IRS Tax on Sale of Company Shares – CAAD Arbitration Decision 634/2015-T

ARBITRATION AWARD

Process No. 634/2015-T

The arbitrators Dr. Jorge Manuel Lopes de Sousa (arbitrator-president), Dr. Catarina Gonçalves and Dr. Maria Isabel Guerreiro, designated by the Ethics Council of the Administrative Arbitration Centre to constitute the Arbitral Tribunal, constituted on 23-12-2015, agree as follows:

1. Report

A… and B…, with Tax Identification Numbers … and …, respectively, hereinafter designated as "Claimants", presented a request for constitution of an arbitral tribunal, pursuant to the combined provisions of Articles 2 and 10 of Decree-Law No. 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter referred to only as RJAT).

The AUTHORITY FOR TAX AND CUSTOMS is the respondent.

The Claimants request an arbitral decision on the legality of the supplementary assessment order for Personal Income Tax (IRS) relating to the year 2010 (numbered 2015…), of the order assessing compensatory interest (numbered 2015…) and of the statement of account reconciliation (numbered 2015…), pursuant to which the obligation to pay the amount of € 259.582,08 is established.

The request for constitution of the arbitral tribunal was accepted by the President of the CAAD and automatically notified to the Authority for Tax and Customs on 23-10-2015.

Pursuant to the provisions of paragraph a) of section 2 of Article 6 and paragraph b) of section 1 of Article 11 of the RJAT, as amended by Article 228 of Law No. 66-B/2012, of 31 December, the Ethics Council designated as arbitrators of the collective arbitral tribunal the signatories hereto, who communicated their acceptance of the assignment within the applicable time period.

On 07-12-2015 the parties were duly notified of this designation, and did not express any intention to refuse the designation of the arbitrators, in accordance with the combined provisions of Article 11, section 1, paragraphs a) and b), of the RJAT and Articles 6 and 7 of the Code of Ethics.

Therefore, in accordance with the provision in paragraph c) of section 1 of Article 11 of the RJAT, as amended by Article 228 of Law No. 66-B/2012, the Arbitral Tribunal was constituted on 23-12-2015.

The Authority for Tax and Customs submitted a response in which it defended the inadmissibility of the claims.

On 15-04-2016, a hearing was held at which the Parties presented oral arguments.

The Arbitral Tribunal is competent and was regularly constituted.

The parties are duly represented, possess legal personality and legal capacity and the Claimants have standing (Articles 4 and 10, section 2, of the same statute and Article 1 of Order No. 112-A/2011, of 22 March).

The proceedings do not contain any nullities and no exceptions were raised.

1. Factual Findings

2.1. Established Facts

The following facts are considered established:

a) In October of the year 2010, the Claimants (jointly) alienated some share holdings, of which the following should be highlighted: in the companies "C…, Lda." (hereinafter only "C…"), "D…, Lda." (hereinafter only "D…") and "E…, Lda." (hereinafter only "E…"), as itemized in the table below:

b) Each of the three companies — C…, D… and E… — in the year 2010, had an annual turnover of less than € 10.000.000, its total balance sheet was below this amount and each employed fewer than 50 persons;

c) Following the alienation in 2010 of the share holdings in the three aforementioned companies, the now Claimants reported this alienation in their Personal Income Tax Declaration Form 3 specifically in Annex G (Table 8) thereof and signaled the aforementioned circumstance of being small enterprises (Table 8A of Annex G);

d) The assessment generated through the submission of Declaration Form 3 was based on the declaration of the alienation of share holdings in companies C…, D… and E…, exactly as the Claimants reported them;

e) Company D… operates a restaurant F… located in …, in Viana do Castelo;

f) Company C… operates a restaurant F… located in Rua …, in Barcelos;

g) The municipalities of Viana do Castelo and Barcelos are adjacent;

h) The distance between the establishments of D… and C… is greater than 30 km;

i) In … Viana … there are other restaurants;

j) The establishment of D… in the years 2008 to 2011 had the following billing:

k) The establishment held and operated by C… (Barcelos) opened to the public on 22-09-2009 (Document No. 6 attached with the request for arbitral decision, the contents of which are reproduced herein), having had the following annual billing values in its first two full years of operation:

l) Company E…, also held and alienated by the Claimants in 2010, opened a restaurant F… in Viana, at …, No. …, on 31 December 2010, at a distance of 1.7 km from the restaurant at … Viana …;

m) The annual billing of E… was as follows:

n) The Authority for Tax and Customs conducted an inspection of the Claimants, relating to Personal Income Tax for the year 2010, in execution of Service Order OI2014…;

o) In that Inspection, the Tax Inspection Report was drawn up which is contained in document No. 2 attached with the request for arbitral decision, the contents of which are reproduced herein, in which the following is mentioned, among other things:

"3.2. Income

In the context of Personal Income Tax, the taxpayers presented their respective income declaration for Personal Income Tax relating to the year 2010, in which A… declared the following income:

(...)

Capital Gains – Category G

Included in this type of income were alienated share holdings, which resulted in a capital gain of €2.252.250,00, resulting from alienation transactions as shown in the table below:

III - DESCRIPTION OF THE FACTS AND GROUNDS FOR CORRECTIONS OF MERELY ARITHMETIC NATURE TO THE TAXABLE MATTER

A. Patrimonial Increments - paragraph a) of section 1 of Article 9 and paragraph b) of section 1 of Article 10 of the Personal Income Tax Code

The income declaration for Personal Income Tax filed by the taxpayers, relating to the year 2010, evidences the obtaining of income (patrimonial increments) relating to capital gains [paragraph a) of section 1 of Article 9C of the Personal Income Tax Code], considered as such under the terms of paragraph b) of section 1 of Article 10 of the Personal Income Tax Code, which provides that, "Capital gains are gains obtained which, not being considered business and professional income, capital or real estate income, result from the paid alienation of share holdings, including their redemption and amortization with capital reduction, and other securities and, also, the value attributed to associates as a result of distribution which, pursuant to Article 75 of the Corporation Income Tax Code, is considered as capital gain:".

The elements with tax relevance for their respective taxation were included in Annex G of that declaration, namely in Tables 8 and 8A: ownership, dates and realization values, dates and acquisition values and identification of the company to which the share holdings belong, with the status of micro and small enterprises.

B. Taxation

Section 1 of Article 43 of the Personal Income Tax Code states that "The value of income qualified as capital gains is that corresponding to the balance calculated between the capital gains and capital losses realized in the same year." According to the information that was reproduced (Table 5) this results in the obtaining of income (capital gain) in the amount of €2.252.250.00.

However, section 3 of Article 43 of the Personal Income Tax Code provides that "The balance referred to in section 1, respecting the transfers provided in paragraph b) of section 1 of Article 10, relating to micro and small enterprises not listed on the regulated or unregulated markets of the stock exchange, when positive, is equally considered in 50% of its value", as provided in section 2 of that rule, regarding transfers made by residents, provided in paragraphs a), c) and d) of section 1 of Article 10 of the Personal Income Tax Code, which results in the calculation of net income of Category G of Personal Income Tax in the amount of €1.126.125,00 (€2.252.250,00 * 50%).

Following the identification, by the taxpayer, that the alienated share holdings are of micro and small enterprises, defined as such pursuant to the annex to Decree-Law No. 372/2007 of 6 November, the calculated income (positive balance between capital gains and capital losses) is subject to autonomous taxation at the rate of 20%, in accordance with section 4 of Article 72 of the Personal Income Tax Code.

Thus and as shown in the Personal Income Tax assessment, associated with the income declaration filed by the taxpayers, the Tax calculated resulting from this autonomous taxation amounted to €225.225,00 (€1.126.125,00 * 20%).

C. Classification

That rate reduction, via autonomous taxation, is conditioned by the fact that the share holdings, subject to alienation, are associated with enterprises that have the status of micro or small enterprises, pursuant to Decree-Law No. 372/2007 of 6 November (amended by Decree-Law No. 143/2009 of 16 July), as provided by section 4 of Article 43 of the Personal Income Tax Code which is transcribed: "For purposes of the previous section, micro and small enterprises shall be understood as the entities defined, pursuant to the annex to Decree-Law No. 372/2007, of 6 November.".

Decree-Law No. 372/2007 of 6 November provided for the regulation of online SME certification, the obtaining of this certification being intended for enterprises that need to prove their status as SMEs, with the Institute for Support of Small and Medium Enterprises and Innovation (IAPMEI) being responsible for conducting SME certification electronically through the creation of a form for that purpose.

As stated in section 3 of Article 3 of that statute (Decree-Law), "the use of SME certification provided for in this decree-law is mandatory for all entities involved in procedures that require SME status".

Thus, through the website www.iapmei.pt, enterprises, after completing the electronic form, obtain their respective certificate where the classification of the entities as micro, small or medium is shown.

In Article 2 of the Annex to Decree-Law No. 372/2007 of 8 November, the criteria for classification of enterprises are found, which have as reference elements, the number of people they employ (workforce), turnover and balance sheet (financial thresholds), as follows:

» Section 1 - The category of micro, small and medium enterprises (SMEs) is composed of enterprises that employ fewer than 250 people and whose annual turnover does not exceed 50 million euros or whose total annual balance sheet does not exceed 43 million euros;

• Section 2 - In the category of SMEs, a small enterprise is defined as an enterprise that employs fewer than 50 people and whose annual turnover or total annual balance sheet does not exceed 10 million euros;

• Section 3 - In the category of SMEs, a micro enterprise is defined as an enterprise that employs fewer than 10 people and whose annual turnover or total annual balance sheet does not exceed 2 million euros,

Section 1 of Article 4 of that Decree-Law states that, "the data considered for the calculation of workforce and financial amounts are those of the last closed accounting period, calculated on an annual basis"

In the specific case under analysis, regarding the share holdings alienated by the taxpayer, the following facts were verified:

» Entity C… - Tax ID: ... according to the certification issued by IAPMEI, on the date of alienation (October 2010), was qualified with the status of Medium entity.

» Entity E… - Tax ID: …. according to the certification issued by IAPMEI, is qualified with the status of Medium entity since October 2012, after the date of alienation (October 2010).

» Entity D… - Tax ID: ... according to the certification issued by IAPMEI, on the date of alienation was qualified with the status of Medium entity.

D. Notification

Given the certificates issued by IAPMEI, under the conditions described, and to verify the classification of the income declared, reported in Table BA of the 2010 Personal Income Tax return, and in compliance with paragraph b) of section 6 of Circular No. 7/2014 of the Personal Income Tax Services Directorate, the taxpayer was notified to present photocopies of the acquisition and alienation contracts of the share holdings and supporting documents proving that the entities associated with the share holdings alienated in October 2010 comply with the requirements provided in Article 2 of the Annex to Decree-Law No. 372/2007 of 6 November, on the date of alienation.

(...)

F. Analysis Conducted

It is noted that the regulation corresponding to Decree-Law No. 372/2007 of 6 November derives from the Recommendation of the Commission of the European Communities of 6 May 2003, regarding the definition of micro, small and medium enterprises.

Following the analysis of the elements and data presented by the taxpayer, it is verified that the analysis was based on the individual values of each of the entities, without taking into account the provision in Article 3 of the Annex to Decree-Law No. 372/2007 of 6 November.

It is important to highlight that pursuant to section 1 of Article 3 of the Annex to Decree-Law No. 372/2007 of 6 November, "An 'autonomous enterprise' is understood to be any enterprise that is not qualified as a partner enterprise within the meaning of section 2 or as an associated enterprise within the meaning of section 3 and section 3 of that rule defines the notion of "associated enterprises", as being those that maintain between themselves one of the following relationships:

a) One enterprise holds the majority of voting rights of the shareholders or partners of another enterprise;

b) One enterprise has the right to appoint or remove the majority of members of the management, administration or supervisory body of another enterprise;

c) One enterprise has the right to exercise dominant influence over another enterprise by virtue of a contract concluded with it or by virtue of a clause in the bylaws of this latter enterprise;

d) One enterprise shareholder or partner of another enterprise controls alone, by virtue of an agreement concluded with other shareholders or partners of that other enterprise, the majority of voting rights of the shareholders or partners of this latter.

That rule (section 3 of Article 3) in its 4th paragraph further states (broadens the definition) that, "Enterprises that maintain one of the relationships described above through a natural person or through a group of natural persons acting in concert are equally considered associated enterprises provided that those enterprises carry out their activities, or part thereof, in the same market or in adjacent markets.".

F.1 - Corporate Relationships

Now, in the present case, and following the capital holdings, directly and indirectly held by taxpayer A…, in the various companies, we are facing associated entities, within the terms of the 4th paragraph of section 3 of Article 3 of the Annex to Decree-Law No. 372/2007 of 6 November, with relevant relationships, resulting from the fact that, through a natural person (A…), they establish one of the relationships provided in the 1st paragraph of that rule, as shown in the following tables, which details the holdings before and after the alienation carried out in October 2010.

[Organizational charts showing shareholding structures before and after alienation]

As can be seen from the diagrams presented, the enterprises are considered associated, before and after the alienation of share holdings, given that directly (before alienation) and indirectly (after alienation), the holdings held by A…, make it possible to establish relationships that meet the necessary conditions for that classification (relevant relationship).

F.2 - Market

Finally, the identified entities have the same corporate purpose, which consists of the operation, management and administration of restaurants of the international "F…" chain, under the franchising regime, whereby they conduct their activity in the same market (as defined in the 5th paragraph of Article 3), fulfilling the other requirement provided in the 4th paragraph of section 3 of Article 3 of the Annex to Decree-Law No. 372/2007 of 6 November.

F.3 - Certificates Issued by IAPMEI

Also, the taxpayer did not consider the certificates issued by IAPMEI, relating to the enterprises whose capital holdings were alienated which, for the reasons mentioned, assigned the following statuses:

» C…, - Tax ID:…, on the date of alienation (October 2010), was qualified with the status of Medium entity, according to the document attached which constitutes Annex 1.

» D…. - Tax ID:…, was qualified with the status of Medium entity since May 2010, according to the document attached which constitutes Annex 2.

» E…- Tax ID: …, was qualified with the status of Medium entity since October 2012, after the date of alienation (October 2010), according to the document attached which constitutes Annex 3.

Based on the legislation indicated, enterprises C… and D… are associated enterprises, whereby pursuant to section 2 of Article 6 of the Annex to Decree-Law No. 372/2007 of 6 November, the determination of data considered for the calculation of workforce (employees) and financial amounts (turnover and balance sheet) is made by aggregation of the values of each of the associated enterprises:

Table 6

In a joint analysis, it is verified that by the number of employees (72), the aforementioned entities have the status of medium enterprises, as the reports of the certificates issued by IAPMEI demonstrate, in compliance with the criteria defined in Article 2 of the Annex to Decree-Law No. 372/2007 of 6 November.

F.4 - Conclusion

Following the elements assessed and the facts described, it is concluded that, for purposes of assigning status to the entities ("C…", "D..." and "E…"), whose share holdings were subject to alienation by the taxpayers, these are considered medium enterprises, in that:

1st - They are considered associated enterprises, by the cumulative fulfillment of the requirements - relevant relationship and market - provided in section 3 of Article 3 of the Annex to Decree-Law No. 372/2007 of 6 November.

2nd - The determination of data considered for the calculation of workforce and financial amounts is made by aggregation of the values of each of the associated enterprises, as stipulated in section 2 of Article 6 of the Annex to Decree-Law No. 372/2007 of 6 November.

Table 7

Values relating to 2009. Entity E… was only created in 2010.

It is concluded that the aforementioned entities have the status of medium enterprises.

G. Correction

Given the above, it is concluded that the capital gain obtained by the taxpayers cannot benefit from the provision in section 3 of Article 43 of the Personal Income Tax Code.

From the declared values results a capital gain, whose tax amount comes to €450.450,00 (€2.252.250,00 x 20%), by applying the rate of 20%, as determined by section 4 of Article 72 of the Personal Income Tax Code, where it states that "The positive balance between capital gains and capital losses, resulting from the transactions provided in paragraphs b), e), f) and g) of section 1 of Article 10, is taxed at the rate of 20%.".

In accordance with the Personal Income Tax assessment of the income declaration for the fiscal year 2010, the amount of tax calculated via that autonomous taxation amounted to €225.225,00, whereby the amount of the correction will be €225.225,00 (€450.450,00 - €225,225,00)."

p) The Claimants exercised the right to be heard before the preparation of the Tax Inspection Report;

q) The Authority for Tax and Customs gave its pronouncement on what the Claimants alleged in exercising the right to be heard, saying, among other things, the following:

"B.2. Position of the Authority for Tax and Customs

As stated in the draft tax inspection report, the three entities, C… - Tax ID:... E… - Tax ID: … and D… - Tax ID: … are qualified as Medium entities. It is concluded that the capital gain obtained by the taxpayers cannot benefit from the provision in section 3 of Article 43 of the Personal Income Tax Code.

Such conclusion results from the detailed analysis of the facts verified, elements obtained and clarifications presented by the taxpayer and the respective applicable legislation."

r) IAPMEI issued the certifications contained in pages 20 and following of document No. 2 attached with the request for arbitral decision, the contents of which are reproduced herein;

s) Following the Inspection, on 05-06-2015, the Authority for Tax and Customs issued Personal Income Tax assessment No. 2015…, the assessment of compensatory interest No. 2015 … and carried out the compensation No. 2015…, from which resulted an amount due of € 259.572,08 (document No. 1 attached with the request for arbitral decision, the contents of which are reproduced herein);

t) On 12-10-2015, the Claimant submitted the request for arbitral decision which gave rise to the present proceedings.

2.2. Facts Not Established

There are no facts relevant to the decision of the case that are considered not established.

2.3. Justification of the Establishment of the Factual Findings

The established facts are based on the documents attached by the Claimant.

The Authority for Tax and Customs did not present an administrative file.

1. Legal Findings

The tax arbitration proceedings, as an alternative means to judicial appeal proceedings (section 2 of Article 124 of Law No. 3-B/2010, of 28 April), is, like the latter, a procedural means of mere legality, in which the aim is to declare the illegality of acts of the types indicated in Article 2 of the RJAT and to eliminate the legal effects produced by them, by annulling them or declaring their nullity or non-existence [Articles 99 and 124 of the Administrative Court Procedure Code, applicable by virtue of the provision in Article 29, section 1, paragraph a), thereof].

Therefore, since the assessment act practiced by the Tax Administration is the object of the proceedings, its legality must be assessed in the light of its precise terms, as they occurred, with the reasoning used in it, other possible reasoning that could serve as a basis for other acts, with decision content totally or partially coinciding with the act practiced being irrelevant. Thus, reasoning invoked a posteriori, after the end of the tax procedure in which the act whose declaration of illegality is requested was practiced, is irrelevant ( [1] ).

In the case at hand, it is observed that in the Tax Inspection Report underlying the challenged assessment, the judgment on the identity of the market of operation of the companies in question does not depend on the alleged concerted action of the partners, or on the creation of a Holding company, nor on the existence of a control position, nor on the companies having the same address, which the Authority for Tax and Customs invoked in its Response.

In fact, the reasoning for the position assumed by the Authority for Tax and Customs on the identity of the market of operation of the companies in question, which it understood to justify their being considered as associated, is summarized in the points "F.1 – Corporate Relationships" and "F.2 – Market" of the Tax Inspection Report in which it is stated that, "in the present case, and following the capital holdings, directly and indirectly held by taxpayer A…, in the various companies, we are facing associated entities, within the terms of the 4th paragraph of section 3 of Article 3 of the Annex to Decree-Law No. 372/2007 of 6 November, with relevant relationships, resulting from the fact that, through a natural person (A…), they establish one of the relationships provided in the 1st paragraph of that rule, as shown in the following tables, which details the holdings before and after the alienation carried out in October 2010" and that "the identified entities have the same corporate purpose, which consists of the operation, management and administration of restaurants of the international "F…" chain, under the franchising regime, whereby they conduct their activity in the same market (as defined in the 5th paragraph of Article 3), fulfilling the other requirement provided in the 4th paragraph of section 3 of Article 3 of the Annex to Decree-Law No. 372/2007 of 6 November".

Thus, given what was said about the object of the proceedings, it is in the light of this reasoning that the legality of the assessment act must be assessed.

4.1. Disputed Question

Article 9, section 1, of the Personal Income Tax Code establishes that "patrimonial increments constitute, provided that they are not considered income of other categories (...) capital gains, as defined in the following article".

Article 10 of the Personal Income Tax Code establishes that, among other things, "capital gains are gains obtained which, not being considered business and professional income, capital or real estate income, result from (...) paid alienation of share holdings".

Article 43 of the Personal Income Tax Code, as amended by Law No. 15/2010, of 26 July, establishes the following, in what is relevant here:

Article 43
Capital Gains

1 - The value of income qualified as capital gains is that corresponding to the balance calculated between the capital gains and capital losses realized in the same year, determined pursuant to the following articles.

(...)

3 - The balance referred to in section 1, respecting the transfers provided in paragraph b) of section 1 of Article 10, relating to micro and small enterprises not listed on the regulated or unregulated markets of the stock exchange, when positive, is equally considered in 50% of its value.

4 - For purposes of the previous section, micro and small enterprises shall be understood as the entities defined, pursuant to the annex to Decree-Law No. 372/2007, of 6 November.

The Claimants presented a Personal Income Tax Declaration Form 3 relating to the year 2010, in which they declared alienation of share holdings relating to three companies, stating that all of them were small enterprises.

The Claimants obtained capital gains subject to Personal Income Tax with the paid transfer of holdings in companies C… and D…, which is not a matter of controversy.

The Authority for Tax and Customs understood that the alienated share holdings did not relate to micro or small enterprises, in light of the annex to Decree-Law No. 372/2007, because the enterprises should be considered "associated enterprises".

The said annex establishes the following, in its Articles 2 and 3, and in what is relevant here:

Article 2
Workforce and Financial Thresholds Defining Enterprise Categories

1 - The category of micro, small and medium enterprises (SMEs) is composed of enterprises that employ fewer than 250 people and whose annual turnover does not exceed 50 million euros or whose total annual balance sheet does not exceed 43 million euros.

2 - In the category of SMEs, a small enterprise is defined as an enterprise that employs fewer than 50 people and whose annual turnover or total annual balance sheet does not exceed 10 million euros.

3 - In the category of SMEs, a micro enterprise is defined as an enterprise that employs fewer than 10 people and whose annual turnover or total annual balance sheet does not exceed 2 million euros.

Article 3
Types of Enterprises to be Considered with Regard to the Calculation of Workforce and Financial Amounts

(...)

3 - "Associated enterprises" are understood to be enterprises that maintain between themselves one of the following relationships:

a) One enterprise holds the majority of voting rights of the shareholders or partners of another enterprise;

b) One enterprise has the right to appoint or remove the majority of members of the management, administration or supervisory body of another enterprise;

c) One enterprise has the right to exercise dominant influence over another enterprise by virtue of a contract concluded with it or by virtue of a clause in the bylaws of this latter enterprise;

d) One enterprise shareholder or partner of another enterprise controls alone, by virtue of an agreement concluded with other shareholders or partners of that other enterprise, the majority of voting rights of the shareholders or partners of this latter.

It is presumed that there is no dominant influence in the case where the investors indicated in the second paragraph of section 2 do not directly or indirectly intervene in the management of the enterprise in question, without prejudice to the rights they hold in their capacity as shareholders or partners.

Enterprises that maintain one of the relationships referred to in the first paragraph through one or several other enterprises, or with the investors referred to in section 2, are equally considered associated.

Enterprises that maintain one of the relationships described above through a natural person or through a group of natural persons acting in concert are equally considered associated enterprises provided that those enterprises carry out their activities, or part thereof, in the same market or in adjacent markets.

Adjacent market is understood to mean the market of a product or service situated directly upstream or downstream of the relevant market.

The Parties are in agreement regarding the verification in relation to each of the enterprises referred to of the characteristics that would make it possible to qualify them as small enterprises, at the level of annual turnover and number of workers, since none of them presented, in the year 2010, annual turnover exceeding € 10.000.000,00 and each employed fewer than 50 workers.

The controversy is limited to the possibility of being qualified as "associated enterprises", which, if successful, will imply that the data relating to turnover and number of workers be considered together, pursuant to sections 2 and 3 of Article 6 of the same annex to Decree-Law No. 372/2007, which, if this occurs, implies the failure to assign the qualification of small enterprises, since the number of workers exceeds 50.

Regarding the classification of enterprises, it is not questioned that Taxpayer A… held holdings in the three aforementioned enterprises, generating a situation that can be framed within the hypotheses provided in the paragraphs of section 3 of Article 3 of the annex to Decree-Law No. 372/2007.

It is also agreed that all the enterprises were qualified by IAPMEI as "medium enterprises".

The Authority for Tax and Customs defends, in the first place, that certification by IAPMEI is relevant to assign the enterprises the qualification of micro, small and medium enterprises (SMEs).

Furthermore, the controversy is limited to the fulfillment of the condition provided in the penultimate paragraph of that section 3, which is that those enterprises carry out their activities, or part thereof, in the same market. ( [2] )

On this point regarding "Market", the Authority for Tax and Customs stated in the Tax Inspection Report that "the identified entities have the same corporate purpose, which consists of the operation, management and administration of restaurants of the international "F…" chain, under the franchising regime, whereby they conduct their activity in the same market (as defined in the 5th paragraph of Article 3), fulfilling the other requirement provided in the 4th paragraph of section 3 of Article 3 of the Annex to Decree-Law No. 372/2007 of 6 November.

The Claimant disagrees with this conclusion of the Authority for Tax and Customs on the identity of market of the activities of the aforementioned enterprises, regarding D… and C…, which were those that had employees in 2010 and those whose transfers of share holdings generated capital gains.

In the understanding of the Claimant, in summary:

– while company D… operates a restaurant F… located in the shopping center …, in Viana do Castelo (…), C… operates an analogous establishment located in Barcelos, in Rua…;

– each of the F… establishments is located in a distinct city, at a considerable distance and whose urban areas are not adjacent;

– the route between the two establishments is always more than 30 Km (in any case imposing a journey by car or similar), necessarily including a section on a motorway, subject to tolls, with an estimated travel time always exceeding 30 minutes to get there and the same for the return;

– to these geographic data is added the circumstance that both municipalities have quite distinct options for offering "casual restaurants", since in the shopping center … itself there are several, the same not occurring in Barcelos;

– the establishment of … did not suffer any decline in billing following the opening of the Barcelos establishment, because although the latter had billing in 2010 - the first full year of operation - of over 2 million euros, the restaurant of …, despite this, increased its billing from 2009 to 2010 by 2% (in fact already during 2009 that establishment had increased its billing by about 7% despite the opening in Barcelos on 22 September);

– on the contrary, when on 31 December 2010 the restaurant located in … opened, also in Viana do Castelo, the business volume of D… was immediately affected, having contracted by about 26% (from € 2.492.316,30 to € 1.841.357,46);

– therefore, it is to be concluded that "the establishments of … Viana and Barcelos do not belong to the same geographic market", "the establishments of Viana do Castelo (Rua…) and Barcelos do not belong to the same geographic market" and "the two establishments of Viana do Castelo (… and Road …) belong to the same geographic market";

– Decree-Law No. 372/2007 and its annex adopt the concepts and criteria that correspond to those provided in Recommendation No. 2003/361/, of the European Commission, of 6 May, published in the Official Journal of 20 May 2003, series L, No. 124, p. 36 onwards, hereinafter "European Commission Recommendation";

– notwithstanding that at the European level a "recommendation" has no binding effect, the Portuguese legislator gave general binding force to the content of the annex of the European Commission Recommendation, as it published it in the Official Gazette, as an integral part of the Decree-Law, in accordance with its Article 2;

– consequently, it shall be as national law that the content of the annex of the European Commission Recommendation, now received and transformed into national law by the Decree-Law, with general binding force, should be interpreted and applied;

– the practical utility of the concept "same market" is linked to the need felt by the European Commission to restrict the notion of SMEs, avoiding it encompassing other types of economic realities, namely legally independent enterprises but belonging to the same broader economic group, endowed with dimension and capacity substantially superior to those of the various units that constitute it;

– the preamble of the Recommendation mandates recourse "whenever necessary, to the definition by the Commission of relevant market, the subject of the Communication from the Commission on the definition of relevant market for the purposes of Community competition law", Communication No. 97/C 372/03, published in Official Journal C 372 of 09.12.1997;

– a relevant market always results from the intersection of two realities: (i) the analysis of products and services that can be intersubstitutable and (ii) the analysis of the geographic scope in which that substitution can occur;

– a relevant product market comprises all products and/or services considered interchangeable or substitutable by the consumer due to their characteristics, prices and intended use;

– the relevant geographic market comprises the area in which the enterprises in question supply products or services, in which the conditions of competition are sufficiently homogeneous and which can be distinguished from neighboring geographic areas due to the fact, in particular, that the conditions of competition are considerably different in those areas;

– the determination of the geographic market from the supply side relates to the possibility of the same supplier being able to supply customers or sell its goods or services in another geographic space without incurring significant additional costs or risks;

– from the product perspective, the 3 establishments about which the request for arbitral decision relates will always integrate the same market, be it the broader market of casual restaurants be it the narrower market of casual restaurants in a chain;

– the time factor has fundamental relevance in the choices of consumers when they choose which establishment to go to eat or pick up their meal (take-away) and, similarly, which home-delivery companies;

– in the case of modern food retail establishments the demand is constituted by the end consumer (families) who travel to the establishment to satisfy their needs;

– the Competition Authority, for purposes of authorizing concentration transactions, chose to define geographically the market as a local market (not national), based on an area of influence or attraction of each of the establishments over consumers living around it;

– it has been common practice to place the perimeter of that area based on an estimated travel time by car (which is longer the larger the establishment in question) or, for convenience, based on administrative divisions such as municipalities or, when justified, subdividing these;

– the Competition Authority, for activities in which the consumer must travel to acquire a certain good or enjoy a certain service, but in which, due to the characteristics of the goods to be acquired or the service to be provided (namely its economic value), is not willing to travel (on foot or by car) except within a very short radius of action, understands that the markets are local in nature, corresponding to an area of influence of the establishment and which, for convenience of analysis, are most often reduced to the municipality;

– even when it came to acquiring several establishments located in adjacent municipalities, the Competition Authority understood that it was more appropriate to consider a local market for each municipality and not a single market for the various adjacent municipalities;

– the correct determination of the relevant geographic market should be made by considering the area of influence of each establishment, that is, by estimating the geographic area in which its potential customers can be situated, and checking what competitive constraints exist therein (in other words competing operators);

– in the case of casual dining or fast-food markets, there are two essential characteristics to consider, first and foremost, by definition the consumer does not intend to spend much time on the meal, therefore also will not want to do so with travel to the establishment and its return and, on the other hand, the reduced economic value of the meal is incompatible with a disproportionate expense in travel (namely in terms of fuel consumption and tolls);

– we will therefore be considering tendentially short trips on foot or by car or very short public transport, with a travel time of 10 minutes;

– the substantive test to be done for this purpose would always be the following: if one of the establishments in question increased prices significantly and not transiently (between 5% to 10%), what alternatives would the consumer prefer? The consumer would not go to an establishment located more than 5-10 minutes away (by car) or more than 30 minutes travel on foot (approximately 3 Kms);

– the relevant market for casual restaurants should be local and correspond to an area of influence that is no more than 5-10 minutes away (by car) from the location of the establishment;

– each of the establishments of each of the companies is located in a distinct city whose urban areas, moreover, are not even adjacent;

– being, however, two adjacent municipalities, the distance between the establishments is always more than 30 Km (in any case imposing a journey by car or similar), necessarily including a section on a motorway, subject to tolls, and with an estimated travel time always exceeding 60 minutes (considering round trip);

– it is therefore inescapable to conclude that the establishments are located in distinct relevant markets from the geographic perspective;

– this conclusion is especially reinforced by the circumstance that the establishment of … Viana (of D…) does not suffer any competitive influence from the establishment of Barcelos (of C…), since, proven, it did not experience any decline in billing following the opening of the latter.

The Authority for Tax and Customs defends, in summary, the following:

– in section 3 of Article 3 Decree-Law No. 372/2007 states that "the use of SME certification provided for in this decree-law is mandatory for all entities involved in procedures that require SME status";

– in the case at hand, as attested by the IAPMEI certification itself, the enterprises in question here are not autonomous entities, but associated ones;

– the existence of certification issued by IAPMEI, valid at the date of alienation of the share holdings cannot fail to presume, or at least suggest, the verification of the material requirements contained in the Annex, whereby it must be relevant, as suitable proof of the status of micro, small or medium enterprise;

– such certification, which given its content and official nature, as it is issued by those who have legitimacy to do so, pursuant to the aforementioned Decree-Law, shall have a reinforced character, concurrently its evidentiary value should be measured as such;

– on the date of alienation of the share holdings, and regarding the two enterprises alienated, both enterprises were certified with the status of "Medium";

– it is the legal competence of IAPMEI to verify the legal requirements for enterprises to be classified as to their dimension (micro, small, medium or large);

– it is from this verification that the Certification results, which results in the criteria set forth in Article 6 of the Decree-Law, which provides that it is the responsibility of the interested party to provide all necessary data and requested there, particularly the type of enterprise;

– in this way, since IAPMEI did not consider that enterprises C… and D… were small or micro enterprises, neither can the Respondent nor its Inspection Services consider differently in the context of a tax procedure, thus substituting itself for the information provided by the sole entity with legal competence to do so;

– it is not clear what the relevance is of bringing to bear the concept of market from Community competition law, especially since such arguments are completely contradicted by the facts that clearly emerge from this record;

– in fact, the facts demonstrate that C… and D… are controlled by a natural person (1st Claimant) or by a group of natural persons acting in concert (1st and 2nd Claimant) and conduct their activities within the scope of the same market both enterprises are restaurants, selling the exact same services and products, in the fast food market and under a franchising regime (F…);

– it is also added that within the scope of the franchising regime, it can be stated, without a shadow of doubt, that the enterprises and their partners act in a concerted and associated manner;

– moreover, it results from the Tax Inspection Report that the Claimants created themselves a Holding company, due to the intuitus personae character of the franchise contracts, the content and, above all, the fact that it must be the franchisor itself to consent to the organization/association/aggregation of the companies in a Holding company;

– it further results from the facts that the companies have their registered office at the same address, a characteristic per se revealing the interdependence of the enterprises and their partners;

– the fact that there are special corporate relationships between the entities implies, without a shadow of doubt, a control position on the part of the partners, both before alienation and after alienation, removing their nature as allegedly autonomous entities and reinforcing their character as associated enterprises, and it should also be noted the economic power that results from these same special corporate relationships;

– given the facts contained in the record it is unequivocal that the enterprises in question, given the corporate purpose they pursue, operate in the same market, whereby, that premise being verified, it is dispensable by unnecessary any incursion (or digression) into the interpretative concepts of market, set forth in European competition law, especially because, in this scope, as the Claimants themselves state in their request for arbitral decision, there is no decision pronouncing on a case analogous to the present arbitral proceedings;

– in their arguments, the Claimants mention several proceedings at European level and at national level, in the context of the definition of geographic market concluding, ultimately, that there is no decision that focuses on autonomous establishments or groups of small establishments (Articles 104 to 106 of the Procedural Instructions);

– in line with what was decided in arbitral case No. 510/2014-T, "the products that both market, being the same, cannot fail to be qualified as 'interchangeable or substitutable by the consumer due to their characteristics, prices and intended use', by reference to the definition of 'relevant product market' contained in the Recommendation of the Commission, of 6 May 2003"; "also the great geographic proximity between the restaurants operated by both enterprises allows supporting, in the absence of detailed studies proving otherwise, that both operate in the same relevant geographic market".

4.2. Relevance of Certification Conducted by IAPMEI

Section 3 of Article 43 of the Personal Income Tax Code establishes that "the balance referred to in section 1, respecting the transfers provided in paragraph b) of section 1 of Article 10, relating to micro and small enterprises not listed on the regulated or unregulated markets of the stock exchange, when positive, is equally considered in 50% of its value".

Section 4 of the same article establishes that "for purposes of the previous section, micro and small enterprises shall be understood as the entities defined, pursuant to the annex to Decree-Law No. 372/2007, of 6 November".

The Authority for Tax and Customs defends, in the first place, that certification of the quality of small or micro enterprise by IAPMEI is relevant to the application of that section 3 of Article 43.

However, this interpretation is not supported by the text of section 4, because the expression "entities defined, pursuant to the annex to Decree-Law No. 372/2007, of 6 November" clearly refers to the definitions contained in this statute (Article 2 of the annex) and not to the content of any prior administrative act of assignment of the qualification of enterprises as micro or small enterprises, namely the decision provided for in Article 7 of that statute.

Thus, on the assumption that the legislator knew how to express its intention in adequate terms, as must be presumed by virtue of section 3 of Article 9 of the Civil Code, the reference to "entities defined" and not to "entities certified" contained in section 3 of Article 43 of the Personal Income Tax Code must be understood as referring to the definitions contained in Decree-Law No. 372/2007.

Moreover, it is to this conclusion that the application of the special interpretative rule of Article 11, section 3, of the General Tax Law also leads, which requires that the "economic substance of tax facts" be understood preferentially.

The Supreme Administrative Court has already decided in this sense, in its ruling of 16-12-2015, delivered in case No. 0196/14:

I - Section 3 of Article 43 of the Personal Income Tax Code, as amended by Law No. 15/2010, of 26 July, provides that the balance calculated between the capital gains and capital losses realized in the same year, respecting the paid transfers of share holdings of micro and small enterprises not listed on the regulated or unregulated markets of the stock exchange, when positive, be considered only in 50% of its value.

II - Section 4 of the same article, for purposes of applying the aforementioned taxation exclusion regime, refers the definition of micro and small enterprises to the terms of the annex to Decree-Law No. 372/2007, of 6 November, a statute that regulates the certification of SMEs by IAPMEI, whereby the material requirements for that qualification are set forth in its annex.

III - Neither the letter of the law nor its rationale permit the conclusion that the application of that taxation regime is dependent on certification of the quality of SME by IAPMEI.

Consequently, the certification issued by IAPMEI is irrelevant, and it is in light of the definitions contained in Decree-Law No. 372/2007 that it must be assessed whether the regime of Article 43, section 3, of the Personal Income Tax Code is applicable to the Claimants.

4.3. Concept of Relevant Market

There is agreement between the Parties that each of the enterprises of which share holdings were transferred in the year 2010 should be qualified as a small enterprise: each presented, in that year, annual turnover of less than € 10.000.000,00 and each employed fewer than 50 workers.

Should it be considered that the aforementioned enterprises should be qualified as "associated enterprises", in light of the definition in Article 3 of the annex to Decree-Law No. 372/2007, the data relating to turnover and number of workers must be considered together, pursuant to sections 2 and 3 of Article 6 of the same annex to Decree-Law No. 372/2007, which, in this case, if this occurs, will imply the failure to assign the qualification of small enterprises, since the number of workers exceeds 50.

For purposes of possible framing of the situation of the enterprises within the concept of "associated enterprises", it is established that Taxpayer A… held holdings in the three aforementioned enterprises, generating a situation that can be framed within the hypotheses provided in the paragraphs of section 3 of Article 3 of the annex to Decree-Law No. 372/2007.

Thus, for framing of the situation in this concept only remains to be clarified whether, in the year 2010, those enterprises carried out "their activities, or part thereof, in the same market or in adjacent markets".

The concept of adjacent market is provided by the same section 3 of Article 3, as being "the market of a product or service situated directly upstream or downstream of the relevant market".

In the case at hand, the products marketed by the enterprises in question are identical, whereby the qualification of associated enterprises derived from operation in adjacent market is ruled out.

Therefore, the only question is whether the enterprises carry out "their activities or part thereof in the same market".

In the case at hand, the Authority for Tax and Customs concluded, in the Tax Inspection Report, that the aforementioned enterprises operated in the same market because "the identified entities have the same corporate purpose, which consists of the operation, management and administration of restaurants of the international "F…" chain, under the franchising regime, whereby they conduct their activity in the same market (as defined in the 5th paragraph of Article 3), fulfilling the other requirement provided in the 4th paragraph of section 3 of Article 3 of the Annex to Decree-Law No. 372/2007 of 6 November" (point "F.2 – Market" of the Tax Inspection Report).

In accordance with Article 2 of Decree-Law No. 372/2007, the concepts and criteria to be used to assess its status as a small enterprise correspond to those provided in Recommendation No. 2003/361/EC, of the European Commission, of 6 May.

In Recital 12 of this Recommendation it is stated that, "in order to reserve the advantages resulting from various regulations or measures in favor of SMEs for enterprises that really need them, it is also desirable that consideration be given, where appropriate, to relationships existing between enterprises through natural persons. In order to limit to what is strictly necessary the analysis of these situations, it is appropriate to restrict the taking into account of these relationships to cases of companies that carry out activities in the same relevant market or in adjacent markets, referring, whenever necessary, to the definition by the Commission of relevant market, the subject of the Communication from the Commission on the definition of relevant market for the purposes of Community competition law".

This Communication is published in OJ C 372/03 of 09-12-1997, page 5, stating therein, among other things, the following:

– the objective of defining a market both in terms of its product and in terms of its geographic dimension is to identify the actual competitors of the enterprises in question capable of restricting their behavior and preventing them from acting independently from effective competitive pressure (point 2);

– "a relevant product market comprises all products and/or services considered interchangeable or substitutable by the consumer due to their characteristics, prices and intended use" (point 7);

– "the relevant geographic market comprises the area in which the enterprises in question supply products or services, in which the conditions of competition are sufficiently homogeneous and which can be distinguished from neighboring geographic areas due to the fact, in particular, that the conditions of competition are considerably different in those areas" (point 8);

– "the relevant market within which a given competition issue should be assessed is therefore determined by the combination of product and geographic markets" (point 9);

– "basically, the exercise of defining the market consists in identifying the actual alternative sources of supply for the customers of the enterprise in question, both in terms of products/services and in terms of the geographic location of the suppliers" (end of point 13).

As expressly stated in the cited point 9, for the definition of the concept of relevant market account should be taken of the "combination of product and geographic markets".

Comparing this concept with that used by the Authority for Tax and Customs in the Tax Inspection Report to conclude whether the enterprises in question operate in the "same market", it is observed that this concept was misinterpreted in the Tax Inspection Report underlying the challenged act, because, for it to be considered that the enterprises operate in the same market, it is not sufficient that the products marketed are identical, which, in the case, the Authority for Tax and Customs considered demonstrated by saying that the enterprises in question "have the same corporate purpose, which consists of the operation, management and administration of restaurants of the international "F…" chain, under the franchising regime, whereby they conduct their activity in the same market".

In fact, as results from the said Communication, market identity must be defined through the combination of product and geographic markets, and it is clear that this geographic element is manifestly relevant in situations where the product marketed is, by its characteristics, intended for consumers located in the area where the marketing enterprise is situated, as is evident regarding fast food products, which are served in a state ready for immediate consumption, as is a well-known fact occurring in the restaurants of that international chain.

Therefore, from the outset, it must be concluded that the challenged assessment is subject to a defect of violation of law, by error regarding the legal premises, embodied in erroneous interpretation of the applicable law.

In any case, the few factual elements available in the record with relevance for analysis of the geographic element necessary to ascertain whether there is market identity also lead to the conclusion that the conclusion on which the Authority for Tax and Customs based the challenged assessment is wrong.

In fact, in order to conclude that the enterprises operate in the same geographic market it is necessary, in accordance with the cited point 13, to ascertain that the establishments are mutual alternatives of supply of products for their respective customers.

The fact that it is marketing of rapid service and low cost food products, totally identical, leads to the conclusion that the distance of about 30 Km between the Barcelos establishment and those in Viana do Castelo will normally, in light of common experience, be an obstacle to customers residing in the Barcelos area choosing to use the Viana do Castelo establishments and to residents in that area choosing to use the Barcelos establishment, because the cost of transport will significantly burden the overall cost to be borne, in addition to the inconvenience and time inherent in travel and there will be no advantage in terms of products to be consumed, as they will be identical and at the same cost.

Moreover, the evolution of the billing values of the establishments manifestly points in the direction of the Claimants' thesis, as there are no negative consequences for the Barcelos establishment derived from the creation of a new establishment of the same type in Viana do Castelo nor for the one initially existing in Viana do Castelo, following the operation of the one in Barcelos.

Thus, the elements available in the record point in the direction of the thesis defended by the Claimants being correct.

But even if it is not considered proven that the Viana do Castelo and Barcelos establishments are not mutually alternative sources of supply of products for their respective customers, it is unquestionable that the proof of such alternation was not made, whereby we will be faced with a situation of non liquet, to be resolved in light of the rules of burden of proof.

These rules, in the case at hand, in which the proof of facts necessary for the fulfillment of the concept of "same market" invoked by the Authority for Tax and Customs as a prerequisite of the assessment act is at issue, require that doubts be valued against the Authority for Tax and Customs and not in its favor (Articles 74, section 1, of the General Tax Law and 100, section 1, of the Administrative Court Procedure Code), which is procedurally equivalent to considering that such factual prerequisite does not exist.

Therefore, it is concluded that, in addition to the aforementioned error regarding the legal premises, the assessment act is subject to error regarding the factual premises, errors which constitute a defect of violation of law, which justifies the annulment of the assessment act (Article 163, section 1, of the Code of Administrative Procedure of 2015).

4.4. Compensatory Interest and Statement of Account Reconciliation-Compensation

The Claimants request the annulment of the assessment of compensatory interest No. 2015 … and of the statement of account reconciliation (compensation No. 2015…).

Compensatory interest is part of the tax debt itself, with which it is jointly assessed (Article 35, section 8, of the General Tax Law).

Both the assessment of compensatory interest and the compensation have, as a prerequisite, the Personal Income Tax assessment, whereby they are subject to the same defects that affect this.

Therefore, the annulment of the assessment of compensatory interest and of the compensation is justified.

1. Decision

In accordance with the above, the arbitrators of this Arbitral Tribunal agree to:

a) Declare the request for arbitral decision well-founded;

b) Annul the Personal Income Tax assessment No. 2015…, the assessment of compensatory interest No. 2015 … and the statement of account reconciliation (compensation No. 2015…), from which resulted an amount due of € 259.582,08.

1. Value of the Proceedings

In accordance with the provisions of Article 305, section 2, of the Code of Civil Procedure and Article 97-A, section 1, paragraph a), of the Administrative Court Procedure Code and Article 3, section 2, of the Regulation of Costs in Tax Arbitration Proceedings the value of the proceedings is established at € 259.582,08.

1. Costs

Pursuant to Article 22, section 4, of the RJAT, the amount of costs is established at € 4.896,00, pursuant to Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, to be borne by the Authority for Tax and Customs.

Lisbon, 23 March 2016

The Arbitrators

(Jorge Manuel Lopes de Sousa)

(Catarina Gonçalves)

(Maria Isabel Guerreiro)

[1] Essentially in this sense, the following rulings of the Supreme Administrative Court can be seen, regarding a parallel situation that arises in contentious administrative appeal proceedings:

– of 10-11-98, of the Plenary, delivered in appeal No. 32702, published in AP-DR of 12-4-2001, page 1207.

– of 19/06/2002, case No. 47787, published in AP-DR of 10-2-2004, page 4289.

– of 09/10/2002, case No. 600/02.

– of 12/03/2003, case No. 1661/02.

In similar sense, the following can be seen:

– MARCELLO CAETANO, Manual of Administrative Law, Volume I, 10th edition, page 479 in which he refers that it is "irrelevant that the Administration come, already during the contentious appeal proceedings, invoke other reasons as determining motives, not set out in the act", and Volume II, 9th edition, page 1329, in which he writes that "the respondent authority cannot (...), in the response to the appeal, justify the practice of the act challenged by different reasons than those contained in its express reasoning".

– MÁRIO ESTEVES DE OLIVEIRA, Administrative Law, Volume I, page 472, where he writes that "the objectively existing reasons but which are not expressly adduced as grounds of the act cannot be taken into account in assessing its legality".

[2] In the case at hand, the question of whether the qualification of "associated enterprises" can result from the enterprises operating in "adjacent markets" does not arise, in light of the definition provided by the last paragraph of that section 3, as the hypothesis of the enterprises operating in "market of a product or service situated directly upstream or downstream of the relevant market" is not even suggested.