CAAD 585/2018-T: IRC SGPS Capital Gains Deductibility Under Art. 32(2) EBF and Circular 7/2004

ARBITRAL DECISION (consult full version in PDF)

The arbitrators Dr. Jorge Lopes de Sousa (arbitrator-president), Dr. Hélder Faustino and Dr. Arlindo José Francisco designated by the Deontological Council of the Centre for Administrative Arbitration to form the Arbitral Tribunal, constituted on 04-02-2019, agree as follows:

1. Report

A..., Lda., legal entity no. ..., with registered office at ... street no. ..., ... - ... ..., hereinafter referred to as "A..." or "Claimant", filed a request for constitution of a collective arbitral tribunal, pursuant to the combined provisions of articles 2, no. 1, paragraph a), and 10, nos. 1 and 2, of Decree-Law no. 10/2011, of 20 January (hereinafter "RJAT"), with a view to obtaining a declaration of illegality of the Corporate Income Tax (IRC) assessment no. 2017..., relating to the 2013 tax year issued following a correction to taxable profit during tax inspection, which resulted in a reduction of the fiscal loss determined by the Tax Group in the amount of €934,408.94.

The request for constitution of the arbitral tribunal was accepted by the President of CAAD and notified to the TAX AUTHORITY AND CUSTOMS AUTHORITY on 23-11-2018.

The signatories communicated acceptance of performance of their functions within the applicable deadline.

On 14-01-2019, the Parties were notified of the designation of the arbitrators and did not manifest any intention to refuse, in accordance with the combined provisions of article 11, no. 1, paragraphs a) and b) of RJAT and articles 6 and 7 of the Code of Ethics.

Thus, in accordance with the provision of paragraph c) of no. 1 of article 11 of RJAT, the collective arbitral tribunal was constituted on 04-02-2019.

The Tax Authority and Customs Authority responded, defending the inadmissibility of the request for arbitral pronouncement.

By order of 20-03-2019, the value of the case was set at €934,408.09.

By order of 16-04-2019, it was decided to dispense with the holding of the meeting provided for in article 18 of RJAT and arguments.

The arbitral tribunal was regularly constituted and is competent.

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

The case does not suffer from nullities.

It is necessary to decide.

2. Matters of Fact

2.1. Proven Facts

The following facts are considered proven:

• The Claimant is the dominant company and responsible for the payment of Corporate Income Tax (IRC) of the Group ("Tax Group") to which in the 2013 tax year the Special Tax Regime for Groups of Companies (RETGS) was applicable, and which was composed of itself and the following companies:

  • Clinical Analysis Laboratory B..., SGPS, S.A. (hereinafter B...);
  • C..., Lda;
  • D..., Lda.; and

• The Claimant is a company that manages equity investments;

• A tax inspection was carried out on the Claimant relating to the 2013 tax year, in which the Tax Inspection Report was prepared, which is attached as document no. 1 with the request for arbitral pronouncement, whose content is reproduced below, in which it is referred to, among other things, the following:

CHAPTER III - DESCRIPTION OF FACTS AND GROUNDS FOR PURELY ARITHMETICAL CORRECTIONS TO TAXABLE MATTER

III.1. Correction effected in the individual sphere of LABORATORY OF CLINICAL ANALYSES B... SGPS, SA

Following the inspective action authorized by internal work order no. 012016..., on the individual result of the company LABORATORY OF CLINICAL ANALYSES B... SGPS, SA, TIN no. ..., relating to the 2013 tax year, it was concluded that the taxable person was in non-conformity with what is established in no. 2 of article 32 of the Tax Benefits Statute.

According to the instructions explained in Circular no. 7/2004, of 30 March, of DSIRC, the value of deduction was determined and should have been added to the company's tax result, by entering the respective value in field 779 of table 07 of the tax return, was €934,408.94.

The facts and conclusion are set out in the Tax Inspection Report resulting from Work Order no. OI2016..., which are transcribed below:

"IRC - Financial Charges Attributable to Capital Shares

III.1.1. Matters of Fact

From the analysis of the 2013 analytical trial balance, before determining results, it was verified that the items "Other Expenses and Losses" (account 68) and "Interest and Similar Expenses Borne" (account 69) of the Statement of Results present the following composition:

[table content in original]

According to information provided by the taxpayer, it is verified that the expenses and losses shown in the table above result, in their majority, from loans obtained from the following related companies:

[table content in original]

When the taxpayer was questioned about the justification for the indispensability of financing expenses for the development of activity, in accordance with article 23 of CIRC, in the email of 11-05-2017, it informed that "the financial expenses borne were incurred in pursuit of the company's activity, that is, in the management of equity investments in other companies, as an indirect form of exercise of economic activities". Being that, in the email of 02-06-2017, it complements the previous answer, explaining the application of loans obtained, stating that "the loans obtained, which justify the financing expenses borne (account 69114 Interest IC), were used for:

• Treasury management of its subsidiaries;

• Acquisition of equity investments (carried out in previous years);

• Performance of supplementary contributions (in the year and in previous years);

• Performance of capital increases in previous years"

On 14-06-2017, the following question was raised, via email:

"2. Taking into account the application of loans obtained set out in the response to point 3, of the email of 2017-06-02, and considering that the company Clinical Analysis Laboratory B... SGPSA, SA is a company managing equity investments, justify the reasons for non-application, regarding the financial charges borne in the 2013 tax year, of the provisions of no. 2 of article 32 of EBF and Circular no. 7/2004, of 30 March, that is, not having increased in Table 07 of the IRC Form 22 the value of financial charges attributable to capital shares"

In the response obtained on 2017-06-22, the taxpayer invokes having existed "Lapse in the preparation of Table 07 of Form 22, due to lack of knowledge".

III.1.2. Tax Framework

The company LABORATORY B... SGPS exercised the activity of "Company Managing Equity Investments", whereby it was subject to the provisions of article 32 of the Tax Benefits Statute (EBF).

The regime instituted, in no. 2 of article 32 of EBF, added by no. 5 of article 38 of Law no. 32-B/2002, of 30/12, in the wording in force at the date of the facts, provides that "the gains and losses realized by SGPS and SCR through onerous transmission, whatever the title by which it operates, of capital shares of which they are holders, provided they are held for a period not less than one year, and likewise, the financial charges borne with their acquisition, do not concur for the formation of taxable profit of these companies".

On this matter (financial charges borne with the acquisition of capital shares in SGPS) the Tax Authority came to clarify, through Circular no. 7/2004, of 30 March, from the Corporate Income Tax Services Directorate (DSIRC), the following:

• with respect to financial charges, the new regime "is applicable in tax periods beginning after 1 January 2003, even if they relate to financing contracted before that date", as per point 5);

• in the tax year in which the financial charges should be disregarded as costs for tax purposes, "correction of those borne with the acquisition of holdings that are likely to benefit from the special regime established in no. 2 of article 31 of EBF should be carried out, in the year to which they relate, regardless of whether all conditions for the application of the special regime for taxation of gains have already been met", as per point 6);

• "as to the method to be used for the purpose of allocating the financial charges borne to the acquisition of equity investments, given the extreme difficulty of using (...) a method of direct or specific allocation and the possibility of manipulation that the same would allow, such allocation should be effected based on a formula that takes into account the following: the remunerated liabilities of SGPS and SCR should be allocated, first, to remunerative loans granted by these to the subsidiary companies and other interest-bearing investments, with the remainder being allocated to the remaining assets, namely equity investments, proportionally to their respective acquisition cost.", as per point 7).

III.1.3. Proposed Correction

In accordance with no. 2 of article 32 of EBF, the charges borne by SGPS, with the acquisition of capital shares, provided they are held for a period not less than one year, do not concur for the formation of taxable profit.

In accordance with the instructions explained in Circular no. 7/2004, of 30 March, of DSIRC, the value of financial charges, borne by the taxpayer, in the 2013 tax year, not deductible amounts to €934,408.94, as demonstrated below:

[table content in original]

This value was omitted by the taxpayer, in the determination of the taxable profit for the 2013 tax year, in that it was not entered in field 779 (Financial Charges not deductible - article 32, no. 2 of EBF) of table 07 of the IRC Form 22.

In view of the above, it is proposed that the tax loss declared by the company LABORATORY B... SGPS, in the 2013 tax year, be corrected to €276,480.66, calculated as follows:

[table content in original]

(...)

III.2. Correction to Tax Result declared by the group

In accordance with the provisions of no. 1 of article 70 of CIRC, the taxable profit of the group "is calculated by the dominant company, through the algebraic sum of taxable profits and tax losses determined in the individual periodic tax returns of each of the companies belonging to the group". Thus, the corrections detected in the individual IRC Form 22 of the aforementioned company have an impact on the tax result of the group.

Thus, in the 2013 tax year, it is proposed to alter the algebraic sum of the tax results (loss) of the group of companies from -€1,150,575.05 to -€216,166.11, as per the following table:

[table content in original]

III.3. Correction to Deductible Tax Losses of the Group

The taxpayer declared in field 303 - Deductible Tax Losses of table 09 of the IRC Form 22, the amount of €5,496,699.32. When questioned about how this was determined, it informed that the amount indicated resulted from the sum of the group's tax results for the years 2010, 2011 and 2012, as follows:

[table content in original]

From the analysis carried out it was ascertained that the amount of the deductible tax loss of the group declared is incorrect, considering that:

• In the 2010 tax year, the company E... LDA, was not part of the consolidation scope of the group, whereby the value of its tax loss should not be included;

• In the 2011 tax year, in addition to the companies considered, companies C... LDA and F..., LDA were part of the consolidation scope, whose taxable results were not included.

In view of the above, the correct value of Deductible Tax Losses, to be declared in field 303, of table 09 of form 22, is €4,861,840.93, decomposed as follows:

[table content in original]

• Following the inspective action, the Claimant, in its capacity as the dominant company of the aforementioned Tax Group, was notified of the IRC assessment no. 2017..., relating to the 2013 tax year which is attached as document no. 2 with the request for arbitral pronouncement), in which the reduction of the tax loss determined by the Tax Group in the amount of €934,408.94 is materialized (reduction of the tax loss of €1,150,575.05, indicated in the tax return attached as document no. 5, to €216,166.11);

• The Claimant filed a gracious complaint against the said IRC assessment relating to the 2013 tax year, and on 29-08-2018 was notified of the decision denying it, by order issued on 22-08-2018 by the Chief of the Tax Services Office of ... (document no. 3 attached with the request for arbitral pronouncement, whose content is reproduced below);

• The decision denying the gracious complaint manifests agreement with the information contained in document no. 6 attached with the request for arbitral pronouncement, whose content is reproduced below, in which it is referred to, among other things, the following:

On the appreciation of the request

The complainant is the dominant company of a group of companies that is framed, for IRC purposes, in the Special Tax Regime for Groups of Companies, hereinafter RETGS.

In the case at hand, what is at issue is whether the positive correction/increase, carried out by the Tax Inspection, relating to financial charges borne with the acquisition of capital shares, in application of no. 2 of article 32 of the EBF, suffers from error in factual assumptions and violation of law.

According to what is contained in no. 2 of article 32 of EBF "the gains and losses realized by SGPS and SCR through onerous transmission, whatever the title by which it operates, of capital shares of which they are holders, provided they are held for a period not less than one year, and likewise, the financial charges borne with their acquisition, do not concur for the formation of taxable profit of these companies" Wording given by Law no. 32-B/2002 of 30 December.

With regard to the tax regime applicable to financial charges provided for in the aforementioned article, Circular 7/2004, of 30 March, from the Corporate Income Tax Services Directorate, comes to sanction the following understanding with respect to the method to be used for the purpose of allocating financial charges to equity investments.

"given the extreme difficulty of using, in this matter, a method of direct or specific allocation and the possibility of manipulation that the same would allow, such allocation should be effected based on a formula that takes into account the following: the remunerated liabilities of SGPS and SCR should be allocated, first, to remunerative loans granted by these to the subsidiary companies and other interest-bearing investments, with the remainder being allocated to the remaining assets, namely equity investments, proportionally to their respective acquisition cost".

The aforementioned Circular merely establishes the methodology to be observed in the calculation of financial charges attributable to capital shares, to thereby operationalize the application of no. 2 of article 32 of EBF.

The fact that the Tax Inspection resorts to the Circular to proceed with the quantification of the amount of financial charges attributable to capital shares does not translate into a diminution of the rights and guarantees of the complainant who was the object of a tax inspective action.

The performance of the TA resulted from the aforementioned legal provision, the criteria and method proposed for the purpose of determining financial charges are characterized by objectivity, adequacy and reasonableness given the difficulties that the adoption of a method of direct allocation presents, resorting to the circular only to ascertain the calculation method, without thereby belying the scope of the actual incidence legally established, nor distorting the legal text, not disregarding the effective nature of the charges nor the moment when they are incurred, nor restricting the application of tax law, always considering the ultimate objective pursued by the legislator in establishing the non-deductibility of the charges in question, whereby it does not offend the principles of legality and typicality. As Saldanha Sanches states, "administrative guidelines, in the form of circulars or in other forms, are an interpretation of tax law and an instrument unifying the decisions, necessarily decentralized, of the administration and have their specific function in the mass process that constitutes the tax process, as an attempt to reconcile the decentralized decision and the definitiveness of tax acts, even when carried out on the basis of the pyramid of fiscal administrative organization. The administrative guidance, a circular from any TA Service or a superiorly approved opinion, can thus be considered, within these limits, as a source of law like any other form of doctrine".

The TA is bound by the content of the circulars it issues regarding the understanding of applicable tax norms, and it is certain that such binding results in express and unequivocal form from what is provided in no. 1 of article 68-A of LGT and constitutes a necessary consequence of the principles of good faith and equality, which govern the exercise of administrative activity, as embodied in no. 2 of article 266 of CRP.

Let us cite the Decision of the Constitutional Court no. 583/09, in Case no. 873/08, of the 3rd Section of the Constitutional Court "The circumstance that the TA is bound (no. 1 of article 68-A of LGT) by the generic guidelines contained in circulars in force at the time of the tax fact and has the duty to proceed with the conversion of binding information or other type of understanding given to taxpayers into administrative circulars, in certain circumstances (no. 3 of article 68 of LGT), does not alter this perspective because it does not transform that content into a norm with external effect. It is certain that the administrado can invoke, in confrontation with the administration, the content of the publicized administrative guidance and, if appropriate, enforce it before the courts, even at the cost of sacrificing the principle of legality. But it is under the principle of good faith and legal certainty, not by its normative value, that the content of the circulars prevails. The administrado only complies with them if and as long as it suits him, for the same reasons that justify that he may invoke individual binding information that favors him (paragraph e) of no. 3 of article 59 and article 68 of LGT)" "Consequently, lacking heteronymous binding force for individuals and imposing on the judge only the doctrinal value they may possess, the prescriptions contained in the TA 'circulars' do not constitute norms for purposes of the constitutional control system of the jurisdiction of the Constitutional Court, namely to open the avenue of appeal provided for in paragraph a) of no. 1 of article 70 of LTC".

Thus, the correction made to financial charges does not suffer from error in factual assumptions or violation of law.

We fully subscribe to the RIT.

Therefore, we understand that the pretension of the complainant should be dismissed.

• At the end of the 2013 tax period, as the TA presents in the Inspection Report (Doc. no. 1, page 7), the investment portfolio of B... SGPS had the composition and acquisition costs reproduced below, totaling €13,147,686.96;

• Applying the formula of Circular no. 7/2004 taking as capital shares also supplementary and ancillary contributions made, the Tax Authority and Customs Authority determined a percentage allocation to capital shares of the financial charges borne of 99.82% thereof (table on page 7 of RIT, in Doc. no. 1: €934,408.94 / €936,070.93 = 99.82%);

• The financing obtained by the Claimant that generated charges in the 2013 tax year were intended for

• Treasury management of its subsidiaries;

• Acquisition of equity investments (carried out in previous years);

• Performance of supplementary contributions (in the year and in previous years);

• Performance of capital increases in previous years (information referred to in the Tax Inspection Report);

• On 22-11-2018, the Claimant filed the request for arbitral pronouncement that gave rise to the present case.

2.2. Unproven Facts and Justification of the Decision on Matters of Fact

The facts were proven on the basis of the facts alleged by the Claimant that are not contradicted by any evidence presented by the Tax Authority and Customs Authority and by the documents attached to the initial petition.

The Tax Authority and Customs Authority did not submit an administrative file.

3. Matters of Law

The Tax Authority and Customs Authority made corrections to the taxable matter of the Claimant, for the 2013 tax year relating to financial charges borne in 2013, which it considered are not deductible by virtue of the provisions of no. 2 of article 32 of EBF, in the amount of €934,408.94, a value that was determined by applying the method provided for in point 7 of Circular no. 7/2004, of 30 March.

To determine this value the Tax Authority and Customs Authority included the value of supplementary contributions which it considered "capital shares", for purposes of no. 2 of article 32 of EBF.

3.1. Question of the Illegality of the Application of the Method Provided for in Point 7 of Circular no. 7/2004

Article 32 of EBF, in the wording in force in 2013 (introduced by Law no. 64-B/2011, of 30 December), establishes the following:

2 - The gains and losses realized by SGPS of capital shares of which they are holders, provided they are held for a period not less than one year, and likewise, the financial charges borne with their acquisition do not concur for the formation of taxable profit of these companies.

In Circular no. 7/2004, of 30 March, the Corporate Income Tax Services Directorate came to clarify its understanding of the application of this norm, saying, among other things, the following:

Method to be used for the purpose of allocating financial charges to equity investments

7. As to the method to be used for the purpose of allocating the financial charges borne to the acquisition of equity investments, given the extreme difficulty of using, in this matter, a method of direct or specific allocation and the possibility of manipulation that the same would allow, such allocation should be effected based on a formula that takes into account the following: the remunerated liabilities of SGPS and SCR should be allocated, first, to remunerative loans granted by these to the subsidiary companies and other interest-bearing investments, with the remainder being allocated to the remaining assets, namely equity investments, proportionally to their respective acquisition cost.

The general regime of relevance of gains and losses and financial charges for the formation of taxable profit of entities subject to IRC was translated into the inclusion of gains and financial charges, in full [articles 20, no. 1, paragraph h), and 23, no. 1, paragraph a), of CIRC in the wording resulting from Decree-Law no. 159/2009, of 13 July), and the inclusion of losses in 50% [pursuant to articles 23, no. 1, paragraph l) and 45, no. 3, of the same Code].

For SGPS, article 32, no. 2, of EBF (in addition to other situations provided for in its no. 3), established a special regime, which did not necessarily reduce to a benefit, which was translated, in general, into the irrelevance for the formation of taxable profit of SGPS of gains and losses realized from capital shares held for at least one year, accompanied by the non-inclusion for the formation of taxable profit of financial charges borne with their acquisition.

In no. 2 of article 32 of EBF it is established that the "financial charges borne with their acquisition" do not concur for the formation of taxable profit, referring to capital shares, whereby it must be concluded that its literal content indicates that only financial charges that are connected with the acquisition of equity investments are covered by the non-deductibility established therein.

Beyond this being the interpretation that results from the literal content, it is corroborated by the explanation for its introduction in the EBF that was given in the State Budget Report for 2003 (Law no. 32-B/2002, of 30 December).

In fact, as referred to in Circular no. 7/2004, the regime of this norm was introduced in the EBF by Law no. 32-B/2002, of 30 December, which approved the State Budget for 2003, giving new wording to article 31, whose regime came to be contained in article 32 after the renumbering carried out by Decree-Law no. 108/2008, of 26 June.

In Bill no. 28-IX, which came to give rise to the Budget Law for 2003, the text of that article 31, no. 2, with wording identical to that in force in 2012 (in article 32, no. 2) was contained, the only difference being the addition of the reference to "VCR" (abbreviation of "venture capital investors"), which is irrelevant for the interpretation of the norm.

In the aforementioned State Budget Report for 2003, after finding a drop in the budget execution of 2002 regarding IRC announced the introduction of several measures aimed at the "expansion of the tax base and moralization and neutrality measures", among which that of non-deductibility of financial nature charges directly associated with the acquisition of equity shares by SGPS, which is announced in the following terms:

"It is established the disregard of the deductibility, for purposes of determining taxable profit, of charges of a financial nature directly associated with the acquisition of equity shares by SGPS";

It is unequivocal, thus, that it was intended that only financial charges directly associated with the acquisition of equity shares be covered by the non-deductibility.

By that express reference in the Report to the need for financial charges to be directly associated with the acquisition of equity shares (which is also expressed in the text of the norm through the reference to "financial charges with their acquisition"), it is concluded that it is not enough, to determine the non-deductibility of financial charges, the finding that the SGPS is holder of equity investments and bore financial charges, it being necessary to demonstrate that there is a direct relationship between certain financial charges and the acquisition of determined equity investments.

It is a corollary of this interpretation, imposed by the literal content of article 32, no. 2, that, if certain investments were not acquired with liabilities generating financial charges (namely, those obtained by contributions in kind or with use of own capital), they are irrelevant for the purpose of the application of that norm, in the part that refers to the non-deductibility of financial charges.

It is also a corollary of this interpretation that, with respect to equity investments acquired with financing generating charges, only the charges derived from the financing relating to their acquisition are non-deductible.

There is thus no legal support to set aside the rule of deductibility of financial charges, which is contained in paragraph c) of no. 1 of article 23 of CIRC, in relation to charges that are not directly associated with the acquisition of equity investments.

Therefore, it is clear, in light of the letter of the final part of no. 1 of article 32 and the explanation given in the Budget Report for 2003, that the non-deductibility of charges applies only to those that are directly derived from financing used for acquisition of equity investments.

Being this the regime that is provided for in law, it cannot be altered by regulatory means, since precepts created by acts of a legislative nature cannot be, with external efficacy, interpreted, integrated, modified, suspended or revoked by acts of another nature (article 112, no. 5, of CRP). Furthermore, as the Claimant also argues, article 32, no. 2, of EBF is a norm that deals with tax incidence, in broad sense, by decisively influencing the determination of taxable matter, whereby it is included in the reserve of law, pursuant to articles 103, no. 2, and 165, no. 1, paragraph i), of CRP. Therefore, point 7 of Circular no. 7/2004 violates the principle of legality.

The principle of legality, invoked by the Claimant, which is supported in articles 266, no. 2, of CRP and 55 of LGT, results that "the organs of Public Administration must act in obedience to law and law, within the limits of the powers that are attributed to them and in conformity with the purposes for which the same powers are conferred on them" [article 3, no. 1, of the Administrative Procedure Code of 1991, in force in 2013, subsidiarily applicable pursuant to article 2, paragraph c), of LGT].

In light of this norm, the principle of legality ceased to have "a formulation that was only negative (as in the period of the Liberal State), to pass to have a positive formulation, constituting the foundation, the criterion and the limit of all administrative action".

From these norms it results that the use of indirect methods of determination of taxable matter can only take place in the situations provided for in law, namely in article 87, no. 1, of LGT and, even in them, can only be carried out to the extent that the use of direct methods is not viable, as results from the rule of subsidiarity, imposed by article 85.

No. 2 of article 32 of EBF governs "the formation of taxable profit" of SGPS, as is expressly referred to in its final part, imposing on the determination of its taxable matter three special rules in relation to the general regime:

– a rule that favors them in relation to the general regime, which is that of irrelevance for the formation of taxable profit of gains realized with capital shares held for more than one year, setting aside the rule of determination of taxable matter that is contained in article 20, no. 1, paragraph h), of CIRC;

– two that disadvantage them, which are that of irrelevance for the formation of taxable profit of losses realized and financial charges borne with the acquisition of capital shares, which set aside the application of the rules of determination of taxable matter provided for in paragraphs c) and l) of no. 1 of article 23 of CIRC (in the wording in force in 2013).

Both rules of determination of taxable matter of IRC are those that indicate the income, patrimonial variations and expenses that are relevant for the formation of taxable profit and those that indicate the income, patrimonial variations and expenses that have no relevance for that purpose.

Both is norm of determination of taxable matter of IRC the paragraph h) of no. 1 of article 20 of CIRC, which provides for the relevance for that purpose of gains realized, as is that of article 32, no. 2, of EBF that sets it aside with respect to losses obtained with capital shares held by SGPS for more than one year.

Both are norms of determination of taxable matter of IRC those of paragraphs c) and l) of no. 1 of article 23 of CIRC, which provide for the relevance of financial charges and losses realized as is that of article 32, no. 2, of EBF that sets aside that relevance in the case of capital shares held by SGPS for more than one year.

Therefore, there is no reason not to attribute to the three rules provided for in article 32, no. 2, of EBF the qualification of special rules of determination of taxable matter of SGPS, which, being special, prevail, in their domain of application, over the general rules on this matter.

Being thus, the procedural rules provided for in LGT on the determination of taxable matter are applicable in this matter, namely those of subsidiarity of indirect methods and situations in which their use is authorized, provided for in articles 81, no. 1, 85, no. 1, and 87, no. 1, of LGT invoked by the Claimant.

The rule of subsidiarity of the use of indirect methods has as a corollary that, to the extent that the use of direct method is viable, the determination of taxable matter should be effected with its use, only indirect methods being used as to the determination of taxable matter that cannot be effected directly. This is the reach of that rule which is made explicit in no. 2 of article 85 of LGT, in which it is established that "to indirect assessment apply, whenever possible and the law does not prescribe otherwise, the rules of direct assessment".

That is, even if one is faced with a situation in which it is not viable to carry out the determination of taxable matter in its entirety by direct methods and there is a need to resort to the use of indirect methods, direct methods must be used to the extent that this is possible, only indirect methods being able to be used to the residual part of the determination of taxable matter.

One is faced with the use of direct methods of determination of taxable matter when one aims to determine the real value of income or goods subject to taxation and use of indirect methods when one aims the determination of the value of taxable income or goods from indicia, presumptions or other elements that the tax administration has available (article 83 of LGT).

With respect to the determination of financial charges borne by SGPS with the acquisition of capital shares, one is faced with the use of direct method when one aims to determine the real allocation of financial charges to the acquisition of capital shares, namely by ascertaining exactly whether there was financing to acquire each of the capital shares acquired and the financial charges that resulted from them. And one is faced with the use of indirect methods when one does not aim to reach that real allocation, but rather a presumed allocation, based on a formula in which one considers the value of the capital shares held by SGPS, the values of the totality of its assets and liabilities and the totality of financial charges borne.

In this light, point 7 of Circular no. 7/2004 of 30 March, of DSIRC (Corporate Income Tax Services Directorate), in establishing that "... given the extreme difficulty of using, in this matter, a method of direct or specific allocation and the possibility of manipulation that the same would allow, such allocation should be effected based on a formula..." manifestly provides for an indirect method of determination of financial charges borne with the acquisition of capital shares, since with it one does not aim to determine exactly whether there was financing connected with the acquisition of capital shares and the charges effectively borne with that financing, but rather one aims to determine such charges based on a presumption that the financing (remunerated liabilities) of SGPS are allocated first to remunerative loans to subsidiaries and other investments generating interest and, as remainder, to the remaining assets, proportionally to their respective acquisition cost.

Embodying the application of the method provided for in this point 7 of Circular no. 7/2004 the use of an indirect method of determination of taxable matter, it can only be applied if one is faced with a situation included in the exhaustive list contained in article 87, no. 1, of LGT ("indirect assessment can only be carried out...").

Upon examining the situations enumerated in this norm, only the possibility of framing the situation in the present case in paragraph b) is foreseen, which permits indirect assessment in case of "impossibility of direct and exact proof and quantification of the elements indispensable to the correct determination of taxable matter of any tax".

In the Tax Inspection Report there is no demonstration of the need to use indirect methods, and it is even expressly stated, in part IV of the Tax Inspection Report, relating to "REASON AND EXPOSITION OF FACTS THAT IMPLY RESORTING TO INDIRECT METHODS", that "Not applicable to the case under consideration".

Furthermore, by force of the principle of hierarchy of norms, enunciated in article 112, no. 5, of CRP, an act of a regulatory nature, such as Circular no. 7/2004, cannot, with external efficacy, interpret, integrate, modify, suspend or revoke any norm of a legislative nature, such as those of LGT.

Thus, the mere fact that the corrections effected were based on the indirect method referred to in point 7 of Circular no. 7/2004, not provided for in law and without the conditions for the application of indirect methods being met, is sufficient to conclude its illegality.

In fact, pursuant to the provisions of article 81 of LGT, "taxable matter is assessed or calculated directly according to the criteria specific to each tax, the tax administration only being able to proceed to indirect assessment in cases and conditions expressly provided for in law".

Therefore, the use of indirect methods could only take place if it was based on the identification of one of the situations provided for in article 87 of CIRC and, in the case of demonstrating "impossibility of direct and exact proof and quantification of the elements indispensable to the correct determination of taxable matter", provided for in paragraph b) of no. 1 of article 87 and in paragraph a) of article 88 of LGT, the fixation of taxable matter could only be based on the elements indicated in article 90 of the same Law and with application of the procedures provided for in its article 91.

With effect, the extreme difficulty and possibility of manipulation that are indicated in point 7 of Circular no. 7/2004 and the calculation formula there provided, which does not take into account any of the elements provided for in law, are not "cases and conditions expressly provided for in law", as required by that article 81 to enable the use of indirect methods.

Thus, as the Supreme Administrative Court has uniformly and repeatedly understood, the Tax Authority and Customs Authority used a method provided for in point 7 of Circular no. 7/2004, which is "an indirect, presumptive method of allocation of financial charges in disrespect of articles 87 to 90 of LGT being, therefore, illegal" (decisions of 08-03-2017, delivered in case no. 0227/16; of 31-05-2017, delivered in case no. 01229/15; of 31-05-2017, delivered in case no. 01229/15; of 24-01-2018, delivered in case no. 0745/15; and of 31-01-2018, delivered in case no. 01157/17).

The use of this method "affronts the principle of tax legality" (decision of the Supreme Administrative Court of 29-11-2017, delivered in case no. 01292/16).

Thus, in line with this uniform case law, because the Tax Authority and Customs Authority applied an illegal indirect method of determination of taxable matter, it must be concluded that the impugned assessment suffers from a defect of violation of law, in the part in which it is based on corrections effected based on the application of article 32, no. 2, of EBF.

This defect justifies the annulment of the assessment, pursuant to article 163, no. 1, of the Administrative Procedure Code subsidiarily applicable pursuant to article 2, paragraph c), of LGT.

3.2. Question of the Inclusion of the Value of Financial Charges Connected with Supplementary Contributions to Determine the Financial Charges Borne with the Acquisition of Capital Shares

Part of the financial charges borne by the Claimant in the 2013 tax year are connected with the performance of supplementary contributions, as is affirmed by the Claimant, without any evidence to the contrary.

Article 32, no. 2, of EBF makes reference to "capital shares" and to "financial charges borne with their acquisition".

The Claimant argues that the charges borne with supplementary contributions are not covered by the non-deductibility provided for in that article 32, no. 2, because these are not included in the concept of "capital shares".

"In determining the meaning of tax norms and in the qualification of facts to which they apply, the general rules and principles of interpretation and application of laws are observed" (article 11, no. 1, of LGT), which constitutes a referral to article 9 of the Civil Code.

In no. 2 of the same article 11 it is established that "whenever, in tax norms, terms proper to other branches of law are employed, the same must be interpreted in the same sense as they have therein, unless otherwise results directly from law".

From this norm it results that, although the rule is that the terms used in tax norms should be interpreted with the same reach that they have in other branches of law, there is an exception, which is that it results directly from tax law that the meaning of the term used in tax law is different from what it has in other branches of law.

Incidentally, this exception is in harmony with another general interpretative rule, which is that special law prefers general law in its specific domain of application. That is, if it results directly from a tax norm, special for the situation it regulates, the meaning of a certain term, it will not be interesting to know whether that meaning corresponds or not to that used in general law, since that meaning directly resulting from law for a specific situation will necessarily be the one that must be adopted, with disregard of the meaning with which the concept is used in any norm that is not of a special law character for the referred situation.

In any case, from no. 2 of article 11 of EBF it results that, in good hermeneutics, the first task of the interpreter of tax law to ascertain the reach of a term used therein is to ascertain whether from tax law directly results the meaning of that term.

Only if one is not faced with a situation of this type, could one appeal to the meaning of the terms used in other branches of law.

Now, in the case at hand, for clarification of the question of whether supplementary contributions are covered by the concept of "capital shares" there is a norm from which it directly results that those are not encompassed in this concept, which is no. 3 of article 45 of CIRC, in the wording of Decree-Law no. 159/2009, of 13 July, in force in the year 2011.

It is established in this no. 3 of article 45 the following:

3 – The negative difference between gains and losses realized through onerous transmission of capital shares, including their redemption and amortization with capital reduction, as well as other losses or negative patrimonial variations relating to capital shares or other components of shareholders' equity, namely supplementary contributions, contribute to the formation of taxable profit in only half their value.

Two concepts are used in this norm: that of "capital shares" and that of "other components of shareholders' equity".

"Capital shares" are also "components of shareholders' equity", as is inferred from the word "other", but the reach of "capital shares" is necessarily more restricted than that of "shareholders' equity", which will encompass, in addition to "capital shares" also "the other components".

As the norm is worded, supplementary contributions will be encompassed in the concept of "other components of shareholders' equity" and not in "capital shares", since the reference to those appears following this latter concept and not the former.

In fact, if it were understood, for this purpose, that supplementary contributions were integrated into the concept of "capital shares", it would be obvious that the reference to them would be included following this concept and not following the concept of "shareholders' equity": that is, it would be said "(...) losses or negative patrimonial variations relating to capital shares, namely supplementary contributions, or other components of shareholders' equity contribute to the formation of taxable profit in only half their value".

That reference to supplementary contributions did not exist in the wording of article 42 of CIRC of Law no. 32-B/2002, of 30 December, only being made in the wording introduced by Law no. 60-A/2005, of 30 December, whereby the legislative amendment was made with the aim of clarifying the tax reach of the concepts used, namely the concept of "capital shares", showing that this, in the perspective of the legislator of CIRC, did not encompass supplementary contributions.

Dealing with an amendment with a clarifying reach, it is to be presumed with reinforcement that the legislator knew how to concretize adequately the purpose (article 9, no. 3, of the Civil Code), and intended to make explicit that supplementary contributions, for purposes of IRC, are framed between the "other components of shareholders' equity" and not in "capital shares".

This delimitation of the concept of "capital shares" which is extracted from the referred no. 2 of article 45 is made for purposes of determination of losses, which is included in the subject matter dealt with by article 32, no. 2, of EBF (it is a norm that sets aside in relation to SGPS the tax relevance generally provided for in CIRC for gains and losses) whereby, having to presume that the legislator expressed its thought in adequate terms (pursuant to the referred article 9, no. 3, of the Civil Code), the conclusion that the same concept of "capital shares" that was used in the norm providing for general tax relevance was used in the special norm is justified.

Furthermore, the norm of article 32, no. 2, of EBF was reformulated by Law no. 64-B/2011, of 30 December, already after the amendment introduced by Law no. 60-A/2005 in article 45 of CIRC and the new wording of that norm maintains the reference only to "capital shares" without any allusion to "other components of shareholders' equity" to which article 45, no. 2 alludes.

This conclusion, extracted from the literal content of article 32, no. 2, of EBF, combined with article 45, no. 2, is confirmed by the raison d'être of the special regime of gains and losses realized by SGPS, which does not hold with respect to supplementary contributions, as is proficiently explained in the decision of CAAD delivered in case no. 12/2013-T, in the following terms:

"in general, the regime of gains aims to grant a special favorable regime to tangible and financial fixed assets (shares and quotas) of companies, as a way of combating the lock-in effect – a phenomenon in the tax system of realization that conditions the rational flow of economic assets (buying and selling) for reasons that relate to constraints of a fiscal nature (payment of tax). Essentially, avoiding the scenario of a subject who does not sell an asset (share or quota) of which he is holder – and all economic reasons advise him to do so – only because he will pay a substantial tax at that moment (because taxation is only charged with the sale of the asset and not in the cadence of its annual appreciation). It is this reason that justifies the undertaxation of tangible and financial assets (shares and quotas), embodied in a special tax regime for taxation of gains.

And none of this occurs with supplementary contributions. They are returned, at par, according to the rules of commercial law. There does not exist, nor is one trying to force the existence, of a (secondary) market of voluminous transactions of supplementary contributions. And it is not credible that the scarce holders of supplementary contributions below par do not want to receive their nominal value, with fear or dread of the payment of tax associated; or that this be an economic obstacle such that it justifies creating or inserting them in the special regime of gains and losses."

Thus, it is concluded that article 32, no. 2, of EBF, in the wording in force in 2013, in establishing, referring to "capital shares", that the "financial charges borne with their acquisition" do not concur for the formation of taxable profit of SGPS, does not set aside the relevance for the formation of taxable profit of financial charges borne with supplementary contributions, since these are not framed in the concept of "capital shares", at least for this fiscal purpose.

Therefore, also for this reason the impugned correction does not have legal support in article 32, no. 2, of EBF.

3.3. Question of Unconstitutionality Raised by the Tax Authority and Customs Authority

The Tax Authority and Customs Authority affirms in its response that "any interpretation that does not apply the norm contained in article 32, no. 2 of EBF, when interpreted in light of circular no. 7/2004 of CIRC, in the terms raised by the Claimant, having underlying the assumption that such norm incurs in violation of the principle of parliamentary reserve provided for in articles 103, no. 2 and 3, and 165, no. 1, paragraph i), of the Constitution of the Portuguese Republic, or of any other Constitutional precept that may be considered, being, consequently, unconstitutional" "or having underlying the assumption that such norm incurs in violation of the principle of taxation of real income, prohibited by the Constitution of the Portuguese Republic, being unconstitutional".

As to the first question, it is not even understood which Constitutional norm the Tax Authority and Customs Authority understands to be violated by the non-application of the interpretation provided for in Circular no. 7/2004, since this is not a legislative norm and, therefore, its non-application in a situation in which it affronts legislative rules does not affront the principle of parliamentary reserve, rather concretizes it.

On the other hand, as to the principle of taxation of real income, there will, certainly, be an error regarding the reach of article 32, no. 2, of EBF, since, in any interpretation, by not considering for the formation of taxable profit some financial charges effectively borne, consubstantiates precisely a departure from the principle of taxation fundamentally based on real income, generically assured, in the matter of expenses, by the rules of article 23 of CIRC.

Therefore, if article 32, no. 2, of EBF were not applied in the situation at hand, one would be approximating the taxation of real income of the Claimant and not violating that constitutional principle.

In any event, nor is one faced with a situation of non-application of article 32, no. 2, of EBF, but rather of applying it with the interpretation that should be made of it in light of the rules of interpretation of law applicable.

3.4. Questions of Prejudiced Knowledge

Justified by the reasons set out for the annulment of the assessment, it becomes unnecessary to appreciate the remaining questions of illegality raised by the Claimant, whereby knowledge thereof is not taken, in accordance with the provisions of articles 130 and 608, no. 2, of CPC, subsidiarily applicable by force of the provisions of article 29, no. 1, paragraph e), of RJAT.

4. Decision

In accordance with the foregoing, the members of this Arbitral Tribunal agree to:

• Judge the request for arbitral pronouncement well-founded;

• Annul the Corporate Income Tax assessment no. 2017....

5. Value of the Case

In accordance with the provisions of articles 296 and 306, no. 2, of CPC and 97-A, no. 1, paragraph a), of CPPT and 3, no. 2, of the Regulation of Costs in Processes of Tax Arbitration and as was already decided by the order of 20-03-2019, the value of the case is fixed at €934,408.94

6. Costs

Pursuant to article 22, no. 4, of RJAT, the amount of costs is fixed at €13,158.00, in accordance with Table I attached to the Regulation of Costs in Processes of Tax Arbitration, to be borne by the Tax Authority and Customs Authority.

Lisbon, 26-04-2019

The Arbitrators

(Jorge Lopes de Sousa)

(Hélder Faustino)

(Arlindo José Francisco)