Summary
Full Decision
ARBITRAL DECISION
I – Report
1. A..., S.A., NIPC..., with headquarters at..., ...–... ..., ..., filed a request for constitution of an arbitral tribunal, under the provisions of article 2, no. 1, paragraph a), and articles 10 et seq. of Decree-Law no. 10/2011, of 20 January, to assess the legality of the act of additional assessment of Corporate Income Tax (IRC) under number 2016... and assessment of compensatory interest identified in the interest statement under number 2016..., in the total amount of € 7,221,619.35, as well as tacit dismissal of the administrative appeal filed against the additional corporate income tax assessment act.
The request is based on the following grounds.
The correction of the IRC assessment was based on the disallowance, by the Applicant, as income for the fiscal year of debit interest accruals recorded in relation to various customers for late payment of invoices, non-acceptance of results of construction contracts declared and accounting of impairment losses on customer receivables that should not be accepted for tax purposes.
With regard to debit interest, the Applicant argues that the processing of debits functions as a way to pressure non-compliant customers, and in most cases the debits are subsequently cancelled and only when they are effectively received are they included in taxable profit, with no intentional omission of such amounts to manipulate the fiscal year results. And, moreover, given that this corresponds to a common practice of the Applicant, there would have to be deducted from taxable profit in the fiscal year 2012 the amounts debited in prior fiscal years and whose actual payment was then subject to deferral.
As to the determination of results of construction contracts whose execution extends beyond one year, the Applicant states that it used the percentage of completion method and that the Tax Authority did not introduce any new accounting elements to alter the result indicated by the taxpayer, adding, in the alternative, that the increase to taxable profit made by the Tax Authority for the year 2011 should be deducted in 2012 from the opening balance of deferred revenues in the fiscal year 2011.
Regarding the disallowance of impairment losses on receivables as expenses, the Applicant argues that it is the responsibility of the taxpayer to identify the risk of uncollectibility and the moment when such risk materializes, the maintenance of commercial relations with the debtor or the nature of the debtor as a public company not constituting evidence of non-uncollectibility – as the Tax Authority contends –, it being further demonstrated, as regards receivables relating to B... and C..., S.A., that the liquidity of such receivables was dependent on the outcome of actions initiated by D..., S.A. and by C..., S.A. against the Municipality of E....
The Tax Authority, in its reply, considers that the inclusion in taxable income for 2012 of debit notes for compensatory interest issued during that year corresponds to the application of the accrual principle, provided for in article 18 of the IRC Code. And, on the other hand, the deduction, in that fiscal year, of interest that was received in that year but debited in 2011 or in prior fiscal years would result, in practice, in the non-taxation of such amounts due to the impossibility of accruing to taxable profit for 2011.
Regarding construction contracts, the correction determined by the Tax Authority relates to work already performed but not yet invoiced as a result of a gap existing between the measurement records relating to 2012 and the degree of completion declared by the taxpayer, and it should be understood that the determination of taxable profit, also in this case, must observe the principle of economic accrual in accordance with the percentage of the degree of completion.
Regarding impairment losses, the Administration considers that the risk of uncollectibility does not subsist, either because these are regular customers who maintained the commercial relationship with the Applicant (F.../H...), or because the debtor is a company with public capital (G..., S.A.), or also because the requirement of paragraph b) of no. 1 of article 36 of the IRC Code is only verified when judicial recovery of the receivables is initiated by the taxpayer (B.../C..., S.A.).
It concludes by finding the request unsubstantiated.
2. Following the proceedings, the meeting referred to in article 18 of the RJAT was held and witness evidence requested by the parties was produced.
In arguments, the parties reiterated their previous positions.
3. The request for constitution of the arbitral tribunal was accepted by the President of CAAD and notified to the Tax and Customs Authority in accordance with regulatory procedures.
Pursuant to paragraph b) of no. 2 of article 6 of the RJAT, in the version introduced by article 228 of Law no. 66-B/2012, of 31 December, the arbitrators were designated by the parties, with the Deontological Council indicating the third arbitrator.
The collective arbitral tribunal was thus constituted by the signatories hereto, who communicated acceptance of the appointment within the applicable time period.
The parties were duly notified of this designation and did not manifest a desire to reject it, in accordance with the combined provisions of article 11, nos. 4 and 5, of the RJAT and articles 6 and 7 of the Deontological Code.
Thus, in accordance with the provision of no. 7 of article 11 of the RJAT, in the version introduced by article 228 of Law no. 66-B/2012, of 31 December, the collective arbitral tribunal was constituted on 5 March 2018.
The arbitral tribunal was regularly constituted and is materially competent, in accordance with the provisions of articles 2, no. 1, paragraph a), and 30, no. 1, of Decree-Law no. 10/2011, of 20 January.
The parties have legal personality and capacity, are legitimate and are represented (articles 4 and 10, no. 2, of the same statute and 1 of Ordinance no. 112-A/2011, of 22 March).
The proceedings do not suffer from nullities and no exceptions were invoked.
3. The meeting referred to in article 18 of the RJAT was held and witness evidence indicated by the Applicant was produced.
The parties submitted written arguments in successive periods in which they analyzed the factual matter and reiterated their previous positions.
It is for us to assess and decide.
II – Reasoning
Factual Matter
4. The factual matter relevant to the decision of the case is as follows:
a) The Applicant was subject to an external inspection relating to IRC, following External Service Order no. 0I2016... whose procedure commenced on 4 August 2016;
b) In the Tax Inspection Report, a correction to taxable profit of € 20,938,689.00 was proposed, which gave rise to the additional IRC assessment for the fiscal year 2012, under number 2016..., dated 14 November 2016, and respective interest assessments under numbers 2016..., 2016... and 2016..., of the same date, in the total amount of € 7,221,619.35;
c) On 11 April 2017, the Applicant filed an administrative appeal against the assessment acts which was not decided within the legally prescribed time period;
d) The corrections to the taxable matter resulting from the tax inspection relate to unreported income with respect to compensatory interest debited to customers for late payment, unreported income relating to multi-year construction contracts based on the degree of completion and disallowance of expenses for impairment losses;
e) In the fiscal year 2012, the Applicant issued debit notes for compensatory interest for late payment of invoices in relation to various customers, in the total amount of € 3,850,087.52;
f) These debits were not declared as taxable income for that period, having been included in account 2829 as constituting deferred revenues;
g) The Applicant issues debit notes as a form of pressure on non-compliant customers and in various situations cancels the debits when in subsequent negotiations it agrees with the customers for the actual collection of the invoices;
h) In 2012, the Applicant accounted as taxable income interest that had been debited in 2011 and that was only collected during that year;
i) The Tax Authority did not question, in relation to fiscal years prior to 2012, the procedure used by the taxpayer of not considering as income for the fiscal year compensatory interest invoiced, leaving the inclusion in taxable income for the later moment when the amount of debited interest is actually received;
j) In 2012, works CO 10/..., CO 11/..., CO 11/..., CO 11/... and CO 12/... had a declared degree of completion of 78.67%, 45.99%, 22.58%, 25.73% and 55.85%, respectively;
l) According to the measurement records, the degree of completion of these works was 98.70%, 120.45%, 67.55%, 88.27% and 98.80, respectively;
m) With regard to construction contracts, the Tax Authority made a correction to taxable income, in the amount of € 3,578,833.94, considering that the percentage of completion declared does not correspond to the degree of completion evidenced by the measurement records;
n) In the fiscal year 2012, the Tax Authority proceeded with the correction of taxable income by disallowance of expenses for impairment losses, in the total amount of € 13,826,093.34, with respect to the following customers: F..., Lda. (€ 25,036.05), H..., SA (€ 177,719.07), G..., S.A. (€ 119,371.38), B... (€ 4,885,483.16), C..., S.A. (€ 4,880,171.49);
o) The Tax Authority considered the risk of uncollectibility not verified with respect to these companies for the following reasons:
- F..., Lda.: is a regular customer that makes payments regularly;
- H..., SA: is a customer with a continued commercial relationship who made payments during the fiscal year 2012 and to whom the taxpayer made supplies;
- G..., S.A: is a limited company with public capital with respect to which the risk of uncollectibility is not verified;
- B...: the requirement of uncollectibility is not verified due to the pendency of judicial action insofar as the Applicant is not a party to the proceedings;
- C..., S.A.: the requirement of uncollectibility is not verified due to the pendency of judicial action since the case in question was initiated by the shareholders (including the Applicant) against the Municipality of E... and not against the debtor entity;
p) The Applicant made efforts to collect debts through its own employees by fax or telephone or through personal visits to the headquarters of the debtor companies.
q) F..., Lda. was involved in the construction of a hotel in Porto and as a result of the crisis in 2010 began to have collection difficulties and difficulties in paying its debts;
r) The continuation of supplies by the Applicant to F... was justified to allow the company to maintain its activities;
s) H... was involved in the construction of the shopping center ..., a work that was suspended due to lack of payments, having been resumed only in 2013 after financing granted by I...;
t) D..., S.A. initiated an arbitral action against the Municipality of E... relating to the works contracts for the execution of the water supply network of the municipality of E..., of which B... was the adjudicatee;
u) The private shareholders of C..., S.A., which included the Applicant, initiated an arbitral action against the Municipality of E... to be compensated for expenses incurred in the execution of works that constituted the object of that company;
The Tribunal formed its conviction as to the proven facts on the basis of the documents attached to the petition and those contained in the administrative proceedings presented by the Tax Authority with its reply, as well as on the witness evidence produced.
II – Reasoning
Preliminary Issue: Suspension of Proceedings
5. The Tax Authority requests suspension of the arbitral proceedings, in accordance with the provisions of article 272, no. 1, of the Code of Civil Procedure, on the grounds that the corrections negative to taxable profit that are under analysis in the arbitral proceedings, with respect to impairment losses, may be influenced by the decision to be given in four judicial challenge proceedings pending before the Administrative and Fiscal Court of ..., relating to prior fiscal years, thus understanding that there is a relationship of prejudiciality between the present proceedings and those other judicial actions.
The aforementioned article 272, no. 1, subsidiarily applicable, provides that "the court may order suspension when the decision of the case is dependent on the judgment of another already filed or when another justified reason occurs", it being understood that this is merely a discretionary power of the judge that may be exercised optionally according to the circumstances of the case.
Now, the suspension of proceedings on the grounds of the pendency of proceedings with identical subject matter in the courts would be likely to undermine, first and foremost, the principle of procedural expedition, neutralizing the Applicant's interest in having the dispute with the Tax Authority resolved in due course through recourse to tax arbitration. Particularly because it would be difficult to foresee when the legal situation under consideration in the prejudicial cases would be definitively stabilized, so as to allow in the subordinate case a decision consistent with the prior judgment.
On the other hand, systematic suspension of proceedings on grounds of prejudiciality in relation to other proceedings already filed in which the same legal question is discussed, even if relating to different fiscal years, would in practice make it impossible to exercise the right to effective judicial protection, implying that the interested party would be prevented from obtaining an independent jurisdictional appraisal in relation to each of the different judicial claims it has raised.
And in any case, where the correction of taxable income by impairment losses is concerned, nothing prevents the underlying legal question from being decided in divergent terms according to the factuality that, in each case, may be ascertained, without any necessary dependence between successive judicial pronouncements.
Finally, it should be recalled that, in the event of an annulment judgment, it will always be possible for the Tax Authority to take the necessary acts and operations to reconstitute the violated legal situation, promoting corrections to the taxable matter that become justifiable to give effect to the sentence that may be issued both within the scope of this arbitral proceedings and within the scope of any of the judicial proceedings still pending.
There is no reason, therefore, to determine the requested suspension of proceedings.
Issues on the Merits
Compensatory Interest Debits
6. The first issue raised concerns compensatory interest for late payment of invoices in relation to various customers, which the Applicant did not account for as taxable income in the fiscal year corresponding to the date of issuance of the debit note, but as a credit in the "deferred revenues" account, on the basis of the understanding that compensatory interest would only be relevant as income when accepted by customers, which would only happen upon their actual receipt.
The Tax Authority understands that this accounting procedure violates the principle of economic specialization of fiscal years (now, accrual of taxable profit) referred to in article 18, no. 1, of the IRC Code.
The aforementioned article 18 of the IRC Code, in the part most relevant to consider, provides as follows:
1 - Income and expenses, as well as 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 accrual regime.
2 – Positive or negative components considered as relating to prior periods are only attributable to the taxation period when on the date of closure of the accounts of that to which they should have been attributed they were unforeseeable or manifestly unknown.
(...).
No. 1 establishes the accounting principle of economic specialization of fiscal years, which consists in including in fiscal results the revenues and costs (now, income and gains) corresponding to each fiscal year, independently of their actual receipt or payment. No. 2 allows revenues or costs relating to prior fiscal years to be attributable to another fiscal year only when on the date of closure of the accounts of that to which they should have been attributed they were unforeseeable or manifestly unknown.
This is an accounting criterion that reflects the principle of annual accrual of the tax and which means that the cost or revenue is trendily associated with the moment of issuance of the supporting document.
In the case at hand, it is established that the Applicant issued debit notes for compensatory interest for late payment of invoices in the fiscal year 2012, which were not declared as taxable income for that period, and were recorded as deferred revenues. It is also established that this procedure is used as a form of pressure on customers who are in default and that, sometimes, these debits end up being cancelled on the basis of the understanding that compensatory interest would only be relevant as income when accepted by customers, which, in the Applicant's view, would only happen upon payment. It was further demonstrated that the Applicant accounted as taxable income in the year 2012 interest that had been debited in 2011 and that the Tax Authority did not question prior to 2012 the procedure used by the taxpayer of deferring compensatory interest to the moment of its actual receipt.
As has been recognized by case law, it is not always justified to interpret the principle of accrual referred to in article 18 of the IRC Code in a strictly literal sense, especially when the attribution of the revenue or cost to a fiscal year different from the one to which it pertained does not result in prejudice to the National Treasury and the correction could result in a tax increase to the taxpayer.
As stated in the STA judgment of 13 October 1996 (Case no. 20404), without calling into question the tax relevance of the principle of specialization of fiscal years, the attribution of costs to other fiscal years is admissible when it has not resulted from voluntary and intentional omissions aimed at operating a transfer of results between fiscal years, as is the case when a period of exemption is about to end or begin, when there is an interest in reducing losses of a given fiscal year or in deriving benefits from their carryforward and when it is intended to reduce the amount of taxable profits. The same principle may be understood to apply to the attribution of gains.
It does not appear, however, that this case law understanding – which allows the principle of specialization of fiscal years to be articulated with the principle of justice – is relevant to the case at hand.
There being an obligation of compensatory interest, the corresponding income must be attributed to the taxation period in which the debit note was issued, independently of its receipt. The Applicant argues, however, that, in accordance with the practice it has been adopting, the compensatory interest debited in the course of 2012 may not correspond to income actually received, as will happen when the debit notes have been cancelled, and, in other cases, it may be income intended to be included in subsequent fiscal years when it is subject to actual collection. As this is a habitual procedure intended to function as a means of pressure on customers who are in default, the Applicant concludes that the deferral of income does not constitute a voluntary and intentional omission aimed at manipulating income and operating a transfer of results between fiscal years.
The point is that the application of the income accrual criterion cannot be made dependent on business management decisions that the Tax Authority cannot control. The accrual of taxable income is intended to define the moment when income should actually be subjected to taxation and is intended to facilitate the obtaining of information, not only by the State, but also by companies, which may calculate their costs and revenues on an annual basis for financial and tax purposes. Despite the greater flexibility of the accrual principle in accounting law regarding the timing of revenue recognition (cf. notably, paragraphs 18 and 22 of NCRF 20), the fact is that this cannot justify, at the tax level, the use of a random criterion in which the attribution of expenses or revenues to a given fiscal year is determined on the basis of mere business management options.
As noted before, the principle of income accrual in IRC can be flexibilized in certain circumstances for reasons of material justice. But that is not the situation in this case. If the taxpayer decides that it should forgo the collection of compensatory interest debited to certain customers, the corresponding amounts may be brought to costs in the fiscal year in which it lost the patrimonial advantage. There is no tax increase or disregard of revenues that the taxpayer ceased to benefit from. What happens is that income and costs are attributed to the fiscal years in which they were accountingly obtained or incurred.
The Applicant further argues, in the alternative, that, given that the Tax Authority questioned, for the first time with regard to the year 2012, the practice of deferring revenues relating to compensatory interest, then there would have to be a correction to taxable income by means of the deduction of amounts recognized as income in 2012 but that correspond to amounts debited in prior years.
First, it should be noted that we are dealing with a situation of deferral of the moment of payment of tax, that is, something from which the Applicant obtained an advantage, so the initiative for such a correction could only logically fall to the Tax Authority. Furthermore, the application of the principle of justice in the matter of accrual of taxable income, referred to above, would always prevent such a correction, insofar as this would result in the "transfer" of income to fiscal years in relation to which the statute of limitations on the right to assess has already expired.
Moreover, with the subject matter of the arbitral proceedings being delimited by the additional assessment relating to the fiscal year 2012, it does not fall to the tribunal to pronounce on tax acts relating to prior fiscal years, nor can it make relevant in the appraisal of the present claim the incidences of prior assessment that are covered by the case decided.
For all these reasons, the request is, in this part, unsubstantiated.
Construction Contracts – Degree of Completion
7. The Tax Authority determined the correction of taxable profit relating to a set of construction works of a multi-year nature in relation to the year 2012 on the grounds that there is a gap between the percentage of completion declared on the basis of the proportion between costs incurred and estimated costs and the degree of execution of the work revealed by the measurement records, the divergence in question being that which results from paragraphs j) and l) of the agreed factual matter.
The issue is related to the principle of income accrual referred to in article 18 of the IRC Code and the specific criterion for determining results of construction contracts set forth in the subsequent article 19.
Article 18, no. 1, establishes the principle whereby "income and expenses, as well as 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 accrual regime", and for that purpose, paragraph c) of no. 3 of that article specifies that "income and expenses from construction contracts must be accrued having regard to the provisions of article 19."
That article 19, applicable to the taxation and accrual of taxable profit from multi-year construction contracts, in the version in force at the date of the facts, established the following:
1 - The determination of results of construction contracts whose production cycle or execution time exceeds one year is made according to the percentage of completion criterion.
2 – For the purposes of the foregoing, the percentage of final completion for each taxation period corresponds to the proportion between costs incurred up to that date and the sum of those costs with those estimated for completion of the work.
(...).
As results from the transcribed no. 2, the solution of tax law is based on the determination of the percentage of completion through the proportion between costs incurred up to the balance sheet date and the sum of these costs with those estimated for completion of the contract, taking a clear option among the possible methods of income accrual from construction contracts contained in the Accounting Standards and Financial Reporting (NCRF).
The accounting rule, recognizing the difficulty of attributing the income and costs of the contract to the accounting periods in which the construction work is being performed (NCRF 19, paragraph 1), points to three possible methods for determining the percentage of completion in construction contracts: a) the proportion between contract costs incurred in work performed and total estimated contract costs; b) survey of work performed; c) the proportion of physical performance of contracted work (NCRF 19, paragraph 30).
And, as has been seen, the rule of article 19, no. 2, of the IRC Code, by stipulating, for the determination of income from construction contracts, a rule based on the percentage of completion relating to costs incurred and estimated, manifests a preference for one of the criteria admissible at the accounting level, ruling out the possibility of correction of net income being made through the physical percentage of completion that may be revealed by measurement records or any other form of inspection of the work site.
In the case under analysis, as results from the Tax Inspection Report, the Tax Authority found a divergence between the degree of completion declared by the taxpayer and the value of work performed on the basis of three following factors: i) in relation to a set of works, the estimated cost is identical to the total contract value; ii) for the five works in question, the measurement records reveal, in 2012, a degree of completion significantly higher; iii) in a physical visit to the sites of two works, evidence was obtained that these were already completed in 2013, but continued in 2015 with a degree of completion of approximately 50%. On these grounds, the Tax Authority determined the correction to taxable income, in the amount of € 3,578,833.94, considering that the declared degree of completion was lower than the execution percentage of the works, thus intending to attribute to the 2012 period income that had already been realized but had not yet been subjected to taxation.
It should first be noted that the assessment of the degree of completion by inspection of the site has no relevance to the case, since the Tax Inspection Report refers to a degree of completion relating to 2013 and, consequently, to a fiscal year after that which is under scrutiny in the present proceedings. And, thus, the determining reasons for the correction of taxable profit are, by exclusion, the finding of a gap between the declared percentage of completion and the percentage of completion executed that is revealed by the measurement records and, apparently, confirmed by the additional argument that, in some cases, the estimated cost of the work corresponds to the total contract value.
This latter circumstance is not proven by the elements on the record, and especially by the table contained in annex 6 of the Tax Inspection Report, which is reproduced at page 16 of that Report. In any case, the demonstration, through the inconsistency of accounting data or the results of measurement records, of the existence of a gap between the declared percentage of completion and the percentage of completion executed, is not, by itself, justification for the correction of taxable income.
As has been clarified, the criterion for determining taxable income that must be followed, in accordance with article 19, no. 2, of the IRC Code, is not that of the percentage of physical execution of the work, but that of the percentage of completion in accounting terms, based on costs incurred up to the end of the taxation period and costs estimated up to completion of the work. This means that the Tax Authority would have to transpose the reality evidenced by the measurement records to the accounting formula that is set forth by law, so as to establish in this way the degree of completion of work to be considered for tax purposes.
It is certain that, in invoking the gap existing between the degree of completion defined on the basis of accounting records and the degree of completion revealed by the measurement records, the Administration calls into question the presumption of truthfulness of the data and determinations contained in the accounts, implying that the burden of proof of the facts contained in the records falls on the taxpayer (article 75, no. 1, and no. 2, paragraph a)).
The point is that, despite this, the Administration could not substitute the legally defined criterion for determining the degree of completion with another that is based on the survey of work execution – and which, as such, is based solely on measurement records –, there being rather to determine taxable income through the legally applicable criterion, which, as we have seen, is based on the accounting calculation of costs incurred and estimated costs (in this sense, the arbitral judgment given in Case no. 724/2016-T, which ruled on a similar case).
The tax assessment act thus violates the provisions of article 19, no. 2, of the IRC Code.
Impairment Losses
8. There is also the question of disallowance of expenses for impairment losses in relation to various companies with respect to which the Tax Authority considered the risk of uncollectibility not verified. The non-acceptance for tax purposes of the expenses was due, in this case, to various reasons: maintenance of a continued commercial relationship with the Applicant (F..., Lda./H..., SA); legal qualification of the debtor entity as a company with exclusively public capital (G..., S.A); inapplicability of the criterion of judicial recovery of the receivable referred to in article 36, no. 1, paragraph c), of the IRC Code (B.../C..., S.A).
The applicable legal regime results from the combined provisions of articles 35 and 36 of the IRC Code.
Article 35, no. 1, paragraph a), of the IRC Code, in the version in force at the date of the facts, provided that impairment losses recorded in the same taxation period or prior taxation periods may be deducted for tax purposes "relating to receivables arising from normal activity that, at the end of the taxation period, may be considered doubtful of collection and are evidenced as such in the accounts".
For the purposes of determining impairment losses provided for in that provision, the subsequent article 36, in the part most relevant to consider, provided as follows:
1 - For IRC purposes, doubtful collection receivables are those in which the risk of uncollectibility is duly justified, which occurs in the following cases:
a) When the debtor has a pending execution proceeding, insolvency proceeding, special revitalization proceeding or company recovery procedure by extrajudicial means;
b) When the receivables have been claimed judicially or in arbitral tribunal;
c) When the receivables are in arrears for more than 6 months from the date of their maturity and there is objective evidence of impairment and that collection efforts have been made.
(...)
3. The following are not considered doubtful collection receivables:
a) Receivables from the State, autonomous regions, municipalities and public entities in general or receivables in respect of which these have provided a guarantee;
b) Receivables covered by insurance;
c) Receivables from natural or legal persons who directly or indirectly hold more than 10% of the capital;
d) Participations held, directly or indirectly, in more than 10% of the capital".
In the case at hand, the issue essentially concerns the uncollectibility criterion set forth in paragraphs b) and c) of no. 1 and paragraph a) of no. 3 of article 36. In accordance with the said paragraph b) of no. 1, the risk of uncollectibility is considered duly justified when the receivables have been claimed judicially or in an arbitral tribunal, and according to the provision of paragraph c) of that number, it must be proven that there are receivables in arrears for more than 6 months and there is objective evidence of impairment and that collection efforts have been made. In turn, paragraph a) of no. 3 disregards as doubtful collection receivables, in particular, receivables from the State, autonomous regions, municipalities and public entities in general.
As can be seen, in order for impairment losses to be accepted as tax expenses, they must be recorded and relate to doubtful collection receivables as evidenced in the accounts, and no. 1 of article 36 enumerates various situations indicative of uncollectibility, while no. 3 identifies other situations in which the risk of uncollectibility is ruled out.
Preliminarily, it should also be emphasized that it is the responsibility of the taxpayer to assess, when deciding to record impairments, whether the risk of uncollectibility is normal, or whether, at a given moment, it has become excessive. In any case, it is not for the Tax Authority to impose its risk assessment criteria on the businessman, but only to assess whether, given the facts considered, the decision appears reasonable and sufficiently justified.
In this case, it is established that the Applicant made efforts to collect debts through its own employees by fax or telephone or through personal visits to the headquarters of debtor companies.
Moreover, and regarding the first group of customers, it is established that the company F... was involved in the construction of a hotel unit in Porto and faced financial difficulties as a result of suspension of payments for work performed, and the company H... was also involved in the construction of the shopping center, a work that was suspended due to lack of payments and was resumed only in 2013.
The argument invoked by the Tax Authority to disregard for tax purposes the impairment losses, in that case, centers on the maintenance of commercial relationships with customers through the regularity of supplies and partial payments of amounts owed.
However, the maintenance of commercial relationships with debtors in arrears, as well as the assumption of the risk of granting credit to customers, constitutes a business management decision in which the Tax Authority does not have to interfere. What is relevant, considering the provision of article 36, no. 1, paragraph c), is whether the receivables are in arrears for more than 6 months and collection efforts were made and whether there is objective evidence of impairment. With the two first requirements proven in the case, it remains to ascertain whether objective evidence of impairment subsists.
On this point, NCRF 27 - Financial Instruments - is of particular relevance, applicable by force of the principle of partial dependence of the determination of taxable profit on that of accounting profit, which describes some of the indicators that could justify the business decision of impairment.
It provides as follows:
23 - At the date of each financial reporting period, an entity should assess the impairment of all financial assets that are not measured at fair value through results. If there is objective evidence of impairment, the entity should recognize an impairment loss in the statement of results.
24 - Objective evidence that a financial asset or a group of assets is impaired includes observable data that draw the asset holder's attention to the following loss events:
(a) Significant financial difficulty of the issuer or debtor;
(b) Contractual breach, such as non-payment or default in payment of interest or debt repayment;
(c) The creditor, for economic or legal reasons related to the debtor's financial difficulty, grants the debtor concessions that the creditor would not otherwise consider;
(d) It becomes probable that the debtor will enter into bankruptcy or any other financial reorganization;
(e) The disappearance of an active market for the financial asset due to the debtor's financial difficulties;
(f) Observable information indicating that there is a decrease in the estimated future cash flows of a group of financial assets since their initial recognition, although the decrease cannot yet be identified for a given individual financial asset in the group, such as adverse national, local or sector economic conditions.
In the case, facts were established (paragraphs q) and s) of the factual matter) that evidence that the companies in question went through significant financial difficulty that may be attributed to adverse national economic conditions, which allows the situation to be framed in paragraphs a) and f) of no. 24 of NCRF 27. And, on the other hand, the maintenance of the commercial relationship with the debtor companies – which the Tax Authority interprets as evidence of the absence of uncollectibility risk – can be seen, on the contrary, as objective evidence of impairment that may be framed in paragraph c) of that no. 24 of the accounting standard, insofar as it reveals the creditor's purpose to facilitate the commercial relationship due to the debtor's financial difficulty.
And, thus, there is no reason to disregard the impairment losses in these cases.
9. Another issue that arises in this context concerns the impairment loss relating to invoices that are outstanding by G..., S.A.
On this point, the Tax Authority merely states that G... is a company with exclusively public capital, with respect to which the requirements of article 36 of the IRC Code regarding the risk of uncollectibility cannot be considered verified, which suggests that G... is considered an entity equivalent to the State for purposes of the provision of article 36, no. 3, paragraph a), of the IRC Code.
Now, G..., incorporated by Decree-Law no. 32/95, of 11 February, and whose legal regime is currently defined in Decree-Law no. 42/2007, of 22 February, is characterized as a public company, which is governed by commercial law and the regime of the state business sector.
It is precisely the circumstance that it is a corporate entity with respect to which the State exercises dominant influence by virtue of, in particular, the holding of the majority of the share capital, which determines its qualification as a public company. A public company, despite exercising powers of authority that may be specially attributed to it by legal provision or concession contract, is incorporated in accordance with commercial law, has its own legal personality and is subject to a regime of private law (articles 14, no. 1, and 22, no. 1, of Decree-Law no. 133/2013, of 3 October).
It is thus wholly clear that G..., despite being qualified as a public company, is an entity under a private legal form and cannot be confused with the State, and consequently cannot be considered included in the rule of article 36, no. 3, paragraph a), of the IRC Code. Thus the receivables that the Applicant may have against that entity cannot fail to be included in the uncollectibility risk for purposes of determining impairment losses if the general requirements defined in paragraph c) of no. 1 of that provision are met.
The Tax Authority not questioning the verification of these requirements, since it merely invoked the circumstance that it is a company with exclusively public capital, there is no reason to rule out, in this case, the impairment losses declared.
10. There are also discussed the impairment losses with respect to B... and C..., S.A, on the grounds that it was understood by the Tax Authority that the receivables in question do not fall under the provision of article 36, no. 1, paragraph b), of the IRC Code.
The justification advanced by the Applicant for considering the impairments verified is similar. In one case, it is based on the decision given by an arbitral tribunal in a dispute that opposed B... to the Municipality of E... which had as its subject various works contracts for the execution of water supply in which that entity was the adjudicatee. In another case, the entities that held part of the share capital of C..., S.A, among which was the Applicant, initiated an action in arbitral tribunal against the Municipality of E... to be compensated for damages resulting from breach of contract relating to infrastructure works of a sports and cultural nature that constituted the object of the public-private partnership.
In the first case, the Applicant was a subcontractor in relation to the contracts that were the subject of the dispute. In the second case, the Applicant was a shareholder of C..., S.A and in that capacity initiated the action jointly with other shareholders.
The already transcribed rule of article 36, no. 1, paragraph b), of the IRC Code, then in force, considered as doubtful collection receivables those that "have been claimed judicially or in an arbitral tribunal". It is a requirement that the judicial claim refers to the receivables themselves that are the object of impairment losses and that the action be initiated against the debtor entity. It is the very circumstance that the creditor feels the need to bring a judicial claim against the debtor for breach that allows the receivable to be characterized as being of doubtful collection.
That is not the case when the procedural means is activated not against the debtor, but against a third entity, so the situation cannot be considered as falling within the mentioned rule of article 36, no. 1, paragraph b). The Applicant could have deducted such impairments, at least partially, under the provision of paragraph a) of that rule, provided its other requirements were met, but the fact is that it did not.
Compensatory Interest
9. The Applicant also challenges the assessment of compensatory interest in relation to any of the IRC assessment acts.
Pursuant to article 35, no. 1, of the General Tax Law, "compensatory interest is due when, owing to an act attributable to the taxpayer, the assessment of all or part of the tax due or the payment of tax to be paid in advance, or withheld or to be withheld within the scope of tax substitution, is delayed".
As has been the prevailing understanding, compensatory interest due under said provision constitutes a civil indemnity intended to compensate the Tax Authority for the loss of availability of an amount that was not assessed in a timely manner. As a civil indemnity, it is only exigible if there is a nexus of causality between the taxpayer's action and the delay in assessment and that action can be censurable on grounds of fraud or negligence.
Now, with respect to compensatory interest, it has been demonstrated that the deferral of compensatory interest debited for late performance constituted a habitual practice of the taxpayer that the Tax Authority had never questioned in relation to fiscal years prior to 2012. The delay in assessment relating to the interest debits cannot, therefore, be attributed to censurable error of the taxpayer when it merely used an accounting procedure that was acceptable and that the Administration had always validated in prior fiscal years.
The finding of the arbitral claim unsubstantiated regarding that additional assessment is not determinative, consequently, of the recognition of the right to compensatory interest.
On the other hand, there is no place for compensatory interest with respect to the degree of completion in construction contracts and to the situations of impairment losses in which the Applicant succeeded.
III – Decision
Terms of the Decision
To judge the arbitral claim substantiated and to annul the act of additional assessment of IRC under number 2016... resulting from corrections to the taxable matter relating to the degree of completion of construction contracts, in the total amount of € 3,578,833.94, and impairment losses with references to companies F..., Lda., in the amount of € 25,036.05, H..., SA, in the amount of € 177,719.07, and G..., S.A, in the amount of € 119,371.38;
Consequently, to judge the arbitral claim substantiated and to annul the acts of assessment of compensatory interest corresponding thereto, as well as the act of assessment of compensatory interest relating to compensatory interest debits;
To judge the arbitral claim unsubstantiated and to uphold the act of additional assessment of IRC under number 2016... in the segments relating to compensatory interest debits, in the total amount of € 3,850,087.52, and impairment losses with references to companies B..., in the total amount of € 4,855,483.16, and C..., S.A., in the total amount of € 4,880,171.49;
It is the responsibility of the Tax Authority, in compliance with the provision of article 24, no. 1, paragraph c), of the RJAT, to review, insofar as necessary, assessments relating to subsequent fiscal years, annulling the income relating to the debit notes that are the object of the present proceedings that may have been considered by the Applicant.
To judge the arbitral claim substantiated and to annul partially the act of tacit dismissal of the administrative appeal filed against the act of additional assessment.
Value of the Claim
The Applicant indicated as the value of the claim the amount of € 7,221,619.35, which was not contested by the Respondent and corresponds to the value of the assessment that it sought to contest, so the value of the claim is set at that amount.
Notify.
Lisbon, 17 October 2018
The President of the Arbitral Tribunal
Carlos Fernandes Cadilha
The Arbitrator member
Rui Duarte Morais
The Arbitrator member
Henrique Fiúza
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