CAAD 587/2014-T: IRC Group Taxation (RETGS) and Taxable Income Dispute Resolution

ARBITRAL DECISION

CAAD: Tax Arbitration

Case No. 587/2014 – T

Subject Matter:

The arbitrators Dr. Jorge Lopes de Sousa (arbitrator-president), Prof. Dr. Paula Rosado Pereira and Prof. Dr. António Martins, appointed by the Ethics Council of the Center for Administrative Arbitration to form the Arbitral Tribunal, constituted on 02-10-2014, hereby agree as follows:

1. Report

A…, SGPS, SA, NIPC …, filed a request for constitution of a collective arbitral tribunal, in accordance with the combined provisions of articles 2 and 10 of Decree-Law No. 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter referred to only as RJAT), in which the TAX AUTHORITY AND CUSTOMS AUTHORITY is the Respondent.

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 01-08-2014.

In accordance with the provisions of paragraph a) of Article 6, n. 2 and paragraph b) of Article 11, n. 1 of RJAT, the Ethics Council appointed as arbitrators of the collective arbitral tribunal the signatories, who communicated acceptance of the appointment within the applicable time period.

On 17-09-2014 the Parties were duly notified of this appointment, and did not manifest any intention to refuse the appointment of the arbitrators, in accordance with the combined provisions of Article 11, n. 1, paragraphs a) and b) of RJAT and Articles 6 and 7 of the Code of Ethics.

In accordance with the provision of paragraph c) of Article 11, n. 1 of RJAT, the collective arbitral tribunal was constituted on 02-10-2014.

The Tax Authority and Customs Authority submitted a response in which, among other matters, it raised the question of the incompetence of the Arbitral Tribunal to assess the request for restoration of the tax loss generated by "C" in 2009, in the amount of €12,675,493.32.

The Applicant made written submissions on this matter.

The meeting provided for in Article 18 of RJAT was held, in which it was decided not to produce oral testimony and for the proceedings to continue with successive written submissions.

The Parties made submissions.

The Arbitral Tribunal was regularly constituted and the Tax Authority and Customs Authority raised two questions regarding the incompetence of the Arbitral Tribunal.

The parties have legal personality and capacity and are parties with standing (articles 4 and 10, n. 2, of the same statute and article 1 of Order No. 112-A/2011, of 22 March).

The proceedings are not affected by any nullities and there is no obstacle to the assessment of the merits of the case.

2. Question of Incompetence to Assess the Request for Restoration of the Tax Loss Generated by "C" in 2009, in the Amount of €12,675,493.32

2.1. Positions of the Parties

The Applicant petitions in paragraph c) of its request for arbitral pronouncement that there be "restored the tax loss generated by 'C' in 2009, in the amount of €12,675,493.32".

The Tax Authority and Customs Authority takes the position that although such a claim may result from the enforcement of judgments that may be issued should the arbitral decision be rendered in favor of the arbitral claim, such enforcement exceeds the competence of this Tribunal.

Furthermore, the Tax Authority and Customs Authority takes the position that the value of the claim also exceeds the maximum permitted by Order No. 112-A/2011, of 22 March.

The Applicant responded to these matters by stating, in summary, that the claim identified in c) of the request for arbitral pronouncement has as its object the declaration of illegality of the act of correction of the taxable income of the Applicant in the context of Corporate Income Tax, relating to the fiscal year 2009, in the amount of €9,079,706.09, corresponding to the non-acceptance of the tax deductibility of expenses incurred related to financial charges, and that the amount of €12,675,493.32 is the sum of the tax loss not contested by the Tax Authority, in the amount of €3,595,787.23, with that amount of €9,079,706.09, and therefore this entire amount should be entered in box 9 of Form 22 of the Corporate Income Tax declaration.

The Applicant further states that "the claim identified in c) of the request for arbitral pronouncement is an act of fixing taxable income that does not give rise to the assessment of any tax, being therefore a final tax act that may or may not have future repercussions at the level of Corporate Income Tax to be determined in subsequent years".

2.2. Decision on the Question of Incompetence to Assess the Request for Restoration of the Tax Loss

In the legislative authorization on which the Government based itself to approve RJAT, granted by article 124 of Law No. 3-B/2010, of 28 April, it is proclaimed, as the primary directive of the establishment of arbitration as an alternative form of jurisdictional resolution of conflicts in tax matters, that "the tax arbitral process should constitute an alternative procedural means to the judicial review process and to the action for recognition of a right or legitimate interest in tax matters".

The judicial review process is a procedural means that has as its object an act in tax matters, aiming to assess its legality and to decide whether it should be annulled or whether its nullity or non-existence should be declared, as follows from article 124 of the Tax Procedural Code.

By analyzing articles 2 and 10 of RJAT, it is noted that the competences of the arbitral tribunals functioning in CAAD were limited to questions concerning the legality of assessment acts or acts fixing taxable income and second-instance acts that have as their object the assessment of the legality of acts of those types, acts whose assessment falls within the scope of judicial review processes, as results from paragraphs a) to d) of article 97, n. 1 of the Tax Procedural Code.

That is, it is noted that the legislature did not implement, in the legislative authorization as far as it concerned the extension of the competences of the arbitral tribunals to questions that are assessed in the tax courts through an action for recognition of a right or legitimate interest.

However, in harmony with the intent underlying the legislative authorization to create an alternative means to the judicial review process, it should be understood that, regarding requests for declaration of illegality of acts of the types referred to in its article 2, the arbitral tribunals functioning in CAAD have the same competences as the courts in judicial review proceedings, within the limits defined by the commitment made by the Tax Authority and Customs Authority through Order No. 112-A/2011, of 22 March, pursuant to article 4, n. 1, of RJAT.

Although the primary object of the judicial review process is the declaration of nullity or non-existence or the annulment of acts of the types referred to, it has been consistently understood that it may result in orders condemning the Tax Administration to pay indemnity interest and compensation for improper guarantee.

In fact, although there is no explicit rule to that effect, it has been consistently understood in the tax courts, since the entry into force of the tax reform codes of 1958-1965, that an award of indemnity interest in a judicial review process may be combined with a request for annulment or declaration of nullity or non-existence of the act, since in those codes it is stated that the right to indemnity interest arises when, in a claim for reconsideration or in judicial proceedings, the administration is convinced that there was an error of fact attributable to its services. This regime was subsequently generalized in the Tax Procedural Code, which established in n. 1 of article 24 that "there shall be a right to indemnity interest in favor of the taxpayer when, in a claim for reconsideration or in judicial proceedings, it is determined that there was an error attributable to the services", subsequently in the General Tax Law, in whose article 43, n. 1, it is established that "indemnity interest is due when it is determined, in a claim for reconsideration or judicial review, that there was an error attributable to the services resulting in payment of the tax debt in an amount greater than legally due" and finally in the Tax Procedural Code in which it was established, in n. 2 of article 61 (corresponding to n. 4 in the wording given by Law No. 55-A/2010, of 31 December), that "if the decision recognizing the right to indemnity interest is a judicial decision, the payment period is counted from the beginning of the period for voluntary payment".

Thus, similarly to what occurs with the tax courts in judicial review proceedings, this Arbitral Tribunal is competent to assess requests for reimbursement of the amount paid and for payment of indemnity interest.

It is also unequivocal that in judicial review proceedings it is possible to assess requests for orders to pay compensation for improper provision of guarantee, and article 171 of the Tax Procedural Code establishes that "compensation in case of an improperly provided bank guarantee or equivalent will be requested in the proceedings in which the legality of the enforceable debt is disputed" and that "compensation must be requested in the claim for reconsideration, review, or appeal or, if its basis is subsequent, within thirty days of its occurrence".

Thus, it is unequivocal that the judicial review process encompasses the possibility of an order to pay improper guarantee and is indeed, in principle, the appropriate procedural means to formulate such a request, which is justified by obvious reasons of procedural efficiency, since the right to compensation for improper guarantee depends on what is decided regarding the legality or illegality of the assessment act.

The request for constitution of the arbitral tribunal has as its corollary that it will be in the arbitral process that the "legality of the enforceable debt" will be discussed, and therefore, as results from the express wording of that n. 1 of the aforementioned article 171 of the Tax Procedural Code, the arbitral process is also the appropriate means to assess the request for compensation for improper guarantee.

However, absent any legal provision permitting a contrary conclusion, the scope of the judicial review process and of arbitral processes is restricted to questions concerning the legality of acts of the types referred to in article 2 that are encompassed by the commitment made in Order No. 112-A/2011, and cannot, in particular, define the terms on which annulling judgments that may be issued should be enforced.

In fact, as the Tax Authority and Customs Authority rightly notes, the competence to enforce the judgments issued by the arbitral tribunals functioning in CAAD falls, in the first place, to the Tax Authority and Customs Authority itself, as results from the express wording of n. 1 of article 24 of RJAT in stating that "the arbitral decision on the merits of the claim, to which there is no recourse or objection, binds the tax administration from the end of the period provided for recourse or objection, and the administration must...".

On the other hand, should there be disagreement between the Tax Authority and Customs Authority and the taxpayers regarding the manner of enforcement of judgments, it is the tax courts that are competent to assess them, since the arbitral tribunals functioning in CAAD are not granted competences in proceedings for enforcement of judgments and the arbitral tribunals dissolve following the arbitral decision, as results from article 23 of RJAT.

Thus, it is concluded that the Tax Authority and Customs Authority is correct in defending that this Arbitral Tribunal has no competence to assess the request for restoration of the tax loss generated by "C" in 2009.

However, this incompetence to assess one of the claims, when there are others for which this Arbitral Tribunal is competent (the requests for annulment of the additional assessment and the order dismissing the claim for reconsideration), has only the consequence that the claim for which the Tribunal is incompetent is considered "without effect", as can be inferred from what, albeit for another purpose, is stated in n. 4 of article 186 of the Civil Procedure Code, in alluding to situations in which "one of the claims becomes without effect due to the tribunal's incompetence".

Thus, the exception of incompetence regarding the aforementioned request for restoration of the tax loss generated by "C" in 2009 is upheld, and the Tax Authority and Customs Authority is absolved of the instance as to this claim, without prejudice to the assessment of the remaining claims.

2.3. Decision on the Question of Incompetence Based on Value

The Tax Authority and Customs Authority also raises the question of incompetence of this Arbitral Tribunal because the value of €12,675,493.32 exceeds the maximum of €10,000,000.00 provided for in Order No. 112-A/2011, of 22 March.

Article 4, n. 1, of RJAT establishes that "the commitment of the tax administration to the jurisdiction of the tribunals constituted in accordance with the present law depends on an order of the members of the Government responsible for the areas of finance and justice, which establishes, in particular, the type and maximum value of the disputes covered".

Pursuant to this provision, Order No. 112-A/2011, of 22 March, was issued, which establishes, in article 3, n. 1, that "the commitment of the services and bodies referred to in article 1 is limited to disputes of value not exceeding €10,000,000".

In the case at hand, the value of the dispute indicated by the Applicant, without opposition from the Tax Authority and Customs Authority, was €2,269,926.52, below that limit.

Furthermore, as the Applicant notes, what is at issue is not a correction of taxable income in the amount of €12,675,493.32, with the dispute limited to a correction in the amount of €9,079,706.09, as results from article 3 of the request for arbitral pronouncement.

Therefore, even assessing the value of the dispute by this amount of the correction, it must be concluded that the limit provided for in article 3, n. 1, of Order No. 112-A/2011, of 22 March, is not exceeded.

Consequently, the exception of incompetence raised by the Tax Authority and Customs Authority on this point is not upheld.

3. Statement of Facts

3.1. Proven Facts

The following facts are considered proven:

a) The now Applicant is the "parent company" and holding company of "B…" which is subject to the Special Regime for the Taxation of Groups of Companies (RETGS), provided for in article 69 of the Corporate Income Tax Code;

b) The group of companies included, in 2009, among others, the companies C…, S.A., NIF … (hereinafter "C"), D… SGPS, S.A. NIF … (hereinafter "D") and E… SGPS S.A., NIF … (hereinafter "E");

c) The Applicant held 100% of the capital of D, D held 100% of the capital of C and C held 100% of the capital of E, being this the structure of the shareholdings of these companies:

[Capital structure diagram]

d) In compliance with service order OI2013…, an inspection procedure was initiated for the fiscal year 2009, of general scope, of three companies included in the scope of the RETGS of B…, which resulted in tax adjustments to the individual tax loss of one of the companies and autonomous taxation of the other two companies;

e) In the Tax Inspection Report, attached as document no. 1 to the request for arbitral pronouncement, whose content is given as reproduced, a correction was made to the taxable income of Corporate Income Tax of C…, S.A. in the amount of €9,079,706.09, stating, among other matters, the following:

"DESCRIPTION OF FACTS VERIFIED

In the case at hand, we have:

1. "C" was established on 2007-05-04, with the objective of carrying out investments, investment projects and studies of economic and financial viability, consulting services in technical areas, namely accounting and financial, elaboration of studies and market research;

2. It is registered for the exercise of activity, OTHER CONSULTING ACTIVITIES, CAE: 070220, with commencement of activity on 2007-05-08;

3. It is a limited company, held 100% by "D"-SGPS, a company whose purpose is the management of shareholdings in other companies, as an indirect form of exercise of economic activities;

4. It holds the entirety of the capital of "E"- SGPS, a company that was established on 2007-05-11, whose purpose is the management of shareholdings in other companies, as an indirect form of exercise of economic activities;

5. The three aforementioned companies consolidate their financial statements in company A… SGPS, S.A. (B) in accordance with the special regime for the taxation of groups of companies provided for in articles 63 et seq. of the Corporate Income Tax Code, with company B being the dominant company and the other companies as dominated entities;

6. "C" incurred debt, since 2007, with the holder of the capital ("D") as remunerated loans, to enable it to finance, at no cost, its investee ("E"), having borne financial charges which it registered both accounting and tax-wise in the fiscal years 2007, 2008 and 2009, as evidenced by the income statement table/Q07, previously presented;

7. It was verified, by the analysis conducted and previously presented, that the funds initially ceded by "D" (parent company) as remunerated loans, were by "C" granted, this time at no cost, in the form of supplementary/additional contributions, to "E", its investee;

8. Its investee ("E") applied the aforementioned funds in acquisitions of shareholdings in other companies, as demonstrated in the table that follows:

• With the financing obtained from "C", "E" acquired the following financial asset:

[Financial assets table]

From the analysis of the opening balance sheet for the fiscal year 2009 of "C", the following were noted:

• Financial investments in equity stakes, registered in account POC 4111-10132, in the amount of €20,000,000.00 in its investee ("E");

• Loans obtained from shareholders, accounts POC 25211 – ("D" – holder of 100% of the capital, in a total of €287,503,980.00;

• Loans for financing granted, registered in account POC 4131-10132- "Fin. Inv.-Fin.Co.-Enterp. of A… SGPS, SA" made to its investee ("E"), in the amount of €275,937,000.00;

1. On 02 October 2009, "C" recorded a write-off of the entirety of the loan made to its investee ("E") (internal document no. 80012/10), and on that same day recorded an increase of the investment in capital of €275,000,000.00 in its investee ("E"), that is, the loan obtained from its shareholder ("D") was maintained in its investee ("E"), this time, as capital.

2. As a result of the loans obtained, "C" recorded financial charges that affected results, in the amount of €12,500,570.15.

3. These charges are supported by debit notes issued by "D".

4. For the loans granted to "E", "C" did not record any income.

5. In the analysis conducted, it was also found that the funds ceded by "D" originated from the dominant company (B), for which financial charges were debited.

In summary, the situation under analysis as of 31-12-2009 is as follows:

[Corporate structure diagrams]

It is clearly evident from the diagrams that there was actual use by "E" of the financial resources associated with the financial costs borne by "C" in the analysis at hand.

That is, it is confirmed that "C" assumed loans from "D", from which it bore cost, and ceded the funds obtained, without any remuneration, to its investee "E".

FRAMEWORK OF THE OPERATION

As previously mentioned, the cession of funds from "C" to "E", its sole investee, in the amount of €275,937,000.00, registered in account POC-4131-10132, was carried out as supplementary contributions with the character of supplementary capital contributions, in accordance with articles 210 et seq. of the Commercial Companies Code, as documented by the minutes no. 3 of 2007-07-31, from which the following is extracted:

Point One: "Ratification of the performance of supplementary contributions, with the character of supplementary capital contributions, delivered to the company by the sole shareholder 'C... S.A.', which total to the present date, the amount of €51,172,000.00"

Point Two: "Consideration of the proposal for a resolution by the sole shareholder to perform, throughout the remaining year 2007, supplementary contributions, with the character of supplementary capital contributions, in addition to those already performed, up to a maximum amount of €275,937,000.00" (emphasis ours)

Thus, in accordance with the express resolution and commitment by "C", the supplementary contributions made in "E" were subject to the regime of supplementary capital contributions. Therefore, although we are in the presence of a limited company, in the assessment of the contributions in question the conditions of that regime, chosen by the shareholder, must be taken into account.

Among those conditions, defined for supplementary contributions, is established that they cannot earn interest (as per n. 3, article 210 of the Commercial Companies Code: "do not earn interest").

On the other hand, these contributions:

• Do not in themselves result in an increase in the social rights of "C" in "E" (which remain unchanged)

• Only grant the right to their respective reimbursement

That is, whoever makes supplementary contributions retains the right to receive in the future the same and exact amount of the contribution. It does not thus register any income. Even if the debtor is in excellent financial situation, it has only the obligation to pay the value of the contribution, without any income, in accordance with the rules of commercial law.

III. 4.1 - The Financial Charges are not indispensable for the formation of income or gains subject to tax

In the context of Corporate Income Tax, costs that, being duly proven, are indispensable for the achievement of income or gains subject to tax or for the maintenance of the source of production are, as a general rule, tax-deductible costs.

Thus, for a given cost to be tax-deductible it is necessary, first and foremost, to prove that it is indispensable for the achievement of the income or gains subject to tax of the company.

From the facts previously exposed, it is concluded that:

• The income generated by the financial investment made "holding of a stake in 'E'" were completely written off in the calculation of taxable income, namely:

• Income recorded in 2008

o Distribution of Profits from "E" in a total of €3,439,986.02;

• Income recorded in 2009

o Distribution of Profits from "E" in a total of €12,900,000.00;

o Other income and financial gains of €47,257,239.72;

That is, for tax purposes, all these income was completely written off from the result, in box 07 of form 22, in accordance with article 46 of the Corporate Income Tax Code, so that the income recorded for accounting purposes generated no income subject to tax for tax purposes.

• The financial charges relate to capital ceded to "E", as supplementary contributions, and therefore not remunerated, that is, "C" did not obtain, nor can obtain, from "E" any remuneration for the values ceded;

So that it is verified that the charges assumed with the loan obtained were not compensated by taxable income.

Thus, it is concluded that the charges borne cannot be accepted as tax-deductible costs because they do not prove to be indispensable for the achievement of income or gains subject to tax.

III. 4.2 – The Financial Charges were not borne for the maintenance of the source of production

The issue raised in this section is fundamentally concerned with proving the indispensability of the cost for the maintenance of the source of production, in accordance with the provision of article 23 of the Corporate Income Tax Code.

First of all, let us examine the applicability of the liability assumed, loan obtained from "D", in the operation of the company under analysis, ("C").

From the accounting entries made by "C", regarding the destination given to the loans obtained from the shareholder ("D"), it is concluded:

• The loans obtained from "D" were channeled to the equity of the investee ("E"), €20,000,000.00 in share capital and €275,000,000.00 in supplementary contributions with characteristics of supplementary capital contributions;

• In October 2009, the supplementary/additional contributions were transformed into share capital of the investee ("E").

In this sense:

• The loans contracted with its shareholder ("D") were not applied directly in the company's own activity, but rather channeled to the activity developed by its investee ("E"), since the funds were intended for the acquisition of shareholdings in the context of the activity of the investee ("E");

• The interest arising from the loans obtained from the shareholder "D" originated from loans that were used to finance supplementary/additional contributions granted to its investee "E";

• Thus, this liability does not finance the activity of "C", but rather the activity of its investee "E" (another legal and tax entity, with independently organized accounting and registration of income and costs);

• Therefore, we must conclude that such liability is not intended for the maintenance of the source of production since it does not finance this activity;

Thus, the liability assumed was not used in the development of its own activity, having been manifestly diverted from its operation, so that the charges borne with this liability do not fit within what is provided in article 23 of the Corporate Income Tax Code, regarding its tax deductibility.

It was therefore proven that the funds obtained "loans obtained from 'D'" were not applied in the proper operation of "C", so that the charges recorded associated with this liability cannot be accepted as costs of the fiscal year.

The Supreme Administrative Court has consistently held that, in accordance with article 23 of the Corporate Income Tax Code, only costs related to the activity developed by the taxpayer are deductible, sustaining that, even when there is a relationship of dependence or domination, companies have distinct legal and tax personality and capacity.

In this same sense, the Central Administrative Court of the South pronounced itself in the judgment of 24-04-2012, handed down in case 05251/11, in defending that "until the moment of determination of taxable profit by the dominant company, each of the subsidiary companies maintains its own legal personality and capacity (...), with the taxable profit of each of the affiliated companies being determined in its periodic return (...). When the dominant company has resolved to make supplementary capital contributions (...) in its affiliated companies to, among other matters, strengthen their capital, the charges relating to loans contracted for that purpose, because directly connected with the exercise of activity of the affiliated companies, constitutes a tax cost of these, not of the dominant company."

It cannot be argued that the financing of the investee "E" is the indirect exercise of economic activity by "C".

"C" and "E" are autonomous entities, having distinct legal and tax personality not affected by the relationship of domination between them.

The costs of each apply only to it, as referred to in the Judgment of the Supreme Administrative Court, of 12-07-2006, handed down in case No. 186/06: "In this way, each of the companies has its accounting organized independently in relation to the others, which implies, on the one hand, that each has its own income and costs and, as such, must record them, and on the other, that these costs and income cannot be included in the accounting of the others".

(...)

III. 4.4 - CONCLUSION OF THE ASSESSMENT OF TAX DEDUCTIBILITY OF THE FINANCIAL INTEREST BORNE BY "C"

In summary:

The financial charges under analysis relate to funds obtained from the shareholder, "D", and ceded to the investee, "E", in the form of supplementary contributions subject, by resolution of the shareholder, "C", to the regime of supplementary capital contributions, and as such deliberately ceded without remuneration.

The funds in question were used to finance the activity of the investee, "E", and not to finance the company's own activity of "C", so that the interest borne with the debt with the shareholder, "D", is not tax-deductible, in accordance with article 23 of the Corporate Income Tax Code.

Thus, by the use given to the funds and by the terms and conditions of remuneration in force in the regime established, the interest borne to finance the supplementary capital contributions of "E" are not related to the achievement of income or gains subject to tax and cannot be considered as relating to foreign capital applied in the operation of this company, so that they do not meet the requirements and conditions established by article 23, to be considered as a cost for purposes of determining the taxable income of "C".

(...)

III. 5.2 – Proposed Correction

Given the facts determined and the conclusions presented in point III.4, the following correction of the financial costs recorded, associated with the granting of supplementary contributions, is proposed.

Given the transformation, recorded on 2 October 2009, of the supplementary contributions into capital, only the charges recorded with reference to the period until the end of September will be corrected.

The proposed correction was based on the calculations and criteria made by "D" in the recording and allocation of financial charges to "C" and amounts to the following value:

Calculation of the amount to be disregarded from charges underlying loans granted as supplementary/additional contributions:

[Calculation table]

(...)

III. 6 – Entities Subject to the Special Regime for the Taxation of Groups of Companies (RETGS)

Considering that the entities involved are taxed under the Special Regime for the Taxation of Groups of Companies (RETGS), provided for in articles 63 et seq. of the Corporate Income Tax Code, it is appropriate to proceed with the framework of the operation under analysis from this group perspective, and to evaluate whether the consequences would be different in terms of the determination of income tax.

Now the issue that arises and with tax relevance is the necessity of obtaining funds by "C" for financing an investment made by a legal and tax entity that is autonomous in the form of an SGPS, "E", which is subject to its own tax regime (article 32 of the Tax Benefits Statute) with respect to financial charges borne with the acquisition of equity stakes, which are not accepted tax-wise.

Thus, it should be noted that, although under the RETGS framework the taxable profit of the group is calculated through the algebraic sum of the taxable profits and tax losses determined individually by each of the companies belonging to the group, this joint taxation of income does not imply the tax personality of the set of companies.

In fact, each of the companies maintains its individual tax personality completely intact.

Furthermore, the assessment of any operation and the ratio of charges/income must be done from an individualized perspective of each company, to the detriment of a group management perspective.

In this context, the non-deductibility of interest in determining the taxable profit of "C" is assessed from the individual perspective of the company and not from the group in which it is inserted together with the beneficiary investee "E".

Let us now see what would happen if the interest under analysis were determined in the sphere of "E", either because "C" had proceeded with its re-billing, or because the initial financing from "D" had been contracted by "E" directly.

In the individual sphere of "E", the deduction of the aforementioned financial charges would be assessed in light of the aforementioned rule, article 23 of the Corporate Income Tax Code, and also, given its form as an SGPS, in light of the provision of n. 2 of article 32 of the Tax Benefits Statute, having then the corresponding effects on the tax result of the group.

Now it happens that SGPS entities have their own regime for the determination of capital gains and losses and for the treatment of financial charges, which is set forth in n. 2 of article 32 of the Tax Benefits Statute, and determines that "the capital gains and losses realized by SGPS entities, by capital investment companies and by capital research firms from equity stakes that they hold, provided that held for a period of no less than one year, and equally the financial charges borne with their acquisition, do not contribute to the formation of the taxable profit of these companies".

Thus, given that in "E" the funds were used for the acquisition of equity stakes, the financial charges borne with that acquisition would not be considered in the calculation of taxable income.

It is thus demonstrated that the interest charged by "D" to "C":

• Is not tax-deductible in the sphere of "C", individually considered, by virtue of the provision of article 23 of the Corporate Income Tax Code;

• Nor is it in the sphere of the tax group, should its recording have occurred in "E", with the exclusion then being based on the provision of article 32 of the Tax Benefits Statute.

III. 7 – Corrections to Taxable Income

Such costs not being accepted, as already substantiated, a correction to taxable income is determined in a total of €9,079,706.09 to be added in box 07 of Form 22 as follows:

[Correction table]

f) Following the correction to the taxable income of "C", the Tax Authority and Customs Authority corrected the algebraic sum of the tax results determined under the RETGS of the Applicant in the amount of €9,079,706.09 and, taking into account that correction, prepared the Corporate Income Tax assessment No. 2013…, of 31 December 2013, in which the Applicant is the taxpayer, which is contained in document no. 2 attached with the request for arbitral pronouncement, whose content is given as reproduced;

g) The Applicant filed a claim for reconsideration of the aforementioned assessment, only as regards the correction to the taxable income of "C" (document no. 3, attached with the request for arbitral pronouncement, whose content is given as reproduced);

h) By Order of the Head of the Tax Law Division of the Finance Directorate of..., dated 02-07-2014, the correction to the taxable income of "C", in the amount of €9,079,706.09, relating to the non-acceptance of the tax deductibility of expenses incurred related to financial charges, was maintained, the Applicant being notified, through Letter no. 2014…, of 2 July 2014, of the decision to dismiss the claim for reconsideration (document no. 4 attached with the request for arbitral pronouncement, whose content is given as reproduced);

i) On 30-07-2014, the Applicant filed the request for arbitral pronouncement that gave rise to the present proceedings.

3.2. Non-Proven Facts

There are no facts relevant to the decision of the case that have not been proven.

3.3. Substantiation of the Statement of Facts

The determination of the facts is based on the Tax Inspection Report and on the documents specifically indicated attached with the request for arbitral pronouncement, with no controversy regarding that matter.

4. Statement of Law

The issue that is the object of the proceedings is whether amounts corresponding to financial charges borne to carry out financing of a subsidiary through supplementary contributions can be deducted from the taxable income of a company that holds 100% of the capital of another.

4.1. Positions of the Parties

4.1.1. Position of the Applicant

C…, SA, (hereinafter "C") was established in 2007, having as its purpose the carrying out of investments, investment projects and studies of economic and financial viability, in addition to consulting services in technical areas, namely accounting and financial, elaboration of studies and market research.

As of 1 January 2009, "C" had recorded an amount of €287,503,980 as debts to third parties, which related to a financing (loan contribution) granted by its sole shareholder (D… ("D"), SGPS, SA), with "C" incurring charges with this financing, with respect to the fiscal year 2009, in the amount of €12,500,570.15. "C" made supplementary contributions, subject to the regime of supplementary capital contributions, to its 100% investee E… ("E"), SGPS, SA. "E", in turn, applied these funds in various investments, from which it obtained income.

In the Applicant's view, the issue at hand is as follows: are the financial charges borne by "C", which obtained the financing from "D" to make supplementary contributions to its investee E… ("E"), SGPS, SA, tax-deductible or not in accordance with article 23 of the Corporate Income Tax Code?

For the Applicant, it follows from article 23 of the Corporate Income Tax Code that the assessment of the deductibility of tax cost cannot be subsumed only under the direct and immediate causal connection between the cost and a correlative income (whose acquisition may be deferred over time): it is important and should also be assessed whether that cost is indispensable for the maintenance of the source of production.

Costs will be accepted for tax purposes if indispensable for the achievement of income subject to tax or for the maintenance of the source of production. And, the Applicant alleges, there is no doubt that the financial costs incurred by "C", in making supplementary contributions under the regime of supplementary capital contributions in "E", meet both conditions. Not only are they connected with income obtained from the investment in the investee, but they sustain and strengthen this investment as a source of production of an expected economic return.

On the other hand, still according to the Applicant, regarding the ground that financial charges are not tax-deductible in the sphere of "C" because it is not financing its own activity, but rather the activity of its investee, this argument does not hold, given that the activity of a company is not constituted, only, by its normal and current operational activity, also encompassing the taking and strengthening of financial stakes, within the scope of its growth strategy, and such activity – investments – is duly inserted in the respective corporate purpose of "C".

Despite the absence of immediate income requirement (interest), "C" made the supplementary contributions, with the character of supplementary capital contributions, with a view to the appreciation of its assets, through recapitalization of the investee company, profitably enhancing its value and enabling the subsequent receipt of income (subject to tax).

The supplementary contributions made by "C" to "E" enabled the latter to carry out a set of investments, through the acquisition of social stakes, in particular in the following entities:

F… SGPS, S.A. (acquisition value of €35,393,792.41);

G…, S.A. (acquisition value of €155,042,718[amount truncated]);

H…, S.A. (acquisition value of €122,446,437.90).

Such investments contributed to the appreciation of the assets of "E", enabling "C" the subsequent receipt of income, either via dividends distributed by "E", or via capital gains from an eventual sale/dissolution of the investee. Additionally, the Applicant emphasizes that such income – when obtained – is subject to taxation in the sphere of "C", in particular in accordance with the legislation in force at the time of the facts.

In the case of capital gains, they were subject to taxation in accordance with article 43 of the Corporate Income Tax Code (in force at the time), without the possibility of benefiting from any exemption regime (at best, taxation could be mitigated by 50%, through application of the reinvestment regime, should a set of requirements be met).

As for dividends, they were also subject to taxation via articles 18, n. 7 and 20, n. 1, of the Corporate Income Tax Code, although they could benefit from the deduction provided for in the (then) article 46 of the Corporate Income Tax Code. According to the Applicant, the dividends received by "C" and arising from its participation in "E" are always subject to taxation, and can be deducted from the tax base, should the requirements provided for in article 46 of the Corporate Income Tax Code (current article 51) be met.

Now, if the income (dividends) was included in the "tax base", it means that it was subject to taxation. In the Applicant's understanding, the dividends received from "E" were subject to taxation in the sphere of "C", even if it met the requirements to be able to benefit from the deduction provided for in article 46 (current article 51) of the Corporate Income Tax Code, so the argument presented by the Tax Authority would be contrary to the principles of objective scope of Corporate Income Tax. The Applicant thus considers that, with the management option assumed of making supplementary contributions with the character of supplementary capital contributions in "E", "C" pursues the objective of increasing its value, through the strengthening of the economic potential of the company in which it participates.

According to the Applicant's further allegation, it must be verified whether, as the Tax Authority defends, with regard to the instruments of attribution of financial means to companies by the corresponding partners, it is necessary to associate to them a form of remuneration or a duty of compensation by the company that benefits from them. That is, whether the absence of immediate remuneration (interest) removes from those instruments of attribution of financial means by partners to companies the nature of contributions made in the pursuit of their business and therefore applied within the scope of their own operation or activity.

In this regard, the Applicant mentions Arbitral Decision No. 12/2013-T of CAAD, in which it is stated that "commercial law explicitly clarifies that the performance of supplementary contributions (a figure provided for in articles 210 et seq. of the Commercial Companies Code) falls within the capacity of the company, within its lucrative scope, in the licit delineation of its activity, even if they cannot earn any interest, by express legal requirement (article 210, n. 5, of the Commercial Companies Code). What applies to supplementary contributions also applies to supplementary contributions, a figure provided for for limited companies, regarding supplementary contributions without interest earning, by contractual obligation (article 287 of the Commercial Companies Code)."

The position of Raúl Ventura is also cited, which, referring to supplementary contributions, writes: "nothing prevents, in theory, that the partner receives no direct compensation from the company, coming possibly to reimburse itself through other means, such as the profits of its share, proportional or not to the nominal value thereof".

For the Applicant, it will therefore be necessary to conclude that the attribution of financial means in the form of supplementary contributions subject to the regime of supplementary capital contributions, carried out by "C" to its investee "E", is an operation duly provided for and recognized in commercial legislation. Thus, in making such contributions, "C" is acting within the scope of its own activity or operation, even if no form of remuneration is associated with such contributions or a duty of compensation by the company that benefits from them.

The Applicant also considers that the financial charges under analysis would only not be tax-deductible should "C" have incurred such charges to finance illicit activities or activities unrelated to business purposes and to its corporate purpose, which manifestly would not be the case.

"C" has as its corporate purpose the carrying out of investments, investment projects and studies of economic and financial viability, in addition to consulting services in technical areas, namely accounting and financial, elaboration of studies and market research. Nothing prevents, according to the Applicant, that commercial companies that do not assume the form of an SGPS can, within the scope of their activity, make investments in other companies and manage such investments, as happens with "C". In making the supplementary contributions subject to the regime of supplementary capital contributions, "C" pursued the increase in value of the shares held in "E" through the strengthening of the economic potential of the investee company, so it must be concluded that the financial charges in question were incurred within the scope of its activity, evidencing a clear "business purpose".

In this regard, the Applicant emphasizes what is expressed in section "III.5.2 – Proposed Correction" of the Inspection Report, in which it is stated that "given the transformation, recorded on 2 October 2009, of the supplementary contributions into capital, only the charges recorded with reference to the period until the end of September will be corrected".

The Applicant alleges that it does not understand the reason why the Tax Authority accepts the tax deductibility of financial charges borne with the performance of capital contributions and, at the same time, does not accept the tax deductibility of financial charges borne with the performance of supplementary contributions when both institutes are provided for in the Commercial Companies Code, with both instruments being valid forms of own capital and only usable by partners/shareholders.

The Applicant recalls that, at the time the supplementary contributions subject to the regime of supplementary capital contributions were made, "C" was already the sole shareholder of its investee "E", holding 100% of the shares representing its capital. For the reason stated above, in order to capitalize its investee "E", the performance of a capital increase or the granting of supplementary capital contributions was indifferent for "C" in terms of an increase in social rights, since "C" already held the right to all profits and capital gains arising from "E".

In summary, in the Applicant's view, the financial charges borne by "C" and here the object of analysis meet the conditions for their deductibility under the provision of article 23 of the Corporate Income Tax Code.

4.1.2. Position of the Tax Authority

The Tax Authority emphasizes the relevance of what is expressed in the tax inspection report regarding the assessment of the tax deductibility of the financial charges borne by "C":

"The financial charges under analysis relate to funds obtained from the shareholder, 'D', and ceded to the investee, 'E', in the form of supplementary contributions subject, by resolution of the shareholder, 'C', to the regime of supplementary capital contributions, and as such deliberately ceded without remuneration.

The funds in question were used to finance the activity of the investee, 'E', and not to finance the company's own activity of 'C', so that the interest borne with the debt with the shareholder, 'D', is not tax-deductible, in accordance with article 23 of the Corporate Income Tax Code. Thus, by the use given to the funds and by the terms and conditions of remuneration in force in the regime established, the interest borne to finance the supplementary capital contributions of 'E' are not related to the achievement of income or gains subject to tax and cannot be considered as relating to foreign capital applied in the operation of this company, so that they do not meet the requirements and conditions established by article 23, to be considered as a cost for purposes of determining the taxable income of 'C'."

For the Tax Authority, invoking arbitral jurisprudence convoked by the Applicant, specifically the decisions issued in cases no. 12/2013-T and no. 39/2013-T, the purport of such decisions cannot be applied here without taking into account that the same address specific concrete cases, whose underlying facts are the basis of those same decisions. In the case at hand, the Tax Authority alleges that the factuality inherent in those arbitral decisions does not coincide with that underlying the case in question. For while in the arbitral decisions invoked there were at issue companies under the form of SGPS, in the case at hand "C" assumes the form of a limited company. This fact, for the Respondent, not only assumes fundamental importance, but also constitutes an element obstructing the invocation of the decisions handed down in arbitral cases no. 12/2013-T and 39/2013-T.

Furthermore, according to the Tax Authority, jurisprudence on the subject of the Central Administrative Court of the South and the Supreme Administrative Court points to a different legal solution from that revealed arbitrally, with the correction under judicial review being in consonance with that jurisprudence.

For costs to be considered deductible, it is necessary that they meet two essential requirements:

a) That they be proven through documents issued in accordance with law; and

b) That they be indispensable for the achievement of income or the maintenance of the source of production.

With respect to the requirement of indispensability of the cost, the Tax Authority emphasizes that these are equivalent to expenses incurred in the interest of the company. In this way, the tax deductibility of the cost depends on a justified relationship with the productive activity of the company.

First, for the Tax Authority, it becomes necessary to demonstrate the existence of a causal relationship with the activity of the company, that is, it becomes necessary to objectively verify that the expenses were incurred within the scope of the company's activity and that they are indispensable for obtaining taxable income.

And, the Respondent continues, second, it is necessary that the company justify the operation according to normal criteria of economic rationality, that is, the expense incurred must be justified by the taxpayer in light of normal management standards, in accordance with the circumstances of the concrete case.

The Tax Authority also alleges that the supplementary contributions, subject to the regime of supplementary capital contributions, which "C" made for the benefit of "E", with respect to which there is no form of remuneration (interest), do not have the nature of capital stakes, that is, do not translate "per se" into an increase in the social rights of "C" in "E" (which remain unchanged). Consequently, the exploitation of such a financial asset does not give rise to any taxed income, particularly dividends or capital gains.

Being that such income/gains, for purposes of article 23 of the Corporate Income Tax Code, must relate from the outset to the contributing company itself. For the Tax Authority, the mere possibility of being able to have, in the future, gains resulting from the application of those capital in its affiliate does not imply the framework in the concept of tax costs; because for that it is necessary that such charges be indispensable for the achievement of income or gains subject to tax or for the maintenance of its own source of production.

Thus, as argued both in the tax inspection report and in the decision to dismiss the claim for reconsideration, supplementary contributions do not have the nature of capital, but rather a nature similar to a loan, in view of the contours of this legal figure.

Hence the conclusion, by the Tax Authority, that the term "capital stakes" does not encompass, in light of the branch of law from which it originates, claims from the performance of supplementary contributions, claims from the performance of supplementary capital contributions, or any other claims. It encompasses only "social stakes", commonly called shares and equity interests.

This distinction is important for the Respondent, since, in its perspective, supplementary/supplementary contributions, as they result from money contributions that may be reimbursed if certain conditions are met and do not confer upon their holders any rights over the net assets of the investee, are not subject to the same regime of recognition and valuation as capital stakes.

This is because in claims for supplementary/supplementary contributions, their value is not directly related to changes in the value of the net assets of the investee. The Tax Authority sustains that there is a fallacy in the Applicant's assertion that the granting of supplementary contributions is similar to the shareholder's intention to financially strengthen its investment, with the intention of appreciating/monetizing it and subsequent obtaining of income, via receipt of dividends or realization of capital gains. This is because the supplementary contributions in question do not confer upon their holders any rights over the net assets of the investee, since they are not capital stakes. Thus generating, per se, no dividends or capital gains.

The Respondent further emphasizes what is referred to in the final inspection report as follows (cf. pages 14 to 17 thereof):

"From the facts previously exposed, it is concluded that:

• The income generated by the financial investment made "holding of a stake in 'E'" were completely written off in the calculation of taxable income, namely:

Income recorded in 2008

– Distribution of Profits from "E" in a total of €3,439,986.02;

– Income recorded in 2009

– Distribution of Profits from "E" in a total of €12,900,000.00;

– Other income and financial gains of €47,257,239.72

That is, for tax purposes, all this income was completely written off from the result, in box 07 of form 22, in accordance with article 46 of the Corporate Income Tax Code, so the income recorded for accounting purposes generated no income subject to tax for tax purposes. The financial charges relate to capital ceded to 'E', as supplementary contributions, and therefore not remunerated, that is, 'C' did not obtain, nor can obtain, from 'E' any remuneration for the values ceded:

So that it is verified that the charges assumed with the loan obtained were not compensated by taxable income. Thus, it is concluded that the charges borne cannot be accepted as tax-deductible costs because they do not prove to be indispensable for the achievement of income or gains subject to tax."

In summary, the Tax Authority concludes that:

– there is no form of remuneration for the immobilization of the capital ceded – that is, from the performance of such supplementary contributions there does not arise any income with the nature of interest;

– the exploitation of this financial asset supplementary contribution, not having the nature of a social stake, will never give rise to any taxed income, particularly dividends;

– and equally in that measure, it will never generate capital gains or losses.

Indeed, the Tax Authority takes the position that the perspective propounded by the Applicant for analyzing the deductibility of the cost in accordance with article 23 of the Corporate Income Tax Code is biased, since the assessment of the existence of "costs or losses that are proven to be indispensable for the achievement of income or gains subject to tax" must be determined in its own sphere. In any event, for the Tax Authority, jurisprudence is unanimous and abundant regarding the non-deductibility of financial charges borne in situations such as those in the proceedings.

On the other hand, the Tax Authority notes that the Higher Courts have consistently held that, in accordance with article 23 of the Corporate Income Tax Code, only costs relating to the activity developed by the taxpayer itself are deductible, and that even when there is a relationship of dependence or domination, companies have distinct legal and tax personality and capacity, and that unless this is the case, the effects of the exercise of the activities in the pursuit of the corporate purpose of other companies could be attributed to a company with which it has some relationship.

Under penalty of thus not being the case, the effects of the exercise of activities by other affiliated companies in pursuit of their corporate purpose would begin to be assumed by the participating company (the "C" in the present situation), with a resulting assumption of liabilities from one to another, with tax results different from those that would be obtained if the financing were allocated to the companies that need them, disrespecting these rules for determining taxable profit, in the general terms, in particular the allocation of eligible costs for each of them, autonomously and independently.

In the perspective of the Tax Authority, the loans contracted by "C" with its shareholder "D" were not applied in the proper activity of "C", but rather diverted to the activity developed by its investee "E". That is, the loans obtained by "C" were intended for the acquisition of social stakes in the context of the activity of "E". However, this latter liability not only was not used to finance the activity of "C" itself, but in reality was diverted to finance the activity of "E".

Thus, according to the Respondent, the argument invoked by the Applicant that the operation in question aimed to pursue the increase in value of its own shares through the strengthening of the economic potential of "E" and that the expenses in which "C" incurred served to provide "E" with the funds necessary for its activity with the intention of appreciating the asset and seeking to obtain a valorized return on its investment does not take, and therefore the financial charges in question are not deductible under article 23 of the Corporate Income Tax Code.

4.2. General Foundations of a Legal, Doctrinal and Jurisprudential Nature Considered by the Tribunal

In the process of structuring the decision rendered here, the tribunal will begin by presenting the general foundations that it considers applicable to the subject matter at issue. Subsequently, it will invoke such foundations to arrive at the decision regarding the concrete case.

Thus, in this section, the following key questions will be particularly analyzed:

i) The interpretation of article 23 of the Corporate Income Tax Code and the question of "indispensability" of expenses;

ii) The concept of "activity" of business entities;

iii) The concept of asset and of source of production; the notion of financial assets and the nature of their income;

iv) When a subsidiary company incurs debt and cedes those funds to an investee without charging interest, is it developing its own activity or activity of another (i.e., performing acts of management unrelated to its own interest)?

4.2.1. On the Interpretation of Article 23 of the Corporate Income Tax Code and the Question of "Indispensability" of Expenses

The Portuguese Constitution establishes, in its article 104, n. 2, that "the taxation of companies falls fundamentally on their real income". In turn, the General Tax Law provides, in its article 4, n. 1, that "taxes are based essentially on taxpaying capacity, revealed, in accordance with law, through income or its use and assets". The concept of income is therefore a central element in the taxation of business entities in the Portuguese legal and fiscal order.

In the case of companies subject to Corporate Income Tax, it is in article 17, n. 1, of the Corporate Income Tax Code that this concept is defined, there determining that "taxable profit [...] is constituted by the algebraic sum of the net result of the fiscal year and positive and negative variations in assets verified in the same period and not reflected in that result, determined on the basis of accounting and eventually corrected in accordance with this Code".

In a relationship of dependence, albeit partial, between fiscal result and the result determined by accounting, the Corporate Income Tax Code establishes as the basis for determining taxable profit the profit or loss determined by accounting. However, and aiming to safeguard the public interest underlying taxation, it imposes certain requirements on the fiscal consideration of income and costs.

It is in the section on costs that such requirements appear most developed, with article 23 being the provision that establishes the general principle of their acceptance. Article 23 of the Corporate Income Tax Code (of which the respective n. 1 is transcribed below) then provided:

Article 23

Costs or losses

1 – Costs or losses are those which are proven to be indispensable for the achievement of income or gains subject to tax or for the maintenance of the source of production, in particular the following:

a) Those relating to the production or acquisition of any goods or services, such as materials used, labor, energy and other general production, conservation and repair expenses;

b) Distribution and sales charges, encompassing those for transportation, advertising and product placement;

c) Charges of a financial nature, such as interest on foreign capital applied in the operation, discounts, premiums, transfers, exchange differences, expenses with credit operations, debt collection and issuance of shares, bonds and other securities, redemption premiums;

d) Charges of an administrative nature, such as compensation, allowances, pensions or pension supplements, current consumption materials, transportation and communications, rents, litigation, insurance, including life insurance and operations in the "Life" branch, contributions to retirement savings funds, contributions to pension funds and to any supplementary social security regimes;

e) Those relating to analysis, rationalization, investigation and consultation;

f) Of a fiscal and parafiscal nature;

g) Depreciations and amortizations;

h) Provisions;

i) Realized capital losses;

j) Indemnities resulting from events whose risk is not insurable."

Thus in this provision a nuclear requirement appears in the admissibility of costs for tax purposes: their indispensability. What should be understood by "indispensability"? Among us, two analyses are customarily invoked regarding what should be the appropriate interpretation of the concept of indispensability set forth in article 23 of the Corporate Income Tax Code.

These are the analyses by TOMÁS TAVARES, "On the Relationship of Partial Dependence Between Accounting and Tax Law in the Determination of Taxable Income of Legal Persons: Some Reflections at the Level of Costs", in Science and Tax Technique, no. 396, 1999, p. 7-180; and by ANTÓNIO M. PORTUGAL, "The Deductibility of Costs in Portuguese Tax Jurisprudence", Coimbra Publisher, 2004.

Doctrine and jurisprudence frequently rely on those works.

In the first of the aforementioned works, TOMÁS TAVARES extensively analyzes the issue concerning the interpretation of the concept of indispensability contained in article 23 of the Corporate Income Tax Code. The author points out three possible interpretations, defending that only one of them constitutes the correct solution. A first understanding would translate into a necessary or obligatory relationship between costs borne and income obtained. Such an understanding of indispensability would mean that only the "absolute necessity" of an expense to obtain income (profit) would allow it to be deducted as a negative component of taxable profit. The author qualifies such an interpretation as absurd. He does so in the following terms: "...the narrowing proposed by this conception would lead to the fiscal disregard of certain losses actually borne by the organization, in clear and flagrant violation of the principle of taxpaying capacity.... Second, given that, in the limit, the deductibility of costs connected with transactions that proved ruinous for the company would never be accepted, given the absence (or insufficiency) of resulting profits. Yet the truth is that Tax Law cannot censure an unprofitable business policy…Tax Law must recognize the right of the business owner to err."

A second interpretation of the concept of indispensability – meaning "convenience" – is treated by the author as follows: "...this objective does not emerge as the standard of interpretation, whether in light of the numerous practical problems it poses, or especially because it also consents to administrative control over the merit of business decisions. Indeed, convenience is a fragile concept, with an open and indefinite meaning, which fosters interference by the administrative apparatus in the economic choices of taxpayers".

Finally, the author adopts the thesis that the correct interpretation of the concept of indispensability is the one that equates indispensable costs to costs incurred in the interest of the company, in the pursuit of the activities resulting from its corporate scope.

This thesis is expressed in the following terms: "The legal notion of indispensability is thus drawn on an economic and business perspective, by fulfillment, directly or indirectly, of the ultimate motivation for obtaining profit. Indispensable costs are equivalent to expenses incurred in the interest of the company or, in other words, in all acts abstractly subsumable in a lucrative profile. This objective brings, intentionally, economic and fiscal categories together, through an interpretation primarily logical and economic of legal causality. The essential expense is equivalent to any cost realized in order to obtain income and representing an economic decline for the company. As a rule, therefore, the fiscal deductibility of the cost depends only on a causal and justified relationship with the productive activity of the company".

And it continues: "...Indispensability is subsumed in any act performed in the interest of the company…The legal notion of indispensability represses, therefore, acts in violation of the company's scope, not inserible in the social interest, above all because they do not aim at profit…".

Note, for now, that the cited text leaves us no doubt about the position of the author (indispensable costs are equivalent to expenses incurred in the interest of the company). However, the truth is that an excerpt from that text, in particular the relationship between expenses and productive activity, has served interpretive purposes of the concept of indispensability that even the author himself already eliminated clearly in the Judgment relating to Case 12-2013-T of CAAD, as will be seen below.

A. MOURA PORTUGAL, discussing the same concept, addresses above all the history of jurisprudential interpretation made of it since the time of the Industrial Contribution to 2001. In any case, this author, and regarding the issue of knowing what is the best interpretation of the concept of indispensability, adopts the following position:

"The solution accepted among us (at least in doctrine), following the understandings propounded by Italian doctrine, has been to interpret indispensability as a function of the corporate purpose. This position is present from the outset in the writings of Vítor Faveiro, who reduces the indispensability of the expense to its assessment as an act of management according to the specific corporate purpose, refusing that this indispensability can be assessed freely on the basis of any subjective judgment of the law applier".

It is worth mentioning the analysis that the author presents of the position of TOMÁS TAVARES, which is as follows: "Placing emphasis on the cost and its connection to the interest of the company, the author argues that the legal criterion of indispensability merely aims to deny the quality of tax cost to expenses abusively recorded in accounting, but which are not true and real costs of the company". Finally, A. MOURA PORTUGAL sustains that doctrine notes a propensity to interpret the concept of indispensability broadly, "an assertion with which we agree absolutely".

In summary: the most frequently invoked doctrinal works on this issue dismiss the interpretation of the concept of indispensability as meaning a necessary causal link between costs and profits. Both sustain that any economic decline (cost) that has a relationship with the corporate purpose, whether incurred within the scope of activity, or evidences a business purpose, will meet the requirement of indispensability, and should not, for this reason, be denied fiscal acceptance under article 23 of the Corporate Income Tax Code.

Now, some of the analyses and decisions relating to article 23 of the Corporate Income Tax Code, seeking in the positions of TOMÁS TAVARES and A. MOURA PORTUGAL the key interpretive approach of the indeterminate concept of "indispensability", sustain that only expenses arising from a relationship with productive activity would be deductible, as they alone would be indispensable. The position of the authors is, in the view of this tribunal, far from this interpretation.

To conclude that this is so, in addition to a complete reading of the cited text, where the unequivocal interpretive sense of T. TAVARES is clearly marked, it would suffice to consult pp. 138 to 154 of the aforementioned study by the mentioned author.

There the concept of "abnormal act of management" is discussed. For the author, in these "abnormal acts" the benefit of third parties is superimposed on that of the company. Now, at pp. 145 to 152, it is discussed how in intra-group relationships such acts may arise. See what T. TAVARES refers to regarding intra-group loans, already in 1999:

"These operations (gratuitous loans from a parent company to a subsidiary) correspond therefore to normal acts of management, despite the apparent nonconformity with the interest of the sacrificed entity (...) The rationale for these legal options lies in the fact that, with them, the company pursues its business activity with a lucrative aim…".

And in note 427, at pp. 150 of the aforementioned work, the author sustains the following: "In our opinion, this operation (paying interest on the obtaining of a loan, the proceeds of which are loaned without interest to another entity) can fall within the lucrative scope of the sacrificed entity…".

The doctrinal anchor that the Tax Authority, and some jurisprudence, have gleaned from the work of TOMÁS TAVARES regarding the subject here under consideration – according to which the obtaining of funds by a parent company ceded without remuneration to a subsidiary does not constitute activity or interest of the former – was extensively undone by himself, as will be observed below. In case 12-2013-T, in the scope of CAAD, where T. TAVARES was sole arbitrator, decides on the deductibility of these expenses with the following foundations (emphasis by the Tribunal):

"The indispensability between costs and profits is assessed in an economic sense: indispensable costs are those incurred in the interest of the company, which are connected with its capacity, by insertion in its lucrative scope (in a mediate or immediate form) and in the exercise of its concrete activity.

The Tax Authority cannot judge the goodness and timeliness of the company management's economic decisions. It cannot meddle in the freedom and autonomy of the company's management. A cost will be accepted fiscally should it be adequate to the productive structure of the company and to the obtaining of profits, even if it proves to be an unfruitful or economically ruinous operation.

The essential expense is equivalent to all expense incurred in order to obtain profits and representing an economic decline for the company. Article 23 of the Corporate Income Tax Code requires not only an adequate causal connection between the cost and the profit (in the aforementioned economic terms), but is also alternatively connected (as indicated by the word "or") with the maintenance of the source of production – in the sense of an economic link between the expense and the existence and maintenance of the company and its activity.

A company can obtain funds (and pay interest) and then deliver those funds to a subsidiary without any causal and direct remuneration – and still properly exercise its activity, within its capacity and lucrative scope: it can effect a capital increase (article 25 of the Commercial Companies Code), supplementary or supplementary contributions without interest (article 210 and 287 of the Commercial Companies Code) or gratuitous loans (article 243 of the Commercial Companies Code) – and in any of these cases acts completely within its capacity for exercise and with a lucrative intent and in the exercise of its activity".

Thus, equating the notion of indispensability with a relationship to productive activity or with a mandatory nexus of causality with the obtaining of income is not the position upheld by the reference doctrine.

Beyond what has already been said, and still regarding this nexus of causality, see the position of DIOGO LEITE DE CAMPOS AND MÓNICA LEITE DE CAMPOS: "Admitting a posteriori administrative judgment about the financial, commercial, etc., management of the company would involve the constant risk that this judgment is based on supplementary elements that did not exist, or did not exist clearly, at the moment of decision-making and that could not have been taken into account. The tax administration does not have to judge whether a company was well or poorly managed".

See also RUI MORAIS, who sustains: "The invocation of the rule of indispensability of costs can never be made to have the judgment of appropriateness and timeliness of the charges assumed, as they resulted from the decision of the corporate bodies, substituted by another judgment, also of a business nature made by the tax administration or by the courts".

And continues: "We cannot regard as good the orientation of certain jurisprudence that refuses the fiscal credit of certain costs because it is not possible to establish a direct correlation with obtaining of concrete profits. Carried to the extreme, such an understanding would have that expenses with research would only be tax-deductible should such research prove successful, when, as a result, the company began to sell new goods and services…"

To conclude in the following manner: "We defend that the question of whether a cost should or should not be considered indispensable must be resolved on the basis of the objective intent of the transaction, that is, of the business purpose test…We think it is fairly clear the scope of the norm: to refuse fiscal participation in some of the expenses borne by the taxpayer… If the assumption of the expense was preceded by a genuine business motivation… the cost is indispensable. When it must be concluded that the expense was determined by other motivations (personal interest of partners, administrators, creditors, other companies in the same group, business partners, etc.) then such cost should not be deemed indispensable."

Conclude this doctrinal digression with J.L. SALDANHA SANCHES, who states: "...to know whether a certain cost corresponds or not to the most effective defense of the company's interests is a question that cannot be resolved by attributing state intervention power… in order to make a merit judgment on a business management option, just as it cannot validate the qualification of the expense as a cost by subjecting it to the condition of subsequent verification of the actual generation of profits".

Let us now examine jurisprudence on the subject, in a general plane, relating to indispensability and its meaning, that is, without yet addressing financial charges and the operations assessed in this case.

In case 03022/09 – Judgment of 6 October 2009 – of the Central Administrative Court of the South, the following dispute was judged. A company (A) ceded to another (B) its activity of machinery sales. In the scope of that cession, the personnel of A also transferred to company B, and A ceased to exercise commercial activity, limiting itself to receiving rent from a property. However, upon the aforementioned cession, it had been agreed between A and B that the former would bear any eventual expenses with indemnification of personnel should rescissions be negotiated.

In a given fiscal year such negotiations occurred and A bore a certain amount of costs related to said indemnifications which its accounting recorded. The tax inspection disregarded those costs, as in its view, "the company is found without activity and without personnel (having as profits only the rents received), considering that this cost does not become necessary for the formation of profits, in accordance with article 23 of the Corporate Income Tax Code".

In the Judgment handed down, the Central Administrative Court of the South treats the concept of indispensability extensively and does so in the following terms:

"But how should the concept of indispensability be assessed? Accepting that we are before an indeterminate concept in need of fulfillment and accepting that we are not, as to such fulfillment, before any discretionary power (in terms of technical discretionarity) on the part of the Tax Administration, it is important, then, to note the terms in which the law frames such concept. (…)

Appealing to the study of TOMÁS TAVARES (…) we will say, as the author points out, it seems evident that from the legal notion of cost provided by article 23 of the Corporate Income Tax Code does not result that the Tax Administration can question the principle of freedom of management, judging the goodness and timeliness of the company management's economic decisions and considering that only those from which profits directly accrue to the company or that prove convenient to the company can be assumed fiscally.

The indispensability referred to in article 23 (…) requires, only, a relationship of economic causality, in the sense that it suffices that the cost be realized in the interest of the company, in order, directly or indirectly, to obtain profits. (…) And outside the concept of indispensability will remain only acts in violation of the social scope, those that do not fall within the interest of the company, above all because they do not aim at profit".

Also on this subject, and having as reference a decision of the Central Administrative Court of the North – case 00624/05.OBEPRT, Judgment of 12 January 2012 – it is stated there:

"In the consideration and fulfillment of this indeterminate concept – indispensability – it is required that the analysis of a concrete cost be made as a function of corporate activity, that is, as a function of its objective within the scope of the company's activity; indispensable costs will be equivalent to expenses incurred in the interest of the company. The criterion of indispensability was created by the legislature precisely to prevent the fiscal consideration of expenses that, despite being recorded as costs, do not fit within the scope of the company's activity, that were incurred not for its pursuit but for other interests unrelated to it".

Finally, in Judgment of 29/3/2006 – Case no. 1236/05 – the Supreme Administrative Court sustains that:

"The concept of indispensability, being indeterminate, has been filled by jurisprudence on a case-by-case basis (…). The rule is that correctly recorded expenses be tax costs; the criterion of indispensability was created by the legislature, not to allow the Administration to meddle in the company's management, dictating how it should apply its means,[… truncated …]