Process: 607/2017-T

Date: May 3, 2018

Tax Type: IRC

Source: Original CAAD Decision

Summary

This CAAD arbitral decision (Process 607/2017-T) addresses the deductibility of financial costs following a merger by incorporation under Portuguese Corporate Income Tax (IRC) law. The taxpayer, A… Lda., challenged an additional IRC assessment of €2,641,009.79 issued by the Portuguese Tax Authority (AT) for fiscal years 2013-2014. The case involves a complex corporate restructuring where E… was acquired by Luxembourg-based U… S.A.R.L. in 2007 for €122.6 million, followed by capital increases allegedly made in cash and the issuance of an €81.7 million bond loan. Subsequently, E… merged with A… Lda. in December 2008, with the incorporating entity assuming the designation and operations of the incorporated company. The AT's tax inspection questioned whether the capital increases were genuinely made in cash, as accounting records showed no cash movements and suggested the increases were offset against third-party debts. The central tax issue concerns whether financial costs (encargos financeiros) generated by the acquisition debt structure remain deductible for IRC purposes after the merger by incorporation. The taxpayer also sought compensation for wrongful guarantee (garantia indevida). The tribunal was constituted as a collective arbitral panel under RJAT (Decree-Law 10/2011) and found no procedural irregularities. This decision has significant implications for corporate groups undertaking leveraged acquisitions and subsequent mergers in Portugal, particularly regarding the AT's scrutiny of debt financing structures and the application of anti-abuse provisions in IRC cost deductibility rules.

Full Decision

ARBITRAL DECISION

The undersigned arbitrators Dr. Jorge Manuel Lopes de Sousa (president arbitrator), Prof. Dr. Suzana Fernandes da Costa and Dr. António Alberto Franco (member arbitrators), appointed by the Deontological Council of the Centre for Administrative Arbitration to form the Arbitral Tribunal, constituted on 06-02-2018, agree as follows:

1. Report

A…, LDA., NIPC…, with registered office at …, …, …, …-… Sintra (hereinafter, "Claimant"), presented, pursuant to articles 10th and 2nd, n.º 1, subsection a), both of Decree-Law n.º 10/2011, of 20 January (hereinafter "RJAT"), a request for constitution of a collective arbitral tribunal, in which the Tax and Customs Authority is the Respondent, with a view to declaring illegal the additional assessment of Corporate Income Tax (hereinafter, "IRC"), identified with n.º 2016…, of 14-09-2016, in the amount of € 2.641.009,79 and of Statement of Interest Calculation, identified with n.º2016…, of 16-09-2016, which, according to the Statement of Account Settlement, identified with n.º 2016…, gave rise to tax payable in the amount of € 2.641.009,79.

The Claimant further requests the condemnation of the Tax and Customs Authority to pay compensation for wrongful guarantee.

The request for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority on 22-11-2017.

Pursuant to the provisions of subsection a) of n.º 2 of article 6th and subsection b) of n.º 1 of article 11th of RJAT, in the wording introduced by article 228th of Law n.º 66-B/2012, of 31 December, the Deontological Council appointed as arbitrators of the collective arbitral tribunal the signatories, who communicated their acceptance of the appointment within the applicable timeframe.

On 16-01-2018, the parties were duly notified of this appointment, and neither party manifested its will to refuse the appointment of the arbitrators, pursuant to the combined provisions of article 11th n.º 1 subsections a) and b) of RJAT and articles 6th and 7th of the Deontological Code.

Thus, in accordance with the provision in subsection c) of n.º 1 of article 11th of RJAT, in the wording introduced by article 228th of Law n.º 66-B/2012, of 31 December, the collective arbitral tribunal was constituted on 06-02-2018.

The Tax and Customs Authority responded, arguing that the request should be dismissed.

By order of 13-03-2018, the meeting provided for in article 18th of RJAT was waived, and it was decided that the proceedings would proceed with written pleadings.

The Parties presented their pleadings.

The arbitral tribunal was regularly constituted and is materially competent in light of the provisions in articles 2nd, n.º 1, subsection a), and 30th, n.º 1, of RJAT.

The parties are duly represented, are legitimate, and enjoy legal personality and capacity (articles 4th and 10th, n.º 2, of the same statute and article 1st of Order n.º 112-A/2011, of 22 March).

The proceedings do not suffer from any nullities and no exceptions have been invoked.

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

2. Statement of Facts

2.1. Proven Facts

Based on the elements contained in the proceedings and in the administrative file attached to the record, the following facts are considered proven:

  • The Claimant commenced its activity on 19 October 1990 with the designation of B…- SGPS Lda;

  • On 10 January 2006, the Claimant changed its designation to C… Lda (hereinafter C…), having on 26 December of the same year been subject to a division which resulted in the company D…- SGPS Lda, with NIPC…;

  • On 1 August 2007, the Claimant was acquired by E… for the amount of € 122.611.711,00, changing its designation to A… Lda on 4 December of that same year;

  • The Claimant held the entire capital of the following entities:

  1. F…, S.A., NIPC: …

  2. G… LDA, NIPC: …

  3. H… LDA, NIPC: …

  4. I… LDA, NIPC: …

  5. J…, S.A., NIPC: …

  6. K…, S.A., NIPC: …

  7. L… S.A., NIPC: …

  8. M…, S.A., NIPC: …

  9. N…LDA, NIPC: …

  10. O… LDA, NIPC: …

  11. P… S.A., NIPC: …

  12. Q…, S.A, NIPC: …

  13. R…, S.A., NIPC: …

  14. S… SA., NIPC: …

  • The Claimant is currently classified for the practice of "Specialized medical practice activities, on an outpatient basis - CAE 86220", with secondary object "Accounting and auditing activities; tax consultancy - CAE 69200".

  • Until 25 June 2007, E… was held by T… SGPS, S.A., practically without recording any business activity;

  • On 26 June 2007, T… SGPS, S.A., alienated its shares in E… to the company U… S.A.R.L., with registered office …, Luxembourg, (hereinafter "U…"), which subsequently changed its designation to V…;

  • On the date of acquisition, U… proceeded to increase the capital of E…, raising it from € 5.000,00 to € 40.896.711,00, an increase that would allegedly have been made in cash;

  • On 10 December 2007, U… proceeded to another capital increase of E…, raising it from € 40.896.711,00 to € 57.773.878.00 (as per the permanent certificate of the Commercial Registry attached to the RIT), an increase made, according to the certificate, in cash;

  • In July 2008, the company E… became known as W…, Lda. (hereinafter W…) and changed its registered office, previously at …, to the current one at …;

  • In December 2008, W… incorporated, by merger, its subsidiary A… Lda – NIPC …, with the incorporating company adopting as its own the designation that was that of its incorporated entity and thus assuming the functions and corporate purpose of the incorporated company;

  • By virtue of this merger, the Claimant became the direct holder of a series of companies in the healthcare sector, operating mainly in the field of dialysis;

  • In December 2009, the Claimant proceeded to incorporate by merger with the group companies, and from that date onwards dedicated itself to the provision of medical services;

  • The A…, holding NIPC…, corresponds to the previous designations B…– SGPS Lda. (until January 2006) and A... (until August 2007), having ceased activity due to incorporation by merger with the Claimant company here;

  • The Tax and Customs Authority carried out a tax inspection of the Claimant for the years 2013 and 2014, conducted through Service Orders n.ºs Ol2015…, of 10.04.2015 and OI2015…, of 15.06.2015;

  • In this inspection, the Tax and Customs Authority drew up the Tax Inspection Report that appears in the administrative file, the contents of which are reproduced herein, in which the following is referred to, among other matters:

III.1.2 - Of the facts ascertained

In the context of the inspection, the following facts related to these companies were ascertained:

a) E…, until its acquisition in 2007 by U…, was an entity without any type of activity, having recorded small losses resulting from the administrative costs of its existence;

b) After its acquisition, they proceeded to increase the capital from € 5.000,00 to € 40.901.711,00, an increase made in money, according to the statement of the company manager (minutes n.º 13)- (annex 2);

c) By analyzing the accounts of E… for the years 2007 and 2008, carried out in the context of Service Orders n.ºs OI2010…/…, it was possible to verify that the requirement for cash realization NEVER was met, all the more so as during the year 2007 there is no evidence of movements in cash accounts (annex 7, 2 pages), and due to the fact that, in accounting terms, the capital increase was not made in return for cash, but rather as a result of debts from third-party accounts;

d) On 28 June 2007, the entity E… proceeded to issue a bond loan in the amount of € 81.700.000,00, entirely subscribed by the sole shareholder, U… S.A.R.L. (annex 8, 12 pages);

e) For this purpose, it was resolved on 27 June 2007, as per Minutes n.º 14 of E… company (annex 9, 2 pages), that, given the need for capitalization to meet the transactions it proposed to carry out and having the intention to proceed with the payment of the price under the share transfer agreement representing the entire capital of C… company, it would proceed to issue a bond loan in the amount of € 81.700.000,00, which would be entirely subscribed by the sole shareholder (U…S.A.R.L.);

f) For the implementation of the bond loan, X…, S.A. also intervened, which proceeds to pay interest to the subscriber company U..., and Y… SA, which proceeded to register this loan;

g) Once again, from the analysis of the accounts, it was found that the € 81.700.000,00 NEVER entered the entity's accounts, with this amount appearing as third-party debts in return for loans;

h) The acquisition of C… took place on 1 August 2007 for the price of €122.611.711,00 (annex 3);

i) This operation was recorded in the accounts through a transfer of debtor balances - third-party debts - shareholders (from the capital increase and from the bond loan) to financial investments, rather than an outflow of cash, so it is concluded that the monetary means relative to both the capital increase and the bond loan NEVER entered the accounts of E… (annex 10, 2 pages);

j) Regarding interest, as emerges from the accounts of E… for the years 2007 and 2008, it was paid through X…, S.A., by the acquired company C…, because E… never had operational activity, since it served only as a vehicle for the acquisition of C…;

k) This same interest paid to U… was not subject to tax in Portugal, in accordance with Decree-Law n.º 193/2005, of 7 November;

l) In the two years in which the analysis of E…'s accounts was carried out within the framework of the above-mentioned Service Orders, it was found that it had no significant operational results, presenting losses due to negative financial results, arising from the bond loan which, it must be said once more, was paid by C… (entity acquired by E...);

m) In December 2008, they proceeded to incorporate Z… (former C…) in W… (former E…), effective as of January of the following year (annex 5);

n) Given the fact that W… company (formerly E…) held the entire capital of Z… (formerly C…), such incorporation was carried out through a merger process;

o) With this operation, all the assets of the incorporated Z… were transferred to its incorporating entity, W…;

p) In addition to the process of incorporation of these two entities, the firm of the incorporating entity was also changed to A…, Lda., thereby adopting the designation of the incorporated entity;

q) With said incorporation, all assets and liabilities are encompassed in a single entity, and the incorporated entity, which generated income and/or gains, comes to bear the charges established between U… entity and E… entity, arising from the bond loan for the acquisition of C… company;

r) In the years 2013 and 2014, the amount of interest recorded in the current company and paid to the parent company was € 8.473.969,38 and € 8.522.308,56, respectively;

(...)

From the foregoing, we have that U…, a Luxembourg law company, sole holder of E… company's capital, endowed it with capital (in a first phase by increasing its capital and in a second phase by subscribing to all the bonds it issued), with the intention of acquiring C… company through it, its first objective. Given that E… was a company without any operational activity, it served as a "vehicle" for the realization of this transaction.

Thus, following the operations mentioned - capital increase and subsequent issue of bond loan (without the money actually entering at any point), E… company proceeds to acquire C….

Now, from the bond loan arises the payment of interest. It would be expected that this interest would be paid by E…, the beneficiary of the loan. However, given the absence of operational activity on the part of E…, and therefore the absence of gains, it is C… that assumes the payment of this interest to U…, which is equivalent to saying that C… itself bears the interest on the loan contracted for its own acquisition.

Following the acquisition of C…, it became known as Z…, while E… changed its designation to W…. Given that this was the sole holder of Z…'s capital, a merger process occurred effective 01 January 2009. With this operation, all the assets of the incorporated Z… were transferred to its incorporating entity W…, resulting from this process in "A…, LDA", NIPC…, the subject of this inspection. Notwithstanding the combining of all assets and liabilities in a single entity, it continued, however, to be the incorporated entity W… that was responsible for the payment of the financial charges existing between the Luxembourg U… and the former E…, since it continues to be the sole generator of gains.

The process of reorganization and growth of the A… group, through the acquisition of various clinics, using for this purpose E…, a company emptied of operational content, serving only as a "vehicle company", constitutes proof of the artificiality of the operations in which it took part, in particular the allocation, in its sphere of expenses, of interest, which is, in reality, expenses of U…, S.A.R.L.

Through the deduction of interest from the profit of A…, which benefits a third party (U…), it was itself improperly used to obtain excessive expense deductions, or rather, to finance the production of income that is not imputable to it. Indeed, for most entities it is expected that there is a clear correlation between profit and income. Measuring economic activity through the profits generated by that same activity is an effective way to verify and ensure that the ability to deduct interest expenses is offset by activities that generate income and create value for the unit.

Moreover, depending on the definition of gains used, this is a useful indicator of the entity's ability to fulfill its obligations to pay interest and is, therefore, one of the main factors in determining the amount of debt an entity is able to borrow.

As already described, in the case of A…, it did not have the capacity to pay on its own the interest resulting from the bond loan, being obliged to take out a loan with the parent company to meet this interest.

The existence of A… as a legal structure which, while appearing in legitimate form, in reality, perverts the purposes for which it was used in the operations described, goes to the point of rendering null or irrelevant the actual taxation of its operations. It is true that the freedom to choose the legal form adopted for conducting business must be within the legal limits imposed by the legal order, under penalty of being faced with a tax violation. However, and as has been demonstrated, the practice used by A… allowed artificially separating the taxable profit of the entity benefiting from the merger processes from the activities that generate that same profit.

Indeed, given the absence of evidence of capital contributions to the company under inspection, resulting either from the capital increase or the bond loan, leads us to believe we are faced with an operation which, from the perspective of A…, legitimizes the outflow of capital as interest, with the aggravating circumstance that the same was not subject to tax in Portugal (via withholding at source), by virtue of the utilization of a legal provision (Decree-Law n.º 193/2005 of 7 November), constituting the achievement of a tax advantage realized through the reduction of taxable profit, by means of the deduction of expenses incurred with financing.

From the perspective of acquisition finance, the case is of special interest, in which the company acquires control, the acquisition being financed, to a significant extent, through debt; the specificity is that normally a vehicle company is created and it is this that will buy the target company, resorting essentially to outside capital. After the acquisition, vehicle company and target company merge, with the acquired company thus assuming its own debt to acquire it. The acquirer therefore relies on the cash flow generated by the target company to pay the debt.

In conclusion, this operation led to the achievement of a tax advantage, realized through the reduction of taxable profit, by means of the deduction of expenses incurred with financing.

III.1.3 - Of the notification made to the taxpayer

A… was notified on 13 May 2015 and 17 July 2015 to prove the "indispensability" of costs and/or expenses incurred with interest supported by the bond loan for the obtaining of income, for the years 2013 (annex 12, 02 pages) and 2014 (annex 13, 02 pages).

From A…'s corresponding responses, we first highlight the one relating to 2013, dated 2 June 2015 with entry in this Finance Office of Lisbon under n.º … of the same date (annex 14, 37 pages):

year 2013:

  • In 2007, the AA… agreed to acquire part of the C… group business dedicated to the provision of renal health care in various jurisdictions;

  • For this purpose, it established a company with registered office in Luxembourg (V… SARL) with the purpose of acquiring or establishing companies in each of the jurisdictions in which C… had activity, with the aim of completing the acquisition of C… group companies or, if possible, acquiring the assets and liabilities of these same entities;

  • In Portugal, that operation resulted in the acquisition of C… company by E…, since it was in C… that the target of E… was located (dialysis clinics);

  • For this purpose, V… SARL endowed the Portuguese company with capital and debt with the purpose of proceeding to the acquisition of C…;

  • This route was chosen, according to the arguments set forth in the response, as it conforms to best international practices, as it instills financial discipline through the pressure it exerts on results, and the outflow of capital via debt is simpler than the distribution of dividends, among other reasons.

  • It is stated that the intention of the A… group would be the acquisition of the clinics and not the companies, which in our jurisdiction is not possible given the specific rules of Regional Health Administrations;

  • It was also the intention of the group to simplify the structures of the shareholdings it held, which it did through a two-phase reorganization;

  • This reorganization first involved the merger of C… into A… (former E…) and, second, proceeding to merge the remaining entities into A…, which had to be approved by the Regional Health Administrations;

  • The two mergers, regardless of having taken place on different dates, were dated as of 1 January 2009;

  • They highlight at point 24 on p. 6 the economic reasons underlying the merger process, which "from an economic-financial perspective, brought economic benefits to the Group and, consequently, to the National Economy.";

  • Regarding the deductibility of financial charges supported by the bond loan subscribed by the parent company, we have in points 26 to 42 considerations on this matter, which it summarizes at point 42:

"In summary, in order to attest to the indispensability of a given expense for the generation of income or for the maintenance of the income-producing source, the following should be verified:

  • The framing of the expense within the scope of the activity of the taxpayer and not of any other entity, even if related to it;

  • A connection between the expense and the income subject to tax, even if indirect;

  • The expense should have, in its origin and cause, the specific interest of the company or, in other words, should comply with criteria of economic rationality given the statutory objectives and attend to the reasonableness and substantiation of management decisions at the time and circumstances in which they are made."

  • As to the specific case, it divides the exposition into two situations: the deductibility of financial charges prior to merger and after merger;

  • Thus, at a time prior to the merger, we have that the loan was contracted for the acquisition of C…, which was not entirely unrelated to the corporate purpose of the company;

  • The financial charges "were incurred in the strict pursuit of the activity of the Declarant and in its unique and exclusive benefit" and that, without this financing, it would not have been able to complete the acquisition of C…, "an acquisition which, together with the subsequent management of its capital shares, constituted an important part of the Declarant's activity at the time prior to merger.";

  • It further states that, without that acquisition, "it would potentially be deprived of a set of income" and that it did not benefit from the provision of article 32nd of the Statute of Tax Benefits regarding capital gains and losses realized, so the financial charges supported met the conditions to be considered as indispensable for the generation of income;

  • Regarding the period after merger, the indispensability of expenses cannot be questioned since "(i) they are directly related to the activity of the taxpayer as well as its corporate purpose, (ii) they contribute to the generation of income subject to tax and (iii) they are manifestly indispensable.";

  • With regard to the first aspect, we have that the corporate purpose of A… became the following: "1 - Consultancy and provision of business services in the areas of administrative, financial and personnel management, accounting, computer science, scientific research, professional training, the marketing of equipment, utensils and products intended for the health care provision sector and the preparation of studies and provision of medical services in all specialties, as well as the provision of related or similar services. 2 – The activities contained in the corporate purpose may be developed, in whole or in part, indirectly, through the holding of shares or interests in companies with identical or analogous corporate purpose", and this remains to date;

  • This change of activity was intended to accommodate the activities developed by the incorporated companies, with A… proceeding, via merger, to develop all activities developed by the incorporated companies;

  • Thus, "the merger of C… into the Declarant did not result in the disappearance of any asset in its sphere (in particular capital shares) that was at the origin of the bond loan that generated financial charges, but rather in the conversion of that asset into the set of assets and liabilities that those securities already represented.";

  • And as such the financial charges "fitted necessarily within the activity of the Declarant after the merger, i.e., were intended, in substance, to finance the acquisition of the patrimony sufficient and necessary for the development, in its sphere, of the activity of provision of dialysis care previously developed by the subsidiaries, on an individual basis.";

  • As to the indispensability of the expenses, it states that "without the bond loan the Declarant would not have 'acquired' the assets and liabilities, namely the units of business care of health care provision which are, in fact, the source of income - subject to tax - primary of the Declarant at the time following merger.";

Summarizing at point 70 we have that:

  • "The activity developed by the Declarant, after the merger, included the provision of health care, using human and material resources, as well as the assets and liabilities of the incorporated entities, which fits fully within its corporate purpose;

  • Without the financing in question, the acquisition of C… would not have been possible and, without it, the subsequent merger, which allowed the Declarant to develop its income-generating activity subject to tax;

  • In truth, the financing in question can be seen as being intended, from the outset, for the acquisition of the assets and liabilities that comprise the entire patrimony of the incorporated companies.

  • Indeed, the merger should not be viewed as representing a change in the consolidated economic reality of the incorporating and incorporated companies, since it remains intact;

  • There occurred, at no time, any confusion between the financial charges supported by the Declarant and the activity of third parties."

Thus, in these terms, and after the exposition made by the taxpayer, it is incumbent upon us to make our own considerations.

III.1.4 - Of the analysis of the operation and proposed corrections

III.1.4.1 - Costs with bond loan

With the incorporation of A…, Lda. (NIPC…) into its parent company, W…, Lda. (NIPC…), all assets and liabilities were combined in a single entity, with the cash flows released by the activity and the patrimony of the incorporated entity coming to bear the charges resulting from the bond loan entered into between U… and E…, a loan which enabled the acquisition of C… company.

It is the same as saying that, with the merger, the cash flows released by the activity of the incorporated company came to bear the costs of its own acquisition.

(...)

It is thus important, regarding 2013, and given the provision in article 23rd of the IRC Code, at the time, to verify in concreto whether the costs of the bond loan that enabled the acquisition of C… are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the income-producing source.

(...)

In sum, the Supreme Administrative Court understands, in its most recent case law regarding the requirement of indispensability contained in article 23rd of the IRC Code that:

  • costs (. . .) cannot fail to relate, from the outset, to the contributing company itself;

  • for a given sum to be considered a cost of that company it is necessary that the respective activity be developed by it itself, not by other companies;

  • Indispensable costs are equivalent (...) to expenses incurred in the interest of the company (...) the tax deductibility of the cost depends only on a causal and justified relationship with the productive activity of the company;

  • Indispensable costs are equivalent to expenses incurred in the interest of the company or, in other words, in all acts that can be abstractly subsumed in a lucrative profile;

In the specific case we have that the costs of the acquisition of C… company (subsequently A…, Lda.), which had been incurred by E… (subsequently W…, Lda.), through the merger, came to be borne by the cash flows generated by the acquired entity.

With the merger, the activity developed by the incorporating company came to correspond entirely to the activity that was already being carried out by the incorporated company, and the loan obtained by E… had as its sole purpose the obtaining of capital for the acquisition of C….

W… (former E…) arose only as a vehicle to realize the acquisition of C… A…, Lda. (former C…).

Upon the Merger, W… (former E…) assumed the designation of A…, Lda., which in practice resulted, solely and only, in the cancellation of the taxpayer's registration with the NIPC and registration n.º….

Notwithstanding the cancellation of the taxpayer's registration…, it is A…, Lda. (former C…), the company that continues its prior activity, now under NIPC… and not W…, since this company added nothing to the object pursued by A…, Lda. (former C…), which had as its epilogue the adoption of the firm A…, Lda.

The costs subject to analysis only served to reduce the fiscal result of the company resulting from the mergers, with no positive effect having been achieved in financial terms.

In conclusion, the use of the vehicle (E…) as described, allowed the financing costs that would have been borne by the Luxembourg company (U…, S.A.R.L.), in a direct acquisition, to be borne by the patrimony of the operational company (A…), being entirely deducted from the result of this, after the incorporation of its patrimony into the vehicle company, with the respective impact at the fiscal level (EBITDA), as per the analysis carried out at point "II - 3.5.2 Balance Sheet and Statement of Results".

(...)

Now, in the case of A…, the expenses supported with the bond loan are not related to its business activity, nor did they serve to maintain the income-producing source. Such expenses, although recorded in its accounts, do not benefit its activity nor its business interest, but rather benefit a third party (V..., former U… S.A.R.L.), not being accepted for the purposes of calculating the fiscal result, in accordance with subsection c) of n.º 1 of article 23rd of the IRC Code.

As for the response to our notification made on 17 July 2015, relating to the year 2014, which was received at this Finance Office of Lisbon under n.º… (annex 15, 27 pages) we highlight:

year 2014:

Regarding 2014, the taxpayer repeats the argument adduced for 2013, however, establishes a "preliminary point":

  • It draws attention to the fact that the notification made by us on 17 July 2015, for proof of the indispensability of costs and/or expenses incurred with interest supported by the bond loan for the obtaining of income in 2014, did not take into account that Law n.º 2/2014 of 16 January (IRC reform), gave a new wording to article 23rd of CIRC, with the same now establishing, in its n.º1, that "For the determination of taxable profit, all expenses and losses incurred or supported by the taxpayer to obtain or ensure income subject to IR are deductible", thus removing, from the letter of the law, the concept of indispensability which, according to the taxpayer, was a concept "strongly debated", which may have led the Commission that presided over the IRC Reform to present this change with the intention of moving away from the "notorious degree of uncertainty for taxpayers regarding the deductibility of certain expenses", which gave rise to "an appreciable volume of tax litigation";

  • The taxpayer considers that, in this way, the Commission removed "the interpretation of the concept of indispensability as meaning a necessary causal link between expenses and income";

  • The taxpayer further states in this preliminary point that, "notwithstanding the said legislative amendment, the notification now received from AT refers to the prior wording of article 23rd of the IRC Code, even though it was not in force in 2014. However, given the principles of cooperation and good faith (. . .), it will seek to frame and support the deductibility of the financial charges in question, in light of the prior wording of article 23rd of the IRC Code";

  • It further makes reference to an "Arbitral Tribunal Judgment relating to Case n.º 42/2015-T, which opposed the Declarant to AT in the follow-up to an additional assessment made by AT to the Declarant, to the effect of refusing, in particular, the deductibility of financial charges supported by it with the bond loan in crisis, precisely in light of the concept of indispensability... noting that, regarding this concept, the said judgment states that '...the business activity that generates deductible costs must be that which results in operations that have a purpose, an intent (and not a required immediate causal nexus) of obtaining income or the purpose of maintaining the potential of an income-producing source... '";

  • Ultimately, the taxpayer understands that "the evaluation of indispensability, for the obtaining of income, of interest with the bond loan, should attend, in particular, to the context in which that financing was obtained and to the operations that succeeded it and that may be relevant for the purpose identified above";

  • Now it was precisely attending to the context in which that financing was obtained and not, solely, on the basis of the concept of indispensability, that AT disregarded those expenses for the years 2007 to 2012;

  • Indeed, in the inspection report relating to the last of the years subject to correction (2012), AT cites, on its respective page 24, a Judgment of the Centre for Administrative Arbitration (created by Decree-Law nº 10/2011 of 20 January), delivered in Case n.º 14/2011-T, in which it is concluded, regarding a business structure with contours comparable to the case under analysis, that "the funds in question have as their purpose, destination and use the acquisition of the company's own social interests by company D... SGPS, whereby the allocation of the loan is not linked to the activity or assets held by the company of which it is a debtor, here the Claimant, but rather to assets held by its own shareholder". (...) In this way, taking into account these provisions and the merger carried out, it is necessary to conclude that the purpose of the financing in question strictly respects the acquisition of social interests (. . .) It is verified in the case that the entity that can benefit, in its own interest, as a source of income from this asset is not the entity that bears, exclusively, the costs related to the financing of the acquisition of the asset (...), but rather a different entity (...) (emphasis ours)

  • Now, in the case of A…, the expenses supported with the bond loan are not related to its business activity, nor did they serve to maintain the income-producing source. Such expenses, although recorded in its accounts, do not benefit its activity nor its business interest, but rather benefit a third party (V… S.A.R.L., former U… S.A.R.L.), not being able to be, for that reason, accepted for the purposes of calculating the fiscal result, in accordance with subsection c) of n.º 1 of article 23rd of the IRC Code;

  • Thus, by resorting to the use of "a vehicle" (E…), these financing costs were borne by the patrimony of the operational company (A…, Lda), after the incorporation of its patrimony into the vehicle company, being then entirely deducted from its result, with natural impact at the fiscal level (EBlTDA), when, and according to previous argument (reinforced by the case law of the STA and CAAD), these financing costs resulting from the group's restructuring process benefit only V… company, S.A.R.L., (former U… S.A.R.L);

  • Thus, the expenses subject to analysis here ended up serving to reduce the fiscal result of the company resulting from the two merger processes;

  • There thus reside, also in this aspect, the arguments of our position regarding the disregard of such expenses and not solely in the indispensability thereof. Effectively, the notifications we made, in order to request the justification for the occurrence of these financial expenses, were based on article 23rd of CIRC and, as such, made reference to the concept of indispensability that appeared in its text. However, as has just been demonstrated, our decision is not based solely on this concept, so the fact that it is referred to in the notification relating to 2014, even though the wording of the said article no longer contemplates it, does not alter our position in any way.

From the foregoing, to the profit/fiscal loss declared by the taxpayer, we will correct the amount of interest relating to the bond loan, in accordance with subsection c) of n.º 1 of article 23rd of the IRC Code and given the case law that has ruled on this matter and which was referred to above.

The amount of these financial expenses is as follows (as per documents attached in annex 16, 04 pages):

(...)

III.1.4.2 - Charges with Shareholder Loans

Pursuant to subsections j), k) and l) of point III.1.2, we have that, regarding interest, as emerges from the accounts of the taxpayer for the years 2007 and 2008, the same were paid through X…, S.A., by the acquired entity C…, because E… never had operational activity, as already previously mentioned and as evidenced by the operations recorded in the accounts of the entity, reflected in the analytical trial balances for the years 2007 and 2008 of E… (cf. annex 17, 9 pages), which contain only entries in accounts of financial costs and income.

Now, in these same years (2007 and 2008), U…, in addition to the bond loan, proceeded to make loans through shareholder loans to various group companies, with C… being the largest recipient of these shareholder loans, in the amount of € 37.359.426,00 (annex 18, 6 pages).

Thus, we have that C… received shareholder loans from U…, via E…, allocating part of these received shareholder loans to the payment of interest on the bond loan of the parent company (E…), since the same, as we mentioned in the preceding paragraphs, had no operational activity that generated financial inflows.

This interest paid by C… to U… was recorded in E… as a debt to third parties (C…), that is, C… paid interest on a bond loan whose parties were U… (creditor) and E… (debtor), constituting this interest a credit of C… over E….

We note that this credit over E… yielded no income, despite the fact that, as a result, C… was bearing a charge with shareholder loan interest to meet the payment of interest that should have been an actual charge of the parent company E….

Schematically, we have the following:

(...)

The amount of interest that C… paid to U… (responsibility of shareholder E…) in the years 2007 and 2008 amounted to € 11.664.656,99 (annex 11), divided between € 3.874.826,75 relating to 2007 and € 7.789.830,24 relating to 2008. This amount constituted a credit of E… over C… (shareholder loans), to the extent that the latter did not have financial means to pay the interest on the bond loan.

With the merger, the amounts of debts between the Portuguese companies were cancelled, maintaining only the record of the debt to the Luxembourg company in the amount of € 47.399.162,66 relating to shareholder loans, an amount which was influenced by the above-mentioned sum (€ 11.664.656,99) relating to the payment of interest on the bond loan in the years 2007 and 2008 by C….

Thus, and in accordance with the provision in subsection c) of n.º 1 of article 23rd of the IRC Code, we will proceed to correct the interest supported, relating to shareholder loans, in the proportion of € 11.664.656,99 against the value of the shareholder loan debt (€ 47.399.656,99).

Thus, the amounts of interest supported in the referred years and recorded as expenses of the period in the account "691155 - Interest related companies - payable" were of the following amount (annex 19, 2 pages):

(...)

(...)

(...)

Now, given the evolution of the shareholder loan account throughout 2014, and the verification of the interest recorded by A…, we conclude that the interest estimated monthly and recorded by the taxpayer in the account "691155 - Interest rel. Group - payable", were calculated on the basis of the value of the associated liability.

In this way, we believe that the best procedure for correcting the interest recorded there is to consider, at each moment, the value of the liability and not the balance as at 31.12.2014, thereby obtaining a closer approximation to the reality of the estimated interest.

The demonstration of the calculations of the proposed correction is found in the following two tables (in euros):

(...)

III.3 - Summary of corrections

The corrections to be made to that declared by the taxpayer are those contained in the table below

(...)

Thus, the profit/fiscal loss that was declared will be corrected and equal to:

(...)

Following the corrections proposed in the Tax Inspection Report, the Tax and Customs Authority prepared the IRC assessment and compensatory interest with n.º 2016…, of 14-09-2016, in the amount of € 2.641.009,79 (including € 103.983,33 of compensatory interest), the Statement of Interest Calculation, identified with n.º2016…, of 16-09-2016, which, according to the Statement of Account Settlement, identified with n.º 2016…, gave rise to tax payable in the amount of € 2.641.009,79; (documents n.ºs 1, 2 and 3 attached with the request for arbitral judgment, the contents of which are hereby reproduced);

On 22-03-2017, the Claimant filed an administrative complaint regarding the acts referred to in the preceding subsection, which received n.º …2017…;

The administrative complaint was dismissed by order of 23-08-2017, issued by the Deputy Director of Finance in a substitution regime, which expresses agreement with an opinion the contents of which are hereby reproduced, in which the following is referred to, among other matters:

2 - Costs with bond loan:

2.1 - The complainant argues that the deductibility of interest on the bond loan recorded as expenses of the complainant in 2014 should be accepted based on n.º 1 of article 23rd of CIRC, in the wording then in force, because the bond loan issued by E… in 2007 was necessary for the acquisition, in that year, of the C… group in Portugal.

It also appears to argue that the bond loan was necessary for the group activity in Portugal.

Although, in general terms, the owner of a company (or group of companies) influences the manner in which the activity is developed, it does not appear that expenses incurred in connection with a change of ownership should be considered as necessary for the activity.

The complainant appears to argue in the following manner: E… would have had the need to issue the bond loan to finance the development of its activity, undertaken mainly through the acquisition of C…, Lda.

However, the report describes a different reality (at point III.1.2-c), g), i) and j) – p. 365):

E… acted as a vehicle for the acquisition of the C… group in Portugal, a fact already reported in the Management Report of E… for the year 2007 (p. 375-reverse);

The requirement for cash realization of its initial capital was never met (a condition for a bond loan to take place);

The bond loan also did not translate into an actual cash entry.

At points 26º and 27º of the complaint it is explained that these cash entries were not made to E… due to the lack of need for an actual transfer of funds, given that the payment to BB… for the acquisition of shareholdings and credits relating to the Portuguese group company (C…, Lda) was made by U…, with no justification for the passage of money through Portugal.

This leads to the conclusion that the reasons why there was no need for the transfer of money to Portugal (to E…) are the reasons why there was no need for the bond loan, or, more specifically in the case under analysis, the expenses incurred in 2014 with the respective interest (not framing in article 23rd of CIRC).

2.2 - The complainant further argues that the analysis carried out in the report would lead to recourse to the provisions of article 33rd of the General Tax Code (Ineffectiveness of legal acts and transactions).

This argument is not analyzed here, as it has a hypothetical character.

2.3 - It is further argued that it was the incorporating company in the merger that contracted the bond loan and that there was no alteration of this reality with the merger.

Strictly speaking, the now complainant is the company resulting from the merger, which came to incorporate also the former C…, so it does not appear incorrect the fact noted in the report that, with the merger, the former C… (and activity generating income and gains) came to bear the costs of its own acquisition.

2.4 - Nor is the argument justified that the financing costs respected in 2014 the limits provided for in article 67th of CIRC, since that article provides only limits on the deductibility of these costs in calculating taxable profit, the correction subject to complaint not being based on this article, but on article 23rd of the same Code.

2.5 - Regarding the reference to CAAD decisions in the cases mentioned in the complaint - see point I-2-a above (the report also makes reference to the decision in case 42/2015-T - see p. 375-reverse and 371), it should be noted that, as it concerns the year 2009, it is not applicable regarding IRC for the year 2014.

2.6 - Given the above, the correction subject to complaint is to be maintained.

3- Charges with shareholder loans:

Contrary to what is alleged in the complaint, the statement in the report that the amount of € 47.399.162,66 was influenced by the sum of € 11.664.656,99 appears to be correct.

The value of € 11.664.656,99 influenced that of € 47.399.162,66 in the following sense: the financing of the expense relating to interest on the bond loan (used for the acquisition, for the benefit of third parties, of C…'s activities in Portugal - see point II-1-a above) was reflected in the value of the financing needed by the complainant, so that part of the interest supported in 2014 by the complainant from financing by U…/V… (in the proportions mentioned above at point II-1-b) does not prove necessary for the activity for the purposes of the application of n.º 1 of article 23rd of CIRC.

Thus, also in this case, the correction is to be maintained.

(...)

2 - In prior hearing, the complainant presents an exposition (pp. 389 to 393) in which it reiterates what is alleged.

It is alleged that financial charges incurred with the acquisition of social interests should be accepted fiscally. However, it is necessary to distinguish between the acquisition by a company of social interests of others, capable of generating income for that company (profits, capital gains) and the acquisition by third parties of the company itself, in which this does not occur.

It is also disagreed with the statement that the entity which contracted the loan was always the same, before and after the merger. As noted above at point III-2.3, with the merger, the complainant came to incorporate the former C…, that is, the activity generating income and gains.

The Claimant posted guarantee to suspend tax execution n.º …2016…, which was instituted for coercive collection of the liquidated amount (document n.º 4 attached with the request for arbitral judgment, the contents of which are hereby reproduced);

On 21-11-2017, the Claimant presented the request for constitution of the arbitral tribunal that gave rise to the present proceedings.

2.2. Unproven Facts

It was not proven that the value of € 11.664.656,99 relating to shareholder loans influenced the debt of € 47.339.163,32.

The Claimant provides a detailed explanation of how the value of € 47.339.163,32 was determined (articles 300th to 338th of the request for arbitral judgment and 106th to 115th of the Claimant's pleadings) which is not convincingly rebutted by the Tax and Customs Authority.

2.3. Substantiation of the determination of statement of facts

The proven facts are based on the Tax Inspection Report and the documents attached with the initial petition, with no controversy over them.

3. Questions of Law

The Claimant originally had the corporate designation E…, Lda. and was initially domiciled at …, with activity in the provision of accounting and economic services, consultancy and management of companies and other financial and economic activities.

On 26 June 2007, T… SGPS, S.A., alienated its shares in E… to the company U… S.A.R.L., domiciled in Luxembourg, which subsequently changed its designation to V….

In July 2008, E… company changed its firm and registered office to W…, Lda. (hereinafter W…), changing its office, previously at …, and establishing itself in Sintra, at the current registered office. In December 2008, there was a merger of Z… (former C…) into W…, (former E…) effective as of January of the following year. This merger was realized through a merger process and, by means of this operation, all the patrimony of the incorporated Z… was transferred to its incorporating entity, W…. The firm of the incorporating entity was also changed to A…, Lda., with the incorporating entity thus adopting the corporate designation of the incorporated entity.

In this context, the incorporated entity, which generated income or gains, came to bear the charges established between the entity U… and the entity E…, resulting from the bond loan for the acquisition of C… company.

For the Tax and Customs Authority, with the merger, the income generated by the activity of the incorporated company came to bear the costs of its own acquisition, it being certain that the funds were not used in its exploitation. It was considered, in keeping with this, that they were not deductible pursuant to the provision in article 23rd of CIRC, in the wording prior to Law n.º 2/2014, of 16 January.

With the merger, therefore, the amounts of debts between the Portuguese companies were cancelled, maintaining only the record of the debt to the Luxembourg company in the amount of € 47.399.162,66 relating to shareholder loans, an amount which was still influenced, according to the Tax and Customs Authority, by the sum of € 11.664.656,99 relating to the payment of interest on the bond loan in the years 2007 and 2008 by C….

The specific correction made regarding this last point relates to shareholder loan interest corresponding to the portion of shareholder loans necessary for financing costs with the bond loan, which the Tax and Customs Authority understood did not benefit the Claimant. The Tax and Customs Authority understood that it is not demonstrated that the amount of € 11.664.656,99 is not included in the value of the shareholder loans, all the more so as company C…, Lda. paid these interest directly on behalf of company E…, Lda. due to the fact that this company did not have financial means to proceed with the payment of interest. Thus, and for the Tax and Customs Authority, in the absence of such demonstration, the basis for the correction is reduced to that of the correction relating to the bond loan.

The Inspection Report includes substantiation for the years 2013 and 2014, but for the present proceedings, only the assessment relating to the latter year is in question.

Regarding the year 2013, the Tax and Customs Authority used in the Inspection Report substantiation based on the concept of indispensability of costs contained in article 23rd, n.º 1, of CIRC, in the wording then in force, citing case law and doctrine elaborated on the basis of that prior wording.

Regarding the year 2014, the Tax and Customs Authority maintained identical corrections, no longer based on the concept of indispensability of costs, but with the following grounds:

– in the case of A…, the expenses supported with the bond loan are not related to its business activity, nor did they serve to maintain the income-producing source. Such expenses, although recorded in its accounts, do not benefit its activity nor its business interest, but rather benefit a third party (V… S.A.R.L., former U… S.A.R.L.), not being able to be, for that reason, accepted for the purposes of calculating the fiscal result, in accordance with subsection c) of n.º 1 of article 23rd of the IRC Code".

  • thus, by resorting to the use of "a vehicle" (E…), these financing costs came to be borne by the patrimony of the operational company (A…, Lda), after the incorporation of its patrimony into the vehicle company, being then entirely deducted from its result, with natural impact at the fiscal level (EBITDA), when, and according to previous argument (reinforced by the case law of the STA and CAAD), these financing costs resulting from the group's restructuring process benefit only V… company, S.A.R.L., (former U…);

  • thus, the expenses subject to analysis here ended up serving to reduce the fiscal result of the company resulting from the two merger processes;

– there thus reside, also in this aspect, the arguments of our position regarding the disregard of such expenses and not solely in the indispensability thereof. Effectively, the notifications we made, in order to request the justification for the occurrence of these financial expenses, were based on article 23rd of CIRC and, as such, made reference to the concept of indispensability that appeared in its text. However, as has just been demonstrated, our decision is not based solely on this concept, so the fact that it is referred to in the notification relating to 2014, even though the wording of the said article no longer contemplates it, does not alter our position in any way.

Article 23rd, n.º 1, of CIRC, in the wording introduced by Law n.º 2/2014, of 16 January, establishes the principle that "for the determination of taxable profit, all expenses and losses incurred or supported by the taxpayer to obtain or ensure income subject to IRC are deductible".

In light of this new wording, for fiscal relevance of expenses, it is no longer necessary, as was stated in the prior wording, that they "be demonstrably indispensable for the realization of income subject to tax or for the maintenance of the income-producing source".

According to the current letter of the law, it is today clear that it is not required for the relevance of expenses that they have been generators of income, it being sufficient that they have been supported in the interest of the company, with the intention of obtaining or ensuring income subject to IRC, as was already understood previously (in this sense, among many, one can see the arbitral judgment of 13-02-2015, delivered in case n.º 585/2014-T). For an analysis of the doctrinal evolution in the interpretation of the tax concept of expense, see António Martins, "The deductibility of expenses and the new wording of article 23rd, n.º 1 of CIRC: a note", RFPFP (2015), year 8, n.º 1, p. 113.

Thus, the question that arises is whether the expenses supported with the bond loan are related to the business activity or benefit only a third party.

In the arbitral judgment delivered in case n.º 42/2015-T, it was clarified what should be understood as the activity of the company for this purpose:

The productive activity should not be understood in a restrictive sense, but rather broadly, meaning activity related to an income-producing source of the entity that supports the expenses. When seeking the meaning of the concept of company activity, it cannot be limited to mere or simple operations of production of goods or services. To say that a cost must verify a relationship with the activity can only mean to verify a relationship with global economic operations, of exploitation, or with operations or acts of management that are part of the pursuit of the entity's own interest that assumes such costs.

In that sense, the activity of a company will consist of the operations resulting from the use of its patrimony, in particular its assets and the management of its liabilities. That is, in the manner in which its management will use the business patrimony within the scope of the various operations (productive, commercial, investment and disinvestment, general financing, acquisition of financial interests and others) that, as a whole, allow the entity in question to fulfill its economic purpose: the pursuit (immediate or in the long term) of an economic surplus (profit).

The point this tribunal wishes to emphasize is the following: the "activity" of a company is not exhausted, as often seems to emerge from some interpretations, in the set of operational acts. "Activity" is also the set of operations that have as their purpose the realization of investments or the sale of assets, the acquisition of financial interests and their subsequent sale, the application of liquidity in investments or short-term securities and their management, the receipts and payments resulting from operational or non-operational income and expenses, and many others not expressly referred to here.

The management of companies has, in essence, the purpose of obtaining a surplus from the use of the assets that are held by economic-business entities. Such assets are, even through their normative-accounting classification, divided into different types. Tangible fixed/immobilized assets (e.g., machines devoted to production), intangible (e.g., manufacturing patents), financial assets (e.g., social interests), non-current assets held for sale (e.g., machinery that is no longer devoted to production and is intended to be sold in the short term), inventories/assets (e.g., raw materials) and so on.

Constituting this vast range of assets the means that management has to generate income and surpluses, it is natural that the purchase of physical assets for investments and their eventual sale (disinvestment), the purchase and sale of financial interests, the application of liquidity, the receipts and payments of the activity, all of this is part of what are considered normal or appropriate acts of the management of a company.

In the case at hand, it appears to be clear that the expenses supported with the bond loan are related to the activity or interest of the Claimant, since the mergers and the financing destined to them were intended to alter its structure and economic dimension, being connected with the results this dimension makes viable.

On the other hand, the financing had as its destination not only the acquisition of the social interests, but also, necessarily, the assets and liabilities underlying these.

As stated in the arbitral judgment delivered in case n.º 42/2015-T:

Indeed, as a result of the merger operations, the same company (the Claimant) came to hold, as accounting or recognized patrimony elements in its balance sheet, the assets and liabilities of the operational companies (e.g. F…, S.A; G…, Lda, H…, Lda) and continued to record, also in its balance sheet, the equity capital and financial liabilities that supported the social interests that previously represented this set of patrimony elements.

This means that, before the merger, A… held, on the right side of the balance sheet, financing sources provided by U… (now V…) paying interest on those sources that constituted debt; and, in its assets, social interests in the operational entities. With the merger, the same entity (the Claimant) continues to hold the liabilities already referred to (debts to shareholder U…) and replaced the social interests - which were cancelled with the merger - thus coming to recognize the assets and liabilities of the operational companies whose acquisition, it should be recalled, constituted the essential cause of the indebtedness of A… in relation to U… (V…).

In sum: the merger maintains in the Claimant the financing for which this paid interest, and had as its patrimonial consequence the conjunction, in the same balance sheet, of the assets that such debt financed and continued to finance. Not financial assets, but their real translation into operational assets and liabilities.

It is thus clear that the Claimant's debt to the parent company - and the interest resulting therefrom - is inscribed in the interest or activity of A…. There is a clear economic link between the debt that accrues interest and the assets and liabilities that such debt supports.

Moreover, such assets and liabilities (financial debt) come to be recognized in the balance sheet of the same entity. Thus, the Tribunal does not see how - in the Tax and Customs Authority's thesis - the fact that the debt originates from funds that U… ceded to the Claimant can lead, without more, to the non-compliance with the requirement of indispensability then provided for in article 23rd of CIRC.

(...)

Even from a strict perspective of economic nexus between income and expenses, it exists. Income derived from the business is related to the interest paid for its acquisition. From a patrimonial perspective, there is even greater approximation between assets and capital that finance them, now recognized in the same entity. Not questioning the Tax and Customs Authority the economic purpose of the reorganization operations carried out, the disregard of the interest paid has no support in article 23rd of CIRC.

It may even be ventured that, it being certain that in many reorganization operations assets appear in a given entity and the debt that finances them may be in another, in the case at hand the merger led to a conjunction of assets and liabilities whose management operations are, certainly, in the interest or activity of the Claimant.

But, even if doubts were to be understood to subsist regarding the Claimant's interest in the referred operations, with it not currently being required, for fiscal relevance of expenses, proof of the indispensability required by article 23rd, n.º 1, of CIRC in the wording prior to Law n.º 2/2014, these possible doubts about the relationship of the expenses with the interest of the company would have to be procedurally valued, in a jurisdictional process, in favor of the taxpayer and not against him, by virtue of the provision in article 100th, n.º 1, of CPPT, subsidiarily applicable by virtue of the provision in article 29th, n.º 1, subsection c), of RJAT.

Moreover, the reference made in subsection c) of n.º 1 of article 23rd of CIRC to "interest on outside capital applied in exploitation" does not have the scope of limiting to these interest the deductible expenses, since the types of charges of financial nature indicated there are merely exemplificative in nature, as results from the use of the expression "such as", the rule being that which is extracted from the body of n.º 1 at the beginning of subsection c) that, as to financial nature expenses, all expenses (...) incurred or supported by the taxpayer to obtain or ensure income subject to IRC are deductible".

In any case, in the case at hand, the capital obtained by the Claimant, whose availability generated the debt of interest, are applied in the exploitation of the Claimant, in operational assets, it being these that provide it with the income subject to IRC.

As to the question of charges with shareholder loans, it was not proven that the value of € 11.664.656,99 influenced the debt of € 47.339.163,32.

In fact, the Claimant provides a detailed explanation of how the value of € 47.339.163,32 was determined (articles 300th to 338th of the request for arbitral judgment and 106th to 115th of the Claimant's pleadings) which is not put in question by the Tax and Customs Authority.

The Tax and Customs Authority states in article 44th of its Response that "no evidence was found that unequivocally demonstrated that the amount of € 11.664.656,99 is not included in the value of the shareholder loans, all the more so as company C…, Lda. paid these interest directly on behalf of company E…, Lda. due to the fact that this company did not have financial means to proceed with the payment of interest".

But, as already mentioned, in light of the current wording of article 23rd, n.º 1, subsection c), CIRC, in which proof of the indispensability of expenses is not required, founded doubts that may exist on any point of the statement of facts must be procedurally valued in favor of the taxpayer, by virtue of the provision in article 100th, n.º 1, of CPPT, which procedurally amounts to considering that the facts invoked by the Tax and Customs Authority that are not considered proven do not correspond to reality.

Therefore, in addition to the considerations made above regarding the regime in force in 2014 regarding the fiscal relevance of expenses also applying to this question, it must be concluded that the correction relating to shareholder loans is tainted by error regarding the factual presumptions.

From the foregoing, the IRC assessment act under challenge is tainted by a defect of violation of law, due to error regarding the factual and legal presumptions, which justifies its annulment, article 163rd, n.º 1, of the Administrative Procedure Code, subsidiarily applicable by virtue of the provision in article 2nd, subsection c), of the General Tax Code.

The assessment of compensatory interest, which has as its prerequisite the IRC assessment act (article 35th, n.º 8, of the General Tax Code), as well as the decision dismissing the administrative complaint, are tainted by the same defects, and therefore also justify annulment.

4. Compensation for Wrongful Guarantee

The Claimant requests compensation for wrongful guarantee.

Article 171st of CPPT establishes that "compensation in case of a wrongfully posted bank guarantee or equivalent shall be requested in the proceedings in which the legality of the enforceable debt is controverted".

The request for constitution of the arbitral tribunal and for arbitral judgment has as a corollary the passing to the arbitral proceedings that will discuss the "legality of the enforceable debt", so that, as results from the express content of that n.º 1 of the referred article 171st of CPPT, it is also the arbitral proceedings that is adequate to appraise the request for compensation for wrongful guarantee.

The regime of the right to compensation for wrongful guarantee appears in article 53rd of the General Tax Code, which establishes the following:

Article 53rd

Guarantee in case of wrongful provision

  1. The debtor who, to suspend execution, offers a bank guarantee or equivalent shall be compensated fully or partially for the losses resulting from its provision, should the debtor have maintained it for a period exceeding three years in proportion to the outcome in administrative appeal, challenge or opposition to execution that have as their object the debt guaranteed.

  2. The timeframe referred to in the preceding number does not apply when it is verified, in administrative complaint or judicial challenge, that there was error attributable to the services in the assessment of the tax.

  3. The compensation referred to in number 1 has as its maximum limit the amount resulting from the application to the guaranteed value of the rate of indemnity interest provided for in this law and may be requested in the complaint procedure itself or judicial challenge, or autonomously.

  4. Compensation for the provision of wrongful guarantee shall be paid by offset against the revenue of the tax of the year in which payment was made.

In the case at hand, a bank guarantee was posted, and the errors underlying the IRC assessments and compensatory interest under challenge are attributable to the Tax and Customs Authority, since they were of its initiative and the Claimant in no way contributed to this error occurring.

Thus, the requirements provided for in n.ºs 1 and 2 of the transcribed article 53rd are met, so that the Claimant is entitled to compensation for the losses resulting from the guarantee posted, within the limits provided for in n.º 3 of the same article.

As there are no elements that permit determination of the amount of compensation, the conviction must be made with reference to what comes to be calculated in execution of this judgment (article 609th, n.º 2, of the Civil Procedure Code).

5. Decision

For these reasons, this Arbitral Tribunal agrees in:

– declaring the request for arbitral judgment well-founded;

– annulling the IRC assessment and compensatory interest n.º 2016…, the Statement of Interest Calculation, identified with n.º2016…, and the Statement of Account Settlement, identified with n.º 2016…, which gave rise to tax payable in the amount of € 2.641.009,79;

– annulling the decision on the administrative complaint n.º …2017…;

– declaring the request for compensation for wrongful guarantee well-founded and condemning the Tax and Customs Authority

Frequently Asked Questions

Automatically Created

Are financial costs (encargos financeiros) deductible for IRC purposes following a merger by incorporation in Portugal?
Financial costs (encargos financeiros) may be deductible for IRC purposes following a merger by incorporation in Portugal, provided they meet the general deductibility requirements under Article 23 of the IRC Code: they must be indispensable or relevant for obtaining taxable income or maintaining the income source, must be properly documented, and cannot fall under specific exclusions in Article 23-A. Following a merger, the incorporating entity assumes the tax position of the incorporated entity, but the Tax Authority may challenge deductibility if the financial structure lacks economic substance or violates anti-abuse rules. In this case, the AT questioned whether capital increases were genuinely made in cash and whether the debt structure served a legitimate business purpose beyond tax benefits.
What are the CAAD arbitral tribunal rules on cost deductibility after a corporate merger under Portuguese tax law?
CAAD arbitral tribunals assess cost deductibility after corporate mergers by applying the principle of universal succession established in Article 73 of the IRC Code, whereby the incorporating company assumes all tax rights and obligations of the incorporated entity. Tribunals examine whether costs satisfy the requirements of Article 23 IRC (indispensability, documentation, accounting recognition) and whether anti-abuse provisions apply. Key considerations include: (1) whether the merger had valid economic reasons beyond tax benefits; (2) whether financing arrangements reflected arm's length terms; (3) whether capital increases were genuinely realized; and (4) whether transfer pricing rules and thin capitalization limits were respected. The tribunal reviews both the formal legal structure and the economic substance of transactions.
How does the Portuguese Tax Authority (AT) assess additional IRC liquidation after a merger by incorporation?
The Portuguese Tax Authority assesses additional IRC liquidation after a merger by incorporation through external inspection procedures, examining whether the incorporating entity properly applied succession rules and whether financial costs claimed as deductions are legitimate. The AT scrutinizes: (1) the economic substance of pre-merger financing structures; (2) whether capital increases were realized in cash or merely offset against debt; (3) compliance with transfer pricing rules for intra-group financing; (4) application of interest deduction limitations under thin capitalization rules; and (5) whether the merger was designed primarily to obtain tax advantages (anti-abuse analysis). In this case, the AT issued additional assessments totaling €2.6 million after determining that capital increases lacked cash realization and that financial costs should not be deductible.
What legal grounds can be used to challenge an IRC additional tax assessment of over €2.6 million at CAAD?
Legal grounds to challenge an IRC additional tax assessment exceeding €2.6 million at CAAD include: (1) violation of the legality principle if the AT applied law incorrectly; (2) insufficient evidence supporting the AT's factual determinations; (3) failure to respect taxpayer rights during inspection procedures; (4) incorrect application of anti-abuse provisions without demonstrating tax avoidance intent; (5) errors in calculating taxable income or applying deduction limitations; (6) violation of European Union law, including freedom of establishment when cross-border structures are involved; (7) breach of double taxation treaties; and (8) misapplication of corporate succession rules under Article 73 IRC. Taxpayers must demonstrate that costs met Article 23 requirements and that the corporate structure had valid business purposes beyond tax benefits.
Can a taxpayer claim compensation for an undue guarantee (garantia indevida) in CAAD arbitration proceedings?
Yes, taxpayers can claim compensation for wrongful guarantee (garantia indevida) in CAAD arbitration proceedings under Article 171 of the Tax Procedure Code (CPPT). When a taxpayer provides a bank guarantee or other security to suspend enforcement of a contested tax debt, and the arbitral tribunal subsequently rules in favor of the taxpayer, compensation is due for the costs incurred in obtaining and maintaining the guarantee. This includes bank fees, commissions, and interest charges. The claim for compensation must be included in the arbitration request. The tribunal will determine the amount based on documented costs directly attributable to providing the guarantee. However, compensation is only awarded if the taxpayer fully or partially prevails in the substantive challenge to the tax assessment.