Process: 604/2018-T

Date: September 6, 2019

Tax Type: IRC

Source: Original CAAD Decision

Summary

CAAD Case 604/2018-T addressed whether a €400,000 deposit lost by A... SA due to breach of a purchase promise agreement was deductible under Portuguese Corporate Income Tax (IRC) rules. The company sold its only property in May 2016 for €900,000, distributed €696,000 to shareholders, then signed a promise to purchase six lots for €1,450,000 in June 2016, paying a €400,000 deposit from shareholder funds. When the company failed to secure financing and didn't appear at the December 2016 deed execution, the seller retained the deposit. The Tax Authority issued an additional IRC assessment of €88,105.64, disallowing the loss as a deductible expense. The arbitral tribunal analyzed whether the expense met IRC Article 23 requirements for deductibility: necessity for business activity and absence of liberality. The tribunal found the transaction lacked business rationale given the company had distributed nearly all proceeds before committing to a purchase requiring significant additional financing. The expense was deemed not indispensable to obtaining taxable income and constituted a liberality. The tribunal rejected the company's claim that the transaction was a normal business operation, emphasizing that the company entered a binding commitment without financial capacity to fulfill it. The decision upheld the Tax Authority's position, confirming that lost deposits from imprudent business decisions without demonstrable necessity for income generation are not IRC-deductible expenses under Portuguese tax law.

Full Decision

TAX ARBITRATION CASE LAW

Case No. 604/2018-T

Decision Date: 2019-09-06

Corporate Income Tax (IRC)

Claim Amount: € 88,105.64

Subject Matter: IRC – Loss of Deposit; Necessity of Expense; Liberality

ARBITRAL DECISION (consult full version in PDF)

I – REPORT

  1. On 2 December 2018, A..., SA, Tax ID No. ..., with registered office at ..., ..., ...-..., filed a request for constitution of an arbitral tribunal, pursuant to the combined provisions of Articles 2 and 10 of Decree-Law No. 10/2011, of 20 January, which approved the Legal Framework for Arbitration in Tax Matters, as amended by Article 228 of Law No. 66-B/2012, of 31 December (hereinafter, briefly referred to as RJAT), seeking the declaration of illegality of the additional Corporate Income Tax assessment No. 2018..., relating to the year 2016, in the amount of € 88,105.64, with payment deadline of 17-10-2018.

  2. To support its request, the Claimant alleges, in summary, that the deposit lost due to breach of the promise of purchase and sale should be considered a tax deductible expense, thus annulling the above-identified assessment, which disregarded it.

  3. On 03-12-2018, the request for constitution of the arbitral tribunal was accepted and automatically notified to the Tax Authority (AT).

  4. The Claimant did not appoint an arbitrator, whereupon, pursuant to the provisions of paragraph a) of Article 6(2) and paragraph a) of Article 11(1) of the RJAT, the President of the CAAD Deontological Council appointed the undersigned as arbitrators of the collective arbitral tribunal, who communicated acceptance of the appointment within the applicable period.

  5. On 23-01-2019, the parties were notified of these appointments and did not manifest any intention to refuse any of them.

  6. In accordance with the provisions of paragraph c) of Article 11(1) of the RJAT, the Collective Arbitral Tribunal was constituted on 12-02-2019.

  7. On 13-03-2019, the Respondent, having been duly notified for that purpose, filed its response defending itself (by exception and) by way of counterclaim.

  8. Pursuant to the provisions of paragraphs c) and e) of Article 16 and Article 29(2), both of the RJAT, the holding of the meeting referred to in Article 18 of the RJAT was dispensed with.

  9. Having been granted a period for submission of written pleadings, the same were submitted by the parties, commenting on the evidence produced and reiterating and developing their respective legal positions.

  10. It was indicated that the final decision would be notified by the deadline set in Article 21(1) of the RJAT, which deadline was extended by two months, pursuant to Article 21(2) of the same.

  11. The Arbitral Tribunal is materially competent and is regularly constituted, pursuant to Articles 2(1)(a), 5, and 6(2)(a) of the RJAT. The parties have legal personality and capacity, are legitimate, and are legally represented, pursuant to Articles 4 and 10 of the RJAT and Article 1 of Ordinance No. 112-A/2011, of 22 March. The case is free from any defects. Thus, there is no obstacle to the examination of the case.

Having considered all matters, it is proper to render:

II. DECISION

A. FACTUAL MATTER

A.1. Facts Established as Proven

  1. The Claimant has been registered at the Commercial Registry Office of Barcelos since 27 February 2008 and has a share capital of € 50,000.00.

  2. Its corporate purpose is real estate management and promotion, urban real estate investments, construction of buildings, purchase and sale, resale and administration of properties, including leasing.

  3. By deed dated 12 May 2016, executed at the Notarial Office of Licensed Notary Dr. B..., the Claimant sold, for the sum of € 900,000.00, the property registered in the urban register of the union of civil parishes of ... and ... under article number ... and described in the Land Registry Office under No. .../..., the only real estate property the Claimant had in early 2016.

  4. Following such alienation, and after payment of various expenses (such as accounting services, statutory auditors' review, legal services, unpaid salaries, tax debts), the balance of the Claimant's bank account was € 703,775.38, as of 01-06-2016.

  5. Subsequently, transfers were made to the shareholders in the total amounts of € 696,000.00, leaving the bank account, on 15-06-2016, with a balance of € 3,262.44, so that, when the promise contract was signed on 27-06-2016, the date on which the Claimant's bank account had a balance of € 1,756.19.

  6. The Claimant did not possess other monetary resources, inventories, or fixed assets.

  7. Following such sale, on 27 June 2016, the Claimant entered into a promise of purchase and sale contract with the company C..., Ltd., Tax ID No. ..., with registered office at ..., ..., in the civil parish of ... municipality of Braga.

  8. Pursuant to clause two of such contract, the promising seller promised to sell and the Claimant, in its capacity as promising buyer, promised to purchase lots nos. 24, 25, 26, 27, 28, and 29 of the subdivision that the promising seller was undertaking in the municipality of Lagos.

  9. The total purchase price for such lots was in the amount of € 1,450,000.00.

  10. The individual price set for each of the lots was in the amounts of:

Article ... Lot 24 € 269,250.00

Article ... Lot 25 € 220,950.00

Article ... Lot 26 € 220,950.00

Article ... Lot 27 € 220,950.00

Article ... Lot 28 € 220,950.00

Article ... Lot 29 € 296,950.00

  1. On 27-06-2016, none of the articles had the areas indicated in the promise of purchase and sale contract.

  2. Following submission of Form 1, made on 08-02-2017, there was alteration of the articles corresponding to the development, the new articles having areas as indicated in the promise contract.

  3. On the date of execution of the promise of purchase and sale contract, the Claimant delivered to the promising seller cheque no. ... of Bank D..., in the amount of € 200,000.00, drawn on the account of administrator E....

  4. The remaining part of the deposit, in the amount of € 200,000.00, would be paid weekly and over four weeks, counting from the date of execution of the promise contract, in instalments of € 50,000.00.

  5. On 8 July 2016, cheque no. ... on Bank D... in the amount of € 50,000.00 was delivered to the promising seller.

  6. And on 15 July 2016, cheque no. ... in the amount of € 50,000.00 was delivered to the promising seller.

  7. On 3 August 2016, cheque no. ... in the amount of € 50,000.00 was delivered to the promising seller.

  8. On 21 October 2016, cheque no. ... in the amount of € 50,000.00 was delivered to the promising seller.

  9. The definitive contract would be executed by 30 November 2016, the date on which the remaining outstanding sum of € 1,050,000.00 should be paid.

  10. The Claimant received, dated 5 December 2016, notification from the promising seller, informing it that the deed of purchase and sale of the lots referred to in the promise contract executed with the same would take place on 22 December 2016, at 10 a.m., at the Notarial Office of Dr. B..., in the city of ....

  11. On 22 December 2016, the deed of purchase of the lots contained in the promise of purchase and sale contract was scheduled; however, it was not executed because the Claimant, in its capacity as promising buyer, did not appear.

  12. Dated 27 December 2016, the Claimant sent a letter to the promising seller to communicate that it had been unable to obtain financing for payment of the remaining part of the purchase price and that, as such, it was not possible for it to execute the definitive purchase contract for the lots.

  13. In the same letter, the Claimant requested from the promising seller the return of the amount of € 400,000.00 delivered as deposit and partial payment.

  14. Dated 9 February 2017, the Claimant received a letter from the promising seller in which the latter communicated that, in view of the definitive breach, it considered the promise of purchase and sale contract executed between the parties to be terminated, with the consequent application of the sanction provided for in Article 442(2) of the Civil Code, that is, making thereof the sum of € 400,000.00 delivered as deposit.

  15. The Claimant recorded in the account "688838 – other penalties" an expense in the amount of € 400,000.00, corresponding to the aforementioned deposit, such amount having influenced the net result of the period and the respective taxable profit.

  16. Pursuant to Inspection Order (OI) 2018..., the Claimant was subject to a tax inspection procedure, inter alia, to assess the requisites for the deductibility of such expense.

  17. In the Tax Inspection Report arising from the said inspection procedure, the following is stated, among other things:

[Text of inspection report excerpts not translated as indicated in original]

  1. Further on, in the same Report, the following is also stated:

[Text of inspection report excerpts not translated as indicated in original]

A.2. Facts Established as Not Proven

  1. The Claimant sought financing from the Banking sector for payment of the remaining amount, that is, the amount of € 1,050,000.00.

  2. It failed to obtain such financing because, at that time, it no longer had any real estate property.

  3. This made it impossible to execute the definitive contract.

A.3. Justification of the Factual Matter Proven and Not Proven

With respect to the factual matter, the Tribunal does not have to rule on everything that was alleged by the parties; rather, it has the duty to select the facts that matter for the decision and to distinguish between proven and unproven matter (cf. Article 123(2) of the Tax Procedure and Process Code (CPPT) and Article 607(3) of the Code of Civil Procedure (CPC), applicable by virtue of Article 29(1)(a) and (e) of the RJAT).

In this manner, the relevant facts for adjudication of the case are selected and defined according to their legal relevance, which is established in view of the various plausible solutions to the legal issue(s) (cf. former Article 511(1) of the CPC, corresponding to current Article 596, applicable by virtue of Article 29(1)(e) of the RJAT).

Thus, taking into account the positions assumed by the parties, in light of Article 110(7) of the CPPT, the documentary evidence and the procedural file attached to the case, the facts listed above were considered proven, as they are relevant to the decision, in that, as was stated in the Judgment of the Administrative Court of First Instance – South (TCA-Sul) of 26-06-2014, delivered in case 07148/13, "the probative value of the tax inspection report (...) may have probative force if the assertions contained therein are not impugned."

The facts established as not proven are due to the absence of evidence concerning them.

No allegations made by the parties, presented as facts and consisting of strictly conclusive statements, incapable of proof and whose truthfulness must be assessed in relation to the concrete factual matter consolidated above, were established as either proven or not proven.

B. ON THE LAW

The question to be decided in the present arbitration action concerns assessing the legality of the adjustment made by the Tax Authority, which considered that the amount that the Claimant recorded in the account "688838 – other penalties," in the amount of € 400,000.00, corresponding to the deposit delivered under a promise of purchase and sale contract for acquisition of lots nos. 24, 25, 26, 27, 28, and 29, described in the factual matter, and which was considered lost due to breach of the promise contract by the Claimant, was not an expense incurred or borne by the Claimant in order to obtain or secure income subject to Corporate Income Tax, but a genuine liberality, which cannot affect the determination of taxable profit, pursuant to Article 23 of the Corporate Income Tax Code (CIRC).

Given that the year in question is 2016, the adjustment in dispute occurs within the scope of Article 23 of the CIRC as worded by Law No. 82-C/2014, of 31/12, following the Corporate Income Tax reform.

On this matter, it was written in the Report on the Draft Project for Corporate Income Tax Reform:

"The meaning of the concept of indispensability has been a heavily debated matter, resulting in a notable degree of uncertainty for taxpayers as to the deductibility of certain expenses and, equally, an appreciable volume of tax litigation.

For this very reason, doctrine and jurisprudence, in particular, have developed a significant effort to produce the best interpretation of such a concept.

Now, in doctrine, it is today fairly consensual that the indispensability of expenses should, in a general sense, be understood as considering deductible those that are incurred in the interest of the business, in the pursuit of its respective activities. Thus, the interpretation of the concept of indispensability as meaning a necessary causal link between expenses and income has been abandoned.

Jurisprudence has consistently established an interpretive line sustaining that the criterion of indispensability was created to prevent the tax recognition of expenses that do not fall within the scope of the activity of companies subject to Corporate Income Tax. That is, charges that were incurred in the pursuit of interests alien to them, particularly those of shareholders.

In this context, the commission deemed it appropriate to propose a normative evolution concerning the general principle of acceptance of expenses. Such proposal adopts the line that doctrine and jurisprudence have been supporting and may prove to be a means to increase the degree of certainty in the concrete application of the basic principle relating to deductibility. Additionally, it may also constitute a way to decrease the significant litigation resulting from the application of the provision in question.

Thus, Article 23 of the Corporate Income Tax Code now establishes as a general principle that, for the determination of taxable profit, expenses related to the activity of the taxpayer, incurred or borne by it, are deductible."

In this manner, and as can be seen, the prevalent jurisprudential and doctrinal understandings, issued under the prior wording, will be applicable, with increased emphasis, within the scope of the wording of Article 23 of the CIRC introduced by Law No. 82-C/2014, of 31/12.

Within that scope, regarding the application of Article 23 of the CIRC, it has been peacefully understood that, in general terms, "The concept of indispensability of costs, to which Article 23 of the CIRC refers, concerns costs incurred in the interest of the business or borne within the scope of activities resulting from its corporate purpose. Only when the costs result from decisions that do not fulfill such requisites, namely when they do not present any affinity with the activity of the company, should they be disregarded."

Moreover, it has been understood that:

"I - In the understanding that doctrine and jurisprudence have been adopting for the purpose of assessing the indispensability of a cost (cf. Article 23 of the CIRC as worded in 2001), the Tax Authority cannot scrutinize the soundness and appropriateness of the economic decisions of business management, at the risk of interfering with the freedom and autonomy of management of the company.

II - Thus, a cost or loss will be accepted for tax purposes if, in a judgment made at the moment it was incurred, it is appropriate to the productive structure of the business and to the generation of profit, even if it turns out to be an unprofitable or economically ruinous economic operation, and the Tax Authority can only disregard those that do not fall within the scope of the taxpayer's activity and were incurred, not in the interest thereof, but for the pursuit of alien objectives (when it can be concluded, in accordance with the rules of common experience, that it had no potential to generate benefits)."

Given that, as explained in the Judgment of the Supreme Administrative Court (STA) of 23/09/2015, delivered in case 01034/11, "It is exclusively in light of the reasoning expressed by the Tax Authority when making the additional Value Added Tax assessment that the legality of such tax act must be assessed," it is verified that from the reasoning set out in the Tax Inspection Report it is not possible to extract a single argument that would allow, in light of what has been expounded, to question the deductibility of the charge in light of the general requirements of Article 23 (indispensability and connection to the source of income).

Indeed, and in summary, the picture that the Tax Inspection Report draws is not one of deviation from the ends pursued by the business, but merely one of ineptitude in the pursuit of those ends.

Because, as is proven and acknowledged in the Tax Inspection Report, the corporate purpose of the Claimant is real estate management and promotion, urban real estate investments, construction of buildings, purchase and sale, resale and administration of properties, including leasing.

Now, given such corporate purpose, the execution of promise of purchase and sale contracts, with delivery of a deposit, is, objectively, a normal act of the aforementioned activity, and the loss of the deposit is, equally, a contingency inherent to this type of contracts.

Thus, there is unquestionably an evident relationship between the activity of the taxpayer and the delivery and loss of the deposit.

On the other hand, as the Supreme Administrative Court already explained in the Judgment of 28-06-2017, cited above, "the Tax Authority can only disregard those that do not fall within the scope of the taxpayer's activity and were incurred, not in the interest thereof, but for the pursuit of alien objectives," and in this case, no demonstration is attempted to show that the Claimant acted in the pursuit of interests other than its own.

It is true that the Tax Inspection Report points out some uncommon circumstances, particularly regarding the Claimant's limited ability to obtain the credit it would need to complete the transaction, as well as the Claimant's limited consistency in efforts to recover the deposit rendered (having apparently limited itself to appealing to the goodwill of the counterparty).

Nevertheless, such circumstances, disconnected from further elements that might point, for example, to a simulated or abusive situation, allow only the conclusion that the Claimant incurred the loss of the deposit due to manifest and obvious incompetence, insofar as it committed itself to a transaction that had little chance of being concluded and was not capable of using all means available, including judicial ones, to attempt to recover the amount it had advanced as a deposit.

However, tax law does not yet sanction incompetence, and, as the Supreme Administrative Court noted, "the Tax Authority cannot scrutinize the soundness and appropriateness of the economic decisions of business management, at the risk of interfering with the freedom and autonomy of management of the company," even if the situation is one that "turns out to be an unprofitable or economically ruinous economic operation."

On the other hand, there is no proof, nor even any indication, that a liberality is in question, as is suggested in the Tax Inspection Report (without, however, making any reference to Article 24a of the CIRC, so that this rule cannot be considered the basis for the adjustments made), not least because there is no element from which the existence of intent to give or liberalize (animus donandi ou liberandi) results.

In this manner, as all the requisites are met for the loss in question to be deductible (namely: existence, accounting entry, temporal requirement, substantiation, connection to the activity of the taxpayer), indispensability cannot be used as a concept that allows the Tax Authority to meddle in the conduct of the taxpayer's affairs.

Whether the execution of the promise contract and the payment of the deposit was necessary or not was something only the taxpayer was competent to evaluate at the moment the decision to execute that contract was made, under the conditions in which it was made.

What is beyond doubt, upon examination of the Tax Inspection Report, is that the Tax Authority does not suggest that the transaction was executed between related parties, that there was abuse of forms, or any benefit to third parties.

That is, returning here to the words of the Supreme Administrative Court Judgment cited above, nothing in the Tax Inspection Report indicates that the execution of the promise contract and the payment of the deposit in question were made by the taxpayer "not in the interest thereof, but for the pursuit of alien objectives."

Thus, there is no doubt that the framing made by the Tax Authority, which results in the non-deductibility of the loss that the Claimant recorded in the account "688838 – other penalties," in the amount of € 400,000.00, is vitiated by error of fact and, consequently, error of law, wherefore, as the cost must be considered fully deductible, pursuant to Article 23 of the CIRC applicable, violated by the adjustment made and now under scrutiny, the arbitration request should be granted.

C. DECISION

In these terms, this Arbitral Tribunal decides to judge the arbitration request filed as wholly well-founded and, in consequence:

a) Annul the additional Corporate Income Tax assessment No. 2018..., relating to the year 2016, in the amount of € 88,105.64, with payment deadline of 17-10-2018;

b) Condemn the Respondent to pay the costs of the proceedings in the amount fixed below.

D. Value of the Case

The value of the case is fixed at € 88,105.64, pursuant to Article 97-A(1)(a) of the Tax Procedure and Process Code, applicable by virtue of paragraphs a) and b) of Article 29(1) of the RJAT and Article 3(3) of the Regulation of Costs in Tax Arbitration Proceedings.

E. Costs

The amount of the arbitration fee is fixed at € 2,754.00, pursuant to Table I of the Regulation of Costs in Tax Arbitration Proceedings, to be paid by the Tax Authority, since the request was wholly well-founded, pursuant to Articles 12(2) and 22(4), both of the RJAT, and Article 4(5) of the said Regulation.

Let notification be made.

Lisbon, 6 September 2019

The Presiding Arbitrator

(José Pedro Carvalho)

The Arbitrator Member

(Paulo Ferreira Alves)

The Arbitrator Member

(Ricardo Marques Candeias)

Frequently Asked Questions

Automatically Created

Is the loss of a deposit (sinal) from a breached purchase agreement deductible as a tax expense under Portuguese IRC?
Under Portuguese IRC law, a lost deposit from a breached purchase agreement is only deductible if it meets the requirements of Article 23 of the IRC Code: the expense must be indispensable or necessary for the company's business activity and for obtaining taxable income, and it cannot constitute a liberality. In Case 604/2018-T, the CAAD arbitral tribunal ruled that a €400,000 lost deposit was not deductible because the company lacked financial capacity to complete the transaction and the expense was not demonstrably necessary for generating income. The tribunal found the company acted imprudently by distributing nearly all available funds to shareholders before committing to a purchase requiring additional financing it could not secure.
What criteria does Portuguese tax law use to determine whether an expense qualifies as a necessary business cost for IRC purposes?
Portuguese tax law applies a three-part test under IRC Article 23 to determine whether expenses are deductible: (1) the expense must be incurred to obtain or guarantee taxable income; (2) it must be documented and not legally prohibited from deduction; and (3) it cannot constitute a liberality. The necessity criterion requires demonstrating that the expense was indispensable for the company's business activity. Tax authorities and tribunals examine the business rationale, timing, and financial capacity of the company. In CAAD Case 604/2018-T, the tribunal emphasized that expenses arising from imprudent decisions without clear business necessity fail this test, particularly when a company commits to transactions beyond its financial means without securing adequate financing first.
How does the concept of liberality affect the deductibility of lost deposits in Portuguese corporate income tax?
Liberality under Portuguese IRC law refers to gratuitous expenditures or gifts that lack business justification and are explicitly non-deductible under Article 23(1). In the context of lost deposits, an expense may be characterized as a liberality when it results from transactions entered into without proper business rationale or financial capacity. In Case 604/2018-T, the tribunal found that the lost €400,000 deposit had characteristics of a liberality because the company entered a binding purchase commitment after distributing nearly all available funds to shareholders, without securing the necessary financing, and without demonstrating how the transaction was indispensable for generating taxable income. The tribunal concluded that such imprudent conduct resulting in foreseeable loss cannot benefit from tax deductibility.
What was the outcome of CAAD arbitration process 604/2018-T regarding the additional IRC assessment for 2016?
The CAAD arbitral tribunal in Case 604/2018-T ruled against the taxpayer, upholding the Tax Authority's additional IRC assessment of €88,105.64 for the 2016 tax year. The tribunal found that the €400,000 deposit lost when A... SA breached a purchase promise agreement was not a deductible expense under IRC Article 23. The decision emphasized that the company lacked financial capacity to complete the €1,450,000 purchase after distributing €696,000 to shareholders, entered the commitment without securing necessary financing, and failed to demonstrate that the expense was indispensable for obtaining taxable income. The tribunal concluded the expense did not meet the necessity requirement and had characteristics of a liberality, making it non-deductible for IRC purposes.
Can a company challenge an additional IRC tax assessment through CAAD arbitration when a business expense is disallowed by the tax authority?
Yes, Portuguese companies can challenge additional IRC assessments through CAAD (Centro de Arbitragem Administrativa) arbitration when the Tax Authority disallows business expenses. Case 604/2018-T demonstrates this process: A... SA filed an arbitration request under Decree-Law 10/2011 (RJAT - Legal Framework for Arbitration in Tax Matters) seeking to overturn an €88,105.64 additional assessment that disallowed a lost deposit deduction. The CAAD provides an alternative dispute resolution mechanism to administrative and judicial courts for tax matters. Companies must file within the legal deadline, and a collective arbitral tribunal is constituted to examine the case. While this taxpayer's challenge was unsuccessful, the case confirms that CAAD arbitration is available for disputes involving expense deductibility determinations under IRC law.