Summary
Full Decision
ARBITRAL DECISION
The arbitrators Judge Counsellor Dr. Carlos Fernandes Cadilha (arbitrator-president), Doctor Tomás Cantista Tavares and Dr. Jorge Carita (arbitrator-members), designated respectively by the CAAD Deontological Council, by the Claimant and by the Respondent to form the Arbitral Tribunal, agree as follows:
1. Report
A... SGPS, SA NIPC..., with registered office at Av. ..., no...., ..., ...-... Lisbon (hereinafter A... or Claimant) filed a request for constitution of a collective arbitral tribunal, pursuant to the joint provisions of articles 2(1)(a) and 6(2)(b) of Decree-Law No. 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter LFATM), in which the Tax and Customs Authority (TCA) is the Respondent, with a view to the declaration of illegality of the assessment of Corporate Income Tax and compensatory interest and default interest for 2014, in the amount of €172,646.01 (no. 2018...; 2017...; 2017..., account adjustment 2018...) – docs. nos. 1 to 3, attached to the Initial Application (IA).
The request for constitution of the arbitral tribunal was accepted by the President of CAAD and followed its normal proceedings. The collective arbitral tribunal was constituted on 18/2/2019.
The TCA responded by way of objection, defending that the request should be judged unfounded, partially revoked the contested act (as will be explained hereinafter) and requested suspension of the proceedings until decision of case C-751/18, which is pending before the Court of Justice of the European Union (hereinafter CJEU), concerning a question identical to that in the present case.
By unnecessary formality, the meeting provided for in article 18 of the LFATM was dispensed with. The parties were notified to submit written pleadings, if they wished – and only the respondent did so.
The arbitral tribunal was regularly constituted and is materially competent, as provided in art. 2(1)(a) and 4, both of the LFATM.
The parties have legal personality and capacity, are legitimate and are represented (arts. 4 and 10(2) of the LFATM and arts. 1 to 3 of Ordinance No. 112-A/2011, of 22 March).
The proceedings do not suffer from nullities and there is no obstacle to the appraisal of the merits of the case.
2. Factual Matters
2.1. Proved Facts
The following facts relevant to the decision are considered proved:
GENERAL FACTS
a) The Claimant is a holding company (SGPS) whose corporate purpose is the management of shareholdings in other companies, as an indirect form of exercising economic activities.
b) The Claimant is the parent company of a group of companies which in 2014 was subject to the special tax regime for groups of companies (RETGS), which, among others, held 100% of the share capital of the following entities (included in the fiscal consolidation scope): B..., SA [hereinafter B... SA] (Tax ID...) and C..., SA [hereinafter C..., SA] (Tax ID...).
c) The claimant (parent company) was subject to an individual audit of its Corporate Income Tax for 2014, in the course of which corrections to taxable income in the amount of €1,243,235.89 were proposed.
d) B..., SA was subject to an individual audit of its Corporate Income Tax for 2014, in the course of which corrections to taxable income in the amount of €886,426.91 were proposed.
e) C... SA was subject to an individual audit of its Corporate Income Tax for 2014, in the course of which corrections to taxable income in the amount of €820,811.78 were proposed.
f) Subsequently, the claimant was subject to an internal audit procedure, as the dominant company of the group, of limited scope to the Corporate Income Tax for 2014, in order to reflect in the group the inspection procedures conducted individually and referred to in proved facts c) to e).
g) From the inspection report (doc. no. 8 of the IA) a correction to the group result of €2,950,474.58 (€1,243,235.89 + €886,426.91 + €820,811.78) results, thus changing from a loss of €1,050,340.46 to taxable profit of €1,896,134.02.
h) As a result, such corrections were materialized in the assessment (contested in the present case) of Corporate Income Tax and compensatory and default interest for 2014, in the amount of €172,646.01 (no. 2018...; 2017...; 2017..., account adjustment 2018...).
i) On 16/8/2018, the claimant proceeded to full payment of this assessment, in the amount of €172,646.01.
j) The claimant was notified of the inspection report and the assessment.
FACTS RELATING TO THE CORRECTION OF A... OF €1,243,235.89
k) The Claimant accepts and admits that it should not have deducted as a tax cost the amount of €243,235.89 – and that the tax cost would only be €1 million (pursuant to arts. 67 and 23 of the Corporate Income Tax Code – art. 68 of the IA).
l) The TCA partially revoked the contested act: granted the request, as regards corrections of the dominant company, reducing the amount disallowed as an expense for purposes of determining its individual taxable result from €1,243,235.89 to €243,235.89 (Order of 19/1/2019 of the deputy director general of the income tax management area – see art. 10 of the response).
FACTS RELATING TO THE CORRECTION OF C... SA (€820,811.78)
m) C..., SA operates in the sector of communication and direct marketing services, specifically in the distribution of advertising leaflets to indiscriminate mailboxes.
n) C..., SA was entirely held by D..., SGPS, SA.
o) In December 2010, D... alienated 100% of the share capital of C..., SA to company E..., SA (Tax ID...) – entity 100% dominated by Company A..., SGPS, SA (the claimant herein), which in turn is entirely held by fund F... – Risk Capital Fund.
p) E... was incorporated in November 2010 and its purpose was the distribution and dissemination of leaflets, commercial and advertising promotions, marketing and communication actions.
q) F... is a venture capital entity, dedicating itself (in general, through companies dominated by it) to the acquisition of shareholdings and control of companies, with a view to capital appreciation, by improving management quality, and consequently shareholder remuneration.
r) E..., to consummate the purchase of C..., financed itself through: i) Advances granted by shareholder A..., SGPS, SA, of €6.4 million, at the rate of 15%/year; ii) Bank loans (borrowed from ...) of €23 million, with tranche B of €3.5 million being allocated to the purchase of the share capital of C..., SA.
s) In September 2011 (and with accounting effects as of 1/1/2011), E... (incorporated company) merged into C..., SA (incorporating company), by global transfer of the assets of the incorporated company to the incorporating company – an operation usually designated as reverse or inverted merger.
t) Following the merger, C..., SA (incorporating company) assumed (i) all of E...'s debts and (ii) the charges (interest) incurred by E... with the Bank and the shareholder – which in 2014 amounted to €820,811.78.
u) The TCA does not accept the tax deduction of such charges (interest) and consequently promoted the assessment object of the present arbitral proceedings (Corporate Income Tax for 2014), based on art. 23 of the Corporate Income Tax Code.
FACTS RELATING TO THE CORRECTION OF B... SA (€886,426.41)
v) B..., SA is engaged in activities in the transport sector, specifically in road transport of goods for home delivery.
w) B... was entirely held by D..., SGPS, SA.
x) In December 2010, D... alienated 100% of the share capital of B..., SA to company G..., SA (Tax ID...) – entity 100% dominated by Company A..., SGPS, SA (the claimant herein), which in turn is entirely held by fund F... – Risk Capital Fund.
y) G... was incorporated in September 2010 and its purpose was the provision of administrative and support services to transport companies.
z) F... is a venture capital entity, dedicating itself (in general, through companies dominated by it) to the acquisition of shareholdings and control of companies, with a view to capital appreciation, by improving management quality, and consequently shareholder remuneration.
aa) G..., SA to consummate the purchase of B..., financed itself through: i) Advances granted by shareholder A..., SGPS, SA, of €13.6 million, at the rate of 15%/year; ii) Bank loans (borrowed from ...) of €23 million, with tranche A of €19.5 million being allocated to the purchase of the share capital of B..., SA.
bb) In September 2011 (and with accounting effects as of 1/1/2011), G... (incorporated company) merged into B..., SA (incorporating company), by global transfer of the assets of the incorporated company to the incorporating company – an operation usually designated as reverse or inverted merger.
cc) Following the merger, B..., SA (incorporating company) assumed (i) all of G...'s debts and (ii) the charges (interest) incurred by G... with the Bank and the shareholder – which in 2014 amounted to €886,426.91.
dd) The TCA does not accept the tax deduction of such charges (interest) and consequently promoted the assessment object of the present arbitral proceedings (Corporate Income Tax for 2014), based on art. 23 of the Corporate Income Tax Code.
2.2. Unproved Facts
There are no facts of relevance for the appraisal of the merits of the case that have not been proved.
2.3. Justification for Establishing the Factual Matters
The proved facts are based on the documents submitted by the parties, on the consensus of the parties (also regarding documents, amounts and payment dates), on the partial revocation by the respondent and admission by the claimant (proved facts k and l), on official information and other documentation contained in the administrative file.
3. Legal Matters
3.1. Question to be Decided
The questions to be decided in the present case are as follows:
a) Alleged lack (insufficiency) of substantiation of the tax assessment acts and interest.
b) Alleged omission of an essential formality: failure to notify the final tax audit report.
c) Correction (in individual sphere) of A... SGPS, SA (€1,243,235.89).
d) Correction (in individual sphere) of B... SA (€886,426.91) and C..., SA (€820,811.78) – treated as a unit, given the similarity of factual and legal issues.
For systematic convenience, each topic will constitute an autonomous chapter of the decision – wherein the relevant facts, positions and arguments of the parties shall be retained by reference, the applicable laws and legal principles referred to, and the tribunal's decision presented, in view of all factual and legal circumstances.
3.2. Alleged Lack (Insufficiency) of Substantiation of Tax Assessment and Interest Acts – Applicable Law
The claimant invokes in the IA that the assessment is not substantiated, since in that document the grounds, factual and legal, that would justify the administrative act in tax matters (assessment of the tax and compensatory interest) are not explained – nor is there even an express or implied reference to the previous substantiation already delivered to the taxpayer; and this would be legally required, according to the claimant's thesis. As regards compensatory interest, it is also argued that there is no substantiation whatsoever, since its grounds are not explained, but only that it results from wrongful receipt.
The respondent counters by saying, in summary, that the substantiation is based on an exhaustive inspection process, prior to the assessment act, which enables the claimant to know all the facts and arguments on which the TCA's position is based, both as regards the amount of tax and in relation to interest (there were inspections of each of the group entities, and subsequently an internal inspection of the dominant company, to inform it of the corrections made in the individual sphere of each of them, as well as to promote the subsequent issue of additional Corporate Income Tax assessments for the period of 2014, in compliance with the rules of RETGS).
The tribunal decides that there is no lack of substantiation of the Corporate Income Tax assessment and compensatory interest act.
The TCA conducted inspection procedures, where it analyzed various operations of each entity and then, in compliance with RETGS rules, conducted an inspection of the parent company where it informs it of the corrections to each of the group entities. The inspection reports (substantiation) are extensive and explain, in an organized, clear, exhaustive and sufficient manner, what the grounds and reasoning (with attached documents) underlying each of the corrections are – and which subsequently determine the assessment of tax and interest. An average recipient, such as the taxpayer, perfectly understands the content and grounds in question in these proceedings. This is evidenced by the contents of the initial petition, in which the claimant rebuts the arguments of the substantiation, in normal contradiction, a sign that it understood them perfectly. The requirements of substantiation described in articles 268 of the Constitutional Republic, art. 77 of the General Tax Law and arts. 124 and 125 of the Administrative Procedure Code were thus fulfilled.
A different matter, but which also does not merit censure from this tribunal, is whether the assessment document itself (more precisely, the tax and interest assessment document) must contain the substantiation or at least indicate it by reference, under penalty of such formal non-compliance determining the illegality of the assessment for lack of substantiation or omission of an essential formality. The tribunal considers that there is no illegality, holding that the additional assessment act is substantiated by being based on the inspection report, even though it does not make express or implied reference to it – given that it is situated, it cannot but be situated, within the respective legal and factual framework, perfectly clear, clarifying and duly notified. In other words, the taxpayer (claimant) knows that such tax and interest assessment results from substantiation, as a corollary of an inspection to which it was subject (cf. in this sense, Supreme Court of Administrative Justice decision of 9/5/2001, proc. 025832).
There is also no lack of substantiation regarding compensatory interest. Compensatory interest, by legal requirement, results from the delay in the assessment due to a fact attributable (culpable) to the taxpayer (art. 35 of the General Tax Law). Now, from the substantiation it appears that, in the opinion of the TCA, there was a delay in the tax (Corporate Income Tax for 2014) due to acts attributable to the claimant – and therefore, compensatory interest is legally and sufficiently substantiated.
3.3. Alleged Omission of an Essential Formality: Failure to Notify the Final Tax Audit Report
The claimant argues that it was not notified of the inspection report and its substantiation (grounds underlying the assessment) – in violation of arts. 62 and 63 of the Tax Inspection Procedures Code, which in its view would imply the annulment of the contested assessment act, by omission of a legal formality and lack of substantiation.
The respondent counters by saying, in summary, that the TCA prepared and notified the taxpayer of the 3 inspection reports for individual corrections of companies A..., B..., SA and C..., SA; that it was given the opportunity to exercise, if it wished, its right to prior hearing (and that it exercised it); that subsequently an internal inspection was conducted, because of RETGS, which informed the claimant of the individual corrections made in the individual sphere of each of the companies; and that from a reading of the IA, it is demonstrated that the claimant has perfect and complete knowledge of the assessment and its exact grounds.
The tribunal decides that there is no omission of an essential formality, lack of substantiation in the case at hand; that is, no illegality is found, contrary to what was alleged by the Claimant.
The claimant itself, in several articles of the IA (arts. 56 to 76), admits that it received and was notified of and knew of the individual inspections and final reports of each of the group companies; and that it knows and is aware of the subsequent internal inspection, by force of RETGS – and knows the final inspection report, which was notified to it. That is: the claimant obtained all the necessary substantiations to know the exact grounds for the corrections and thus to be able to fully and effectively exercise its defense rights.
3.4. Corrections in A... (€1,243,235.89): Expenses Associated with Income Subject to Corporate Income Tax (Art. 23 and 67 of the Corporate Income Tax Code)
This matter, with corrections to taxable income of €1,243,235.89 (and later reflected in the contested act) was entirely resolved by the parties through (i) partial revocation (by initiative of the respondent) as to the amount of €1 million (ii) and admission of acceptance of the correction by the claimant in relation to the part not revoked (in the amount of €243,235.89).
The Claimant accepts and admits that it should not have deducted as a tax cost the amount of €243,235.89; and the TCA revoked the correction in relation to €1 million, and only maintained the correction of €243,235.89 – which the claimant accepted and did not contest.
Whence, as to this matter there is no issue in dispute between the parties – and the tribunal, thus, merely recognizes such revocation and acceptance.
3.5. Corrections in B..., SA and C..., SA: Financing Expenses, Following Merger (Art. 23 of the Corporate Income Tax Code)
3.5.1. Question to be Decided
As is accepted by the parties, the issue that arises in the present case concerns only the tax treatment to be given to the interest and other charges borne in 2014 by B..., SA and C..., SA, relating to loans (from shareholders and from third parties [bank]) contracted in prior years by their sole shareholders (E... and G...) for the purchase of the share capital of these very entities, and which both came to bear directly (and thus still occurred in 2014) by virtue and as a result of the mergers (inverted), in 2011, with their shareholders E... and G... (which originally incurred such obligations).
In the opinion of the TCA, expressed in the substantiation of the assessment, such interest and charges would not be tax deductible, pursuant to art. 23 of the Corporate Income Tax Code (in the wording and numbering at the date of the facts), because without connection to the activity of the company that subsequently deducts such charges.
For the Claimant, conversely, such interest and charges would be tax deductible by meeting the requirements inherent in art. 23 of the Corporate Income Tax Code.
As appears from the substantiation of the assessment (and from the other documents submitted to the proceedings), the question to be decided does not concern, nor even incidentally, a possible correction of the transfer price in the interest owed to the shareholder (art. 63 of the Corporate Income Tax Code), nor the application of the General Anti-Abuse Rule (art. 38(2) of the General Tax Law or art. 73(10) of the Corporate Income Tax Code) for possible abusive linkage of operations with exclusive or preponderant tax purposes, in abuse of legal forms (debt [and resulting interest] for purchase of capital followed by merger of companies, so that the profitable operational entity bears such charges and reduces its annual tax profit).
3.5.2. The Applicable Law
According to art. 23 of the Corporate Income Tax Code (in the wording and numbering at the date of the facts), the following are considered as costs or expenses:
"1. [...] all expenses or losses incurred or borne by the taxpayer to obtain or secure income subject to Corporate Income Tax"
Among which,
"2. c) Of a financial nature, such as interest on third-party capital applied in business [...], expenses with credit operations [...]";
On the other hand, with the merger of companies "the incorporated companies are extinguished [...], with their rights and obligations being transmitted to the incorporating company" (art. 112(a) of the Commercial Companies Code).
3.5.3. The Arguments of the Parties
The substantiation of the assessment (and the response of the Respondent) invokes, in summary, that the interest borne by C..., SA and B..., SA following the consummation of the mergers (and as a result of such operations) relating to the financing originally contracted by G..., SA and E..., SA directly for the acquisition of the capital of C..., SA and B..., SA is not covered by art. 23 of the Corporate Income Tax Code, given that it was not expenses connected with the activity of this company nor would it be suitable for the realization or maintenance of profits subject to tax: after the mergers they no longer finance the acquisitions of shareholdings (and are not applied in business); there would have to be, in each year in which interest is recorded, a balance between the financial charges borne and the profits and existence of the asset; such interest would not be linked with the normal activity of the claimant and the associated asset does not exist and would not contribute in the future to taxable income. And the short time intervals between the constitution of the vehicle companies for the purpose of purchase and their subsequent extinctions by merger (inverted) would prove such non-fulfillment of the requirements of art. 23 of the Corporate Income Tax Code.
The Claimant argues, conversely, that the interest borne in 2014 by C..., SA and B..., SA meets the requirements of art. 23 of the Corporate Income Tax Code, and is therefore to be qualified as a tax expense. The interest is borne by C..., SA and B..., SA in the exercise of their activity; the loans (and, consequently, the interest arising therefrom), when originally incurred (by G..., SA and E... SA), were applied in business and were indispensable to the profits and maintenance of the productive source – and if they were at the initial moment, they must be forever, whatever subsequent modifications (even with the merger); the merger, among its normal effects, leads to the economic and tax result of the case; the merger is an operation permitted by commercial and tax law and the TCA, in the substantiation of the act, does not invoke the alleged abuse of the merger operation, pursuant to art. 38(2) of the General Tax Law. Non-acceptance of this tax expense would imply a violation of the Mergers Directive (Council Directive 2009/133/EC) which recognizes absolute tax neutrality to such corporate restructuring operations.
3.5.4. Decision
The arbitrators analyzed all the rhetoric advanced by the parties (in all written documents and materials presented throughout the proceedings), as well as the argumentation and consideration of previous arbitral decisions on the subject – which were, moreover, explained by the parties – but always keeping in mind the (small) particularities of the case ("each case is a case").
Indeed, several arbitral decisions (for example, in proceedings 14/2011-T and 87/2014-T) refused the tax deduction of interest borne by post-merger incorporating companies, relating to financing contracted by pre-merger incorporated companies with a view to the acquisition of the share capital of the future incorporating company. Conversely, there are many other arbitral decisions, for example, in proceedings 101/2013-T, 42/2015-T (here in a non-inverted merger, but the considerations are the same), 92/2015-T and 93/2015-T, 108/2015-T, 537/2016-T, 120/2018-T and 607/2018-T, 143/2018-T which pronounced themselves in the opposite sense, accepting the deduction of such financial charges, by considering them linked with profits subject to tax.
The arbitrators considered all the arguments of the parties and the content of all the aforesaid decisions and decided in favor of annulment of the contested assessment. They considered that such interest and charges borne by the Claimant meet the requirements inherent in art. 23 of the Corporate Income Tax Code to legitimize their tax deductibility, based on the arguments explained below: (i) by adherence to the content of decision 537/2016-T which, with due respect, they reproduce below; (ii) but also taking into account further considerations, set out after citation of Award 537/2016-T, which relate to the interpretation and application of the new wording of art. 23 of the Corporate Income Tax Code.
Beginning of transcription of Award No. 537/2016-T – adapted to the factual circumstances of this proceeding.
"Let us begin with FOUR framework notes, entirely undisputed, which help to delineate the decision of the case.
First, and as already mentioned, the subject matter of the case is limited only to the application of art. 23 of the Corporate Income Tax Code to the interest borne in 2014 by C..., SA and B..., SA, relating to the loans (from shareholder and from third parties) contracted for the purchase of the share capital of C..., SA and B..., SA themselves and which both bear by virtue and as a result of the merger with its shareholder G... and E..., which originally incurred such debts.
As a second note – relevant to the decision – it is necessary to bear in mind the content of the Supreme Court of Administrative Justice decision of 2/12/2011, proc. 0865/11 (in a case of split-merger).
That judgment established that the fiscal notion of merger (subject to tax neutrality) is broader than the legal definition in the Corporate Income Tax Code which required, at the time, the legal formalism of allocation to the respective shareholders of securities representing the share capital of the other entity. There is tax neutrality in the merger operation regulated in commercial law, even though it does not involve the allocation to shareholders of securities representing capital – as happens, symptomatically – among other cases, in the situation of inverted merger. That is: the Supreme Court of Administrative Justice equated in tax terms inverted merger and non-inverted merger, recognizing the tax neutrality of both operations, even though they do not involve the allocation of shares to shareholders.
This jurisprudence illuminates the decision of the case: it is an established fact that mergers, inverted or non-inverted, have the same legal framework, both under commercial law and in tax matters, namely as regards the tax regime of tax neutrality described in art. 73 et seq. of the Corporate Income Tax Code. In other words, the merger operation described in commercial law – whether inverted or not – merits the same treatment and regime for tax law: both as regards tax neutrality (deferment of taxation of income associated with these merger operations); and, in general, the tax consequences, direct or indirect, resulting therefrom.
There is not, so to speak, a first-class merger – non-inverted – with tax neutrality and, in general, tax acceptance of the ruling imposed by commercial law; and a second-class merger – the inverted – in which such rulings either would not occur or would occur in a more case-by-case and exceptional manner.
Nothing of the sort: there is only the merger operation, encompassing both inverted and non-inverted, exactly with the same tax legal regime, and with the same exact reasons for the various tax consequences associated with it.
This means, looking at the case at hand, that the legal answer is the same, whether or not an inverted merger exists. The regime of tax acceptance of the interest in question has the same framework, considerations and solution, whether the merger was non-inverted (with the incorporation of C..., SA and B..., SA into G... and E...), or in the case of inverted merger chosen by the parties. Nor does there even have to be additional substantiation by the claimants to explain why they chose one and not the other. This is within the total freedom of the parties, which the interpreter must respect, on the assumption, evidently, that a true and real merger occurs – and this is an established fact in the proceedings, since no one disputes it.
The third note concerns the merger regime from a legal and commercial law perspective. A merger (inverted or not) does not resemble, in economic terms, a liquidation of companies. Here, the legal and economic disappearance of a company occurs, because it has exhausted its corporate purpose or interest.
In merger, conversely, the legal disappearance is not associated with the economic death of the enterprise, which continues, albeit restructured, in the company resulting from the merger, both from the perspective of the company (continuation of activity) and from the standpoint of the shareholders (equal engagement in those activities). The incorporated company is extinguished, certainly; but all rights and obligations are transmitted to the Incorporating Company, which continues the activity of the "deceased" (art. 112(a) of the Commercial Companies Code). There is a legal modification, with economic continuity (Decision of the Supreme Court of Administrative Justice of 13-04-2005, rendered in proceeding 01265/04 and Decision of the Administrative Court of Appeal-South of 17-04-2012, rendered in proceeding 04172/10, consultable at www.dgsi.pt).
The fourth note – fact accepted by the parties – concerns the peaceful acceptance, express and implicit, of the deduction of such financial charges if the merger had not occurred, by fulfillment of the requirements of art. 23 of the Corporate Income Tax Code. Here, in 2010 and 2011 a company (G... and E...) to acquire an asset (share capital of C..., SA and B..., SA), as a form of exercise of its activity and profit perspective, has to finance itself with third parties (bank and shareholders), bearing, over time, the inherent annual financial charges associated with the financing. It is not questioned – and we believe rightly – that prior to the merger, in the perspective of G... and E..., we were in the presence of interest on third-party capital applied in business (art. 23(1)(c) of the Corporate Income Tax Code).
Well then:
The question of the case is thus whether the merger – inverted or not – alters this state of affairs; whether the interest, once accepted in tax terms (peacefully), cease to be so after the merger, by subsequent non-fulfillment of the requirements of art. 23 of the Corporate Income Tax Code (general requirement of indispensability and special requirement of application in business).
The answer, as we have said, goes in the direction of tax deduction of such interest, even after the merger, now in the sphere of the Claimant, based on three main arguments, explained below – and bearing in mind the prior considerations.
The FIRST concerns the analysis of the literal content of art. 23(1) of the Corporate Income Tax Code [current art. 23(2)(c)]: the deduction of financial charges requires that "interest on third-party capital is applied in business". And everyone agrees that, at the initial moment, the credit obtained (from banks and shareholders) was applied in business, with the acquisition of the shareholding in the Claimant, by G..., SA and E..., SA – subsuming within the exercise of its activity and pursuit of profit.
A merger then occurs, according to the legal rules of commercial law – whether inverted or not (as seen, the standard for the specific case is the same). With such operation, it cannot be said that third-party capital ceased to be applied (the financing continued) and remains dedicated to business, now restructured by legal effects of the merger (transmission of rights and obligations to the incorporating company). That is: there is no diversion of financing, in an abusive intent, in the sense that it now serves the furtherance of extra-business interests, e.g., for the benefit of a shareholder. Nothing of the sort: what occurs is only the production of the normal economic effects of the merger, consented to and imposed by commercial law, and it is impossible to conclude that the effects of such operation, following the strict dictates of commercial law, result in the protection of interests alien to corporate interest, solely to abusively benefit third parties to the merger operation. This interpretive result would be a true contradiction in its terms, because it would be equivalent to admitting that commercial law, in regulating the merger (inverted or not) would permit results that would violate the protection of the interests safeguarded by such legal discipline.
In short: if the interest was fiscally accepted prior to the merger (because third-party capital was applied in business), then it will also be accepted after the merger (inverted or not), which merely followed the rules of commercial law, of transmission of all rights and obligations of the incorporated company, because after the merger they continue to be considered interest on third-party capital applied in business.
The SECOND argument weighs the similar situation (identical to the case at hand) in which, whether or not a subsequent merger, the Company decided to abandon the object of the investment (because it is not profitable), but would evidently have to maintain the financing that provided the financial means for the investment.
Let us suppose that a company X buys a machine of high value to pursue a new activity – and finances itself with the Bank to buy it and will pay €100,000 in interest over 10 years (and at the end will have to amortize the capital). Now imagine that the company concludes, at the end of the 4th year, that such activity is not profitable, since there is no market for the products produced by the machine, and therefore decides to abandon production and the machine is shut down and "abandoned". Of course it will have to continue paying the annual interest of €100,000. But will such interest, from the 5th year onwards, not be deductible from tax income, on the grounds that they are not applied in business or that they are not indispensable for profits or maintenance of the productive source?
Now, such charges will remain deductible, notwithstanding the disappearance – by way of a business decision – of the object in which third-party capital that remunerate them were applied. Third-party capital was applied in business at the initial moment – giving rise to the productive investment. And that is sufficient and adequate to legitimize the tax deduction of the interest arising therefrom, regardless of the future business vicissitudes of such investment. The financial charges continue to be deductible, even though the investment has failed or proved to be a bad investment or an unfruitful business decision – since, and this is what matters, the third-party capital was linked to an investment that at the initial moment was applied in business.
And if this is so, regardless of the occurrence of any merger (but in economic disinvestment), it will be even more so in the case of a merger, in which, as seen, there is no subjective decision of any disinvestment, but only the objective transmission of rights and obligations, by legal effect of such institute of commercial law.
Of course, the prior considerations could be confronted – in tax terms – and this is the THIRD argument, with the existence of a linkage of operations purposely designed to provide an undesired tax result, of abusive tax saving, translated into an acquisition of shareholdings with use of financing, immediately followed by merger (inverted or not) with the purpose of abusively reducing the taxes to be paid in subsequent years by the operational and profitable company (by effect of the financial charges that had been borne for its acquisition). We are not saying that such abuse occurred in the case at hand. What it is important to stress is that the TCA, in the substantiation of the tax act, did not invoke such argumentative arsenal to justify the assessment, in substitution or cumulative with art. 23 of the Corporate Income Tax Code. Despite suspecting the temporal and chronological linkage of the operations and the "tax saving" assured with the deduction of the financing interest for the acquisition of C..., SA and B..., SA from the operational profits of those same companies (post-merger), it did not sustain the tax correction on art. 38(2) of the General Tax Law or art. 73(10) of the Corporate Income Tax Code or even art. 63 of the Corporate Income Tax Code (invoking an excessive quantification of interest between related companies). And the adjudicator, in tax litigation, has to focus on the object of the proceedings, as delineated by the substantiation, under penalty of illegal substantiation after the fact and intrusion into the duty power of the executive branch.
And, finally, art. 23 of the Corporate Income Tax Code is not reducible to an anti-abuse rule, which could be used as a substitute for art. 38(2) of the General Tax Law, art. 73(10) of the Corporate Income Tax Code or art. 63 of the Corporate Income Tax Code. Each rule has different prescriptive content – and art. 23 of the Corporate Income Tax Code does not function as an anti-abuse rule substituting those other provisions. Art. 23 of the Corporate Income Tax Code limits its scope of action to the non-deduction of expenses thus recorded, but which, when incurred (or investments made) do not fall within the economic interest of the Company, but serve extra-corporate interests, of administrators or third parties. Let us suppose that a Company bears the interest on financing contracted by it to make an investment solely for the private benefit of a shareholder or administrator (and this is not reduced to income in kind of the natural person). Or that it finances from the bank to deliver such financial amount to third party, without any consideration, outside the group or outside its corporate purpose. In such cases, the interest that it comes to bear with such funds is not tax deductible because it was not (ab initio and forever) applied in the business of the Company.
The case at hand is totally different. Third-party capital was applied in business; and if it were intended to invoke that all operations would be reducible to an abusive scheme of linkage of operations, even if lawful from a civil law standpoint, to obtain a tax gain – what at some points in the inspection is what is implied – then the substantiation would not have to resort to the institute of art. 23 of the Corporate Income Tax Code but, as already explained, to other institutes at the mercy of tax law to try to achieve such corrective result.
The argumentation presented is sufficient to proceed with the annulment of the contested assessment. It is thus not necessary to explore the other arguments presented by the challenging party (impact of the tax neutrality of the merger operation on the deduction of financial charges arising from loans transmitted via neutral merger) and which derive from the other court proceedings (financial assistance).
End of citation from proceeding 537/2016-T
Adherence to the content of Award 537/2016-T just made requires that further consideration be made, bearing in mind the case at hand – where the decision to annul the contested assessment is reinforced even further.
The wording of art. 23 of the Corporate Income Tax Code was partially amended, with effects as of 1/1/2014 – and in the case at hand the assessment for the year 2014 is being examined, when in those other awards (and also in the cited one) they relate to prior fiscal years, before the interpretation and application of the old law.
The new law (new wording of art. 23 of the Corporate Income Tax Code) does not substantially alter the data of the issue and the definition of the notion of tax expense.
First, because the former art. 23(1)(c) is identical to the current (2)(c), in the sense of tax deduction of charges "of a financial nature, such as interest on third-party capital applied in business" – what manifestly occurs in the cases at hand and in the interest relating to prior years.
And then, because the new wording of art. 23 of the Corporate Income Tax Code removed the word "indispensability" from the notion of tax expense, in the sense that now, but not previously, a relationship of indispensability between the expense and the associated profit is not required; that is, if previously the deduction of the financial charges in question presupposed a certain causal relationship with profits or maintenance of the productive source, requiring a logical and teleological interpretation of the word indispensability; now, conversely, in the absence of such word, it is clear that the law wishes to accept all expenses (in the sense of qualification as tax expenses), also financial ones, borne in the exercise of its activity, in the sense that they may give rise to income subject to tax. And that is what occurs in the case at hand: those expenses were borne for the acquisition of assets (capital shares) as a form of exercise of the company's activity. In short: if an expense was deductible under the prior wording of art. 23 of the Corporate Income Tax Code, it is also under the new wording, as occurs in the case at hand, since the new law merely became more comprehensive and clarifying as to the acceptance of the qualification of accounting expenses as tax expenses.
Finally:
The Respondent requested suspension of the proceedings (with opposition from the Claimant), with immediate referral of the present proceeding to the Court of Justice of the European Union, to the extent that the matter in dispute concerns the application of the Mergers Directive (Council Directive 2009/133/EC), as was, moreover, indicated by the Claimant in its Initial Petition, and following what was decided in another arbitral case with similar subject matter (deduction of interest after inverted merger), namely in proc. 521/2017-T and 144/2018-T.
The Tribunal decided, as seen, in favor of annulment of the assessment – and in this decision segment, the Award never contends with the hypothetical violation of the EU legal norm and law. An interpretation of art. 23 of the Corporate Income Tax Code was advocated that does not create tax distortions to the merger operation with tax neutrality: the interest was deductible pre-merger and continues to be tax deductible after the merger (as it would be if such restructuring operation did not occur). Therefore, the interpretation of art. 23 of the Corporate Income Tax Code, as recommended in this arbitral award, can never result in an obstacle to tax neutrality of the merger, whatever the meaning and scope of such tax neutrality indicated by EU Law. The request for preliminary ruling is thus unfounded.
4. As to Indemnificatory Interest
Art. 43(1) of the General Tax Law provides that indemnificatory interest is owed in favor of the taxpayer when it is determined in judicial challenge (and arbitral action is included in such legal requirement, for coherence and unity of the legal system) that there was error attributable to the services from which results payment of a tax debt superior to that owed.
Now, that is what occurs in the case at hand. The TCA, by producing the additional Corporate Income Tax assessment – now annulled – implied a payment of tax by the taxpayer, ultimately undue and required only by error attributable to the services of the TCA (which issued an illegal tax assessment).
Whence, meeting the requirements of art. 43 of the General Tax Law, the TCA must proceed with the payment of indemnificatory interest, at the legal rate, from the moment of payment by the taxpayer until full reimbursement to the taxpayer of the tax paid by it (see also art. 24 of the LFATM and art. 100 of the General Tax Law).
5. Decision
In accordance with what is stated above, this Arbitral Tribunal agrees on:
a. To judge the request for declaration of illegality of the contested assessment of Corporate Income Tax and compensatory and default interest for 2014, in the amount of €172,646.01 (no. 2018...; 2017...; 2017..., account adjustment 2018...) to be well-founded
And, as a consequence:
b. To order the reimbursement to the claimant of the Corporate Income Tax and interest for 2014 already paid by it (€172,646.01) – with the exception of the part of the assessment value and associated interest for or arising from the correction to taxable income of €243,235.89 (point 3.4 above);
c. To condemn the TCA to pay indemnificatory interest to the Claimant, at the legal rate, on the amount referred to in the preceding point, from the moment of payment (18/6/2018) until full reimbursement.
6. Value of the Proceeding
In accordance with the provision in art. 97-A(1)(a) of the Tax Procedure and Process Code and 3(2) of the Regulation of Costs in Tax Arbitration Proceedings the value of €172,646.01 is assigned to the proceeding.
Notify.
Lisbon, 25 June 2019
The Arbitrators
Carlos Fernandes Cadilha (Arbitrator-President)
Tomás Cantista Tavares (Arbitrator-Member)
Jorge Carita (with dissenting vote)
(Text prepared by computer, pursuant to article 131(5) of the Code of Civil Procedure, applicable by reference under article 29(1)(e) of the Legal Framework for Arbitration in Tax Matters)
DISSENTING VOTE
With all due respect for the position that prevailed in this Collective Arbitral Tribunal, I dissent from the present Decision, as I have done in prior proceedings in which the same facts and the same legal issue are at stake, which I do in the manner already used, among others, in Proc. No. 143/2018-T, which likewise refers to an identical vote rendered in Proc. No. 120/2018-T, which I hereby transcribe.
"I dissented, because the arguments to support the thesis of non-indispensability of costs relating to the price that a company pays for the acquisition of itself, did not convince me.
But I subscribe to the first wave of Arbitral Decisions (Proc. 14/2011-T, 87/2014-T) and likewise in the most recent dissenting votes (Proc. No. 92/2015-T, 93/2015-T and 88/2016-T) that could not discern the absolute indispensability of such expenses, borne in relation to an asset, the ownership of itself, unfortunately disappeared at the time of the merger due to its own nature.
It becomes evident that in all these decisions participated some of the best specialists in tax law currently collaborating with CAAD.
I cannot understand how, in a company that showed modest monthly financial costs in 2008, it becomes, after an inverted merger operation of a group (on top of everything that was done before to get there), to bear almost €10 million in the first year, which the Tax Authority has to continue to accept as deductible for tax purposes, in the years following and as far as 2012 is concerned, given this Tribunal's decision.
It is notable the finding of the evolution of the taxable income of the Claimant before the merger and after the merger, as well stated in the Inspection Report and which is transcribed here:
Taxable Income 2005 €4,761,972.91
Taxable Income 2006 €8,843,208.32
Taxable Income 2007 €10,369,376.60
Taxable Income 2008 €7,645,442.00
Taxable Income 2009 €234,135.10
And paying the interest owed by the loans contracted by the "mother" to buy the "daughter" and accepting fiscally as a cost of the daughter, is exactly the same as buying raw materials to manufacture and sell metal scrap and waste!!!
It all happens, indeed, as if the activity of the Claimant were its own acquisition, as the TCA says in other proceedings in which the same situation is at stake, or rather, the costs "relate to its Self-acquisition".
And everybody knows that this is indeed the case and that it is typical, it is inherent in any Leveraged Buyout (LBO) acquisition, which constitutes a mechanism used to make inadmissible costs in tax efficiency. (There is no need to resort to the application of the General Anti-Abuse Rule, it would be enough not to accept such interest as a cost).
And neither should it be said that the character of indispensability of costs should be assessed when the debt is contracted, completely forgetting the moment when the interest is actually borne (goodbye principle of exercise specialization, and let alone talk about the always necessary nexus of causality between costs and profits).
Indeed, I have difficulty accepting that interest contracted by a company to acquire another company in which it itself came to be incorporated can be accepted for tax purposes.
And, while I have no doubt that at the moment the debt was contracted the respective charges were a cost for tax purposes, I already have doubts that they can continue to be so after the (inverted) merger and that moreover there is whoever understands that if they were at that moment, when they were contracted "they will have to be forever…" (position of the Claimant in Proc. No. 88/2016-T, p. 7), regardless of the changes that may occur, including the merger, even more so if inverted (no one doubts that the merger is an operation provided for in law and is not in question here the application of a General Anti-Abuse Rule, but rather the application of art. 23 of the Corporate Income Tax Code).
How can it be said that "… the interest expenses in question correspond to third-party capital that was applied in the business of the entity that bears them" (Proc. No. 88/2016-T, p. 9), when they served for third parties to acquire precisely the company that currently bears them.
It is hard for me to understand!!! I confess.
It would be the same as in the context of a corporate restructuring, covered by the tax benefits in art. 60 of the Tax Benefits Code, which includes an inverted merger, after the exemptions from Transfer Tax, Stamp Duty, etc., the interest from identical borrowing would still be considered as a tax cost of the subsidiary company that incorporates the mother that bought it.
How can it be affirmed that third-party capital was applied in business by the incorporating company, when it did not buy the capital stock of any other company!!!
It is said that it matters to ascertain "… the actual and concrete allocation of the financing of which the supported interest is the remuneration or, in other words, it matters to verify the destination or use of the funds obtained in relation to which the taxpayer intends to deduct fiscally, …, the interest and other associated charges that it bore." (Decision cited, p. 11/12)
But what is the doubt?
Did not the financing serve to pay the price of the Claimant's acquisition by the company that came to incorporate it. The interest derives from the borrowing of third parties, with the debt being contracted before the merger.
In that way, the company is paying to its own shareholders (or part of them, depending on the merger exchange ratio) the price for the acquisition of its own shares.
In the CAAD proceedings that I analyzed and that are dissected in the present Decision, I cannot therefore fail to subscribe to the Dissenting Vote signed by Dr. António Brás Carlos (Proc. No. 88/2016-T), particularly when he expresses his disagreement with the thesis of the continuation of the existence of the incorporating company.
In turn, the factual summary made there lays bare the purpose of the entire operation, naturally raising the question of whether the interest borne can continue to have tax relevance in the post-merger period.
Categorical point 8 of this dissenting vote, which I hereby transcribe, with due respect:
"8. All steps of the operation are inserted in the same "unity of intention and action" and are, from the beginning, solely directed to the objective referred to in the preceding number. An objective alien to the business interest of the Claimant, the financing and payment of the concomitant charges not being necessary to its activity, nor indispensable for the pursuit of its specific business interest materialized in the production of its income subject to tax or in the maintenance of its generating source. The obligation to pay the charges under analysis was never, from the outset, contracted in the business interest of the Claimant, and it is clear to me that it could not, after the merger, come to be considered that such financing was for it indispensable for the purposes of no. 1 of article 23 of the Corporate Income Tax Code."
Dr. António Brás Carlos is right when he states in summary conclusion (point 10) that the decision therein in that proceeding does not respect, but rather clearly contradicts, the jurisprudence of the Superior Courts (Supreme Court of Administrative Justice/Administrative Court of Appeal).
"10. Consequently, bearing in mind the above, the charges relating to those loans, borne by the Claimant, do not meet the requirement of indispensability to which no. 1 of article 23 of the Corporate Income Tax Code refers, because, in summary:
a) They do not relate to the activity developed by it (Supreme Court of Administrative Justice decision, proc. 171/11);
b) The costs corresponding to the interest borne by an incorporating company by virtue of the acquisition of third-party capital by the incorporated company to acquire 100% of the shares of the first are not indispensable for such incorporating company, because they were not established in its business interest, and are not therefore necessary for the pursuit of its corporate purpose (Supreme Court of Administrative Justice decision, proc. 164/12 and Administrative Court of Appeal-South decisions, proc. No. 5327/12 and proc. No. 8137/14);
c) There is no causal nexus between those charges and its profits or gains, explained in terms of normality, necessity, congruence and economic rationality (Administrative Court of Appeal-South decision, proc. No. 6754/13);"
It is also important to take into account in this context the Dissenting Vote of Prof. João Menezes Leitão in Proceedings No. 92/2015-T and 93/2015-T.
Here the reference to the jurisprudence of the Tax Tribunals is reiterated which hold that "costs (…) cannot fail to relate, from the outset, to the contributing company itself. That is, for a certain amount to be considered a cost thereof it is necessary that the respective activity be developed by it itself, not by other companies" (Supreme Court of Administrative Justice Award of 30.05.2012, Proc. 0171/11).
It is therefore vast the analysis of the jurisprudence that, making correct use of the reading of the principle of indispensability of costs, leads to the result of its application the non-indispensability of those that in such Decisions are at stake (92/2015-T and 93/2015-T)
"… that such expenses do not relate to the activity developed by the contributing company itself, lack relationship with the activity pursued by the taxpayer, were not incurred in the interest of the enterprise, in the pursuit of its activities, are foreign to the company's activity, it is not possible to discern in them any causal nexus with the profits or gains, explained in terms of normality, necessity, congruence and economic rationality, were incurred beyond the corporate purpose, that is, in the pursuit of another interest than the business one." (emphasis mine). Isn't that enough!!!
I also have to agree with Prof. Menezes Leitão when he states that:
"… assume the indicated financing costs the Claimant is obligated to divert resources extracted from its assets, which should be intended for the pursuit of its activity and the realization of its corporate purpose, for the payment of the debt and the financial charges relating to the acquisition of shareholdings in its capital by another." (p. 62 and 63 of the Decision)
With application ipis verbis to the case at hand!!!
And if the company does not have financial support to bear charges of such magnitude (interest on millions) and enters into insolvency proceedings?!!
"Being thus, the referred financial costs do not have a framework in the definition of costs and losses (expenses) for the purposes of determining taxable profit, since the assumption of the charges in question was determined by business motivations within a policy of particular interests dictated by those responsible for the interconnected companies and that concern only them, and, accordingly, such costs should not be deemed indispensable, in harmony with what is provided in art. 23 of the Corporate Income Tax Code".
For which reason I cannot accompany the learned decision rendered.
The well-founded Report of the Tax Authority deserved a better fate."
Finally, a few notes on the specific text of the Decision rendered in this Proceeding.
i). In paragraph t) of the Factual Statement, which is repeated in paragraph cc), only the transmission of the liability is given as proved, without any reference to the transmission of the asset, and if later it is invoked that all of this is very typical of the merger, then by the merger "the incorporated companies are extinguished [...], with their rights and obligations being transmitted to the incorporating company" (art. 112, al. c) of the Commercial Companies Code). (with emphasis ours)
Therefore, I do not see how not to likewise give as proved that rights are transmitted equally, but to third parties, not to the Claimant.
I could, for example, conclude the final part of paragraph i) with the following:
", without the assets having been transmitted to it."
Then, probably, in this case we are not in the presence of a merger, because the Rights were not transmitted to the incorporating company, only the Obligations.
ii). On p. 14, 1st paragraph, after stating that:
"The incorporated company is extinguished, without doubt; but all rights and obligations are transmitted to the Incorporating Company, which continues the activity of the "deceased", does not fully correspond to reality, for the reasons already stated in i) of this Dissenting Vote.
First, because all obligations are transferred, but not all rights (the shares and the rights they represent go to third parties and are not transferred to the Claimant).
Second, because the incorporated company ceases to develop the activity of the incorporating company.
iii). When it is said on p. 14, 2nd paragraph that the interest was applied in business, it is important to consider that after the merger the business is not the same.
iv). The example given regarding the machine does not help reinforce my modest position on this matter. To wit.
The interest on a loan intended to buy a machine that is later "abandoned".
This situation is completely different from what happens in our case.
Here, the shares of the Claimant do not disappear, they were transmitted to third parties.
That is, there is a third party that will benefit in the future from the distribution of dividends of the Claimant, or will obtain a capital gain when it resells them.
The shares were not "abandoned".
They are even in good hands and will be very profitable.
They were not "shut down".
They are alive and valuable.
If one were to accept this tax deductibility, we could end up in a situation like this:
There will be a sole shareholder of the Claimant, but it is the Claimant that pays the following interest:
a) To the Bank that financed the incorporated company so that it itself was bought;
b) It stops paying itself, because it incorporates the company that was the creditor of such interest, the interest on the advances;
c) To the Bank that financed its sole shareholder to occur the increase in its share capital.
Reasons for which I cannot accompany the learned decision rendered in this proceeding, without prejudice to what is decided in points 3.2, 3.3 and 3.4.
(Jorge Carita)
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