equity variations relating to the ownership of those instruments.

Indeed, the intention of the legislature when adopting the fair value model, duly evidenced, assumed and expressly, was to maintain "the application of the realization principle with respect to financial instruments measured at fair value whose counterpart is recognized in equity, as well as equity interests corresponding to more than 5% of the share capital, even if recognized at fair value through profit or loss".

As for "financial instruments" corresponding to less than "5% of the 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 accordance with this legislative intention, article 18, no. 9, of the CIRC came to provide that, as a general rule, "Adjustments arising from the application of fair value do not contribute to the formation of taxable profit, being recognized as income or expenses in the tax period in which the elements or rights that gave rise to them are disposed of, exercised, extinguished or liquidated.", which constitutes an evident and deliberate manifestation of the assumed realization principle.

However, the same rule, in its paragraph a), establishes the exception to this regime, "when: a) They relate to financial instruments recognized at fair value through profit or loss, provided that, in the case of equity 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, when "income or expenses (...) relate to financial instruments recognized at fair value", "contribute to the formation of taxable profit" "provided that":

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

b) They are "equity instruments";

c) They "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 met:

a) income resulting from the application of fair value in financial instruments is considered [article 20, no. 1, paragraph f), of the CIRC]; and

b) expenses resulting from the application of fair value in financial instruments are considered [article 23, no. 1, paragraph i) of the CIRC].

In this way, where previously we had a single fiscal relevance, at the time of the transaction of those instruments, we now have a continuous fiscal relevance. That is, in light of the new rules constituting 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 affect the formation of taxable profit [articles 20, no. 1, paragraph f), and article 23, no. 1, paragraph i), of the CIRC] of the very year in which they occur, provided that certain conditions are met (article 18, no. 9, of the CIRC), which include price formation in a regulated market, and the equity variations are not taxed as capital gains or losses [article 46, no. 1, paragraph b), of the CIRC].

In this framework, there are no longer any needs relating to the fight against tax fraud and evasion, not only because the fiscal relevance of equity variations no longer depends on an act of will of the taxpayer, but also because the valuation is objectively fixed.

On the other hand, and for the same reasons, there is equally no sense in any measure to condition the taxpayer's will, in order to favor economically more "desirable" behaviors and, as such, conforming to the interests of broadening the tax base and budgetary consolidation.

Notwithstanding these amendments introduced by Decree-Law 159/2009, of 13 July, the previous article 42, no. 3 of the CIRC, renumbered to article 45, no. 3, maintained its continued validity, with its wording unchanged.

Hence the question arises, as occurs in the proceedings, whether such rule will apply, or not, to depreciations relating to financial instruments, which contribute to the formation of taxable profit, in accordance with article 18, no. 9, paragraph a), of the CIRC.

In a first analysis, based exclusively on the literal wording of no. 3 of article 45, an affirmative answer is suggested by this question, in light of the comprehensiveness of the provision of this rule.

But a careful and coordinated interpretation of the normative provisions relevant to the analysis of the issue, which have been indicated, leads to a different conclusion.

In fact, article 45, no. 3, of the CIRC states that:

"The negative difference between capital gains and capital losses realized through the sale of equity interests, including their redemption and amortization with reduction of capital, as well as other losses or negative equity variations relating to equity interests or other components of equity, namely supplementary contributions, contribute to the formation of taxable profit only at half of their value."

The analysis of the normative text reveals clearly that the legislature chose, to include in it, three types of situations that should be regarded, by virtue of the presumption of good legislative technique, as distinct, namely:

a) "The negative difference between capital gains and capital losses realized through the sale of equity interests";

b) "other losses (...) relating to equity interests or other components of equity";

c) "other (...) negative equity variations relating to equity interests or other components of equity".

Let us then see whether the situation in the proceedings falls under any of the enumerated situations.

The situation referred to in paragraph a) above will manifestly be inapplicable, not only because there was no realization effected through the sale, but also because article 46, no. 1, paragraph b), of the CIRC excludes the situations described in article 18, no. 9, paragraph a), from the concept of realized capital gains.

In this manner, there remain the possibilities of the integration of the situation in the proceedings in one of the situations enumerated in paragraphs b) and c) above.

The apparent indiscriminate comprehensiveness of the provisions in question can, however, reasonably be mitigated if one notes that "losses" and "other negative equity variations" are concepts that, while not redundant, have a specific and distinct meaning.

To understand this fact, it will be necessary to go back to articles 23 and 24 of the same Code, taking into account the terminological evolution effected by article 159/2009, of 13 December.

Indeed, prior to the entry into force of the latter statute, the aforementioned articles of the CIRC stated, respectively, that:

– "Expenses shall be deemed to include costs or losses that are demonstrably indispensable for the realization of the income or profits subject to tax or for the maintenance of the source of income, including in particular the following: (...)";

– "Under the same conditions referred to for costs or losses, negative equity variations not reflected in the net result of the fiscal year also contribute to the formation of taxable profit, except: (...)".

It is thus verified that at the time of the consecration of the current wording of article 45, no. 3, of the CIRC, this Code expressly distinguished, to the extent relevant here, three types of situations, namely:

a) Expenses;

b) Losses;

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

The provision of article 42, no. 3 (predecessor of the current 45, no. 3), should thus be considered as referring to these concepts, defined in articles 23 and 24, in the wordings prior to Decree-Law no. 159/2009.

Thus, and for obvious reasons, the provision of that rule should have excluded from its scope expenses relating to "equity interests or other components of equity", including there only losses (as defined in article 23) and negative equity variations (as defined in article 24), relating to those interests.

And that this is indeed so, that is, that the expression "other losses or negative equity variations" used in the current article 45, no. 3, of the CIRC does not have an indiscriminately comprehensive meaning, but rather a precise meaning defined in articles 23 and 24, follows immediately from the fact that the legislature used the same distinction.

Furthermore, the inclusion in the scope of the rule in question not only of losses (as defined in article 23) and negative equity variations (as defined in article 24), but also of expenses (as defined in article 23 in the wording prior to Decree-Law no. 159/2009), would lead to the fact that, for example, the cost of acquisition of equity interests would only contribute at half of its respective value to the determination of taxable profit, which would obviously be inconceivable for a reasonably prudent legislature.

The normative amendment implemented by Decree-Law 159/2009, of 13 July, will not have altered anything of relevance in the matter in question. Indeed, notwithstanding the body of article 23 having come to refer only to expenses, the fact is that the CIRC continues to use the expression "losses", including in article 23 itself (cf. no. 1, paragraph h)). This occurs in consistency, moreover, with the SNC, which pursuant to 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, no. 3, of the CIRC shall refer to:

a) negative differences between capital gains and capital losses realized through the sale of equity interests;

b) other losses relating to equity interests or other components of equity; and

c) other negative equity variations relating to equity interests or other components of equity.

Being that by "losses" should be understood the facts that are qualifiable as such in light of the CIRC, and by "negative equity variations" should be understood negative equity variations not reflected in the net result of the fiscal year, as defined in article 24.

Facts that are qualifiable as "expenses" in light of the CIRC shall not be included in the scope of the rule in question, even if relating to equity interests or other components of equity.

The Tax Authority itself seems to recognize this, since in the "Manual for Completion of Table 07, Form 22"[1], regarding field 737, it states that "In this field are entered, at 50%, the amounts relating to other losses (other than capital losses, as these follow the 'mechanism' of capital gains and losses) relating to equity interests or other components of equity. For example, amounts corresponding to 50% of losses from fair value reductions are entered in this field 737, when these fall within the scope of article 23, no. 1, paragraph i), by virtue of the provision of article 18, no. 9, paragraph a)".

It happens that article 23, no. 1, paragraph i), of the CIRC does not refer to the amounts in question as "losses", but as "expenses", so their entry in the field in question will be incorrect.

Moreover, and if there were any doubt, had the legislature, when Decree-Law 159/2009 of 13 December came into force, intended to cover the situations enumerated in article 18, no. 9, paragraph a), of the CIRC, within the scope of article 45, no. 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 the CIRC ( [2] ); or

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

In the framework that has just been set out, it should then be considered that Decree-Law 159/2009, of 13 July, introduced, with regard to the part covered by the acceptance of the application of the fair value model in financial instruments, a special regime of fiscal relevance for the calculation of taxable profit, justified both by its own objectivity and by the confessed intention of approximation of accounting to taxation.

This circumstance is, in light of the current wording of the CIRC, not susceptible of generating any type of doubts, as is verified, in particular, by the wording of articles 20, no. 1, paragraphs f) and h), 23, no. 1, paragraphs i) and l), and, in particular 46, no. 1, paragraph b), in light of which the intention of the legislature to remove the adjustments arising from the application of the fair value criterion in financial instruments, in accordance with what is recognized by the CIRC, from the regime of capital gains and losses, is clearly evident.

Meanwhile, the regime resulting from the combination of articles 45, no. 3, and 46 of the CIRC, only makes sense from the perspective of the consideration of the equity variations in question under the prism of the aforementioned realization principle.

That is, being in question, in light of such principle, the assessment of the equity variation as a function of a transaction, there will always be a voluntary factor in relation to it.

That is, in the regime for which the rule of article 45, no. 3 was thought and established, the realization of capital losses, and other situations enumerated, was dependent on a voluntary action corresponding to the realization thereof. Now, in this framework, it will be understandable that the legislature institutes mechanisms to discourage an action susceptible of being considered as undesirable, in this case the realization of capital losses or other negative equity variations. By providing that such situations will only be relevant at 50% of the amount accounted for, the fiscal legislature is, objectively, conditioning the actions covered by the legal provision, imposing a negative incentive to the same.

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

However, those aspects will no longer apply in the situations covered by article 18, no. 9, paragraph a). Here, being in question adjustments arising from the accounting of fair value, determined by objective criteria (with "a price formed in a regulated market"), there is no question or intervention of the taxpayer's will in the verification of the negative or positive equity adjustment. That is, these will occur or not, regardless of the action and will of the taxpayer.

Now, penalizing, in these cases, the taxpayer with a disregard of 50% of the expense incurred would be entirely unjustified, both from an economic point of view and from a legal point of view.

That is, recall, this situation of contingent (random, even) unjustified penalty would only occur by virtue of the exception of the situations covered by article 18, no. 9, paragraph a), of the CIRC to the regime of the realization principle. That is, if with respect to these situations the general regime of the body of article 18, no. 9 were to apply, according to which they would not "contribute to the formation of taxable profit, being recognized as income or expenses in the tax period in which the elements or rights that gave rise to them are disposed of, exercised, extinguished or liquidated", the pointed incoherence would not occur, since the fact that would trigger the contribution to the formation of taxable profit would only occur by the will of the taxpayer, so it would be up to the taxpayer to choose to realize the negative equity variation, with the consequent fiscal penalty, or to defer this to a time when it was less voluminous or even positive, reducing or eliminating the penalty resulting from the operation for itself and for the Public Treasury. It is the exception of paragraph a), by removing the situations provided therein from the scope of the realization principle, that justifies the new regime of fiscal relevance for taxable profit, which was instituted.

Evidence of all that has been said is presented in the table elaborated below, which demonstrates the unreasonableness of the application of the rule of article 45, no. 3, to the situations covered by article 18, no. 9, paragraph a):

The non-application of the rule of article 45, no. 3, of the CIRC to expenses, and specifically to "Expenses resulting from the application of fair value in financial instruments", with the full consideration of the equity repercussions verified, whether positive or negative, leads to a coherence of taxation whatever the time at which the disposal of the financial instrument occurs. That is, whatever time is chosen to proceed with the disposal of the financial instrument, the positive and negative equity changes offset each other, so that, in the end, 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 rule of article 45, no. 3, of the CIRC were to be applied, as the Tax Authority contends, from the moment a negative equity change occurs, there would be a discrepancy between the fiscal relevance of negative and positive equity variations, without any justification, as has been said, since those variations occur in an objective way 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 the disposal of the financial instrument in question, despite having realized a capital gain of only 20 (which would be taxed as such under the realization principle), would, in fact, have paid tax on 30 (40-10). In the same way, if it proceeded to that disposal at the end of the third year, it would have paid tax on 20, notwithstanding having had no equity increase with the operation. And if it proceeded to the same disposal at the end of the sixth year, it would have paid tax as if it had had an equity increase of 30 (80-50), notwithstanding having had an actual equity variation of -20, which, under the realization principle enshrined in the CIRC, would be considered, even if only at 50% of the respective value (-10)!

It is clear that such results, merely random and without any substantial justification to support them, could not have been intended by a reasonable legislature, which, by virtue of article 104, no. 2, of the CRP, must base the taxation of companies fundamentally on their actual income.

It is true that the alternative solution, which excludes the application of article 45, no. 3, leads to the fact that, if ultimately a capital loss occurs, it will have been considered at 100%, and not at 50%, as would occur under the realization principle. This would be the case of, in the example in the table above, the disposal occurring in years 4 or 6. However, this positive discrimination (or rather, non-negative discrimination) by the choice of the fair value criterion can be justified, first, because in the regime of article 18, no. 9, paragraph a), it no longer makes sense for any disincentive to the realization of capital losses, since they will be recognized for tax purposes independently of their actual realization. Neither should it be overlooked that, on the one hand, accounting at fair value is considered more in line with the approximation between accounting and taxation, a purpose confessedly pursued by the legislature of Decree-Law no. 159/2009, of 13 July, and, on the other, the fact that we are faced with objectively assessed realities, without significant margin for fiscally convenient manipulations.

That is, as had been advanced already, the reasons for the fight against tax fraud and tax evasion, nor the reasons of budgetary consolidation, which demonstrably were at the genesis of the rule of article 45, no. 3, of the CIRC, are not present.

Thus, situations in which its raison d'être does not apply should be removed from the field of application of this article 45, no. 3, in harmony with the old maxim "cessante ratione legis cessat eius dispositio (where the raison d'être of the law ends, its reach ends)" ( [3] ). "The teleological method has been increasingly moving to the forefront in relation to literal interpretation. According to the principle long known: cessante ratione legis, cessat lex ipsa, the end and the raison d'être should matter more than the respective literal meaning. The ratio should impose itself, not only within the limits of an often equivocal literal content, but also breaking the bonds of that literal content or restricting a legal formula with scope that is too broad". ( [4] )

In this manner, and in sum, in obedience to the hermeneutic impositions of article 9 of the Civil Code, according to which "Interpretation should not be confined to the letter of the law, but should reconstruct from the texts the legislative thought, 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" (no. 1), and "In fixing the meaning and scope of the law, the interpreter shall presume that the legislature consecrated the most correct solutions and knew how to express its thought in adequate terms." (no. 3), it is understood that article 45, no. 3, of the CIRC should be interpreted in the sense that its provision does not include expenses resulting from the application of fair value in financial instruments, which are relevant for the formation of taxable profit in accordance with paragraph a) of no. 9 of article 18.

In these terms, considering that article 18, no. 9, paragraph a), of the applicable CIRC imposes the contribution "to the formation of taxable profit", without reservations or limitations, of "income or expenses" which "(...) relate to financial instruments recognized at fair value", "provided that" they are recognized "through profit or loss"; they are "equity 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", and that article 45, no. 3, of the said Code is not applied in these cases, to the extent that they are not covered by the normative provision thereof, it is understood that the petition merits approval.

Consequently, the corrections made by the Tax Authority and Customs Authority that are underlying the assessments being contested suffer from a defect of violation of law, due to erroneous interpretation of article 45, no. 3, of the CIRC, so that a declaration of their illegality is warranted.

1. Decision

In accordance with the foregoing, this Arbitral Tribunal agrees to:

Rule that the petition for a declaration of illegality of the Corporate Income Tax assessments nos. 2014 … and 2014 …, relating to the fiscal years of 2010 and 2011, respectively, is well-founded, due to erroneous application of the regime of article 45, no. 3, of the CIRC, which constitutes a defect and violation of law.

1. Case Value

In accordance with the provisions of article 306, no. 2, of the CPC and 97-A, no. 1, paragraph a), of the CPPT and no. 3, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the case value is fixed at €225,992.32.

1. Costs

Pursuant to article 22, no. 4, of the LFATM, the amount of costs is fixed at €4,284.00, in accordance with Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, to be borne by the Tax Authority and Customs Authority.

Lisbon, 09 June 2015

The Arbitrators

(Jorge Manuel Lopes de Sousa)

(Sérgio de Matos)

(Álvaro José da Silva)

[1] Available at http://info.portaldasfinancas.gov.pt/NR/rdonlyres/BAFFC60A-E1B8-4217-89E1-17440629A6BA/0/ ManualQ07201104052V.pdf, p. 31.

[2] Strictly speaking, this would be incoherent, insofar as article 18, no. 9, a) refers to "financial instruments recognized at fair value through profit or loss", and article 24 refers, as seen, to "negative equity variations not reflected in the net result of the fiscal year".

[3] BAPTISTA MACHADO, Introduction to Law and the Discourse of Legitimation, page 186.

[4] KARL ENGISCH, Introduction to Legal Thought, page 120.