Process: 625/2017-T

Date: May 29, 2018

Tax Type: IRC

Source: Original CAAD Decision

Summary

CAAD Decision 625/2017-T addresses the deductibility of financing costs under Article 23 of the Portuguese Corporate Income Tax Code (IRC). The case involved A... Lda., which obtained third-party financing and granted interest-free subordinated loans totaling €220,004.20 to its 74.5%-owned subsidiary, B... Lda. The Portuguese Tax Authority (AT) rejected €23,238.63 in financial charges, arguing these costs failed the indispensability test because the borrowed funds were used to provide non-remunerated loans to a subsidiary rather than to generate taxable income or maintain the company's production source. The taxpayer challenged this through administrative complaint and subsequently arbitral proceedings at CAAD, arguing the charges were banking commissions and costs from international trade, not interest on loans. The tribunal applied the well-established indispensability doctrine, which assesses costs economically: expenses must serve the company's profit purpose and business activity. While tax authorities cannot scrutinize management appropriateness, costs must demonstrate adequate causal connection to revenue generation. The decision emphasizes that indispensable expenses are those incurred in the company's interest and linked to its productive capacity, even if ultimately unfruitful. The AT's position was that financing costs related to interest-free loans to a separate legal entity with its own capacity could not satisfy Article 23's requirements, as they neither generated taxable income nor maintained the lender's production source. The case demonstrates strict application of the indispensability test to related-party financing arrangements where borrowed funds do not directly benefit the borrowing entity's taxable activities.

Full Decision

ARBITRAL DECISION

REPORT

A..., Lda., taxpayer no. ..., with registered office at Rua ..., no. ..., ..., ..., in ... (hereinafter referred to as "Claimant"), filed on 28/11/2017 a request for arbitral pronouncement regarding the challenge to the rejection of the administrative complaint no. ...2017..., lodged against the Corporate Income Tax (IRC) assessment no. 2016..., in the amount of € 6,968.22, relating to the tax period of 2012.

The Honorable President of the Ethics Council of the Administrative Arbitration Center (CAAD) designated, on 15/01/2018, the undersigned as sole arbitrator in this decision.

On 07/02/2018 the arbitral tribunal was constituted.

In compliance with the provisions of article 17, paragraph 1 of the Legal Regime of Tax Arbitration (RJAT), the Tax and Customs Authority (AT) was notified on 08/02/2018 to, if it so wished, submit a reply and request the production of additional evidence.

On 13/03/2018 the AT submitted its reply, accompanied by the administrative file.

As this concerned exclusively a question of law, the arbitral tribunal decided on 19/03/2018 to dispense with the holding of the meeting referred to in article 18, paragraph 1 of the RJAT, based on the principle of the arbitral tribunal's autonomy in the conduct of proceedings, inviting both parties to, if they so wished, submit optional written submissions and scheduled the date for the delivery of the final decision.

On 21/03/2018, the Claimant submitted a motion to the effect of not waiving the production of witness evidence indicated in the request for arbitral pronouncement.

The arbitral tribunal on 22/03/2018 requested that the Claimant specify the factual matters subject to witness evidence, having the Claimant submitted a motion on 28/03/2018 referring to all the factual matters contained in the request for arbitral pronouncement (cf. Point III of the request for arbitral pronouncement).

The arbitral tribunal on 18/04/2018 decided to dispense with the production of additional evidence beyond the documentary evidence already incorporated in the file, as well as with the holding of the meeting referred to in article 18, paragraph 1 of the RJAT, inviting both parties to, if they so wished, submit optional written submissions and extended the date for the delivery of the final decision.

Neither the AT nor the Claimant submitted optional written submissions.

PRELIMINARY MATTERS

The arbitral tribunal was regularly constituted and is materially competent.

The parties have legal personality and capacity and are legitimate, with no defects in representation occurring.

There are no nullities, exceptions or preliminary issues that would impede the examination of the merits and which must be considered ex officio.

Consequently, the conditions are met for the delivery of the final decision.

POSITIONS OF THE PARTIES

As the basis for the request, the Claimant alleges, in summary, that the corrections to the financial charges made by the AT, as they do not fall within the provision of article 23 of the Corporate Income Tax Code (IRC), constitute commissions and costs derived from banking services (arising from international trade) that have nothing to do with interest on loans granted by banks.

On the other hand, the AT takes the position that the request should be dismissed and, consequently, that the aforementioned assessment should be upheld, on the grounds that the financial charges in question were not used either in expenses proven to be indispensable for the realization of income subject to tax or in the maintenance of the source of production, thus not respecting what is provided for in article 23 of the IRC Code in the sphere of the Claimant's activity.

FACTUAL MATTERS

FACTS CONSIDERED PROVED

In light of the documents submitted to the proceedings, the following are deemed proved:

The Claimant filed an administrative complaint against the IRC assessment no. 2016..., in the amount of € 6,968.22, relating to the tax period of 2012.

The aforementioned assessment resulted from a tax inspection process for the tax period of 2012, initiated by service order no. OI2015..., from which corrections arose, in the amount of € 23,238.63, to financial charges that do not comply with the provisions of article 23 of the IRC Code.

During the inspection action it was demonstrated that the Claimant obtained financing from third parties and granted non-remunerated loans to the subsidiary – Society B... Lda. (subsidiary holding 74.5% of the capital stock) in the amount of € 220,004.20 in the form of subordinated loans – in the proportion of 6.97%.

The aforementioned administrative complaint was dismissed, with the AT concluding that "the financial charges in the amount of €23,238.63 relating to the subordinated loan granted free of charge to the subsidiary do not respect what is provided for in article 23 of the CIRC, that is, the amount of €220,004.20 was not used for the obtaining of income subject to tax nor for the maintenance of its source of production. It was instead applied in the activity of another company with its own legal capacity and personality, the subsidiary B..., Lda.".

On 28/11/2017, the Claimant filed the request for arbitral pronouncement that gave rise to the proceedings in question.

FACTS NOT CONSIDERED PROVED

There are no facts with relevance to the decision that have not been deemed proved.

THE LAW

Given the positions of the parties, the central issue to be resolved by the present arbitral tribunal consists of assessing the legality of the IRC assessment act.

In the case in question, the breach of article 23 of the IRC Code constitutes the only legal ground invoked by the AT, which allowed it to make the correction in question, which is why it is in light of this legal provision that we will assess the correction and the consequent additional assessment claimed.

In fact, the AT's reasoning could have been supported under the general anti-abuse clause or in accordance with the application of the rules on transfer pricing, which, it is reiterated, did not occur.

It is, therefore, in light of the provisions of article 23 of the IRC Code that the case in question must be assessed, seeking to determine whether the financing expenses subject to correction, and resulting from loans contracted by the Claimant, meet or do not meet the requirements of the aforementioned legal provision.

In accordance with the analysis of the aforementioned legal provision, the admissibility of expenses for tax purposes follows, provided that: their indispensability for the realization of income subject to tax or for the maintenance of the source of production is verified.

On the concept of indispensability, jurisprudence and doctrine have long pronounced themselves on what understanding should be given to this concept.

We refer to the following understanding, made in the context of case no. 12/2013-T, CAAD:

"The indispensability between costs and revenues is assessed in an economic sense: indispensable costs are those incurred in the interest of the company, which are linked to its capacity, by insertion in its profit purpose (whether directly or indirectly) and in the exercise of its concrete activity.

The Tax Authority cannot scrutinize the appropriateness and expediency of the company's management's economic decisions. It cannot interfere with the freedom and autonomy of the company's management. A cost will be accepted for tax purposes if it is appropriate to the company's productive structure and to profit generation, even if it turns out to be an unfruitful or economically ruinous business operation.

An essential expense is equivalent to any expense incurred in order to obtain revenues and which represents an economic detriment to the company. Article 23 of the CIRC requires not only an adequate causal connection between the cost and the revenue (in the aforementioned economic terms), but it also connects alternatively (as the word "or" indicates) with the maintenance of the source of production – in the sense of an economic link between the expense and the existence and maintenance of the company and its activity.

A company may obtain funds (and pay interest) and then deliver those funds to a subsidiary without any causal and direct remuneration – and still properly carry out its activity, within its capacity and profit purpose: it may effect a capital increase (article 25 of the CSC), supplementary or accessory contributions without interest (articles 210 and 287 of the CSC) or subordinated loans without interest (article 243 of the CSC) – and in any of these cases it acts entirely within its capacity for exercise and with a profit intention and in the exercise of its activity" [our emphasis].

We concur with the understanding endorsed in that decision, whereby we understand that the indispensability between costs and revenues should be assessed in an economic sense, and in this way the essential expense is equivalent to any expense incurred in order to obtain revenues and which represents an economic detriment to the company.

Indeed, it follows from the statutory provision that expenses are to be considered as those which are proven to be indispensable for the realization of income subject to taxes.

And it should further be stated that equating the notion of indispensability to a relationship with productive activity or to a mandatory causal nexus with the obtaining of income is not, therefore, a position endorsed by reference doctrine, as will be transcribed below.

Regarding the understanding to be given to the causal nexus, see the position of Rui Morais who, in an identical sense, argues: "The invocation of the rule of indispensability of costs can never be made to substitute the judgment of appropriateness and expediency of the charges assumed, as they result from the decision of the corporate bodies, with another judgment, also of a business nature made by the tax administration or courts". (…) "We cannot consider good the guidance of certain jurisprudence that denies the tax accreditation of certain costs because it is not possible to establish a direct correlation with the obtaining of specific revenues. Taken to the extreme, such an understanding would mean that expenses with research would only be tax deductible when such research was successful, when, as a result, the company began to sell new goods and services…" (…) "We argue that the question of whether a cost should or should not be considered indispensable should be resolved based on the objective purpose of the transaction, that is, the business purpose test… We believe it is reasonably clear what the purpose of the rule is: to refuse tax participation in some of the expenses borne by the taxpayer… If the assumption of the charge was preceded by a genuine business motivation… the cost is indispensable. When it should be concluded that the charge was determined by other motivations (personal interest of partners, directors, creditors, other group companies, commercial partners, etc.), then such cost should not be considered indispensable.".

An equal position is taken by Diogo Leite de Campos and Mónica Leite de Campos: "To admit an administrative judgment a posteriori on the company's financial, commercial, etc., management would involve the constant risk that this judgment would be based on supplementary elements that did not exist, or did not exist clearly, at the moment of decision-making and which could not have been taken into account. The tax administration does not have to judge whether a company was well or poorly managed".

And in that same sense, we conclude with the position of J. L. Saldanha Sanches: "(…) knowing whether a certain cost corresponds or not to the most effective defense of the company's interests is a question that cannot be resolved by attributing a power of intervention by the State… so as to make a substantive judgment on a certain business management option, just as it cannot validate the qualification of the expense as a cost by subjecting it to the condition of the a posteriori verification of the effective generation of revenues".

See also the Supreme Administrative Court (STA) judgment of 29/03/2006 delivered in case no. 1236/05:

"In light of the current CIRC, it can be stated from the outset that, by all accounts, the expense that the law itself imposes constitutes an essential cost. Even by the most restrictive criterion – that of necessity, which tends to only consider as deductible expenses without which revenues could not be obtained – this type of expense is eligible. Nevertheless, it must be taken into account that not all of these costs, whose incurrence the company cannot avoid, are deductible – recall the municipal surtax, which the law excludes from deductible costs, and which prompted extensive jurisprudential output.

(…) The rule is that correctly recorded expenses are tax costs; the criterion of indispensability was created by the legislator, not to allow the Administration to interfere with company management, dictating how it should apply its resources, but to prevent the tax consideration of expenses which, although recorded as costs, do not fall within the scope of the company's activity, were incurred not for its pursuit but for other extraneous interests.

Strictly speaking, these are not true company costs, but expenses which, given their object, were abusively recorded as such. Without the Administration being able to assess the indispensability of costs in light of criteria relating to their appropriateness and merit.

The concept of indispensability not only cannot be equated with a strict judgment of imperative necessity, as already stated, but also cannot be based on a judgment about the appropriateness of the expense, made necessarily a posteriori. For example, expenses incurred with an advertising campaign that proved unsuccessful cannot, solely on account of this result, be said to be dispensable.

The judgment about the appropriateness and expediency of expenses is exclusive to the business owner. If he decides to make expenses with a view to pursuing the object of the company but is unsuccessful and those expenses turn out to be ultimately unproductive, they do not cease to be tax costs. But every expense that he records as a cost and proves to be unrelated to the end of the company is not a tax cost, because it is not indispensable.

We therefore understand that all expenses that relate directly to the production process (for our purposes, it does not matter to consider investment ones) are tax-deductible expenses, namely, those related to the acquisition of factors of production, such as labor. And that, on pain of violation of the principle of contributory capacity, the Administration can only exclude expenses not directly barred by law under a strong motivation that convinces that they were incurred beyond the social objective, that is, in the pursuit of another interest that is not the business one, or, at least, with clear excess, deviating, given the objective needs and capacities of the company.".

And it further states "that, on pain of violation of the principle of contributory capacity, the Administration can only exclude expenses not directly barred by law under a strong motivation that convinces that they were incurred beyond the social objective, or, at least, with clear excess, deviating, given the objective needs and capacities of the company".

And in this same sense, see the judgment of October 6, 2009, of the South Administrative Court of Appeal (TCA Sul), in case no. 03022/09:

For the tax concept of cost, the definition contained in the aforementioned article 23 of the C.I.R.C. applies, which, after transmitting to us, in a broad manner, the notion of costs or losses as encompassing all expenses incurred by the company that are, proven to be indispensable for the realization of revenues or for the maintenance of the productive source, proceeds to a merely illustrative enumeration of various expenses of this type. We are dealing with a cost concept that can be considered common to both the tax balance sheet and the commercial balance sheet. The tax definition of cost, as a broader concept than production and acquisition costs, starts from a broad perspective of the company's activity and necessity, thus establishing an objective connection between this activity and the expenses that will inevitably result from it. And it does so with a clearly fiscal purpose, which consists of distinguishing between costs that can be accepted for tax purposes and which, therefore, will influence the calculation of taxable profit and those that cannot be accepted for such purpose (cf. judgment TCA Sul - 2nd Section, 7/2/2012, case 4690/11; judgment TCA Sul - 2nd Section, 16/4/2013, case 5721/12; judgment TCA Sul - 2nd Section, 29/5/2014, case 7524/14; judgment TCA Sul - 2nd Section, 16/10/2014, case 6754/13; J. L. Saldanha Sanches, The Quantification of the Tax Obligation, Lex Lisboa 2000, 2nd Edition, p.237 et seq.; António Moura Portugal, The Deductibility of Costs in Portuguese Tax Jurisprudence, Coimbra Publisher, 2004, p.101 et seq.).

Company costs or losses thus constitute the negative elements of the profit and loss account, which are deductible for tax purposes when, being properly proven, they are indispensable for the realization of revenues or for the maintenance of the productive source of the company in question. The absence of any one of these requirements entails the non-consideration of the aforementioned elements as costs, and the respective amounts should therefore be added back to the accounting result (cf. judgment TCA Sul - 2nd Section, 7/2/2012, case 4690/11; judgment TCA Sul - 2nd Section, 16/4/2013, case 5721/12; judgment TCA Sul - 2nd Section, 29/5/2014, case 7524/14; judgment TCA Sul - 2nd Section, 16/10/2014, case 6754/13; F. Pinto Fernandes and Nuno Pinto Fernandes, Corporate Income Tax Code, annotated and commented, Rei dos Livros, 5th edition, 1996, p.206 et seq.).

The requirement of indispensability of a cost has been jurisprudentially interpreted as an indeterminate concept requiring case-by-case application, as a result of an analysis from an economic-business perspective, in the perception of an economic causal relationship between the assumption of a charge and its realization in the interest of the company, considering the commercial object of the entity in question, with the Tax Authority prohibited from taking actions that would put in question the principle of freedom of management and autonomy of the taxpayer's will. Nevertheless, if the Tax Authority reasonably doubts the insertion of a certain expense in the company's interest, the burden of proof rests on the taxpayer that such operation falls within the company's purpose (cf. judgment STA - 2nd Section, 29/3/2006, case 1236/05; judgment TCA Sul - 2nd Section, 17/7/2007, case 1107/06; judgment TCA Sul - 2nd Section, 16/4/2013, case 5721/12; judgment TCA Sul - 2nd Section, 16/10/2014, case 6754/13; judgment TCA Sul - 2nd Section, 10/7/2015, case 8473/15).

It should also be noted that companies are required to maintain organized accounting in accordance with commercial and tax law, which allows the control of taxable profit (cf. article 98 of the C.I.R.C., in the version in force in 1998; articles 29 and 31 of the Commercial Code).

Regarding the application of the aforementioned article 23 of the C.I.R.C., reference should be made to three judicial precedents relating to the application of such provision: 1 - It is the understanding of jurisprudence that the Tax Authority cannot assess the indispensability of costs in light of criteria relating to the appropriateness and merit of the expense of a subjectivist nature. A cost is indispensable when it relates to the company's activity, such that costs unrelated to the company's activity will be only those in which it is not possible to discern any causal nexus with the revenues or gains (or with income, in the current wording of the code - cf. article 23, no. 1, of the C.I.R.C.), explained in terms of normality, necessity, congruence and economic rationality (cf. judgment STA - 2nd Section, 21/04/2010, case 774/09; judgment STA - 2nd Section, 13/02/2008, case 798/07; judgment TCA Sul - 2nd Section, 17/11/2009, case 3253/09; judgment TCA Sul - 2nd Section, 16/10/2014, case 6754/13; judgment TCA Sul - 2nd Section, 22/1/2015, case 5327/12; judgment TCA Sul - 2nd Section, 10/7/2015, case 8473/15);

2 - An essential cost does not have to be a cost that directly entails the obtaining of revenues. There are various costs that only medially fulfill this function and that, for this reason, are not considered indispensable, within the terms of article 23 of the C.I.R.C. (cf. judgment TCA Sul - 2nd Section, 1/6/2011, case 4589/11; judgment TCA Sul - 2nd Section, 22/1/2015, case 5327/12; judgment TCA Sul - 2nd Section, 19/2/2015, case 8137/14; judgment TCA Sul - 2nd Section, 10/7/2015, case 8473/15);

3 - The question of the burden of proof of the indispensability of the cost operates apart from the presumption of accuracy of correctly organized records (cf. article 75, no. 1, of the General Tax Law) since it is not the accuracy (existence and amount) of the recorded expense that is questioned but its relevance, in light of the law, for tax purposes, in this case, its qualification as a deductible cost, under the aforementioned article 23 of the C.I.R.C. (cf. judgment TCA Sul - 2nd Section, 2/2/2010, case 3669/09; judgment TCA Sul - 2nd Section, 16/10/2014, case 6754/13; judgment TCA Sul - 2nd Section, 22/1/2015, case 5327/12; judgment TCA Sul - 2nd Section, 19/2/2015, case 8137/14; judgment TCA Sul - 2nd Section, 10/7/2015, case 8473/15).".

Also on this matter, and with reference to a decision issued by the North Administrative Court of Appeal (TCA Norte) – case no. 00624/05.OBEPRT, of January 12, 2012 – it is stated there:

"In the consideration and fulfillment of this indeterminate concept – indispensability – it is necessary that the analysis of a concrete cost be made in function of the company's activity, that is, in function of its objective within the scope of the company's activity; essential costs will be equivalent to expenses incurred in the interest of the company. The criterion of indispensability was created by the legislator precisely to prevent the consideration at the tax level of expenses which, despite being recorded as costs, do not fall within the scope of the company's activity, which were incurred not for its pursuit but for other interests unrelated to it".

Indeed, the interpretation of the concept of "indispensability" contained in article 23 of the IRC Code has been understood by doctrine and extensive jurisprudence to mean that costs are considered indispensable when they are equivalent to expenses incurred in the interest of the company; to expenses borne within the scope of activities resulting from its corporate purpose. Only when costs result from decisions that do not meet such requirements should they be then disregarded.

Under article 23 of the IRC Code, the tax deductibility of the financial charges borne by the Claimant, like any other expense, depends on a judgment as to its indispensability for the realization of revenues or income subject to tax or for the maintenance of the source of production (body of no. 1).

Now, the STA has understood, regarding the meaning and functioning of the requirement of indispensability of costs for tax purposes, that "the requirement of indispensability of a cost must be interpreted as an indeterminate concept requiring case-by-case application, as a result of an analysis from an economic business perspective, in the perception of an economic causal relationship between the assumption of a cost and its realization in the interest of the company, considering the corporate object of the entity in question" (cf., by way of example, the STA judgments of 29/03/2006, case no. 01236/05 and of 15.6.2011, case no. 049/11; in the wake of these decisions and in the same sense, see, for example, the judgment of TCA Sul of 16/10.2014, case no. 06754/13).

It is therefore a matter of determining whether the financial charges subject to correction have the capacity to positively influence the obtaining of revenues by the Claimant.

In other words, to proceed with the application to the case in question of the requirement of indispensability of costs, it is decisive to ascertain, on the basis of all relevant facts and circumstances, the actual and concrete allocation of the financing.

We have already noted above that there must be a causal nexus between the financing charge borne and the activity developed by the Claimant. And it was also in that sense that the STA decided in the judgment of 10/07/2002, case no. 0246/02, in which it decided "the costs provided for in article 23 must relate to the taxpayer company itself", such that "for a certain amount to be considered a cost of that company, it is necessary that the respective activity be developed by it itself, not by other companies even if in a relationship of control", reiterating, in the subsequent judgments of 07/02/2007, case no. 01046/05, of 20/05/2009, case no. 01077/08, of 30/11/2011, case no. 0107/11, of 30/05/2012, and case no. 0171/11, that "the costs must first relate to the taxpayer company itself, that is, for a certain amount to be considered a cost of that company, it is necessary that the respective activity be developed by it itself, not by other companies", since, "[o]therwise, how could the exercise of another company's activity with which it had some relationship be attributed to a company".

Referring to the specific case, we have the Claimant granting subordinated loans to its subsidiary in the context of the approval of investment projects, so as to accompany the investment co-financed by European funds and by the Portuguese State.

Indeed, in the relationship of economic causality of the cost with the interest of the company, we have that the business interest assessed is that of the company itself that tax-deducts the cost.

On another level, it is equally explicitly stated by jurisprudence that it is a required presupposition of the application of article 23 of the IRC Code "the individualized consideration of each company or institution such that here cannot interfere reasoning in which appeal is made to criteria of "group" management or even of financing – even if free of charge – of its partners or even the will of these which is irrelevant in this matter, since it is a legal criterion, and only the legal entity whose costs are under review is relevant" (cf. the judgments of TCA Sul of 16/10/2007, case no. 01276/06 and of 18/12/2008, case no. 02515/08).

Hence, in compliance with the provisions of no. 1 of article 23 of the IRC Code, it is perfectly appropriate to verify whether the requirements of tax deductibility of costs with financing charges were met in regard to the Claimant's activity and the tax period in question, such that the only requirement required by the application of article 23 of the IRC Code is, we stress, the individualized consideration of each company or institution, and here cannot interfere criteria of "group" management or even of financing.

We concur with the understanding endorsed in the extensive jurisprudence and doctrine, and therefore we understand that the indispensability between costs and revenues should be assessed in an economic sense, and in this way the essential expense is equivalent to any expense incurred in order to obtain revenues and which represents an economic detriment to the company. Indeed, it follows from the statutory provision that expenses are to be considered as those which are proven to be indispensable for the realization of income subject to taxes.

Thus, and in accordance with the established facts, it is not possible to conclude that the assumption of the charge by the Claimant was due to a genuine business motivation, and consequently that the cost is indispensable.

From the foregoing it is indisputable that the indispensability of the costs borne by the Claimant underlying the subordinated loans granted to Company B... Lda. is not verified.

And therefore, it must be concluded that, in the situation of the case, the affirmative judgment of subsumption in the company's activity by which essential expenses are equivalent to expenses incurred in the interest of the company is not verified.

Accordingly, it is concluded that the request for arbitral pronouncement is without merit, the disputed tax assessment act remains in the legal order, and the AT is accordingly absolved of the request.

DECISION

Based on the grounds set out, the arbitral tribunal decides:

  1. To dismiss the request for arbitral pronouncement, with all legal consequences;

  2. To order the Claimant to pay costs.

VALUE OF THE PROCEEDINGS

The value of the proceedings is fixed at € 6,968.22 (six thousand, nine hundred and sixty-eight euros and twenty-two cents), in accordance with article 97-A of the Tax Procedure and Process Code (CPPT), made applicable by virtue of paragraphs a) and b) of no. 1 of article 29 of the RJAT and no. 2 of article 3 of the Regulation of Costs in Tax Arbitration Proceedings (RCPAT).

COSTS

Costs to be borne by the Claimant, in the amount of € 612 (six hundred and twelve euros), in accordance with Table I of the Regulation of Costs in Tax Arbitration Proceedings, in accordance with no. 2 of article 22 of the RJAT.

Notify accordingly.

Lisbon, May 29, 2018

The Arbitrator,

(Hélder Filipe Faustino)

Text drawn up by computer, in accordance with the provisions of no. 5 of article 131 of the Civil Procedure Code, made applicable by remission of paragraph e) of no. 1 of article 29 of the RJAT. The wording of this decision is governed by the orthography prior to the Orthographic Agreement of 1990.

Frequently Asked Questions

Automatically Created

What does Article 23 of the Portuguese IRC Code say about the deductibility of financing costs?
Article 23 of the Portuguese IRC Code establishes that costs and losses are deductible for tax purposes only if they are indispensable for the realization of income subject to tax or for the maintenance of the source of production. This indispensability requirement is assessed economically: expenses must be incurred in the company's interest and linked to its profit-generating capacity through insertion in its business purpose and concrete activity. The provision requires an adequate causal connection between costs and revenues. Financing costs, including interest and banking charges, must meet this test to be deductible, meaning they must serve the taxpayer's own income-generating activities rather than funding operations that do not produce taxable revenue for the entity incurring the expense.
How does the CAAD apply the indispensability test to financing expenses for IRC purposes?
The CAAD applies the indispensability test to financing expenses by examining whether costs were incurred in the company's own interest and are economically linked to its profit-generating capacity. As stated in CAAD case 12/2013-T and applied in Decision 625/2017-T, indispensability is assessed in an economic sense, not merely formal terms. The tribunal examines whether expenses are appropriate to the company's productive structure and profit generation, while recognizing that tax authorities cannot scrutinize the appropriateness of management decisions or interfere with business autonomy. However, this deference has limits: a cost must demonstrate adequate causal connection to revenue. In the context of financing costs, if borrowed funds are used to provide interest-free loans to subsidiaries rather than for the lender's own taxable activities, the financing expenses fail the indispensability test because they do not generate taxable income or maintain the source of production for the entity claiming the deduction.
Can a company deduct interest and financing costs if they are not directly linked to taxable revenue under Portuguese tax law?
Under Portuguese tax law and Article 23 of the IRC Code, companies generally cannot deduct interest and financing costs that lack direct economic linkage to taxable revenue generation. While the Tax Authority cannot question the business wisdom of management decisions, the indispensability requirement establishes clear boundaries. Financing costs must serve the taxpayer's own income-producing activities or maintain its production source. In Decision 625/2017-T, the CAAD faced a scenario where the taxpayer obtained third-party financing but used the funds to provide interest-free subordinated loans to a subsidiary. The AT successfully argued that €23,238.63 in related financial charges were non-deductible because the borrowed amount was not used for obtaining taxable income or maintaining the lender's production source, but rather was applied to another company's activity—a separate legal entity with its own capacity and personality. This demonstrates that related-party financing arrangements require careful structuring to ensure deductibility, with interest-free loans to subsidiaries particularly vulnerable to challenge when the parent company seeks to deduct its own borrowing costs.
What is the procedure for challenging an IRC tax assessment through gracious complaint and arbitral proceedings at CAAD?
The procedure for challenging an IRC assessment in Portugal involves two stages. First, taxpayers may file a gracious administrative complaint (reclamação graciosa) with the Tax Authority challenging the assessment. The AT reviews and issues a decision either upholding or revoking the assessment. If the taxpayer disagrees with the outcome, they can pursue arbitral proceedings at the Centro de Arbitragem Administrativa (CAAD) under the Legal Regime of Tax Arbitration (RJAT). The taxpayer files a request for arbitral pronouncement specifying the legal and factual grounds. The CAAD President designates an arbitrator (or panel), and the tribunal is constituted. The AT is notified and may submit a reply with the administrative file. Under Article 17 RJAT, parties can request additional evidence. The tribunal may dispense with hearings under Article 18 RJAT if only legal questions are involved, based on procedural autonomy principles. Parties may submit optional written submissions. In Decision 625/2017-T, the process began with administrative complaint dismissal, followed by arbitral request on 28/11/2017, tribunal constitution on 07/02/2018, AT reply on 13/03/2018, and the tribunal's decision to proceed without hearing, inviting optional submissions before rendering final judgment.
What was the outcome of CAAD decision 625/2017-T regarding the deductibility of financing costs under IRC?
While the full outcome is not explicitly stated in the excerpt provided, the decision's structure and legal analysis suggest the Tax Authority's position was likely upheld. The tribunal framed the central issue as assessing whether financing expenses met Article 23 IRC Code requirements for indispensability. The facts established that the taxpayer obtained financing and granted €220,004.20 in interest-free subordinated loans to its subsidiary, with the AT rejecting €23,238.63 in related financial charges. The AT's reasoning—that these costs did not serve obtaining taxable income or maintaining the production source because funds were applied to another legal entity's activities—aligns with established CAAD jurisprudence on indispensability. The tribunal emphasized that while tax authorities cannot scrutinize management appropriateness, costs must demonstrate adequate causal connection to revenue. The taxpayer's alternative argument that charges were banking commissions from international trade rather than loan interest appears insufficient to overcome the fundamental issue: the underlying funds financed interest-free loans to a subsidiary, failing to generate taxable income or maintain the taxpayer's own production source, thus not satisfying Article 23's indispensability requirement for deductibility under Portuguese corporate income tax law.