Deductibility of Financial Costs in IRC: Article 23 CIRC and Cost Indispensability in CAAD Arbitration

ENGLISH TRANSLATION

The arbitrators José Baeta Queiroz (presiding arbitrator), Nuno Cunha Rodrigues and Ricardo Rodrigues Pereira, designated by the Deontological Board of the Administrative Arbitration Center to form the Arbitral Tribunal, agree on the following:

I. REPORT

1. On 25 September 2015, the commercial company A… – … Unipessoal, Lda., NIPC …, with headquarters at Avenida …, …, …, Lisbon (hereinafter, Claimant), filed a request for constitution of an arbitral tribunal, pursuant to the combined provisions of Articles 2, n. 1, paragraph a), and 10, nn. 1, paragraph a), and 2, of Decree-Law no. 10/2011, of 20 January, which approved the Legal Framework for Arbitration in Tax Matters, as amended by Article 228 of Law no. 66-B/2012, of 31 December (hereinafter, briefly referred to as RJAT), seeking the declaration of illegality and consequent annulment of the Corporate Income Tax (IRC) assessment act no. 2014 …, relating to the fiscal year 2010, the respective compensatory interest assessments and the reconciliation statement no. 2014 …, with a total amount payable of € 1,790,611.54, following the dismissal of the administrative complaint no. …2015….

The Claimant attached 13 (thirteen) documents and called one witness, having not requested the production of any other evidence.

The Respondent is the AT – Tax and Customs Authority (hereinafter, Respondent or AT).

1.1. In essence and in brief summary, the Claimant alleged the following (which we mention mostly by transcription):

• The referred additional tax assessment results from a correction to the taxable income for IRC purposes made by the Tax Inspection Services of the AT, in the amount of EUR 11,194,291.77, relating to the disallowance, for the purposes of determining taxable profit for IRC purposes, of the expense corresponding to interest borne by the Claimant on loans contracted, essentially considering that such expenses are not indispensable for the realization of income subject to tax or for the maintenance of the income source, pursuant to Article 23 of the Code of Corporate Income Tax ("IRC Code"), as worded at the time of the facts;

• In the context described, an Administrative Complaint was filed - on 22 December 2014 - with the Tax Service Lisbon …, against the referred assessment, and the Claimant was notified of its express dismissal, by registered letter with proof of receipt received on 30 June 2015;

• The AT alleges that the interest borne by the Claimant resulting from loans contracted for the acquisition of 70% of the capital of B… - …, Unipessoal, Lda. II & Comandita, are not deductible as expenses;

• Understanding that such shareholding already belonged to a "group company" – C… –, resulting from such fact a manifest absence of economic interest in the acquisition of the shareholding, the expenses with interest not being indispensable for the realization of income, which would prevent – in the AT's opinion – their deduction pursuant to Article 23 of the IRC Code;

• Moreover, it further insinuates that, since the Claimant was leasing the space from B…, the amount of the rents already incorporated the financial expenses borne by the latter for acquisition of the real property used, while additionally bearing the financial expenses with the acquisition of shareholdings in the same, whose appreciation is essentially due to the value of the real property, generating a duplication of deductions;

• The operation of acquisition of the financial participation was not effected between entities of the same group, but rather between managing entities representing investment funds that are completely independent from one another;

• The fact that both managing entities are held by a common entity cannot ever be understood as a group structure capable of sustaining the absence of economic interest in the acquisition of the shareholding, the fact on which the AT bases – in essence – the tax disallowance of the interest, nor capable of exercising directly or indirectly significant influence over the management decisions of one another (for transfer pricing purposes);

• The AT makes the economic irrationality of the operation, and consequently the non-deductibility of the expenses, dependent on the fallacious premise that the two managing entities / the two funds, were two pockets of the same parent entity, capable of influencing the decisions of both for its own interest;

• The acquisition of shareholdings in B… was made by the Claimant for purely economic reasons and not for tax reasons, whereby the interest incurred by the Claimant would always be considered deductible as it was indispensable for the realization of income subject to tax and for the maintenance of the income source;

• The subliminal reasoning presented by the AT points predominantly to a logic of abuse, camouflaged by the lack of economic interest, whereby the tax disallowance of the financial expenses could never have been made under Article 23 of the IRC Code, but at most under the General Anti-Abuse Clause, which was not done (or possibly under the application of transfer pricing rules);

• Even if the genesis of the acquisition involved tax motivations, these should always be deemed legitimate either under the constitutionally recognized right to tax planning, or under the jurisprudence of the Court of Justice of the European Union, whereby this argument (invoked by the AT) should not be equally determinative;

• The grounds used by the AT to sustain the assessment above identified do not have sufficient legal basis, the assessment incurring in the defect of violation of law, due to error in the assumptions of law and fact;

• As to the ground used by the AT that the acquisition of the commercial complex …, which determined significant financing by the Claimant, had as its main objective the creation of tax expense, it is important to note that the transaction necessarily had to occur at market price, since it was a transaction between investment funds with different investors, in strict compliance with the applicable legal and regulatory provisions;

• Nor could it be otherwise, since the investors in the investment fund D… intended to be remunerated (at market prices) for the sale of assets and the fund E… intended to have in its assets shareholdings (real property) acquired and valued, equally, at market price, that is, the former would not accept receiving less than the fair value of the assets and the latter would not accept paying more than that value;

• Considering that (a) the transaction occurred in 2007, the year in which real estate assets reached very high values compared to those subsequently practiced as a result of the subsequent economic-financial crisis, (b) the commercial complex F… was purchased at market price, and (c) in 2007, there was great ease of access to credit given the availability of capital existing, the investors in fund E… understood that it would be more advantageous to acquire part of the commercial complex F…, including 70% of the capital of B…, through the use of financing;

• However, the granting of this financing depended on it being allocated to the Claimant or to B…, since these were the two entities that held the assets of the commercial complex F… – real property and operating profits resulting from the operation of F… – and that, for that reason, were in a position to provide guarantees;

• The need to align the financing with the assets given as collateral (whether the real property itself or shareholdings) results from impositions arising from the negotiation of the financing with the bank, which wanted to ensure that the financing was registered in the company that freed higher levels of cash-flow and, therefore, was in better conditions to satisfy the financial obligations inherent to the liability;

• Whereby, the acquisition of 70% of the capital of B… and the financings contracted did not aim to obtain a tax saving at the level of the Claimant but had an economic motivation which was to obtain financing and provide the necessary guarantees to pay the price for the acquisition of the referred shareholding in B…;

• Additionally, the present operation had as its purpose the creation of a business unit in Portugal, in which the set of economic activities directly related to F… were concentrated, namely the management of the real property itself and, also, the management of commercial activities developed therein;

• In fact, the fact that the Claimant acquired 70% of the capital of B… allowed it to have greater control over its business upstream, to the extent that it became the majority owner, albeit indirectly through B…, of the real property upon which its activity depended entirely;

• The fact that the Claimant was paying rent to B… and the latter was attributing 70% of its taxable income to the Claimant, was not the reason for acquisition of the referred shareholding in B…;

• It makes no sense to assert that in the corporate structure of the commercial complex F… there is a duplication of expenses at the level of the Claimant, which results from the interest it bears and the interest that contributed to the determination of the taxable income of B… that is subsequently attributed to it, to the extent that they relate to two completely distinct economic realities: on one hand, the expenses recorded in B… relate to the acquisition of the real property; on the other hand, in the sphere of the Claimant, the financial expenses refer to the acquisition of the shareholding (at market value) in B…, that is, also considering the financial liability recorded in its balance sheet and associated with the real property;

• Nor would it be necessary to "resort" to tax transparency, nor to the present corporate structure to "obtain" a tax saving as, identical result would be achieved if both companies were covered by the Special Tax Regime for Groups of Companies ("RETGS");

• Notwithstanding the fact that there are several arguments that the AT uses to support the correction to the taxable income of the Claimant in the amount of EUR 11,194,291.77, which determined tax payable of EUR 1,790,611.54, such correction is based – in essence - on the fact that the AT does not consider deductible for tax purposes the totality of the financial expenses (EUR 11,194,291.77);

• According to the AT, the interest borne by the Claimant in the fiscal year 2010 as a result of the loan obtained for acquisition of 70% of the capital of Forum B… are not demonstrably indispensable for the realization of income or gains subject to tax or maintenance of the income source of the Claimant, pursuant to Article 23 of the IRC Code, whereby they should be added to the taxable income of that fiscal year;

• Note that Article 23 of the IRC Code is the only legal ground invoked by the AT for the correction made;

• It is therefore in light of this sole legal ground invoked by the AT that the correction in question and the assessment now claimed should be evaluated, being that in the understanding of the Claimant, the key question is whether the interest that was the object of correction (resulting, it is reiterated, from loans contracted to acquire a shareholding) has the capacity to positively influence the realization of income by the Claimant;

• Within the framework of the concept of indispensability of costs, it is indisputable that we are dealing with a management decision of the Claimant (ultimately of the investment fund E…) regarding the acquisition of 70% of the capital of B…, with the objective of increasing income and thereby generating taxable income, and therefore the test for application of Article 23 of the IRC Code is met, as regards the tax deduction of expenses related to such acquisition;

• Being that it is indisputable that the acquisition of 70% of the capital of B… which hold a high-value real property asset, is always an operation capable of enhancing the increase of income (if only through the sale of the shareholding), whereby the expenses related to such acquisition should always be accepted for tax purposes under Article 23 of the IRC Code;

• To support documentarily the expense with the financial expenses, the Claimant has in its possession (i) the loan contracts that gave rise to the payment of interest, (ii) schedules with the calculation of interest and withholding tax by maturity period, (iii) account statements evidencing the payment of interest and cost increases and (iv) payment orders and respective bank statements with evidence of payment of interest;

• The fact that the operation was conducted between funds whose participation units are held by different participants and, consequently, with different interests, will be sufficient to demonstrate the economic rationality of the operation, to the extent that, nothing more will be required for the verification of this requirement than the certainty that the operation respected market conditions;

• In relation to the operation whose economic interest is being questioned, the AT had already recognized that same economic interest with the approval of the request for maintenance of tax losses made by the Claimant under Article 47 of the IRC Code (at the time of the facts) – case no. …/07;

• The AT then became aware of the transaction in its entirety including, therefore, the acquisition by the Claimant of a 70% participation in the capital of B…, in the exact terms that are now being questioned by the AT, whereby the conduct of the latter appears to configure a venire contra factum proprium that violates the principle of justice and good faith to which it is bound, pursuant to Article 55 of the General Tax Law;

• The conduct of the AT created in the spirit of the Claimant a (quite) reasonable confidence, of a legitimate character, since it could reasonably presume that the position assumed reflected, at the time, the legal understanding of the AT before all cases that would merit analogous treatment;

• That is, the conduct of the AT constituted an administrative conduct creating confidence, the situation of confidence occurred and the Claimant invested in that confidence to the extent that it acted in conformity with the guidance of the AT;

• Now, the principle of protection of confidence, inherent in Article 2 of the Constitution of the Portuguese Republic and which has reception in European Union Law (binding the Portuguese State and the entities that represent it), assumes itself as a classifying principle of the Democratic Rule of Law, and implies a minimum of certainty and security in the rights and in the legally created expectations to which is immanent the protection of the confidence of citizens and of the community in the legal order and in the conduct of the State;

• What the AT truly does in the present Report is evaluate the soundness of the management acts practiced in the operation of acquisition of 70% of the capital of B…, being that at no moment truly evaluated the question of indispensability of the expenses, pursuant to Article 23 of the IRC Code;

• As a result of the non-consideration of the financial expenses as tax expense in the amount of EUR 11,194,291.77, in the fiscal year 2010, the Claimant moved from a situation of tax loss to taxable profit;

• In this way, the special payments on account relating to the fiscal years 2008 and 2009, in the total amount of EUR 123,097.88, which were pending in the fiscal year 2010 for deduction, were deducted ex officio by the AT upon issuance of the IRC assessment no. 2014 … which is now claimed;

• The referred special payments on account in the total amount of EUR 123,097.88, had already been deducted by the Claimant in its self-assessment of IRC, relating to the fiscal year 2013;

• However, in light of the ex officio IRC assessment for 2010, namely the deduction of the special payments on account in the amount of EUR 123,097.88, the AT also proceeded to the ex officio correction of the assessment no. 2014 … (IRC for 2013), in which it disallowed a deduction of special payments on account of equal value;

• The additional assessment relating to the fiscal year 2010 lacks legal foundation, whereby after the annulment thereof, the assessment no. 2014 … relating to IRC for 2013 should equally be corrected by the AT, in order to deduct the special payments on account, relating to 2008 and 2009, in the amount of EUR 123,097.88, as per the self-assessment of IRC for 2013 presented by the Claimant;

• In this way, after annulment of the assessment no. 2014 … (IRC 2010) which is now claimed and correction of the assessment no. 2014 … (IRC 2013), the amount of EUR 123,097.88 should equally be reimbursed to the Claimant;

• On 23 and 27 March 2015, the Claimant proceeded to payment of the tax relating to the additional IRC assessment for the fiscal year 2010 and accruals, in the amount of, respectively, EUR 1,790,611.54, and EUR 52,837.58;

• Thus, if the interpretation made by the AT is considered illegal and the decision dismissing the Administrative Complaint presented comes to be annulled, the Claimant should be compensated for the period of time during which it was deprived of the improperly paid amount, being owed compensatory interest, to be calculated from the date of payment until the effective and complete reimbursement by the AT.

1.2. The Claimant concludes its initial pleading by requesting the following:

«A) That the correction to the IRC taxable income for 2010, in the amount of EUR 11,194,291.77, be annulled, on the ground that such correction incurs in the defect of violation of law, due to error in the assumptions of law and fact, translated in the erroneous application of Article 23 of the IRC Code;

B) That the IRC assessment no. 2014 … and respective reconciliation statement no. 2014… in which the total amount of tax and accruals of EUR 1,843,449.12, relating to the fiscal year 2010, is determined, be annulled, on the ground that the same suffers from a defect of violation of law, proceeding with the reimbursement of the amounts improperly paid by the Claimant accrued with compensatory interest accrued and accruing, calculated at the maximum legal rate, until effective and complete payment, all with the legal consequences;

D) That the IRC assessment no. 2014 … for the fiscal year 2013 be corrected, in order to consider the deduction of special payments on account in the amount of EUR 123,097.88, and in consequence, that the amount of EUR 105,303.10 be reimbursed to the Claimant resulting from the difference between the amount of EUR 2,543,431.28 (which should have been reimbursed by the AT) and the amount of EUR 2,438,128.18 (which was reimbursed by the AT), accrued with compensatory interest accrued and accruing, calculated at the maximum legal rate, until effective and complete payment, all with the legal consequences.»

1. The request for constitution of an arbitral tribunal was accepted and automatically notified to the AT on 9 October 2015.

2. The Claimant did not proceed to the appointment of an arbitrator, whereby, pursuant to the provisions of paragraph a) of n. 2 of Article 6 and paragraph a) of n. 1 of Article 11 of the RJAT, the President of the Deontological Board of the CAAD designated as arbitrators of the collective Arbitral Tribunal Counselor José Baeta Queiroz, Prof. Doctor Nuno Cunha Rodrigues and Doctor Ricardo Rodrigues Pereira, who communicated acceptance of the appointment within the applicable time period.

3. On 23 November 2015, the parties were duly notified of this appointment, having not manifested any intention to refuse the appointment of the arbitrators, pursuant to the combined provisions of Article 11, n. 1, paragraphs b) and c), of the RJAT and Articles 6 and 7 of the Deontological Code of the CAAD.

4. Thus, in conformity with the provision of paragraph c) of n. 1 of Article 11 of the RJAT, the collective Arbitral Tribunal was constituted on 9 December 2015.

5. On 26 January 2016, the Respondent, duly notified for such purpose, presented its Response in which it raised the dilatory exception of material incompetence of the Arbitral Tribunal and specifically impugned the arguments adduced by the Claimant, having concluded for the merit of that exception, with its consequent absolution from the instance or, if not so understood, for the lack of merit of the present action, with its consequent absolution from the request.

At the same time, the Respondent attached to the record its administrative file (hereinafter, briefly referred to as PA).

6.1. In essence and also in brief form, it is important to extract the most relevant arguments on which the Respondent based its Response (which we mention mostly by transcription):

The Respondent begins by invoking the exception of incompetence of the Arbitral Tribunal ratione materiae, wielding the following argument:

• It results clearly from the request formulated under paragraph D) that the Claimant intends that the Tribunal issue a corrective decision regarding the IRC assessment no. 2014 … for the fiscal year 2013, as a consequence of the annulment of the IRC assessment no. 2014 …, relating to the fiscal year 2010;

• Even if such intent could eventually derive from the execution of judgments that would be carried out in the event that the arbitral decision issued were to be meritorious, such request goes beyond the competence of the present Tribunal, since the competence of arbitral tribunals is, from the outset, restricted to the matters indicated in n. 1 of Article 2 of the RJAT, combined with the provisions of Ordinance no. 112-A/2011, of 22 March, by virtue of Article 4 of the RJAT;

• Beyond the competence for the direct evaluation of the legality of assessment acts, arbitral tribunals operating in the CAAD may evaluate second or third degree acts that have as their object the evaluation of the legality of acts of those types, namely acts that decide administrative complaints and hierarchical appeals, with no legal support existing that allows pronouncements of a different nature than those resulting from the powers set forth in the RJAT, even if they would constitute a consequence, at the level of execution, of the declaration of illegality of assessment acts;

• It is manifest that the evaluation of the request for correction of the said assessment, made by the Claimant, does not fall within the scope of these competences, which prevents the evaluation of the merit of this claim;

• For this reason, the present arbitral instance is materially incompetent to know of the referred request formulated in the present proceedings by the Claimant;

• To this extent, there is the existence of a dilatory exception, consisting of the material incompetence of the arbitral tribunal, which prevents knowledge of the request, and, therefore, should determine the absolution of the Respondent entity from the instance, in view of the provisions of Articles 576, n. 1 and 577, paragraph a), of the CPC, applicable by virtue of Article 29, n. 1, paragraph e), of the RJAT.

Following this, the Respondent proceeds to defend itself by impugning, arguing the following which we highlight here:

• The purely arithmetic corrections made by the AT that gave rise to the additional assessment now impugned, and which were maintained on administrative complaint, had as their ground Art. 23 of the IRC Code, the interest recorded in the accounts of financial expenses in the fiscal year 2010 in accounts 6911 – interest on obtained financing, 691391 – other obtained loans – G…, LDA and 6921392 – other obtained loans-other interest – H…, in the global amount of € 11,194,291.77, not being accepted, and as such a correction was made corresponding to the totality of these expenses, for not contributing to the formation of taxable profit;

• The services understood that the expenses in question were not indispensable for the realization of income subject to tax or for the maintenance of the income source and that the same were not properly documented;

• Although the corrections made were supported on a legal basis in Art. 23 of the IRC Code, the same were made following and as a consequence of what was ascertained in the administrative complaint procedure, in which the financing operation was analyzed and deeply investigated in order to "dismantle" it and verify its merit, but always aiming to determine whether the claimant satisfied the assumptions of Art. 23 of the IRC Code regarding the indispensability of the cost;

• It is not demonstrated, convincingly, that the financing would only be possible through a company resident in Portugal because the assets capable of constituting a guarantee are located in Portugal, all the more so since one of the loans granted by one of the related entities – by I… – did not have any associated guarantee;

• Also the Claimant does not demonstrate that the fact of holding 70% of the capital of B… and coming to have greater control of its business upstream, over the real property upon which its activity depended entirely, is an advantage, since the same also says that the owner of the real property was limited to making an operation "in a passive manner" ("bare walls")", therefore, it is not discerned where the stated advantage lies;

• It is evident that the decision of the group to allocate to the claimant the participation in B… and the financing associated with its acquisition, as well as the concomitant alteration of the property structure of F…, from the tax point of view, had a strong impact on the legal sphere of the claimant resulting from the financial expenses that it came to bear, whereby it can be affirmed that the fiscal factor was certainly not absent from the decision-making process;

• From an operational point of view everything remained unchanged, that is, B… continued to operate the real property in a passive manner, maintaining its lease to the claimant and the latter continued to ensure the management of the commercial complex;

• In fact, nothing changed with respect to the commercial relations established between the Claimant and B…, since the Claimant pays and continues to pay a rent for the operation of the commercial complex to B…;

• By force of the application of the tax transparency regime, the integration, in the taxable profit of the Claimant, of 70% of the taxable income attributed by B…, has the effect that 70% of the expenses recorded by this taxpayer, as title of depreciation of the real property, interest and other inherent expenses, as well as 70% of the income from rents, come to be assumed as own expenses and income, consequently, it is undeniable that its taxable profit is influenced by the double deduction of financial expenses, with different origin, it is true, but which have in common the fact that they relate directly and indirectly to the same asset – the real property of F…;

• That is, the interest that, in its entirety, contributes to the determination of the taxable profit of the Claimant, differently from what the claimant intends, do not relate to two economically distinct realities, but rather, as a result of the application of the tax transparency regime are reduced to a single economic reality: the real property whose operation is carried out by the claimant;

• The expense recorded by the Claimant arising from the loans contracted for the acquisition of 70% of the shareholding in B…, first and foremost, does not withstand a test that proves its necessity, suitability, normality or connection to a profitable business;

• The deductibility of financial expenses, by force of the principle of indispensability provided for in n. 1 of Art. 23 of the IRC Code, and made concrete in its paragraph c), presupposes that the borrowed capital ceded by third parties be applied in the operation of the business, which points to the existence of an economic causal nexus between the costs in question and their realization in the interest of the business;

• The case sub judice is of some singularity that results from the fact that the final effect, on the taxable profit of the Claimant, of the attribution of taxable income, will consist only of the expenses borne by the transparent entity, which include the financial expenses borne with the acquisition/construction of the real property;

• We thus have that the financial expenses borne by the Claimant add to the financial expenses borne by B… and have no counterpart in the realization of present or future fiscal income generated by this entity, in the form of dividends or possible gains;

• Thus, the holding and consequent management of this shareholding not only is not linked to the corporate purpose of the Claimant but also excessively burdens it, not only by the duplication of financial expenses, but also in terms of the need to manage a shareholding that until then it did not hold;

• For this reason, either by the effect of "duplication" of the financial expenses borne by the Claimant, or because the AT did not discern any connection between such expenses and the activities pursued by the Claimant or by B…, is it to be concluded that the requirement of indispensability required by n. 1 of Art. 23 of the IRC Code is not met, and, therefore, the disallowance of its deductibility does not suffer from any vice of illegality;

• The cost was equally deemed improperly documented for being supported only in internal documents from which does not ensue the necessary relation between the cost borne by the Claimant and the effective receipt by the entities benefiting from that payment;

• In fact, it would always be necessary the existence of an external document that proved the effective loan payments supposedly made by the Claimant;

• The operation in question in the present proceedings was analyzed from the perspective of the cost realized and whether the same was, or was not, indispensable and was properly documented having been that the ground that determined the correction and not that of the eventual lack of an economic rationality of the operation;

• That is, the recognition, or not, of economic interest in the operation of acquisition of the shareholding in B… does not interfere with the judgments relating to the deductibility of the expenses that result from such operation, whose formulation follows a different rationale as they are based on the fulfillment of the requirements set forth in n. 1 of Art. 23 of the IRC Code;

• Whereby, the Claimant has no reason when it invokes that the present assessment was made in clear venire contra factum proprium and in violation of the principle of confidence, since within the scope of the present proceedings there was at stake the evaluation of the operation according to another optic, that of the deductibility, or not, of the cost;

• Whereby, being correct and in conformity with law the corrections made by the AT, in the amount of € 11,194,291.77 corresponding to interest borne by the Claimant in the year 2010 and relating to loans contracted for the acquisition of 70% of the shareholding in B…, for the same not meeting the assumptions of Art. 23 of the IRC Code, the same should be maintained as well as the additional assessments now impugned;

• In the case at hand, there is no existence of any error attributable to the services in the issuance of the impugned assessment, whereby it is unfounded, the request for payment of compensatory interest.

The Respondent thus concludes its pleading:

«In these terms, and in the other respects that Your Excellencies will duly supplement, the exception invoked should be judged meritorious, absolving the respondent from the instance, or, if not so understood, the present request for arbitral pronouncement should be judged lacking in merit, the tax assessment act impugned remaining in the legal order and the respondent entity being absolved from the request, all with the due and legal consequences.»

1. On 3 March 2016, the meeting referred to in Article 18 of the RJAT took place – in which was addressed what is contained in the respective minutes which are hereby reproduced –, and the witness called by the Claimant was examined.

2. Both Parties presented written pleadings, in which they reiterated the positions previously assumed in their respective pleadings.

II. PRELIMINARY MATTERS

The Arbitral Tribunal was duly constituted.

The proceedings do not suffer from any nullities.

The parties possess legal personality and capacity, are duly represented and are legitimate.

II.1. OF THE INCOMPETENCE OF THE ARBITRAL TRIBUNAL RATIONE MATERIAE

The Respondent raised this exception, invoking the following argument which we hereby recover:

• It results from the request formulated under paragraph D) that the Claimant intends that the Tribunal issue a corrective decision regarding the IRC assessment no. 2014 … for the fiscal year 2013, as a consequence of the annulment of the IRC assessment no. 2014 …, relating to the fiscal year 2010;

• Even if such intent could eventually derive from the execution of judgments that would be carried out in the event that the arbitral decision issued were to be meritorious, such request goes beyond the competence of the present Tribunal, since the competence of arbitral tribunals is, from the outset, restricted to the matters indicated in n. 1 of Article 2 of the RJAT, combined with the provisions of Ordinance no. 112-A/2011, of 22 March, by virtue of Article 4 of the RJAT;

• Beyond the competence for the direct evaluation of the legality of assessment acts, arbitral tribunals operating in the CAAD may evaluate second or third degree acts that have as their object the evaluation of the legality of acts of those types, namely acts that decide administrative complaints and hierarchical appeals, with no legal support existing that allows pronouncements of a different nature than those resulting from the powers set forth in the RJAT, even if they would constitute a consequence, at the level of execution, of the declaration of illegality of assessment acts;

• It is manifest that the evaluation of the request for correction of the said assessment, made by the Claimant, does not fall within the scope of these competences, which prevents the evaluation of the merit of this claim;

• For this reason, the present arbitral instance is materially incompetent to know of the referred request formulated in the present proceedings by the Claimant;

• To this extent, there is the existence of a dilatory exception, consisting of the material incompetence of the arbitral tribunal, which prevents knowledge of the request, and, therefore, should determine the absolution of the Respondent entity from the instance, in view of the provisions of Articles 576, n. 1 and 577, paragraph a), of the CPC, applicable by virtue of Article 29, n. 1, paragraph e), of the RJAT.

The Claimant pronounced itself on this exception, seeking its lack of merit, in the following terms which are important to extract:

• From the analysis of the diverse paragraphs of the request formulated by the Claimant, it is verified that (i) what is requested in paragraph B) is a consequence of what is requested in paragraph A) and (ii) what is requested in paragraph D) is a consequence of what is requested in paragraphs A) and B);

• It is thus verified that the Claimant simply enumerated all the consequences that should be taken into account by the AT upon execution of the decision of the CAAD, should the same prove favorable to the Claimant's claim;

• In the case at hand, it is verified that, should the present action be judged meritorious, in the exact terms requested by the Claimant, the AT will equally and pursuant to Article 100 of the LGT, have to proceed to the immediate correction of the IRC assessment no. 2014 … for the fiscal year 2013;

• Thus, the decision that comes to be issued by the Arbitral Tribunal will have, even if indirectly, as its mediate effect, an impact on the IRC assessment for the fiscal year 2013;

• Whereby, the exception invoked should not succeed, for being unfounded.

Given that the scope of material competence of the tribunal is of public order and its knowledge precedes that of any other matter (Art. 13 of the CPTA applicable by virtue of Art. 29, n. 1, paragraph c), of the RJAT) and that the infraction of the rules of competence ratione materiae determines the absolute incompetence of the tribunal, which is subject to official knowledge (Art. 16, nn. 1 and 2, of the CPPT applicable by virtue of Art. 29, n. 1, paragraph a), of the RJAT), it is important to evaluate, primordially, the dilatory exception raised by the Respondent regarding the incompetence of the arbitral tribunal.

As a starting point for the evaluation of this question, we must look to the literal tenor of the request formulated by the Claimant, with respect to which the Respondent understands that the stated material incompetence of the Arbitral Tribunal is verified, which we shall now transcribe:

«D) That the IRC assessment no. 2014 … for the fiscal year 2013 be corrected, in order to consider the deduction of special payments on account in the amount of EUR 123,097.88, and in consequence, that the amount of EUR 105,303.10 be reimbursed to the Claimant resulting from the difference between the amount of EUR 2,543,431.28 (which should have been reimbursed by the AT) and the amount of EUR 2,438,128.18 (which was reimbursed by the AT), accrued with compensatory interest accrued and accruing, calculated at the maximum legal rate, until effective and complete payment, all with the legal consequences.»

This request formulated by the Claimant emerges directly from what is alleged in Articles 226 to 231 of the petition for arbitral pronouncement, namely:

• As a result of the non-consideration of the financial expenses as a tax expense in the amount of EUR 11,194,291.77, in the fiscal year 2010, the Claimant moved from a situation of tax loss to taxable profit;

• In this way, the special payments on account relating to the fiscal years 2008 and 2009, in the total amount of EUR 123,097.88, which were pending in the fiscal year 2010 for deduction, were deducted ex officio by the AT upon issuance of the IRC assessment no. 2014 … which is now claimed;

• The referred special payments on account in the total amount of EUR 123,097.88, had already been deducted by the Claimant in its self-assessment of IRC, relating to the fiscal year 2013;

• However, in light of the ex officio IRC assessment for 2010, namely the deduction of the special payments on account in the amount of EUR 123,097.88, the AT also proceeded to the ex officio correction of the assessment no. 2014 … (IRC for 2013), in which it disallowed a deduction of special payments on account of equal value;

• The additional assessment relating to the fiscal year 2010 lacks legal foundation, whereby after the annulment thereof, the assessment no. 2014 … relating to IRC for 2013 should equally be corrected by the AT, in order to deduct the special payments on account, relating to 2008 and 2009, in the amount of EUR 123,097.88, as per the self-assessment of IRC for 2013 presented by the Claimant;

• In this way, after annulment of the assessment no. 2014 … (IRC 2010) which is now claimed and correction of the assessment no. 2014 … (IRC 2013), the amount of EUR 123,097.88 should equally be reimbursed to the Claimant.

Additionally, as the Claimant itself affirms in its response to this matter of exception, «from the analysis of the diverse paragraphs of the request formulated by the Claimant, it is verified that (i) what is requested in paragraph B) is a consequence of what is requested in paragraph A) and (ii) what is requested in paragraph D) is a consequence of what is requested in paragraphs A) and B)».

Having said this. In the legislative authorization on which the Government based itself to approve the RJAT, granted by Article 124 of Law no. 3-B/2010, of 28 April, it is proclaimed, as a primordial directive of the institution of arbitration as an alternative form of jurisdictional resolution of conflicts in tax matters, that «the tax arbitration process should constitute an alternative procedural means to the judicial impugn process and the action for recognition of a right or legitimate interest in tax matters».

The judicial impugn process is a procedural means that has as its object a tax act, aiming to evaluate its legality and decide whether it should be annulled or its nullity or non-existence be declared, as results from Article 124 of the CPPT.

From the analysis of Articles 2 and 10 of the RJAT, it is verified that only the legality issues of assessment acts or of taxable income fixing acts and second degree acts that have as their object the evaluation of the legality of acts of those types were included in the competences of the arbitral tribunals operating in the CAAD, acts whose evaluation is inserted within the scope of judicial impugn processes, as results from paragraphs a) to d) of n. 1 of Article 97 of the CPPT.

That is, it is found that the legislator did not implement in the legislative authorization regarding the part in which the extension of the competences of the arbitral tribunals was foreseen to questions that are evaluated in tax tribunals through action for recognition of a right or legitimate interest.

But, in harmony with the intention underlying the legislative authorization of creating an alternative means to the judicial impugn process, should be understood that, as to requests for declaration of illegality of acts of the types referred to in its Article 2, the arbitral tribunals operating in the CAAD have the same competences that state tribunals have in judicial impugn proceedings, within the limits defined by the undertaking that the Tax and Customs Authority came to make through Ordinance no. 112-A/2011, of 22 March, pursuant to Article 4, n. 1, of the RJAT.

Although the judicial impugn process has as its primary object the declaration of nullity or non-existence or the annulment of acts of the types referred to, it has been understood pacifically that pronouncements can be issued therein condemning the Tax Administration to pay compensatory interest and indemnification for wrongful guarantee.

In truth, despite there being no express norm to that effect, it has been understood pacifically in tax tribunals, since the entry into force of the codes of the fiscal reform of 1958-1965, that a request for condemnation to the payment of compensatory interest can be cumulated in a judicial impugn process with the request for annulment or declaration of nullity or non-existence of the act, by the codes referring that the right to compensatory interest arises when, in administrative complaint or judicial process, the administration is convinced that there was error of fact attributable to the services. This regime was, subsequently, generalized in the Tax Procedure Code, which established in n. 1 of its Art. 24 that «there will be a right to compensatory interest in favor of the taxpayer when, in administrative complaint or judicial process, it is determined that there was error attributable to the services», following, in the LGT, in whose Art. 43, n. 1, it is established that «compensatory interest are owed when it is determined, in administrative complaint or judicial impugn, that there was error attributable to the services from which results payment of the tax debt in amount superior to that legally owed» and, finally, in the CPPT in which it was established, in n. 2 of Art. 61 (to which corresponds n. 4 in the wording given by Law no. 55-A/2010, of 31 December), that «if the decision that recognized the right to compensatory interest is judicial, the period of payment counts from the beginning of the period of its spontaneous execution».

Thus, similarly to what happens with tax tribunals in judicial impugn proceedings, this Arbitral Tribunal is competent to evaluate the requests for reimbursement of the amount paid and for payment of compensatory interest.

It is also unequivocal that in judicial impugn processes it is possible to evaluate requests for condemnation to payment of indemnification for wrongful guarantee, Art. 171 of the CPPT, establishes that «the indemnification in case of banking or equivalent guarantee wrongfully provided will be requested in the process in which the legality of the enforceable debt is contested» and that «the indemnification should be requested in the complaint, impugn or appeal or in case of its ground being supervenient within 30 days after its occurrence».

Thus, it is unequivocal that the judicial impugn process encompasses the possibility of condemnation to payment of wrongful guarantee and it is even, in principle, the appropriate procedural means to formulate such request, which is justified by evident reasons of procedural economy, since the right to indemnification for wrongful guarantee depends on what is decided regarding the legality or illegality of the assessment act.

The request for constitution of the arbitral tribunal has as its corollary that it is in the arbitral process that the «legality of the enforceable debt» will be discussed, whereby, as results from the express tenor of that n. 1 of the referred Art. 171 of the CPPT, is also the arbitral process the appropriate one to evaluate the request for indemnification for wrongful guarantee.

But, in the absence of any legal disposition that allows concluding otherwise, the scope of the judicial impugn process and of the arbitral processes is restricted to the legality questions of the acts of the types referred to in Article 2 that are covered by the undertaking that was made in Ordinance no. 112-A/2011, not being able, namely, to define the terms in which annulatory judgments that come to be issued should be executed.

In truth, as the Tax and Customs Authority rightly refers, the competence to execute the judgments issued by the arbitral tribunals operating in the CAAD falls, in the first place, to the Tax and Customs Authority itself, as results from the express tenor of n. 1 of Article 24 of the RJAT in stating that «the arbitral decision on the merit of the claim for which there is no room for appeal or impugn binds the tax administration from the end of the period provided for appeal or impugn, having the latter to...».

On the other hand, if there is disagreement between the Tax and Customs Authority and the taxpayers regarding the manner of execution of judgments, the tax tribunals are competent for its evaluation, since the arbitral tribunals operating in the CAAD are not attributed competences in judgment execution proceedings and the arbitral tribunals are dissolved following the arbitral decision, as results from Article 23 of the RJAT.

Thus, it is concluded that the Tax and Customs Authority is correct in defending that this Arbitral Tribunal does not have competence to evaluate the request formulated in paragraph D).

However, this incompetence to evaluate one of the requests, there being others for which this Arbitral Tribunal is competent – those formulated in paragraphs A) and B) –, has only as a consequence that the request for which the Tribunal is incompetent be considered "without effect", as is inferred from what, although for another purpose, is referred to in n. 4 of Article 186 of the CPC, in alluding to situations in which «one of the requests is without effect due to incompetence of the tribunal».

Thus, the exception of material incompetence of the Arbitral Tribunal is judged meritorious as to the request formulated in paragraph D) – «That the IRC assessment no. 2014 … for the fiscal year 2013 be corrected, in order to consider the deduction of special payments on account in the amount of EUR 123,097.88, and in consequence, that the amount of EUR 105,303.10 be reimbursed to the Claimant resulting from the difference between the amount of EUR 2,543,431.28 (which should have been reimbursed by the AT) and the amount of EUR 2,438,128.18 (which was reimbursed by the AT), accrued with compensatory interest accrued and accruing, calculated at the maximum legal rate, until effective and complete payment, all with the legal consequences.» –, whereby the Tax and Customs Authority is absolved from the instance, as to this request, without prejudice to knowledge of the remaining requests.

There are no other exceptions or preliminary matters that prevent knowledge of the merit and of which it is necessary to know.

III. REASONING

III.1. FACTUAL MATTERS

§1. PROVEN FACTS

The following facts are considered proven:

a) The Claimant is a commercial company constituted in the form of a unipessoal limited liability company, having been incorporated on 29 May 2000 and begun activities on 19 June 2000, and in the year 2010, had as its corporate purpose «the lease, operation and management of the commercial center designated "F…", including the acquisition of any assets or rights, movable or immovable, as necessary for the referred purposes». [cf. Doc. 9 attached to the Initial Petition and PA attached to the record]

b) At the date of its incorporation, the Claimant was held by the sole shareholder "C…", with headquarters in Germany, and from 31 July 2007, the Claimant came to be held by the sole shareholder "H…", NIPC …. [cf. Doc. 9 attached to the Initial Petition and PA attached to the record]

c) The Claimant, on 31 December 2010, was structured and inserted in a group constituted according to the following organizational chart [cf. PA attached to the record]:

d) As results from the transfer pricing file relating to the fiscal year 2010, of the Claimant, "E…" is a sub-fund of "Q…", an open common fund specialized in the placement of investments in funds, launched by "R…", on 4 June 2007. [cf. PA attached to the record]

e) The said fund is identified as a contractual form of collective investment that operates under the laws of the Grand Duchy of Luxembourg and which approved a structure intended to manage different sets of assets and liabilities, in the interest of its owners, by a common managing company, "S…". [cf. PA attached to the record]

f) The fund "E…" is directed to European institutional investors, with the objective of creation of a diversified pan-European retail portfolio, the same having invested in real property, in Spain and Portugal, through its investees "L…", "H…" and "M…". [cf. PA attached to the record]

g) The commercial company "B… – …, Unipessoal, Lda. II & Comandita", NIPC …, was incorporated as a limited company, on 27 February 1997, with the name "T…, S. A.", having been transformed, in September 2000, into a limited partnership, having then as general partner "C…", holder of a shareholding with a nominal value of € 9,999,995.00, and as limited partner the Claimant, holder of a shareholding with a nominal value of € 5.00. [cf. PA attached to the record]

h) On 31 October 2007, "C…", general partner in "B…" proceeded to divide its shareholding in this company into two parts, one with a nominal value of € 6,999,995.00, which it transferred to the Claimant, and another with a nominal value of € 3,000,000.00, which it transferred to "M…, SARL". [cf. PA attached to the record]

i) In the year 2010, "B…" had as its general partner "M…, SARL", holder of a shareholding with a nominal value of € 3,000,000.00, and as its limited partner the Claimant, holder of a shareholding with a nominal value of € 7,000,000.00, having as its corporate purpose the «purchase and sale of real property, as well as the simple or mere administration of its own real property maintained for enjoyment and intended for the Commercial Center "F", therein including namely its lease, as well as any other acts or transactions directly related with the above mentioned activity». [cf. PA attached to the record]

j) "B…" is a company for simple administration of assets and, as such, is subject to the tax transparency regime, pursuant to the provisions of Art. 6, n. 1, of the IRC Code, attributing to its shareholders the taxable income it determines annually. [cf. PA attached to the record]

k) The «Commercial Complex F…» includes: the Commercial Center "F…", composed of 216 shops, 34 restaurants, a cinema complex and a leisure space; and a Retail Park next to the commercial center, composed of 3 shops, a warehouse, a control center and 204 parking spaces [cf. PA attached to the record]

l) "B…" is the owner of the separate units "C" to "AO" of the Commercial Center "F…". [cf. PA attached to the record]

m) On 1 September 2005, a Lease Agreement was executed between "B…", as lessor, and the Claimant, as lessee, by which the former leased to the latter the separate units "C" to "AO" of the Commercial Center "F…", for a period of six months from 1 July 2002, automatically renewable for equal and successive periods of time, with payment of monthly rent of € 1,750,000.00. [cf. PA attached to the record]

n) The contractual conditions set forth in that Lease Agreement were in force until August 2010 – with "B…" receiving a monthly amount of € 1,750,000.00 for the units of the Commercial Center, and a monthly amount of € 50,000.00 for the Retail Park –, and on 1 December 2010, the parties agreed to revise downward, with effects from August 2010, the monthly rent for the units of the Commercial Center, which passed to be € 1,400,000.00, and the monthly rent for the Retail Park, which passed to be € 40,000.00. [cf. PA attached to the record]

o) The amounts of rents paid by the Claimant to "B…" are recorded in the statement of income by nature in the item "FSE – Supplies and External Services" and recorded in the expense accounts "626111 – Rents F…" – which presented, on 12/31/2010, an amount of € 15,400,000.00 – and "626112 – Rents U… (Retail Park)" – which presented, on 12/31/2010, an amount of € 440,000.00. [cf. PA attached to the record]

p) The Claimant is directly responsible for the day-to-day administration of the Commercial Center, developing the promotion and commercialization of the shops and their strategic promotion. [cf. PA attached to the record]

q) The Claimant enters into "store utilization agreements" with shop chains or other types of users, usually called tenants, which set forth the rights and obligations of both contracting parties, and in those agreements, among other obligations, the tenants undertake to pay a monthly fee consisting of the sum of two portions – one fixed (minimum remuneration) and another variable – and to participate in the expenses and charges of operation and use of the Commercial Center. [cf. PA attached to the record]

r) The amounts (fixed and variable monthly remuneration and other expenses), billed by the Claimant to each of the tenants are recorded in the statement of income by nature in the item "Rents and services provided". [cf. PA attached to the record]

s) The Claimant acquired the acquisition of the shareholding held by "C…" in "B,,,", referred to above in paragraph h), for the amount of approximately 175.3 million Euros, having for such purpose resorted to three financings, namely: one with "H…", in the amount of € 96,844,069.52; another with "K… – Branch in Portugal", in the amount of € 35,800,000.00; and another with "I… – …, Unipessoal, Lda.", in the amount of € 42,663,800.00. [cf. PA attached to the record]

t) The resort to financing to carry out that operation was decided by the investors of the fund "E…" who understood that it would be the most advantageous and rational decision.

u) Essential conditions for the granting of the financing were that it be as close as possible to the asset and to the source of income (release of cash-flow necessary to meet financial obligations), whereby the same would have to be made concrete through companies resident in Portugal, that is, the Claimant or "B…".

v) "B…" already had a financing guaranteed with mortgage of the aforesaid real property of which it is the owner (cf. supra paragraph l)), whereby only the Claimant was in a position to contract such financing, since it could provide additional guarantees, namely: the pledge of the shares of "B…" and the operating profits resulting from the operation of the Commercial Center "F…".

w) The referred financing obtained from "H…" was made on 31 October 2007, for a period of 10 years, that is, with maturity date of 31 October 2017, and the parties agreed to an annual fixed interest rate of 7.25% [cf. PA attached to the record]

x) The mentioned financing contracted with "K… – Branch in Portugal" was made on 31 October 2007, for a period of 10 years, that is, with maturity date of 31 October 2017, and the parties agreed to an interest rate corresponding to V… at 7 years, plus a spread of 50 basis points. [cf. PA attached to the record]

y) The said financing obtained from "I… – …, Unipessoal, Lda." was made on 31 October 2007, for a period of 10 years, that is, with maturity date of 31 October 2017, and the financing conditions that were in force until the end of the 1st semester of 2009 provided for payment of a variable interest rate determined on the basis of the 6-month Euribor rate, plus a spread of 0.15%; from the 2nd semester of 2009, the interest rate became fixed, and it was established between the parties that the interest rate would be determined on the basis of the 8-year swap rate, of 1 July 2009, published by Bloomberg, which stood at 3.40%, plus a spread of 1.6%. [cf. PA attached to the record]

z) The referred financings were guaranteed with the operating profits resulting from the operation of the Commercial Center "F…" (non-controlled variable) and with the pledge of the quota corresponding to 70% of the capital of "B…" (controlled variable, but subject to fluctuations in the value of the shareholding, which is directly related to variations in the market value of the real property owned by "B…").

aa) The financial expenses related to the aforesaid financings were recorded by the Claimant in the expense accounts, specifically in the accounts "6911 – Interest on obtained financing (K… loan)", "691391 – Other obtained loans – other interest – G…, Lda. (I… loan)" and "691392 – Other obtained loans – other interest – H… (H… loan)". [cf. PA attached to the record]

ab) The amounts of interest borne and of financings obtained by the Claimant reached the following amounts over the years, until the fiscal year 2010 [cf. PA attached to the record]:

ac) In the fiscal year 2010, the Claimant bore the following financial expenses relating to the financings referred to above in paragraphs s), w), x) and y), the total amount of which rose to € 11,194,291.77 [cf. Doc. 10 attached to the Initial Petition and PA attached to the record]:

ad) Under Service Order no. OI2013…, the Claimant was subject to an external inspection action of partial scope – IRC –, incident to the fiscal year 2010 – by virtue of situations of risk having been identified, namely determination of tax losses in successive years, changes in equity resulting from the transition POC/SNC and high financial expenses –, which was carried out by the Team … of the Division … of the Department … of the Tax Inspection Services of the Directorate of Finance of Lisbon. [cf. PA attached to the record]

ae) On 19 February 2014, within the scope of the referred inspection procedure, the Claimant was notified, pursuant to the provisions of n. 2 of Art. 31, nn. 1 and 4 of Art. 59 and Art. 63 of the LGT, and also of Art. 37 of the RCPIT, to present the following documents [cf. PA attached to the record]:

af) In that consequence, the Claimant presented the following documents to the Tax Inspection Services: excerpts of the bank transfers made and excerpts of accounts 6911, 691391 and 691392, in which the interest of the aforesaid financings that the Claimant obtained are recorded. [cf. PA attached to the record]

ag) The amounts declared by the Claimant, through the Simplified Business Information (IES) and the income statement (Form 22) of IRC, were the following over the years, until the fiscal year 2010 [cf. PA attached to the record]:

ah) Through an official communication from the Tax Inspection Services of the Directorate of Finance of Lisbon, dated 16/05/2014, sent by registered mail (RC…PT), the Claimant was notified of the Draft Report of the Tax Inspection and to, if so desired, exercise the right to a hearing, with the following corrections being proposed in the IRC [cf. PA attached to the record]:

ai) The Claimant exercised that right to a hearing, in the terms set forth in Doc. 8 attached to the Initial Petition and in the PA attached to the record, which are hereby fully reproduced.

aj) The corrections proposed to the IRC of the Claimant, relating to the fiscal year 2010, mentioned in ah), were fully maintained in the Tax Inspection Report, the exercise of the right to a hearing by the Claimant having been the subject of evaluation by the Tax Inspection Services, in the terms set forth in that Report and which are hereby reproduced. [cf. PA attached to the record]

al) In the Tax Inspection Report the following reasoning is presented for the mentioned purely arithmetic corrections made to the IRC of the Claimant, relating to the fiscal year 2010 [cf. PA attached to the record]:

am) The Claimant was notified of the Tax Inspection Report, through official communication no. …, dated 23/06/2014, from the Tax Inspection Services of the Directorate of Finance of Lisbon, sent by registered mail (RC…PT). [cf. Doc. 3 attached to the Initial Petition and PA attached to the record]

an) By virtue of the referred corrections, the following were made: an additional IRC assessment no. 2014 …, dated 30/06/2014, relating to the fiscal year 2010, in the amount of € 831,931.86, compensatory interest assessments no. 2014 …, in the amount of € 77,561.71 and no. 2014 …, in the amount of € 109,788.52, as well as the compensation no. 2014 …, dated 10/07/2014, and the reconciliation statement no. 2014 …, in which a total amount payable of € 1,790,611.54 was determined, with voluntary payment deadline of 08/09/2014. [cf. Docs. 1 and 2 attached to the Initial Petition]

ao) The Claimant proceeded to full payment of the referred amount of € 1,790,611.54, which it did on 23/03/2015, to which was added the amount of € 52,837.58, which the Claimant paid on 27/03/2015. [cf. Docs. 12 and 13 attached to the Initial Petition]

ap) On 23 December 2014, the Claimant presented an administrative complaint – whose initial request is hereby fully reproduced – which had as its object the tax acts referred to above in paragraph an), with the Claimant having petitioned the following therein [cf. Doc. 4 attached to the Initial Petition and PA attached to the record]:

aq) The referred administrative complaint was filed under no. …2015… in the Tax Service of Lisbon - …, having the following draft decision been issued thereon [cf. PA attached to the record]:

ar) The Claimant was notified, through official communication no. …, dated 26.05.2015, from the Administrative Justice Division of the Directorate of Finance of Lisbon, sent by registered mail (RD…PT), of that draft decision and to, if so desired, exercise the right to a hearing. [cf. PA attached to the record]

as) The Claimant did not exercise the right to a hearing, whereby the aforesaid draft decision was converted into a final decision and, consequently, the administrative complaint was dismissed, by order dated 25 June 2015, issued by the Deputy Director of Finance, in substitution regime, of the Directorate of Finance of Lisbon, with the reasoning referred to above in paragraph aq). [cf. Doc. 5 attached to the Initial Petition and PA attached to the record]

at) The Claimant was notified, through official communication from the Administrative Justice Division of the Directorate of Finance of Lisbon, dated 26.06.2015, sent by registered mail (RD…PT) received on 30.06.2015, of the order dismissing the administrative complaint. [cf. Docs. 5 and 6 attached to the Initial Petition and PA attached to the record]

au) On a date not specifically ascertained, the Claimant filed a request for authorization of deduction of tax losses, without the limitation provided for in n. 8 of Art. 52 of the IRC Code, which was granted by Order, dated 17/05/2012, of the Sub-Director-General of IR, issued by sub-delegation of competences, endorsed in information no. …/2012 of the Directorate of Services of Corporate Income Tax. [cf. Doc. 7 attached to the Initial Petition]

av) On 25 September 2015, the Claimant presented the request for constitution of an arbitral tribunal that gave rise to the present proceedings. [cf. information system for procedural management of the CAAD]

§2. FACTS NOT PROVEN

It was not proven that the operation of acquisition of 70% of the capital of "B…" by the Claimant, made with resort to the referred financings from "H…", "K… – Branch in Portugal" and "I… – …, Unipessoal, Lda.", had as its purpose the creation of a business unit in Portugal, in which the set of economic activities directly related to the Commercial Center "F…" were concentrated, namely the management of the real property itself and, also, the management of commercial activities developed therein.

§3. REASONING AS TO FACTUAL MATTERS

As to the proven factual matters, the conviction of the Tribunal was based on the facts alleged by the parties, whose adherence to reality was not questioned, on the documents and on the respective administrative file attached to the record and, also, on the testimonial evidence produced.

With respect to the proven fact contained in paragraph ac), it is necessary to make some additional considerations here, to the extent that the AT understood that «there was a manifest insufficiency in the fulfillment of formal requirements, for the Claimant having not presented any documents issued by the beneficiaries of the income and that the formal requirement of proof was not inappropriate, particularly because we were dealing with companies with special relations» and, for that reason, considered that the justifying/evidencing documents of the costs in question that were presented by the Claimant «did not allow effective control of the economic relations, either on the side of the claimant or of the beneficiary, since, to the revelation of a cost to one agent, is opposed a profit to the other».

First and foremost, it is a contradictio in terminis to allude, as the AT does, to the indispensability of costs that are not deemed proven. In fact, the question of indispensability only arises before proven costs, that is, when that question is raised it is no longer in question the existence of a cost, but rather its qualification [it is, therefore, curious to note that in the Tax Inspection Report the order of the factors is inverted, as first the «criterion of indispensability» is addressed and only then is the «fulfillment of formal requirements» analyzed (cf. paragraph al))]. The question that arises when one addresses the subject of indispensability is, in fact, to know whether a given cost correctly recorded – accounting cost – has or does not have the characteristics that make it subsumable under the legal concept of tax cost.

Having said this. It is a fact that in the Claimant's accounting there are no documents issued by the holders of the income, that is, invoices and/or debit notes relating to the mentioned financial expenses borne by it during the fiscal year 2010. However, following what we believe to be doctrine and settled jurisprudence, after checking document no. 10 attached to the initial petition and whose content is also contained in the administrative file attached to the record, it appears to us without any doubt that the Claimant proved that it incurred/bore the aforesaid costs.

Regarding the testimony given by W… – witness called by the Claimant and who testified clearly, objectively and impartially about the facts to which it was examined, revealing unequivocal direct knowledge of the same, whereby its testimony deserved our total credibility –, it is important to make a very brief summary thereof here, referring to its essential aspects:

While consultant of "Y", it was involved in the operations at issue in the record and, therefore, reported in a detailed manner the unfolding thereof, having done so in total consonance with what, for that purpose, is described in the petition for arbitral pronouncement.

According to what it stated, these were operations between investment funds – represented by their respective managing entities, acting in the interest of their respective investors –, which were subject to the supervision of the German and Luxembourg authorities, having the same not constituted the reorganization of any business group.

It further stated that there was assessment of the assets and of the assets on which the referred operations had an impact.

According to its direct knowledge, the mentioned acquisition of the shareholding of the Claimant in "B…" was justified by the requirements placed by the financing entities to make their respective financings, to the extent that they intended to ensure the service of the debt with the existing sources of income.

When questioned about the interest of the acquisition of the said shareholding, from the perspective of the Claimant, it added nothing beyond what, in this respect, is set forth in the petition for arbitral pronouncement.

Regarding the factual matter not proven, this was thus considered as a result of the absence of any probative elements capable of, unequivocally, proving it.

III.2. LEGAL MATTERS

III.2.1. INTERPRETATION OF ARTICLE 23 OF THE IRC CODE AND ITS APPLICATION TO THE PRESENT CASE

§1. General framework

In the present proceedings there is at stake a request for annulment of an additional tax assessment, resulting from a correction to the taxable income for IRC purposes made by the Tax Inspection Services of the AT, in the amount of EUR 11,194,291.77, relating to the disallowance, for the purposes of determining taxable profit for IRC purposes, of the expense corresponding to interest borne by the Claimant on contracted loans, since it was considered, in essence, that such expenses were not indispensable for the realization of income subject to tax or for the maintenance of the income source, pursuant to Article 23 of the Code of Corporate Income Tax ("IRC Code"), as worded at the time of the facts.

In summary, the annulment of the additional assessment, which proceeded to the correction of the Claimant's taxable income in the amount of EUR 11,194,291.77, and which determined tax payable of EUR 1,790,611.54, is sought on the basis that the AT did not consider deductible, for tax purposes, the totality of the financial expenses borne by the interest paid by the Claimant, in the fiscal year 2010, as a result of the loan obtained for acquisition of 70% of the capital of B….

The AT considered that such expenses were not demonstrably indispensable for the realization of income or gains subject to tax or maintenance of the income source of the Claimant, pursuant to Article 23 of the IRC Code, whereby they should be added to the taxable income of that fiscal year and that, on the other hand, they were not documentally proven.

At stake, in this context, is the evaluation of the legality of the administrative judgment of non-deductibility of the interest relating to the financing in question and of the consequent correction to the taxable income.

It is necessary, in the first place, to proceed to the theoretical framework of the provisions of Article 23 of the IRC Code so that, in the end, the factuality of the present proceedings is subsumed under the referred provision.

§2. On the interpretation of Article 23 of the IRC Code and the question of the "indispensability" of expenses

At the time to which the controversial facts refer, Article 23 of the IRC Code provided, in the part that here is relevant to consider:

«Article 23

Expenses

1 — Expenses are those that are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the income source, including in particular:

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

b) Those relating to distribution and sale, including transportation, advertising and placement of merchandise and products;

c) Of a financial nature, such as interest on borrowed capital applied in operations, discounts, premiums, transfers, foreign exchange differences, expenses with credit operations, debt collection and issuance of bonds and other securities, redemption premiums and those resulting from the application of the effective interest method to financial instruments valued at amortized cost;

d) Of an administrative nature, such as remuneration, including those granted as title of participation in profits, allowances, current consumption material, transport and communications, rent, litigation, insurance, including life insurance and operations in the «Life» branch, contributions to savings funds-retirement, contributions to pension funds and to any supplementary social security regimes, as well as expenses with benefits for cessation of employment and other post-employment or long-term benefits of employees;

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

f) Of a tax and paratax nature;

g) Depreciation and amortization;

h) Adjustments in inventories, impairment losses and provisions;

i) Expenses resulting from the application of fair value in financial instruments;

j) Expenses resulting from the application of fair value in consumable biological assets that are not multi-year forest exploitation;

l) Losses realized;

m) Indemnifications resulting from events whose risk is not insurable.»

There thus arises, in this provision, a nuclear requirement in the admissibility of expenses for tax purposes: their indispensability.

What should be understood by "indispensability"?

Among us, two analyses are usually invoked on what should be the appropriate interpretation of the concept of indispensability set forth in Article 23 of the IRC Code.

The first is authored by TOMÁS TAVARES, in "On the relation of partial dependence between accounting and tax law in the determination of taxable income of legal entities: some reflections at the level of costs", in Science and Tax Technique, no. 396, 1999, p.7-180; and the second by ANTÓNIO M. PORTUGAL, in "The deductibility of costs in Portuguese tax jurisprudence", Coimbra Editora, 2004.

In the first of the mentioned works, TOMÁS TAVARES analyzes extensively the question relating to the interpretation of the concept of indispensability contained in Article 23 of the IRC Code.

The author points out three possible interpretations, defending that only one of them constitutes the correct solution.

A first understanding would translate itself into a necessary or obligatory relation between costs borne and income obtained. Such understanding of indispensability would mean that only the "absolute necessity" of an expense to obtain an income (profit) would allow its deduction as a negative component of taxable profit. The author qualifies as absurd such an interpretation. He does so in the following terms: "...the funneling proposed by this conception would lead to the disregard for tax purposes of certain losses actually and truly borne by the organization, in clear and flagrant violation of the principle of contributive capacity.... In the second place, given that, in the limit, the deductibility of costs connected with businesses that proved ruinous for the company would never be accepted, given the absence (or insufficiency) of the profits resulting therefrom. Now the truth is that Tax Law cannot censure an unprofitable business policy…Tax Law must recognize the right to error of the business owner."

A second interpretation of the concept of indispensability – meaning "convenience" – is dealt with by the author in the following terms: "...this objective does not stand as a guiding principle, both in attention to the numerous practical problems it poses, and, especially, because it also allows administrative control over the merit of business decisions. In fact, convenience is a fragile concept, with an open and undefined meaning, that fosters the intermeddling of the administrative machinery in the economic choices of taxpayers".

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

That thesis is expressed in the following terms: "The legal notion of indispensability is thus outlined, based on an economic-business perspective, by fulfillment, direct or indirect, of the ultimate motivation for obtaining profit. Indispensable costs are equivalent to expenses incurred in the interest of the company or, in other words, in all acts abstractly subsumable in a profit profile. This purpose intentionally brings together economic and tax categories, through an interpretation primarily logical and economic of legal causality. The indispensable expense is equivalent to any cost realized in order to obtain income and that represents an economic loss for the company. As a rule, therefore, the tax deductibility of the cost depends, only, on a causal and justified relation with the productive activity of the company".

And it continues: "...Indispensability is subsumed to any and every act performed in the interest of the company...The legal notion of indispensability thus represses acts inconsistent with the company's purpose, not insertable in the corporate interest, especially because they do not aim at profit….".

It should be noted that the cited text leaves us in no doubt as to the author's position (indispensable costs are equivalent to expenses incurred in the interest of the company). However, the fact is that an excerpt of that text, in particular the relation between expenses and productive activity, has served interpretive purposes of the concept of indispensability that the author himself has already clearly eliminated, in the decision regarding case no. 12/2013-T, of the CAAD.

A. MOURA PORTUGAL, discussing the same concept, addresses mainly the history of the jurisprudential interpretation that was made of it from the time of the Industrial Contribution to 2001.

In any event, this author, and as regards the question of knowing what the best interpretation of the concept of indispensability is, adopts the following position:

"The solution adopted among us (at least in doctrine), following the understandings advocated by Italian doctrine, has been to interpret indispensability in function of the corporate purpose. This position is present from the outset in the writings of Vítor Faveiro, who recounts the indispensability of the expense to its appreciation as a management act in function of the concrete corporate purpose, refusing that this indispensability can be assessed freely from any subjective judgment of the law applicator".

In the present case, Article 23 of the IRC Code is the sole legal ground invoked by the AT for the correction made, whereby it is in light of this provision that the correction and the consequent additional assessment claimed should be evaluated.

In truth, the reasoning of the Fiscal Administration could have been supported under the General Anti-Abuse Clause or in terms of the application of transfer pricing rules, which, it is reiterated, did not happen.

It is, therefore, in light of the provisions of Article 23 of the IRC Code that the present case should be evaluated, seeking to inquire whether the interest that was the object of correction, and resulting from the loan contracts entered into by the Claimant with a view to the acquisition of 70% of the capital of B…, has the capacity to positively influence the realization of income by the Claimant.

We understand that it does, inasmuch as:

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