CAAD 621/2017-T: IRC Deductibility of Expenses – Corporate Tax Base Correction Annulment

ARBITRAL DECISION

The arbitrators, Counsellor Jorge Manuel Lopes de Sousa (arbitrator-president, designated by the other Arbitrators), Dr. Ricardo da Palma Borges and Professor Américo Brás Carlos, designated by the Claimant and Respondent, respectively, to form the Arbitral Tribunal, constituted on 20-02-2018, hereby agree as follows:

1. Report

A..., S.A. (hereinafter the "Claimant"), with registered office in ..., ..., ..., with the single registration and tax identification number ... (hereinafter "Claimant"), came, pursuant to subparagraph a) of paragraph 1 of Article 2, subparagraph b) of paragraph 2 of Article 6, and subparagraph a) of paragraphs 1 and 2 of Article 10 of Decree-Law No. 10/2011, of 20 January (hereinafter "RJAT"), to file petitions for annulment of the correction to the taxable income for Corporate Income Tax (IRC) for the fiscal year 2013, in the total amount of € 316,516.66, and, proportionally, of the Corporate Income Tax assessment act No. 2017..., of the respective statement of account reconciliation No. 2017..., and compensatory interest.

The Claimant contests the assessment only in the part concerning corrections to the taxable income in the total amount of € 199,183.35 (Article 161 of the arbitration petition).

The Claimant further requests reimbursement of the amounts unduly paid, plus indemnificatory interest.

The Respondent is the TAX AND CUSTOMS AUTHORITY.

The Claimant designated Dr. Ricardo da Palma Borges as arbitrator, pursuant to the provisions of Article 6, paragraph 2, subparagraph b), of the RJAT.

The petition for constitution of the Arbitral Tribunal was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority on 28-11-2017.

Pursuant to the provisions of subparagraph b) of paragraph 2 of Article 6 and paragraph 3 of the RJAT, and within the deadline provided for in paragraph 1 of Article 13 of the RJAT, the head of the Tax Administration service designated Professor Américo Brás Carlos as arbitrator.

The arbitrators designated by the Parties agreed to designate Counsellor Jorge Lopes de Sousa as arbitrator-president, who accepted such designation.

Pursuant to and for the purposes of paragraph 7 of Article 11 of the RJAT, the President of CAAD informed the Parties of this designation on 29-01-2018.

Thus, in conformity with the provisions of paragraph 7 of Article 11 of the RJAT, once the deadline provided for in paragraph 1 of Article 13 of the RJAT had passed without the Parties submitting any observations, the Collective Arbitral Tribunal was constituted on 20-02-2018.

The Tax and Customs Authority submitted a response in which it contends that the petition for arbitration should be dismissed.

On 04-05-2018, a meeting was held in which a witness was examined and it was decided that the proceedings would continue with written submissions.

The Parties submitted their submissions.

The Arbitral Tribunal was properly constituted and is competent. The parties have legal standing and capacity and are legitimate (Articles 4 and 10, paragraph 2, of the same enactment and Article 1 of Ordinance No. 112-A/2011, of 22 March) and are properly represented.

There are no obstacles to consideration of the merits of the case.

2. Factual Matters

2.1. Proven Facts

The following facts are considered proven:

• The Claimant's business purpose is wholesale trading of food products and commercial agency, dedicating itself primarily to international trading activities, involving the wholesale acquisition of raw materials and merchandise which it subsequently resells to its customers established in the Angolan (approximately 90% of turnover in 2013) and Mozambican markets;

• The Claimant's customers, namely B... and C..., are established in Angola and Mozambique, respectively;

• In the years 2011 to 2013, commercial and industrial activity in Angola and Mozambique was highly dependent on imports and international payments were subject to foreign exchange control regimes, such that it was not easy for economic agents to continuously obtain foreign currency to sustain their activities;

• These difficulties faced by economic agents in Angola and Mozambique in ensuring payment of goods they acquired at appropriate times created obstacles to their direct operations in international markets, constituted a business opportunity for the Claimant and other companies, consisting of providing their respective customers with the guarantee of regular supply;

• The Claimant's activity, besides the research and acquisition component in international markets, included ensuring payments to suppliers at appropriate times and immediately supplying merchandise to its customers, awaiting payment from them, earning a profit margin;

• The Claimant needs to continuously obtain bank financing to ensure payments to its suppliers, given the extended payment terms from its customers;

• Bank financing obtained by the Claimant reached the amount of € 80,178,137.33 in the year 2013;

• In the years 2011 to 2013, the Claimant invoiced more than 200 million euros per year, constantly maintaining bank financing between 50 and 100 million euros;

• The Claimant, in the year 2011, made payments of commercial expenses on behalf of B..., outside of Angola, in the total amount of € 4,720,797.44, which amount had not yet been paid by the end of 2013;

• In 2013, the Claimant made payments on behalf of company C... in the total amount of € 464,807.04, relating to the acquisition of vehicles, insurance, transport services, among others;

• The financial charges incurred by the Claimant for maintenance of the current account that enables it to satisfy the expenses it incurred on behalf of B... and C... are not invoiced to them as such, but these charges are considered, as many others, to determine the pricing of merchandise sold to these companies, in order to ensure a profit margin for the Claimant;

• The profit margin is not predetermined in advance, as price formation depends on the specificities of each negotiation;

• B... and C... have other suppliers, with whom the Claimant must compete;

• The bank financing obtained by the Claimant is intended for the entirety of its activity and not specifically for determined operations;

• The Claimant's business model, which includes the deferral of payments made by its customers and the advancement of expenses on their behalf, despite implying risks, is profitable and with margins superior to those normal in an intermediation activity in wholesale trading;

• If it did not have this business model, which provides it with a close relationship with its customers, given the specific possibilities of making payments, the Claimant would not have achieved the results it achieved;

• B... was the Claimant's most important business partner, with invoicing with that company representing more than half of that which the Claimant effected in the years 2011 to 2013 (documents nos. 7 and 8 attached to the arbitration petition, the contents of which are hereby reproduced);

• The Tax and Customs Authority conducted a general tax inspection of the Claimant, concerning the fiscal year 2013, pursuant to Service Order No. OI2016..., of 18-02-2016;

• In this inspection, the Tax Inspection Report was prepared, which appears in document no. 4 attached to the arbitration petition, the contents of which are hereby reproduced, wherein the following is stated, among other matters:

III. Description of Facts and Grounds for Purely Arithmetic Corrections to Taxable Income

The references to legislation are as of the date of occurrence of the facts.

III.1. IRC – Corporate Income Tax

III.1.1. Corrections to Taxable Income

III.1.1.1. Expenses to be Charged

III.1.1.1.1. Description of Facts

A... was subject to tax inspection procedures for the fiscal years 2011 and 2012 through service orders nos. OI2015... and OI2015..., respectively.

In both procedures, the fiscal costs of financing interest were corrected.

The aforementioned corrections result from the fact that the taxpayer was bearing expenses on behalf of related companies (B...) and at the end of each fiscal year remained unpaid. Thus, in order to bear them, A... resorts to bank financing, supporting the respective interest and other charges.

In the year 2013, the account "27213050 – Other accounts receivable and payable (OCRP) – Debtors and creditors for accruals (DAG) – Debtors for accrual of income (DAR) – Other income accruals – Expenses to be Charged" presents a debit balance of 16,944.19 €, as per account statement attached to Page 3 of Annex II, and which is presented in the following figure:

Based on the SAFT file, it was verified that the internal documents of miscellaneous operations (SA) allowed the following accounting entries to be made:

The amounts recorded as credit in account 27213050 result from:

Observations:

i. In the period of 2012, the taxpayer recorded as an expense, impairment losses on receivables in the amount of 4,889,785.15 € (1,376.40 € from D..., 384,613.80 € from E... and 4,503,794.95 € from B...). This expense was recorded as a contra-entry to the account "21913000 – Customers – Impairment Losses".

In 2013, through miscellaneous operations document ... of 31-10-2013, the account balance was transferred to the account "27830500 – Other accounts receivable and payable – Other debtors and creditors – Various debtors and creditors – Other customer operations". In turn, the balance of this account was transferred to account 27213050. On pages 4 of Annex II is attached the statement of account 2191300.

ii. This concerns the reversal of document no. ... of 31-12-2013;

iii. Through this document, the estimate of income recorded in fiscal year 2012 was cancelled. This amount was recorded as a contra-entry to a carried-forward results account.

III.1.1.1.2. Tax-Law Framework

The Corporate Income Tax Code establishes in subparagraph c) of paragraph 1 of Article 23 of the Corporate Income Tax Code (CIRC) that:

1. The following are considered expenses those which are demonstrably indispensable for the realisation of income subject to tax or for the maintenance of the source of income production, namely: (...) c) Of a financial nature, such as interest on capital belonging to others applied in the business, discounts, premiums, transfers, exchange differences, expenses with credit operations, debt collection and issue of bonds and other securities, redemption premiums and those resulting from the application of the effective interest method to financial instruments valued at amortised cost (...)

III.1.1.1.3. Proposed Correction

From the description in point III.1.1.1.1. it is noted that the expenses borne by the taxpayer in 2011, in the amount of 4,720,797.44 €, on behalf of B..., still remain in fiscal year 2012.

Given that in past years, the company, in order to incur those expenses, had to resort to bank financing and support the respective financial charges (Interest, banking expenses, among others), it is verified that in 2013 the support of financial charges is maintained.

It is also verified that as a result of non-payment by B... of the expenses borne in its name by A..., it is benefiting from a credit, a financing, without supporting any charge for that fact.

In this sense, given that the granting of financing does not form part of A...'s business purpose, and that there is no compensation underlying the deferral of payment of the expenses borne in the name of B..., the financial charges borne in fiscal year 2013 will not be accepted, as was done in the years 2011 and 2012, in proportion to the expenses paid in that fiscal year (2011).

For the calculation of expenses to be disregarded, the indirect method adopted in previous inspection procedures will be maintained.

It should be noted that the amount considered in the account "27213050 – OCRP – Debtors for accrual of income – Other income accruals – Expenses to be Charged" is purged of the value of 4,889,785.15 €, resulting from the transfer of the balance of the customer impairment losses account via account 27830500, given that this does not relate to the transfer of financial flows but to the annulment of a value evidenced in the balance sheet.

Legend:

27213050 – OCRP – Debtors for accrual of income – Other income accruals – Expenses to be Charged

68120301 – Other expenses and losses – Taxes – Indirect taxes – Stamp duty – Others

69101010 – Financial expenses and losses – Interest on financing obtained – Bank financing

69101080 – Financial expenses and losses – Interest on financing obtained – Other financing

69801010 – Financial expenses and losses – Relating to financing obtained – Bank financing

69808020 – Financial expenses and losses – Other unspecified

In this sense, the amount of 181,329.73 € will be increased in field 752 of schedule 07 of form 22.

III.1.1.2. Expenses to be Charged – C...

III.1.1.2.1. Description of Facts

The account "27830600 – Other accounts receivable and payable – Other debtors and creditors – Other operations with suppliers" presents a debit balance of 11,521,251.20 € as per account statement attached (Page 3 of Annex III). In order to validate that amount, the documents with more significant value were analysed, highlighting the following:

Accounting-wise, the documents moved the following accounts:

Legend:

11930000 – Net financial means – Available funds in transit – Foreign currency purchase

12102012 – Demand deposits – ...Bank – EUR 2471

12108012 – Demand deposits – Bank ...- EUR 1406310001

12201022 – Demand deposits – ... – USD

12204022 – Demand deposits – ...- USD 45309225423

12205022 – Demand deposits – ...- USD 063324

12206022 – Demand deposits – ...- USD 13289140001

12207022 – Demand deposits – ...- USD 1796630001

12208022 – Demand deposits – Bank ...- USD 1406312001

27830600 – Other accounts receivable and payable – Other debtors and creditors – Other operations with suppliers

III.1.1.2.2. Tax-Law Framework

The Corporate Income Tax Code establishes in paragraph 1 of Article 23 of the Corporate Income Tax Code (CIRC) that:

(...)

III.1.1.2.3. Proposed Correction

A... made payments in 2013 on behalf of company C... in the total amount of 464,807.04 €. According to the documents analysed, collected and attached, the payments relate, among others, to the acquisition of vehicles, insurance, transport services, among others.

A...'s trading activity comprises the export of various products to Angola (its largest customer) and Mozambique. To carry out its activity, the company resorts to financing, supporting the respective financing costs (interest and other banking expenses). Thus, it is verified that the company is spending funds to support expenses that are not directly related to its operational area.

It is also verified that as a result of non-payment by C... of the expenses borne in its name by A..., it is benefiting from a credit, a financing, without supporting any charge for that fact.

In this sense, given that the granting of financing does not form part of A...'s business purpose, that there is no compensation underlying the deferral of payment of the expenses borne in the name of C..., and based on the provisions of subparagraph c) of paragraph 1 of Article 23 of the CIRC, corrections will be made to financial expenses in proportion to the amount supported by the taxpayer on behalf of C... . Thus, following the procedure adopted in point III.1.1.1. Expenses to be Charged (indirect method), we have that the value of financing expense costs to be disregarded are those resulting from the calculations below.

It should be noted that in the year 2012 a correction was made with respect to expenses borne by A... on behalf of company C..., with no cancellation having been effected in 2013 with respect to those expenses.

Thus, for the year 2013 we have:

Legend:

27836000 – OCRP – Other debtors and creditors – Various debtors and creditors – Other operations with suppliers

68120301 – Other expenses and losses – Taxes – Indirect taxes – Stamp duty – Others

69101010 – Financial expenses and losses – Interest on financing obtained – Bank financing

69101080 – Financial expenses and losses – Interest on financing obtained – Other financing

69801010 – Financial expenses and losses – Relating to financing obtained – Bank financing

69808020 – Financial expenses and losses – Other unspecified

In this sense, the amount of 36,806.50 € will be increased in field 752 of schedule 07 of form 22.

• Following the inspection, the Claimant was notified of the demonstration of Corporate Income Tax assessment No. 2017 ..., of the demonstration of compensatory interest assessment nos. 2017 ... and, likewise, of the demonstration of account reconciliation No. 2017 ..., in which the amount of € 316,516.66 to be paid was determined (Documents nos. 1 to 3 attached to the arbitration petition, the contents of which are hereby reproduced);

• On 25-08-2017, the Claimant paid the assessed amount (document no. 5 attached to the arbitration petition, the contents of which are hereby reproduced);

• On 27-11-2017, the Claimant filed the petition for constitution of the arbitral tribunal which gave rise to the present proceedings.

2.2. Unproven Facts

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

Notably, the fact that the charges incurred with financing were considered in price formation, alleged in Article 37 of the arbitration petition, is explicitly proven by the testimony of the examined witness and also by a presumption, based on the rules of normality and common experience, as it is normal that a company which continuously obtains profits includes in the formation of the selling prices of its services and products all the charges it incurs.

2.3. Justification of the Factual Decision

The facts were deemed proven based on the Tax Inspection Report, documents attached to the arbitration petition and on the testimony of the examined witness, regarding the facts referred to in subparagraphs a) to p) of point 2.2. above.

The examined witness appeared to testify with impartiality and knowledge of the facts upon which he testified.

3. Matters of Law

3.1. Grounds for Corrections Made by the Tax and Customs Authority

In fiscal year 2011, the Claimant A... paid expenses on behalf of company B..., in the amount of € 4,720,797.44.

Tax inspection actions were conducted on the Claimant relating to fiscal years 2011 and 2012, with fiscal costs of financing interest being corrected in both, on the ground that the Claimant had borne these expenses on behalf of B..., which remained unpaid at the end of these fiscal years.

The Tax and Customs Authority understood that, in order to bear these expenses, A... resorted to bank financing, supporting the respective interest and other charges, with the situation being maintained in fiscal year 2013.

In the understanding of the Tax and Customs Authority, as a result of non-payment by B... of the expenses borne in its name by A..., it was benefiting from a credit, a financing, without supporting any charge for that fact, wherefore it did not accept as expenses the financial charges incurred in fiscal year 2013 in proportion to the expenses paid.

In this fiscal year 2013, the Claimant made payments on behalf of company C... in the total amount of € 464,807.04, related to the acquisition of vehicles, insurance, transport services, among others.

The Tax and Customs Authority understood that, as a result of non-payment by C... of the expenses borne in its name by A..., it was benefiting from a credit, a financing, without supporting any charge for that fact, and made corrections to financial expenses in proportion to the amount supported by the taxpayer on behalf of C... .

The Tax and Customs Authority based its position on the grounds that expenses with financing, in the proportional part to the expenses referred to, are not tax-deductible, pursuant to Article 23, paragraph 1, subparagraph c), of the CIRC, saying, in sum:

– with respect to B...'s expenses, that "the granting of financing does not form part of A...'s business purpose, and that there is no compensation underlying the deferral of payment of the expenses borne";

– with respect to C...'s expenses, that the Claimant's business purpose does not comprise the granting of financing, for which reason the expenses "are not directly related to its operational area", and that "there is no compensation underlying the deferral of payment of the expenses borne".

As can be seen from this justification, the Tax and Customs Authority did not base the corrections on any possible lack of proof that the expenses borne by the Claimant on behalf of its customers are indispensable for their activity, but only on the fact that there is a temporal distance between the moments when these expenses are borne and their reimbursement and there is no compensation underlying the deferral.

The tax arbitral process, as an alternative means to the judicial challenge process (paragraph 2 of Article 124 of Law No. 3-B/2010, of 28 April), is, like the latter, a procedural means of mere legality, aimed at eliminating the effects produced by illegal acts, annulling them or declaring their nullity or non-existence [Articles 2 of the RJAT and 99 and 124 of the CPPT, applicable pursuant to Article 29, paragraph 1, subparagraph a), of the latter], wherefore acts must be assessed as they were performed, and the Tribunal cannot, when noting the invocation of an illegal ground as support for the administrative decision, assess whether its action could be based on other grounds.

For this reason, other possible grounds invoked by the Tax and Customs Authority in the present arbitral process are irrelevant.

Thus, what is at issue is to assess, first and foremost, whether the factual grounds cumulatively invoked by the Tax and Customs Authority in the Tax Inspection Report to effect the corrections it made correspond to reality, which are:

– that the granting of financing is not included in the Claimant's business purpose, which it understood was grounds for concluding that expenses with financing in the part corresponding to expenses borne on behalf of its customers "are not directly related to its operational area"; and

– that there is no compensation underlying the deferral of payment of the expenses borne.

Secondly, if these factual presuppositions are verified, it will be necessary to assess whether, in light of Article 23, paragraph 1, of the CIRC and its subparagraph c), it is justified to partly exclude the tax-deductibility of the financial charges borne by the Claimant, in proportion to the amount of expenses paid by the Claimant on behalf of its customers B... and C... .

3.2. First Ground Invoked by the Tax and Customs Authority

As stated, the first ground invoked by the Tax and Customs Authority for the corrections made is that the granting of financing is not included in the Claimant's business purpose, which it understood would justify the conclusion that expenses with financing, in proportion to the payments it made on behalf of its customers, "are not directly related to its operational area".

It is an established fact that the granting of financing is not included in the Claimant's business purpose.

However, this fact is irrelevant for the assessment of this matter.

In fact, Article 23, paragraph 1, of the CIRC, in the version prior to Law No. 2/2014, of 16 January, established the following:

1 – The following are considered expenses those which are demonstrably indispensable for the realisation of income subject to tax or for the maintenance of the source of income production, namely:

(...)

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

This rule does not provide, as a requirement for the tax-deductibility of expenses, that the activity to which these relate is included in the business purpose of the taxpayer, it being sufficient, in principle, that it is an activity which generates income subject to Corporate Income Tax or is intended to ensure the maintenance of the source producing such income.

On the other hand, even if the activity of the Claimant which is at issue in the present case is considered as "financing" and the Claimant bore financial charges to carry it out, the tax-deductibility does not depend on these charges being related "directly with its operational area" indicated in the business purpose.

In fact, taxable profit "is constituted by the algebraic sum of the net result of the period and positive and negative changes in equity verified in that same period and not reflected in that result" (Article 17, paragraph 1, of the CIRC) and income and expenses are relevant for the determination of taxable profit, in the terms defined in Articles 20 and following of the CIRC, independently of whether or not they are "directly related" to the "operational area" indicated in the business purpose, as is inferred from the fact that even income from unlawful activities is taxable (Article 10 of the LGT).

It results from the factual matter that the Claimant's business model (which the Tax and Customs Authority expressly states in the present case it does not question) includes the advancement of payment of expenses on behalf of its customers, established in countries where there are great difficulties in access to foreign currency which prevent them from making timely payments of expenses necessary for their activity, the Claimant understanding that, by enabling its customers to develop these activities, it increases its business with them. As was exemplified by the examined witness, the lack of timely payments can lead to necessary supplies not being made for the activity of the companies of those customers and the paralysis of these necessarily affects the trading activity to which the Claimant dedicates itself.

Thus, the evidence produced justifies the conclusion that, without the advancement of payments on behalf of its customers, these could not conduct with the Claimant all the business which they conducted, wherefore these advancements are indirectly connected with the Claimant's activity, being payments made with business purpose, necessary and sufficient for the tax-deductibility of expenses.

In fact, as is referred to, among others, in the arbitral decision of 09-05-2017, handed down in case No. 680/2016-T, "the concept of indispensability of costs which appears in Article 23, paragraph 1, of the CIRC, does not require a causal link between costs and income, it being sufficient that the expenses have a relationship with the object of the company, are incurred within the scope of its activity or evidence a business purpose".

For this business purpose to exist, it is not necessary that the expenses have a direct relationship with the operational activity of the taxpayer, expenses which have merely indirect relationship also being relevant, provided they were motivated by the ultimate objective of obtaining profits. ( [1] )

In this case, the Claimant alleged that the payment of expenses on behalf of its customers benefits its income-generating activity and it is perfectly normal that this occurs, in a context of difficult access to foreign currency.

In this context, one cannot lose sight of the enormous importance which the Angolan market has for the Claimant, with which it conducted more than 90% of its sales volume in 2013.

For this reason, it must be concluded that the advancement of expenses on behalf of its customers is made with the business purpose which it alleges.

Thus, the first ground invoked by the Tax and Customs Authority does not justify the partial exclusion of the tax-deductibility of the expenses with financing which the Claimant bore. It must therefore be concluded that those corrections are vitiated by an error as to the legal presuppositions, which constitutes a violation of law.

3.3. Second Ground Invoked by the Tax and Customs Authority

The second presupposition on which the corrections made are based is that "there is no compensation underlying the deferral of payment of the expenses borne in the name" of the Claimant's customers.

The corrections made by the Tax and Customs Authority are based on a presumption that the overall financial charges borne by the Claimant were proportionally increased by the advancement of the expenses borne by the Claimant on behalf of its customers. In fact, the Tax and Customs Authority does not identify any concrete financing that would have been specifically obtained to ensure payment of the expenses paid on behalf of its customers, basing the corrections made on an indirect method, as it states in the Tax Inspection Report.

It results from the evidence produced that the entirety of the financing charges (in which is included the abstract part of them which the Tax and Customs Authority presumed to be connected with the expenses paid by the Claimant on behalf of its customers) were passed on in the invoicing. This was stated by the sole witness presented and is perfectly credible, since the financial charges are continuously borne by the Claimant, in high amounts, and profits were presented in the years 2011 to 2013, which justifies the presumption that these high charges are generically passed on in the prices which it negotiates.

On the other hand, it would be outside the limits of reasonableness to require as a requirement of proof of pass-through in the invoicing of expenses of a general nature (such as, in addition to financial charges not associated with specific operations, are general staff charges, financing, property maintenance, electricity and communications expenses, etc.) the specification in each invoice of the percentages of each of these types of expenses which proportionally were assigned to each operation.

For this reason, in light of the evidence produced, it must be presumed, in a judgment of normality and reasonableness, that in the prices of merchandise and services provided by the Claimant to its customers B... and C... is included the compensation for these expenses of a general nature of the Claimant's activity, which include financing charges.

In this context, being a factual presupposition of both contested corrections the invocation that "there is no compensation underlying the deferral of payment of the expenses borne", it must be concluded that those corrections are vitiated by an error as to the factual presuppositions, which constitutes a violation of law.

3.4. Conclusion

It is concluded, therefore, that the contested assessment is vitiated by errors as to the factual and legal presuppositions, which justify its partial annulment, in accordance with the provisions of Article 163, paragraph 1, of the Code of Administrative Procedure, subsidiarily applicable, pursuant to Article 2, subparagraph c), of the LGT.

The annulment of the Corporate Income Tax assessment relates only to the tax corresponding to corrections to the taxable income of the Claimant in the amount of € 199,183.35 (being € 181,329.73 and € 17,853.62, with respect to B... and C..., respectively).

4. Compensatory Interest

As the Corporate Income Tax assessment contested, in the part relating to the aforementioned corrections in the total amount of € 199,183.35 (€ 181,329.73 + € 17,853.62), is illegal, the corresponding part of the assessment of compensatory interest, which has that assessment as its presupposition, is also illegal.

5. Indemnificatory Interest

The Claimant makes a request for reimbursement of the amount paid, plus indemnificatory interest.

In accordance with the provisions of subparagraph b) of Article 24 of the RJAT, the arbitral decision on the merits of a claim concerning which no appeal or challenge lies binds the Tax Administration from the end of the deadline provided for the appeal or challenge, with the latter being obligated, in the exact terms of the merits of the arbitral decision in favor of the taxpayer and until the end of the deadline provided for the voluntary execution of decisions of the tax courts, to "restore the situation that would have existed if the tax act which is the subject of the arbitral decision had not been performed, adopting the acts and operations necessary for that purpose", which is in keeping with the provisions of Article 100 of the LGT [applicable pursuant to subparagraph a) of paragraph 1 of Article 29 of the RJAT] which establishes that "the tax administration is obligated, in case of full or partial merit of a complaint, judicial challenge or appeal in favor of the taxpayer, to the immediate and full restoration of the legality of the act or situation which is the subject of the dispute, including the payment of indemnificatory interest, if applicable, from the end of the deadline for execution of the decision".

Although Article 2, paragraph 1, subparagraphs a) and b), of the RJAT uses the expression "declaration of illegality" to define the competence of the arbitral tribunals functioning in CAAD, making no reference to condemnatory decisions, it should be understood that its competences include the powers which, in a judicial challenge process, are attributed to the tax courts, this being the interpretation which is in keeping with the sense of the legislative authorization on which the Government based itself to approve the RJAT, in which it is proclaimed, as the first guideline, that "the tax arbitral process must constitute an alternative procedural means to the judicial challenge process and to the action for recognition of a right or legitimate interest in tax matters". The judicial challenge process, despite being essentially a process for annulment of tax acts, admits the condemnation of the Tax Administration to the payment of indemnificatory interest, as is inferred from Article 43, paragraph 1, of the LGT, which establishes that "indemnificatory interest is due when it is determined, in a complaint or judicial challenge, that there was error attributable to the services which resulted in payment of the tax debt in an amount superior to that legally due" and from Article 61, paragraph 4 of the CPPT (in the version given by Law No. 55-A/2010, of 31 December, which corresponds to paragraph 2 in the original version), which states that "if the decision recognizing the right to indemnificatory interest is judicial, the deadline for payment is counted from the beginning of the deadline for its voluntary execution".

Thus, paragraph 5 of Article 24 of the RJAT, when saying that "payment of interest is due, regardless of its nature, in the terms provided for in the general tax law and in the Code of Tax Procedure and Process", should be understood as permitting the recognition of the right to indemnificatory interest in the arbitral process.

As the payment of indemnificatory interest depends on the existence of an amount to be reimbursed, it falls within the competences of the arbitral tribunals functioning in CAAD to assess whether there is a right to reimbursement and to what extent.

It is therefore necessary to assess the requests for restitution of the amount paid plus indemnificatory interest.

The substantive regime of the right to indemnificatory interest is regulated in Article 43 of the LGT, which establishes, as is relevant here, the following:

Article 43
Undue Payment of Tax Obligation

1 – Indemnificatory interest is due when it is determined, in a complaint or judicial challenge, that there was error attributable to the services which resulted in payment of the tax debt in an amount superior to that legally due.

On 25-08-2015, the Claimant paid the assessed amount.

The error of the assessment, in the part which is contested, is attributable to the Tax and Customs Authority, which made it on its own initiative.

Consequently, the Claimant is entitled to reimbursement of the amount unduly paid, in the part corresponding to the corrections which it contested, plus indemnificatory interest, in the terms of Article 43, paragraph 1, of the LGT and Article 61 of the CPPT from the date of the undue payment (25-08-2017), until it is fully reimbursed.

Indemnificatory interest is due at the legal default rate, in the terms of Articles 43, paragraphs 1, and 35, paragraph 10 of the LGT, of Article 24, paragraph 1, of the RJAT, of Article 61, paragraphs 3 and 4, of the CPPT, of Article 559 of the Civil Code and Ordinance No. 291/2003, of 8 April (or any other ordinance that alters the legal rate), from the date of payment until full reimbursement.

6. Decision

In these terms, the Arbitral Tribunal hereby agrees:

• To find the petition for arbitration well-founded;

• To annul Corporate Income Tax assessment No. 2017..., and the corresponding statement of account reconciliation No. 2017..., as well as the assessment of compensatory interest, in the parts corresponding to corrections to taxable income in the amount of € 199,183.35 (being € 181,329.73 and € 17,853.62, respectively, the charges relating to expenses of B... and C... paid by the Claimant);

• To find well-founded the requests for reimbursement of tax unduly paid (corresponding to corrections in the amount of € 199,183.35) and indemnificatory interest calculated on the amount to be reimbursed and to condemn the Tax and Customs Authority to make the corresponding payments to the Claimant.

7. Case Value

In accordance with the provisions of Articles 306, paragraph 2, of the Code of Civil Procedure and 97-A, paragraph 1, subparagraph a), of the Code of Tax Procedure and Process and Article 3, paragraph 2, of the Regulation of Court Costs in Tax Arbitration Proceedings, the value of the case is set at € 65,713.67.

Lisbon, 10-07-2018

The Arbitrators

(Jorge Manuel Lopes de Sousa)

(Ricardo da Palma Borges)

(Américo Brás Carlos)

(dissenting as per attached statement)

DISSENTING OPINION

I voted against the Decision for the following reasons:

Part of the justification of the tax act under judgment is the consideration of the business purpose of the Claimant in the delineation of the tax deduction of financial expenses resulting from financing granted. The respective tax corrections are made "given that the granting of financing does not form part of A...'s business purpose (…)". (pp. 15 and 18 of the Tax Inspection Report - RIT). And, I understand, that is a justification and a delineation in conformity with the law.

With all due respect for the contrary opinion, the concept of "indispensability of expenses" (Article 23, paragraph 1, of the CIRC) cannot dispense with the consideration of the company's business purpose. This business purpose determines, in a decisive manner, the aforementioned requirement of "indispensability".

On the one hand, the assessment of the "proven indispensability of expenses for the realisation of income subject to tax or for the maintenance of the source of income production" to which Article 23, paragraph 1, of the CIRC refers, can only be made in relation to the entity which accounts for and bears them, as results from repeated case law of the Supreme Administrative Court (STA)[2].

On the other hand, the assessment of the proven indispensability of expenses should rest on the idea of proven "necessity" (RUI DUARTE MORAIS, Notes on Corporate Income Tax, Almedina, 2007, p. 83) of the same, "having regard to the corporate business purpose of the commercial entity in question" (Decisions of the Administrative Court of the South of 19.02.2015, case no. 8137/14 and of 22.01.2015, case no. 5327/12.).

Furthermore, according to the Decision of the Administrative Court of the South, of 16.10.2007, case no. 01276/06, in order to be tax-deductible, expenses must be imputed to "the activity of the entity itself delimited by its business purpose".

The substantiation of the general clause of indispensability of expenses, although not implying a judgment of opportunity and merit regarding their implementation, requires that the assessment of such "indispensability" be made "having regard to the corporate business purpose of the commercial entity in question" (Decision of the STA – plenary no. 049/11, of 15.06.11).

Specifically, the STA has ruled on the financing of companies by other entities, giving decisive relevance to the business purpose of the financing company, even when the financing is made to subsidiary companies for the performance of ancillary or supplementary obligations within the scope of contractualized obligations, or to companies in a control relationship, which does not even occur in the present case.

In the first case – financial charges of bank loans contracted for the performance of ancillary obligations – the non-deduction of interest was due to the fact that such amounts were not related to the business purpose and activity pursued by the company, which was dedicated to "the manufacture of tiles and not to the management of shareholdings or financing of venture capital companies" (STA Decision no. 01046/05, of 07.02.07).

With similar reasoning, STA Decision no. 0107/11 also considered non-deductible the charges of bank loans contracted by a company and applied to the financing of its associate companies, in a relationship of total control, in light of Article 23 of the Corporate Income Tax Code. Decisions in line, moreover, with STA Decisions nos. 1077/08, of 20.05.09, and 0171/11, of 30.05.12, on identical matters.

With respect to the financial charges borne by a company in the real estate sector to enable the performance of supplementary obligations, the STA, considering that the purpose of the company concerning ownership and management of shareholdings was not being pursued, recently decided: "financing operations whether of companies in which it holds shares or of any other company are matters which concern those investee companies and companies, not integrating the corporate purpose...", wherefore the "capital reinforcement of the investee company through supplementary obligations made by the claimant is not the exercise of the business activity of […]" and, consequently, "the costs which it incurs with those or because of the performance of such obligations are not tax-deductible costs under Corporate Income Tax in light of Article 23 of the CIRC". (STA Decision no. 01206/17, of 28.02.18).

Even if, as the Decision held, it were considered that the non-inclusion of the granting of financing in the Claimant's business purpose were "irrelevant for the assessment of this matter", with which, as has been seen, I do not agree, there would still be the necessity of imputation of such charges to each operation. This would be required by the burden of "proven indispensability" of expenses.

Now, as the Decision has as proven, "the bank financing obtained by the Claimant is intended for the entirety of its activity and not specifically for determined operations" such imputation of financial charges operation by operation did not occur, nor indeed, it should be said, customer by customer. What is evident is that there are expenses of the customers, of diverse nature (airplane and automobile transport, rent and others) which are borne by the Claimant, and so that it can make such payments the Claimant contracts loans from third parties with the concomitant interest, which, as a whole, it considers tax-deductible for the determination of taxable profit.

The proof of this link between the financial charges borne and the income would always be a burden on the Claimant for the purposes of its tax deductibility, which it did not satisfy. This also made it impossible to assess whether the said capital belonging to others was applied in its business (see Article 23, paragraph 1, subparagraph c) of the CIRC).

In this context, the method of imputation of financial charges to the advancements/financing in question used by the Respondent does not raise objections in my view.

In view of all the foregoing, I understand that the tax act under analysis should have been upheld. And, for this reason, I have drawn up this dissenting opinion.

Lisbon, 10 July 2018

Américo Brás Carlos

[1] In this sense, see TOMÁS TAVARES, On the relationship of partial dependence between accounting and tax law in the determination of taxable income of corporate entities: some reflections at the level of costs, in Tax Science and Technique, no. 396, 1999, pages 136-137:

"The legal notion of indispensability is therefore carved out, over an economic-business perspective, by filling, direct or indirect, the ultimate motivation for obtaining profit. Indispensable costs are equivalent to expenses contracted in the interest of the company or, in other words, in all acts abstractly subsumable in a profitable profile. This desideratum purposely brings together, the economic and fiscal categories, through a primarily logical and economic interpretation of legal causality. The essential expense is equivalent to every cost incurred in order to obtain income and which represents an economic decline for the company. As a rule, therefore, the tax deductibility of the cost depends only on a causal and justified relationship with the productive activity of the company".

(…)

"Indispensability is subsumed in any act undertaken in the interest of the company…The legal notion of indispensability thus restrains acts which do not conform to the purpose of the company, not capable of being inserted in the corporate interest, especially because they do not aim at profit…".

[2] (see, e.g., Decision of 10.7.2002, case no. 246/02; Decision of 07.02.2007, case no. 1046/05; Decision of 20.05.2009, case no. 1077/08; Decision of 30.11.2011, case no. 107/2011).