Process: 636/2015-T

Date: May 12, 2016

Tax Type: IRC

Source: Original CAAD Decision

Summary

This arbitral decision addresses the tax treatment of favorable foreign exchange differences under the transitional regime from Portugal's Official Chart of Accounts (POC) to the Accounting Standardization System (SNC). The claimant, A… S.A., a holding company, challenged an IRC assessment of €42,050.65 for 2011. The dispute centered on €1,426,566.62 in favorable exchange rate variations related to USD-denominated advances from shareholder C… S.A. Under POC rules (section 5.2.2), these medium and long-term foreign exchange gains were deferred and not recorded as revenues, as they were considered potentially reversible. Upon transitioning to SNC in 2010, the company reclassified these amounts directly to equity capital. The Tax Authority argued this reclassification constituted a positive net worth change subject to IRC taxation under Article 5(1) of Decree-Law 159/2009, which governs the SNC transitional regime. The tax inspector contended the amount should be taxed ratably over five years (2010-2014) at €285,313.36 annually. The case proceeded through the CAAD arbitral tribunal system, with a three-arbitrator panel constituted on January 5, 2016, comprising representatives designated by both parties and a president chosen by mutual agreement. The proceedings included witness testimony, documentary evidence regarding exchange rate evolution from 2001-2015, and written submissions from both parties. The core legal question involved whether accounting reclassifications required by the transition to SNC—specifically those affecting previously deferred foreign exchange differences—trigger taxable income recognition for IRC purposes under the transitional regime, and if so, whether the Tax Authority correctly applied the five-year recognition methodology.

Full Decision

ARBITRAL DECISION

The arbitrators Adv. Jorge Manuel Lopes de Sousa (arbitrator-president, designated by agreement of the other Arbitrators), Dr. Paulo Ferreira Alves and Dr. Maria Manuela do Nascimento Roseiro, designated, respectively, by the Claimant and the Respondent, to form the Arbitral Tribunal, constituted on 05-01-2016, agree as follows:

1. Report

A…, S.A., Legal Entity No. …, with registered office at … No. … -…, in Lisbon (…-…) (hereinafter referred to as "Claimant" or "A…"), submitted a request for annulment of the Corporate Income Tax (IRC) assessment No. 2015…, relating to the year 2011, in the amount of € 42,050.65, to which corresponded the statement of account correction No. 2015 … which determined a total tax amount payable of € 43,289.97.

The Respondent is the TAX AND CUSTOMS AUTHORITY.

The Claimant designated an arbitrator, Dr. Paulo Ferreira Alves, under the terms set forth in article 6, no. 2, paragraph b) of the RJAT.

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

Pursuant to the terms of paragraph b) of no. 2 of article 6 and no. 3 of article 11 of the RJAT and within the period provided for in no. 1 of article 13 of the same statute, the head of the Tax Administration service designated as Arbitrator Dr. Maria Manuela do Nascimento Roseiro.

The designated arbitrators designated the third arbitrator, Adv. Jorge Manuel Lopes de Sousa, under the terms of article 11, no. 4 of the RJAT.

The signatories designated to integrate the present collective Arbitral Tribunal accepted the designations, in the terms legally provided.

Pursuant to the terms and for the purposes of the provisions of no. 7 of article 11 of the RJAT, the President of CAAD informed the Parties of this designation on 17-12-2015.

Thus, in compliance with the requirements of no. 7 of article 11 of the RJAT, as amended by article 228 of Law No. 66-B/2012, the Arbitral Tribunal was constituted on 05-01-2016.

The Tax and Customs Authority submitted a response and defended the inadmissibility of the claims.

On 15-03-2016, a meeting was held in which the Parties produced witness evidence and presented documents by the Claimant (concerning the evolution of exchange rates in the years 2001 to 2015), and it was agreed that the proceedings would continue with written submissions.

The Tax and Customs Authority expressed its position on 30-03-2016 regarding the documents submitted by the Claimant at the meeting of 15-03-2016.

The Parties submitted written arguments.

The Arbitral Tribunal is competent and was regularly constituted.

The Parties are duly represented, enjoy legal personality and capacity and the Claimant has standing (articles 4 and 10, no. 2, of the same statute and article 1 of Regulation No. 112-A/2011, of 22 March).

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

2. Statement of Facts

2.1. Proven Facts

The following facts are considered proven:

a) The Claimant commenced its activity of management of holdings in other companies as an indirect form of exercising economic activity on 01-01-1986, being subject, for purposes of IRC, to the general regime for determining taxable income (Report of the Tax Inspection which forms part of the administrative file, whose content is hereby incorporated);

b) On 16-01-2014, the Claimant was notified by the Finance Directorate of Lisbon - Tax Inspection of the submission of a "Request for Tax-Relevant Information" (Document No. 2 attached to the arbitral decision request, whose content is hereby incorporated);

c) On 07-02-2014, A… replied to the notification received, in the terms set forth in the letter attached to the arbitral decision request as document No. 3, whose content is hereby incorporated;

d) By email of 19-03-2014, the Tax and Customs Authority requested from the Official Accountant of A…, Dr. B…, clarifications regarding the following "Accounting entry:

– Debit account …- favorable foreign exchange differences € 1,426,566.62;

– Credit to account …-favorable foreign exchange differences € 1,426,566.82 (document No. 4 attached to the arbitral decision request, whose content is hereby incorporated);

e) To the aforementioned email, the Official Accountant of the Claimant replied by email on 31-07-2014, a copy of which appears in document No. 4 attached to the arbitral decision request, whose content is hereby incorporated, in which he refers, among other things, to the following:

1 - Justification of the accounting entry made

The accounting entry in question accomplishes the reclassification of favorable foreign exchange variations to the Company's Equity Capital within the context of the adoption of the Accounting Standardization System (SNC), approved by Decree-Law No. 158/2009 of 13 July.

The aforementioned favorable foreign exchange variations were associated with advances granted by shareholder C…, S.A. The advances were made in USD (United States dollar) and the aforementioned foreign exchange variations relate to amounts recorded up to the fiscal year ended on 31 December 2009.

2 - Clarification of the underlying fact of the accounting entry of such value to the credit of account … - Favorable Foreign Exchange Differences; and whether such value was ever revenues?

Account #... - Favorable Foreign Exchange Differences (Income to be Recognized under SNC / Deferred Revenues under POC #274), was credited during several fiscal years, until 2009, as a result of foreign exchange variations associated with advances by shareholder C…, S.A.

This procedure was carried out under point 5.2.2 of the Official Chart of Accounts (POC). Within that rule:

a) "Where favorable foreign exchange differences result from medium and long-term debts, they should be deferred, provided there are reasonable expectations that the gain is reversible;

b) These shall be transferred to account … in the fiscal year in which payments or receipts, total or partial, of the debts with which they are related were made, and for the part corresponding to each payment or receipt."

The counterpart to these movements was account #...1 - Shareholders C…, S.A., so that the aforementioned favorable foreign exchange variations were not, under the provisions of point 5.2.2 of the Official Chart of Accounts (POC), recorded as revenues.

f) In response, Tax Inspector Mr. Dr. D…, sent to the Claimant the email dated 01-08-2014, a copy of which appears in document No. 5 attached to the arbitral decision request, whose content is hereby incorporated, in which he refers, among other things, to the following:

"Given your clarification, the favorable foreign exchange differences were not recorded as revenues during the validity of the POC.

The accounting reclassification of favorable foreign exchange variations to equity capital of the company within the context of SNC, appears to have tax relevance under IRC. Thus, and as provided in the final part of no. 1 of art. 5 - Transitional Regime - of Decree-Law No. 159/2009 of 13 July, a positive net worth change should have been recorded in field 703 of table 07 of the income return mod 22 in the amount of €285,313.36 - (…*1/5), in the years 2010/2014. Information on the above mentioned matter is requested.

It is further requested that a bank statement extract be sent showing the values of the advances granted by shareholder C… for the years 2010 and 2014."

g) The Official Accountant of the Claimant sent to the Tax and Customs Authority, on 24-10-2014, the email, a copy of which appears in document No. 6 attached to the arbitral decision request, whose content is hereby incorporated, in which he refers, among other things, to the following:

I apologize in advance for the delay in responding to the information and clarifications requested, which was due to the need to gather internal documentation (possible) supporting the operation since its inception, which dates back more than 20 years.

Please note that, having commenced my functions in the Finance Department of the E… Group only in December 2011, I had not yet studied the details of the operation at the time the questions were posed by Your Excellencies.

Having analyzed the documentation gathered and studied the matter, I believe that the substance of the operation does not point to a 'medium and long-term debt', but rather to a true 'Provision of Accessory Capital Obligations', which should have been properly recorded, from a rigorous accounting perspective, and long ago, in the Equity Capital of the company.

Based on the documentation analyzed, it is unequivocal that:

  1. The initial objective of the alleged 'advance' was intended for conversion into Share Capital of A…, SA or of its subsidiaries;

  2. Of the respective remaining balance (not used in said conversion):

(i) There is no established repayment period;

(ii) The capital has remained permanently in the company for more than ten years;

(iii) No interest is accrued;

(iv) Withdrawal of amounts is permitted, under legal terms, but subject to the express condition - approved at a shareholders' general meeting - that any amounts eventually reimbursed must lead to the necessary realization of share capital in an equal amount.

Consequently, neither the accounting followed historically in the company, nor the accounting reclassification of these positive foreign exchange differences at the time of transition to SNC in 2010, and the consequent inclusion in field 703 of table 07 of Model 22 of an amount equal to 1/5 of that value (€ 285,313.36 = 1,426,566.82*1/5) in the years 2010 to 2014 is justified.

h) By electronic mail of 11-12-2014, the Official Accountant of the Claimant sent to the Tax and Customs Authority the email, a copy of which appears in document No. 7 attached to the arbitral decision request, whose content is hereby incorporated, in which he refers, among other things, to the following:

Further to the previous email, copied below, and to your telephone contact, I am sending herewith supporting documentation which I believe is relevant in order to properly frame the accounting classification of the operations in question.

The attached documentation includes:

  • Minutes No. … General Meeting of 24 May 1991. First item on the Agenda: Decide on the form, period and conditions for repayment of advances made by shareholders;

  • Minutes No. … General Meeting of 17 April 1992. Only item on the Agenda: Decide on the suspension of the accrual of interest on shareholder advances credits;

  • Evolution of the Balance of Advances in Foreign Currency - USD American dollar;

  • Accounting Record of Foreign Exchange Differences in the year following suspension of interest accrual (Year 1992); Recording in account #274 Deferred Revenues;

  • Accounting Record of Foreign Exchange Differences from 2000 to 2009 (last year before SNC transition), as well as confirmation of the balance in question (calculation base) which corresponds to 3,014,838.04 USD as per Document Evolution of Advances Balance (3 - document from this list); Recording in account #274 Deferred Revenues;

  • Accounting Record of Foreign Exchange Differences in 2010 (year of SNC transition), as well as confirmation of the balance in question (calculation base) which corresponds to 3,014,838.04 USD; Recording in Results as per SNC standards.

Based on the attached documentation, I maintain the opinion that the substance of the operation does not point to a 'medium and long-term debt', but rather to a true 'Provision of Accessory Capital Obligations', which should have been properly recorded, from a rigorous Accounting perspective, and long ago, in the Equity Capital of the company.

From the analysis of the attached documentation, and as per the previous email, it is unequivocal that:

  1. The initial objective of the alleged 'advance' was intended for conversion into Share Capital of A…, SA or of its subsidiaries;

  2. Of the respective remaining balance (not used in said conversion):

(i) There is no established repayment period;

(ii) The capital has remained permanently in the company for more than ten years;

(iii) No interest is accrued;

(iv) Withdrawal of amounts is permitted, under legal terms, but subject to the express condition - approved at a shareholders' general meeting - that any amounts eventually reimbursed must lead to the necessary realization of share capital in an equal amount.

i) Under Service Order No. OI 2015… of 11-02-2015, the Claimant was subjected to an internal partial-scope tax audit, concerning the IRC of fiscal year 2011, with the objective of analyzing the treatment given to foreign exchange differences, in accordance with article 5 of Decree-Law No. 159/2009 of 13 July (Report of the Tax Inspection);

j) Within the scope of the tax audit action, the Claimant was notified to exercise the right to be heard, which it did in the terms of document No. 8 attached to the arbitral decision request, whose content is hereby incorporated;

k) Following the exercise of the right to be heard, the Claimant was notified of the decision issued on 04-05-2015 by the Head of Division, in substitution, by subdelegation of the Finance Director of Lisbon, a copy of which appears in document No. 9 attached to the arbitral decision request, whose content is hereby incorporated, in which agreement is expressed with the Tax Inspection Report in which it is referred, among other things, to the following:

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

The trial balances sent by the taxpayer regarding fiscal year 2011 show in account … - Favorable foreign exchange differences, a credit balance in the amount of € 1,426,566.82.

Also, as evidenced from the trial balances, account … - Favorable foreign exchange differences - was moved by debit of account … - Favorable foreign exchange differences. As a result of this accounting entry, account … - Favorable foreign exchange differences, presents itself, at year-end, with a zero balance.

In order to clarify the accounting entry described above, the following questions were sent to the taxpayer by electronic mail:

  • Justification of the accounting entry made,

  • Clarification of the underlying fact of the accounting entry of such value to the credit of account …- Favorable Foreign Exchange Differences and whether such value was ever revenues.

In response, the taxpayer informed that:

"The accounting entry in question accomplishes the reclassification of favorable foreign exchange variations to the Company's Equity Capital within the context of the adoption of the Accounting Standardization System (SNC), approved by Decree-Law No. 158/2009 of 13 July. The aforementioned favorable foreign exchange variations were associated with advances granted by shareholder C…, SA. The advances were made in USD (United States dollar) and the aforementioned foreign exchange variations relate to amounts recorded up to the fiscal year ended on 31 December 2003."

"Account # … - Favorable Foreign Exchange Differences (Income to be Recognized under SNC / Deferred Revenues under POC #274), was credited during several fiscal years, until 2009, as a result of foreign exchange variations associated with advances by shareholder C…, SA.

This procedure was carried out under point 5.2.2 of the Official Chart of Accounts (POC). Within that rule:

a) "Where favorable foreign exchange differences result from medium & long-term debts, they should be deferred, provided there are reasonable expectations that the gain is reversible.

b) These shall be transferred to account … in the fiscal year in which payments or receipts, total or partial, of the debts with which they are related were made, and for the part corresponding to each payment or receipt."

The counterpart to these movements was account #... - Shareholders C…, S.A., so that the aforementioned favorable foreign exchange variations were not, under the provisions of point 5.2.2 of the Official Chart of Accounts (POC), recorded as revenues."

Given the information provided, a new electronic mail was sent, in which it was stated that the accounting reclassification of favorable foreign exchange variations to equity capital of the company within the context of SNC had tax relevance under IRC, and that, as provided in the final part of no. 1 and no. 5 of article 5 – Transitional Regime – of Decree-Law No. 159/2009 of 13 July, a positive net worth change should have been recorded in field 703 of table 07 of the income return mod 22 in the amount of € 285,313.36 = (1,426,566.82*1/5), in the years 2010/2014.

This consideration did not meet with acceptance by the taxpayer, for which it briefly stated the following:

"...the substance of the operation does not point to a 'medium and long-term debt', but rather to a true 'Provision of Accessory Capital Obligations', which should have been properly recorded, from a rigorous accounting perspective, and long ago, in the Equity Capital of the company."

The initial objective of the alleged advance was intended for conversion into Share Capital of A…, SA, or of its subsidiaries;

Of the respective remaining balance (not used in said conversion):

  • There is no established repayment period;

  • The capital has remained permanently in the company for more than ten years;

  • No interest is accrued,

  • Withdrawal of amounts is permitted, under legal terms, but subject to the express condition -approved at a shareholders' general meeting - that any amounts eventually reimbursed must lead to the necessary realization of share capital in an equal amount.

Consequently, neither the accounting followed historically in the company, nor the accounting reclassification of these positive foreign exchange differences at the time of transition to SNC in 2010, and the consequent inclusion in field 703 of table 07 of Model 22 of an amount equal to 1/5 of that value (€ 285,313.36 = 1,426,566.82*1/5) in the years 2010 to 2014 is justified."

What was stated by the taxpayer allows the conclusion that the accounting entry, credit of account to account …- Favorable foreign exchange differences, by debit of account … - Favorable foreign exchange differences, in the amount of € 1,426,566.82, results from the reclassification of favorable foreign exchange variations to the Company's Equity Capital within the context of the adoption of the Accounting Standardization System (SNC), approved by Decree-Law No. 158/2009 of 13 July.

The amount of the accounting entry made results from the accumulation of various amounts relating to foreign exchange differences, whose accounting entries occurred during the fiscal years comprised between 2002 and 2009.

The entry made produced positive effects on the company's equity capital, so the amount € 285,313.36, equal to 1/5 of the value 1,426,566.82, should have been increased in the Model 22 income return, in accordance with no. 1 of article 18 of the IRC and no. 1 and no. 5 of article 5 of Decree-Law No. 159/2009 of 13 July, "The effects on equity capital resulting from the adoption, for the first time, of international accounting standards adopted pursuant to article 3 of Regulation No. 1606/2002 of the European Parliament and of the Council of 19 July, which are considered tax-relevant under the Terms of the Corporate Income Tax Code and its complementary legislation, resulting from the recognition or non-recognition of assets or liabilities, or changes in their measurement, contribute, in equal parts, to the taxation in which such standards apply and the four subsequent periods of taxation." (emphasis ours)

Related to this same matter, considered relevant, it is noted that, based on what was verified in the computer system, the taxpayer in the Model 22 income return, regarding fiscal year 2010, increased for purposes of determining taxable income the amount € 285,313.36, amount mentioned in line 762 of table 07 of Model 22.

The amount increased is exactly equal to the amount proposed for the year 2011, under this action.

In conclusion, the taxpayer did not increase, for purposes of determining the taxable income of fiscal year 2011, the amount € 285,313.36, equal to 1/5 of the value 1,426,566.82, in accordance with no. 1 of article 5 of Decree-Law No. 159/2009 of 13 July.

From the proposed correction results a new determination of taxable income for fiscal year 2011 in the amount of € 198,097.47, as demonstrated:

Model 22, table 07

(...)

IX - RIGHT TO BE HEARD

The taxpayer was notified, pursuant to our letter No. … of 13 March 2015, to exercise the right to be heard on the contents of the draft report, in accordance with article 60 of the General Tax Law and article 60 of the Supplementary Regime of the Tax and Customs Inspection Procedure.

The right to be heard was exercised, as per the document received in this office on 2015-04-01 under registration No. 2015….

In exercising its right to be heard, the taxpayer alleges the following:

A) It begins by summarizing, in paragraphs 1 and 2, the content of the correction proposed in the draft report;

B) Following, in paragraph 3, it states disagreement with the proposed correction, for which it makes reference to an e-mail sent on 11 December 2014, which is translated in this information, chapter III;

C) In paragraphs 4 to 6, the taxpayer states that "... after (re)validation for caution of all facts and assumptions ... with creditor shareholder C…, SA", "The Board of Directors of A… resolved the corresponding accounting change ... given the stability and nature of the balance recorded in account …", ... on the grounds that the shareholder has a credit with materially relevant amounts and dating back more than 20 years, not being reimbursed nor remunerated (with interest), regarding the respective amount", in paragraph 7 it makes reference to the Minutes of the General Meeting of Shareholders, minutes No. 18 of 24.05.1990, which resolved "That shareholders holding advance credits (...) may, upon notice to the company, make withdrawals on account of their credits provided they commit to carry out, through cash contributions in the first capital increase to be undertaken, the amount corresponding to the withdrawals made" to justify the nature of accessory capital provisions;

D) In paragraph 6 it invokes the Minutes of the General Meeting of Shareholders No. 21, of 16.04.1992, to invoke the suspension of interest accrual on the credits, from 1 January 1992;

E) In paragraphs 9 and 10, it states that it proceeded to the accounting reclassification of the balances, for which it sent a copy of the accounting document No. 2, in which the following entries are contemplated:

F) In paragraphs 11 and 12, it considers that the operation constitutes, not a true liability, but rather an equity capital instrument and that the material reality is not subject to any taxation.

In light of the facts presented by the taxpayer, the following is stated:

1 - The taxpayer in no way contradicts the arguments referred to in the draft report for the purpose of sustaining the proposed correction;

2- It did not present any new fact beyond the information known and from which the proposed correction resulted;

3- In fact, the correction proposed in the amount of € 285,313.36, equal to 1/5 of the value 1,426,566.82, results from the provisions of no. 1 of article 18 of the IRC and no. 1 and no. 5 of article 5 of Decree-Law No. 159/2009 of 13 July, already mentioned.

4 - The amount € 1,426,566.82 results from the accumulation of various amounts in account … -Foreign exchange differences - resulting from the accounting of foreign exchange differences associated with advances by the shareholder, in USD (American Dollar)

5 - In year 2010 the following accounting entry was made: credit of account …-Favorable foreign exchange differences, by debit of account … - Favorable foreign exchange differences, which means that, within the scope of the adoption of SNC, that value was transferred to equity capital, and because it is a matter which this regulation gives tax relevance, it must be included in the so-called transition adjustments, as explained in the draft report. Moreover, it is a fact that the taxpayer maintained a debt in USD and thus the favorable foreign exchange difference constitutes taxable income for tax purposes, given that it caused an increase in the taxpayer's assets, in accordance with the general principles of the Corporate Income Tax Code.

6 - The taxpayer makes reference to the reclassification of account … by credit of account …-Accessory Provisions, carried out at the end of year 2014, as mentioned in point E) of this chapter, for which it sent a copy of a trial balance from year 2014, however, this situation does not affect the year under analysis (2011).

7 - Taking into account the trial balance sent, account… - Favorable foreign exchange differences, still evidences as a credit balance the amount € 1,426,566.82, which reflects gains obtained in prior years, resulting from foreign exchange variation of the amount granted by its shareholder;

8 - It was mentioned in the draft report, as considered relevant, that in fiscal year 2010, the amount € 285,313.36 was increased, for purposes of determining taxable income, amount mentioned in line 762 of table 07 of Model 22. This amount is exactly equal to the amount proposed for the year 2011, and is in accordance with the provisions of no. 1 of article 18 of the IRC and no. 1 and no. 5 of article 5 of Decree-Law No. 159/2009 of 13 July.

In these terms, the arguments made by the taxpayer do not merit agreement, and the proposed correction shall be maintained.

l) On 13-05-2015, the Tax and Customs Authority issued the IRC assessment No. 2015…, a copy of which appears in document No. 1 attached to the arbitral decision request, whose content is hereby incorporated, relating to the year 2011, in the amount of € 42,050.65;

m) On 18-05-2015, the Tax and Customs Authority made the compensation No. 2015 …, a copy of which appears in document No. 1 attached to the arbitral decision request, whose content is hereby incorporated, with the amount payable of € 43,289.97;

n) The Claimant did not pay the amount referred to in the preceding item, which led to the institution of enforcement proceedings No. …2015…, which are pending before the Finance Service of Lisbon…, for coercive collection of the debt (document No. 10 attached to the arbitral decision request, whose content is hereby incorporated);

o) On 29-09-2015, the Claimant presented to the Finance Service of Lisbon… the bank guarantee No. …-…-… issued by F…, in the amount of € 55,288.11, for purposes of the suspension of the enforcement proceedings instituted regarding the non-payment of the additional IRC assessment of 2011 referred to above (document No. 10 attached to the arbitral decision request, whose content is hereby incorporated);

p) With the provision of the guarantee, the Claimant spent, until 24-09-2015, the amount of € 658.13 (document No. 11 attached to the arbitral decision request, whose content is hereby incorporated) and from that date incurred € 498.30 in direct additional costs/charges relating to the constitution of the aforementioned bank guarantee (Document No. 1 attached to the Claimant's submissions, whose content is hereby incorporated);

q) A… has as its majority shareholder C…, SA, which in 2011 held 91.85% of the respective share capital;

r) In minutes No. 18 of the General Meeting of shareholders of A…, dated 04-05-1991, attached as Document No. 13 to the arbitral decision request, whose content is hereby incorporated, it is referred, among other things, to the following:

"In consideration of the resolution to repay advances and the respective terms and conditions approved at the General Meeting of the company held on 12 April 1991 and without prejudice thereto, the following is proposed: "That shareholders holding credits for advances referred to in that resolution may, upon notice to the company, make withdrawals on account of their credits provided they commit to carry out, through cash contribution, in the first capital increase to be undertaken, the amount corresponding to the withdrawals made".

Put to discussion the proposal transcribed above and as no shareholder wished to speak, voting proceeded, the proposal being approved unanimously.

s) In the Minutes of the General Meeting of Shareholders of the Claimant No. …, of 17-04-1992 - attached to the arbitral decision request as document No. 14, whose content is hereby incorporated, it is referred, among other things, to the following:

(...) the following proposal was presented:

"ONE. In General Meeting held on 12 April 1991, the shareholders of A… resolved that the credits for advances of shareholders G…, H… and DR. I… would bear interest with effect from 1 January 1989, at the annual rate of 8%, for advances in US dollars and 14% for advances in escudos, or at the maximum rate to be authorized by the Bank of Portugal, if lower than those.

(...)

FIVE. Accordingly, it is proposed that:

a) interest accrual on the credits for advances of shareholders G…, H… and DR. I… be suspended, with effect from 1 January 1992;

b) this suspension shall remain until otherwise resolved by the General Meeting of Shareholders."

The proposal was submitted to voting, approved unanimously.

t) From 01-01-1992, no interest has been accrued or debited on the balance of that account of advances of shareholder C…, SA.;

u) In the Management Report of 1992, which forms part of document No. 15 attached to the arbitral decision request, whose content is hereby incorporated, it is referred, among other things, to the following:

The foreign exchange differences resulting from the foreign exchange update of debts in foreign currency, 83,890,302$40, were not reflected in the result for the fiscal year. They were accounted for in deferred costs due to the volatility of the American currency exchange and because the repayment of the respective advances was not expected in the short term.

v) The balance of the advance account remained unchanged from the year 2000, in the amount referred to in document No. 16 attached to the arbitral decision request, whose content is hereby incorporated;

w) Account POC#... - SNC#...- Favorable Foreign Exchange Differences, was credited during several fiscal years, up to and including the year 2009, as a result of foreign exchange variations associated with advances made in USD (United States dollar) by said shareholder C…, SA;

x) The counterpart of this movement was the debit of account POC #... - Shareholder C…, SA. (and vice versa when unfavorable);

y) Documents Nos. 17 to 19 attached to the arbitral decision request are hereby incorporated;

z) The annual evolution of Euro/Dollar (USD) exchange rates in the period from 2001 to 2015 was as follows:

(...)

aa) The foreign exchange differences, positive or negative, were never recorded as 'revenues' or 'costs' of the Claimant's fiscal years, neither at the accounting level, nor at the tax level;

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

2.2. Unproven Facts

It was not proven that between the years of 2001 it was foreseeable that the positive foreign exchange differences would be irreversible.

2.3. Basis for the Determination of Facts

The proven facts are based on the documents of the administrative file and those attached by the Claimant.

Regarding the unproven fact, although it is subsequently found that there was a tendency for USD depreciation in relation to the euro in the years 2001 to 2009, there is no evidence that would allow the conclusion that it was reasonably foreseeable that the gains obtained from the depreciation would be irreversible, it being certain that in 2005 there was marked depreciation of the dollar and recent evolution is also in that direction.

In particular, no unceasing, continuous and rampant depreciation is detected in the exchange rate evolution as referred to by the Claimant.

On the other hand, the only objective fact that could indicate whether the Claimant had or did not have reasonable expectations that the gain was reversible is the very fact that the Claimant deferred the accounting recognition of foreign exchange differences, which is objectively interpretable as demonstrating that it had reasonable expectations that the gain was reversible, as it is these expectations of reversibility that, in accounting terms, could justify the deferral, in accordance with point 5.2.2 of the POC.

3. Matter of Law

3.1. The Tax Fact

Decree-Law No. 159/2009 of 13 July adapted the rules for determining taxable income contained in the CIRC to international accounting standards as adopted by the European Union, establishing in its article 5 a transitional regime which includes a rule relating to effects on equity capital resulting from the adoption, for the first time, of such standards, which establishes the following:

1 - The effects on equity capital resulting from the adoption, for the first time, of international accounting standards adopted pursuant to article 3 of Regulation No. 1606/2002 of the European Parliament and of the Council of 19 July, which are considered tax-relevant under the terms of the Corporate Income Tax Code and its complementary legislation, resulting from the recognition or non-recognition of assets or liabilities, or changes in their measurement, contribute, in equal parts, to the formation of taxable income of the first period of taxation in which those standards apply and the four subsequent periods of taxation.

In the accounting of the Claimant, account POC#... - SNC#... - Favorable Foreign Exchange Differences, was credited during several fiscal years, up to and including the year 2009, as a result of foreign exchange variations associated with advances made in USD by its majority shareholder C…, SA, the counterpart of such movement being the debit of account POC #... - Shareholder C…, SA (and vice versa when unfavorable).

This accounting was carried out under point 5.2.2 of the POC, which established the following, in points 5.2.1 and 5.2.2:

5.2.1 - Foreign currency operations are recorded at the exchange rate on the date considered for the operation, unless the exchange rate is fixed by the parties or guaranteed by a third entity.

On the balance sheet date, debts to or from third parties resulting from such operations, in relation to which there is no fixing or guarantee of exchange rate, are updated on the basis of the exchange rate on that date.

5.2.2 - As a general principle, the foreign exchange differences resulting from the update referred to in 5.2.1 are recognized as results of the fiscal year and recorded in the accounts … "Costs and financial losses - Unfavorable foreign exchange differences" or … "Revenues and financial gains - Favorable foreign exchange differences."

Where favorable foreign exchange differences result from medium and long-term debts, they should be deferred, provided there are reasonable expectations that the gain is reversible. These shall be transferred to account … in the fiscal year in which payments or receipts, total or partial, of the debts with which they are related were made, and for the part corresponding to each payment or receipt.

With the adoption of international accounting standards provided for in the Accounting Standardization System, the Claimant made an accounting entry resulting in Debit account … - favorable foreign exchange differences € 1,426,566.62 and Credit to account …-favorable foreign exchange differences € 1,426,566.82, by which it proceeded to reclassify favorable foreign exchange variations to the Company's Equity Capital within the context of the adoption of the Accounting Standardization System (SNC), approved by Decree-Law No. 158/2009 of 13 July.

The Tax and Customs Authority, in an electronic mail sent to the Claimant's official accountant, stated that "the accounting reclassification of favorable foreign exchange variations to equity capital of the company within the context of SNC appears to have tax relevance under IRC. Thus, and as provided in the final part of no. 1 of article 5 - Transitional Regime - of Decree-Law No. 159/2009 of 13 July, a positive net worth change should have been recorded in field 703 of table 07 of the Model 22 income return in the amount of €285,313.36 - (1,426,566.82*1/5), in the years 2010/2014".

Following the aforementioned electronic mail, the Claimant responded that the accounting carried out previously, during the validity of the POC, was not correct, as the "substance of the operation does not point to a 'medium and long-term debt', but rather to a true 'Provision of Accessory Capital Obligations', which should have been properly recorded, from a rigorous accounting perspective, and long ago, in the Equity Capital of the company".

The Claimant based this conclusion on the following:

  1. The initial objective of the alleged 'advance' was intended for conversion into Share Capital of A…, SA or of its subsidiaries;

  2. Of the respective remaining balance (not used in said conversion):

(i) There is no established repayment period;

(ii) The capital has remained permanently in the company for more than ten years;

(iii) No interest is accrued;

(iv) Withdrawal of amounts is permitted, under legal terms, but subject to the express condition - approved at a shareholders' general meeting - that any amounts eventually reimbursed must lead to the necessary realization of share capital in an equal amount.

Consequently, neither the accounting followed historically in the company, nor the accounting reclassification of these positive foreign exchange differences at the time of transition to SNC in 2010, and the consequent inclusion in field 703 of table 07 of Model 22 of an amount equal to 1/5 of that value (€ 285,313.36 = 1,426,566.82*1/5) in the years 2010 to 2014 is justified.

The Tax and Customs Authority did not accept this thesis, stating in the Tax Inspection Report:

What was stated by the taxpayer allows the conclusion that the accounting entry, credit of account to account …- Favorable foreign exchange differences, by debit of account … - Favorable foreign exchange differences, in the amount of € 1,426,566.82, results from the reclassification of favorable foreign exchange variations to the Company's Equity Capital within the context of the adoption of the Accounting Standardization System (SNC), approved by Decree-Law No. 158/2009 of 13 July.

The amount of the accounting entry made results from the accumulation of various amounts relating to foreign exchange differences, whose accounting entries occurred during the fiscal years comprised between 2002 and 2009.

The entry made produced positive effects on the company's equity capital, so the amount € 285,313.36, equal to 1/5 of the value 1,426,566.82, should have been increased in the Model 22 income return, in accordance with no. 1 of article 18 of the IRC and no. 1 and no. 5 of article 5 of Decree-Law No. 159/2009 of 13 July, "The effects on equity capital resulting from the adoption, for the first time, of international accounting standards adopted pursuant to article 3 of Regulation No. 1606/2002 of the European Parliament and of the Council of 19 July, which are considered tax-relevant under the terms of the Corporate Income Tax Code and its complementary legislation, resulting from the recognition or non-recognition of assets or liabilities, or changes in their measurement, contribute, in equal parts, to the taxation in which such standards apply and the four subsequent periods of taxation." (emphasis ours)

Related to this same matter, considered relevant, it is noted that, based on what was verified in the computer system, the taxpayer in the Model 22 income return, regarding fiscal year 2010, increased for purposes of determining taxable income the amount € 285,313.36, amount mentioned in line 762 of table 07 of Model 22.

The determination of taxable income is determined based on accounting, with possible corrections, in accordance with article 17, no. 1, of the CIRC.

To achieve this objective, commercial companies are required to have accounting organized in accordance with accounting standardization and other applicable provisions in a manner that allows control of taxable income" (articles 17, no. 3, and 123, no. 1, of the CIRC).

The tax fact provided for in said article 5, no. 1, of Decree-Law No. 159/2009 is the existence of effects on equity capital resulting from the adoption, for the first time, of international accounting standards, it being provided by legal fiction that such effects contribute, positively or negatively, to the formation of taxable income in equal parts in the year in which they occur and in the four subsequent years.

As results from the tenor of this rule, its application is based on the real effects that actually resulted from the adoption of accounting standards and not on those that would hypothetically have occurred if, due to non-compliance by the taxpayer with its duties to maintain accounting in accordance with the applicable standards, the accounting were different from what it is and the effects of the adoption of those standards were different from those that occurred.

Which, moreover, is perfectly understandable in light of the principle of practicability which cannot fail to be considered when viewing the activity of the Tax Administration, as, resulting those effects from the adoption of international accounting standards from the accumulation of the effects of countless prior accounting acts, which could have been carried out over tens of years, it would be an unviable task to make the determination of such effects dependent on the complete analysis of the accounting accuracy of all such acts.

For this reason, being presumable that the legislator established the most correct solution (article 9, no. 3, of the Civil Code), which in this case cannot but be the one that can become effective in terms of reasonableness, it must be concluded that article 5, no. 1, of Decree-Law No. 159/2009 is based only on the real effects that occurred on the basis of the accounting as it was organized up to the year 2010.

Thus, as it is unequivocal that such effects occurred, which were moreover recognized by the Claimant in applying this transitional regime in the return relating to the year 2010, subsequent accounting corrections are irrelevant which could lead to the effects being different from those that did occur, as the fact provided for in that no. 1 of article 5 has occurred and from its occurrence flow the consequences provided for in law, namely, in this case, the relevance as income of 1/5 of the amount of such effects in the year 2011.

In truth, "the tax legal relationship is constituted with the tax fact" (article 36, no. 1, of the LGT).

"The verification of the tax fact leads, as a direct and immediate result, to the birth of the tax legal relationship. This principle of the birth of the tax legal relationship as a result of the verification of the tax fact was already expressed in no. 9 of article 8 of the Corporate Income Tax Code. It determines that 'the tax-generating fact is considered verified on the last day of the period of taxation'". ([1])

The tax obligation is "a legal obligation, because it is an obligation ex lege, an obligation having the law as its source. For this reason it is born from the meeting of the tax-generating fact or tax fact with the legal hypothesis, as prescribed by the LGT in no. 1 of its article 36, by providing that the tax legal relationship is constituted with the verification of the tax fact". ([2])

On the other hand, "the essential elements of the tax legal relationship cannot be altered by the will of the parties" (article 36, no. 2, of the LGT), so acts of taxpayers that, following the constitution of that relationship, are intended to eliminate retroactively its presuppositions are irrelevant.

For this reason, it is irrelevant for the verification of that tax fact provided for in article 5, no. 1, of Decree-Law No. 159/2009 that, at the end of the year 2014, the Claimant operated the accounting reclassification of the balances, debiting account 268 by credit of account …-Accessory Provisions.

Thus, once "effects on equity capital resulting from the adoption, for the first time, of international accounting standards adopted pursuant to article 3 of Regulation No. 1606/2002" resulting from the recognition of an asset have occurred, the situation provided for in that no. 1 of article 5 has been verified, as, for that matter, was recognized by the Claimant, which increased the taxable income of fiscal year 2010 by the amount of € 285,313.36, equal to 1/5 of the value of € 1,426,566.82, as accepted in the present proceedings (articles 33 and 34 of the arbitral decision request).

The circumstance that this tax fact might not have occurred if the Claimant had considered as foreseeable the irreversibility of the USD depreciation and had recognized the foreign exchange differences as results of each fiscal year is irrelevant and does not preclude the application of the regime of that no. 1 of article 5 of Decree-Law No. 159/2009, as, on the contrary, it is precisely this prior lack of accounting and tax relevance that leads to the recognition of the patrimonial increase occurring with the adoption, for the first time, of international accounting standards and, for this reason, that regime being applicable.

3.2. Question of Incorrect Accounting of Advances

For the reasons stated in the preceding point, it is irrelevant for the verification of the tax fact underlying the disputed assessment the possibility of the existence of accounting inaccuracies (those indicated by the Claimant or any others), as the fact that triggers the regime provided for in no. 1 of article 5 of Decree-Law No. 159/2009 is only the finding that effects of the type provided for therein occurred, there being no textual support for excluding the application of this rule in cases in which such effects would not have occurred if the accounting reality were different instead of being what it was at the moment of the adoption for the first time of international accounting standards.

In any case, the prior accounting inaccuracy to 2010 referred to by the Claimant does not occur, as the advances granted by shareholder C…, S.A. could not be considered 'Provision of Accessory Capital Obligations', since their withdrawal was permitted, without any limitation, upon notice to the company, only subordinated to the condition, approved at the shareholders' general meeting of 24-05-1991, that the holders of such credits making withdrawals on account thereof commit to carrying out through cash contributions in the first capital increase to be undertaken, the amount corresponding to the withdrawals made. This commitment, which constituted the assumption of a merely hypothetical obligation with no defined time period, did not prevent the holders of such credits from making withdrawals on account thereof without any other limit than its amount and without verification of any other condition, it being certain that withdrawals actually occurred in the year 2000 (document No. 16 attached to the arbitral decision request, whose content is hereby incorporated), without it being alleged and proven the materialization of a hypothetical obligation to make cash contributions, which was assumed when the withdrawals were made.

The fact that the balance relating to the advances remained creditor in the amount of € 3,014,838.04 from the year 2000 does not preclude that the legal regime to which they were subject in the subsequent period was that which existed before that year, which, as seen, did not prevent withdrawals from being made, without being accompanied by a subsequent capital increase of equal amount, which reveals that the condition approved at the shareholders' general meeting of 24-05-1991 did not have observable efficacy.

Being thus, there is no ground to consider the advances as free accessory capital provisions.

The fact that, on 19-12-2014, the Board of Directors resolved that, on 31 December of that year, the accounting reclassification in favor of shareholder C… of the balances, the reclassification of the advance item to the Equity Capital item – Accessory Capital Provisions would be carried out, irrespective of its accuracy or inaccuracy in accounting terms, has no relevance whatsoever to define the elements of a tax fact already occurred previously, in 2010 and 2011, insofar as the case at hand is concerned.

3.3. Principles of Justice and Taxation Based Fundamentally on Real Income

With regard to the principles of material justice and taxation based fundamentally on the real income of enterprises (article 104, no. 2, of the CRP), invoked by the Claimant, no violation thereof occurs, as the Claimant maintained the debt in the year 2010 the debt in USD and, as stated in the Tax Inspection Report, "the favorable foreign exchange difference constitutes taxable income for tax purposes, given that it caused an increase in the taxpayer's assets".

Only if the Claimant had proven that such income had already been taxed previously could a violation of such principles be raised, but the Claimant assures that "such foreign exchange differences, positive or negative, were never recorded as 'revenues' or 'costs' of the CLAIMANT's fiscal years, neither at the accounting level, nor at the tax level".

On the other hand, the transitional regime provided for in article 5, no. 1, of Decree-Law No. 159/2009 applied to both positive and negative effects on equity capital resulting from the adoption of international accounting standards, so it is not apparent that it is an unjust regime.

3.4. Question of Expiry of the Right to Assess

The Claimant defends that, as all (revenues and costs) are prior to 2010, the expiry of the right to assess has already occurred.

However, in the case at hand, the tax fact is not constituted by the very positive or negative foreign exchange variations, but rather by the effects on equity capital resulting from the adoption, for the first time, of international accounting standards and it is provided by fiction in article 5, no. 1, that 1/5 of such effects are produced in the year 2011.

This article 5, no. 1, is a special rule on the relevance of facts potentially generating IRC, so that, with respect to the year 2011, the tax fact is considered verified on the last day of that period of taxation, by force of the provision of no. 9 of article 8 of the CIRC.

Thus, as the period of expiry of the right to assess is four years, counted from the end of the year in which the tax fact occurred (article 45, no. 1, of the LGT), such expiry of that right has not occurred, as it was exercised in the year 2015.

4. Request for Indemnification for Unwarranted Guarantee

From the foregoing, it follows that the disputed assessment does not suffer from the illegalities attributed to it by the Claimant, so the request for annulment of the assessment must be dismissed.

In harmony with the provision of article 53, no. 1, of the LGT, indemnification for unwarranted guarantee depends on the debtor obtaining "success in administrative appeal, impugnation or opposition to execution that have as their object the guaranteed debt".

Thus, as the arbitral decision request is dismissed, the request for indemnification for unwarranted guarantee is also necessarily dismissed.

5. Decision

In harmony with the foregoing, the members of this Arbitral Tribunal agree to:

a) Dismiss the arbitral decision request;

b) Absolve the Tax and Customs Authority of the claims.

6. Process Value

In harmony with the provision of article 306, no. 2, of the CPC, 97-A, no. 1, paragraph a), of the CPPT and 3, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of the process is fixed at € 42,050.65.

Lisbon, 12 May 2016

The Arbitrators

(Jorge Manuel Lopes de Sousa)

(Paulo Ferreira Alves)

(Maria Manuela do Nascimento Roseiro)

[1] SALDANHA SANCHES, Manual of Tax Law, 3rd edition, page 250.

[2] CASALTA NABAIS, Tax Law, 7th edition, page 238.

Frequently Asked Questions

Automatically Created

What is the SNC transitional regime and how does it affect IRC corporate tax obligations in Portugal?
The SNC transitional regime, established by Decree-Law 159/2009 of July 13, governs the tax implications when Portuguese companies transitioned from the POC (Official Chart of Accounts) to the SNC (Accounting Standardization System). Article 5(1) of this decree stipulates that accounting adjustments resulting from first-time SNC adoption may generate taxable positive or negative net worth changes for IRC purposes. These adjustments must be recognized ratably over five fiscal years starting with the first period under SNC (typically 2010-2014). The regime particularly affects items previously treated differently under POC, such as deferred foreign exchange differences, provisions, and other balance sheet reclassifications. Taxpayers must report these transitional adjustments in field 703 of table 07 of the Model 22 IRC return, calculating one-fifth of the total adjustment amount annually. This mechanism prevents immediate tax shocks while ensuring accounting modernization doesn't create permanent tax arbitrage opportunities.
Can taxpayers request arbitral annulment of IRC tax liquidations through CAAD proceedings?
Yes, taxpayers can request arbitral annulment of IRC tax liquidations through CAAD (Centro de Arbitragem Administrativa) proceedings under the RJAT (Legal Regime for Tax Arbitration). According to Articles 2 and 10(2) of the RJAT, companies subject to IRC with legal personality and capacity have standing to challenge tax assessments through administrative arbitration. The process involves submitting a formal request to CAAD's president, who reviews it for acceptance. If accepted, the request is automatically notified to the Tax and Customs Authority. This arbitration mechanism provides an alternative to judicial courts for resolving tax disputes, offering a specialized, potentially faster forum. The arbitral tribunal's decisions are binding and have the same force as judicial decisions. Taxpayers must comply with specific procedural requirements and timeframes established in the RJAT, and cases can involve various IRC matters including assessment corrections, penalties, and interpretative disputes regarding tax law application.
How does the CAAD arbitral tribunal process work for disputes involving IRC tax assessments?
The CAAD arbitral tribunal process for IRC assessment disputes follows a structured procedure under the RJAT. First, the claimant submits a request and designates an arbitrator (Article 6(2)(b) RJAT). The CAAD president accepts the request and notifies the Tax Authority, which then designates its own arbitrator within the statutory period (Article 13(1) RJAT). These two arbitrators jointly select a third arbitrator to serve as president (Article 11(4) RJAT). Once all three arbitrators accept their designations, the tribunal is formally constituted (Article 11(7) RJAT). The Tax Authority submits a response, potentially raising preliminary objections. The tribunal may hold hearings where parties present witness testimony and documentary evidence. Parties then submit written arguments. The tribunal evaluates competence, party standing, procedural regularity, and substantive merits before issuing a written decision. Throughout the process, strict deadlines apply, and the tribunal must ensure compliance with procedural guarantees. The entire proceeding typically concludes within months rather than the years often required in judicial tax litigation.
What are the legal grounds for challenging an IRC tax liquidation under the RJAT framework?
Legal grounds for challenging IRC tax liquidations under the RJAT framework include substantive and procedural violations. Substantively, taxpayers can contest incorrect application or interpretation of IRC provisions, including timing of income recognition, deductibility of expenses, application of exemptions or benefits, and characterization of transactions. Challenges may involve disputes over accounting-tax alignment issues, particularly under SNC transitional rules, or questions about whether specific items constitute taxable income or deductible costs. Procedurally, grounds include defects in the assessment procedure, violation of taxpayer rights (such as right to be heard), incorrect calculation of tax amounts, and improper application of penalties or interest. Taxpayers can also challenge the factual basis of assessments, arguing the Tax Authority misunderstood or mischaracterized underlying transactions. The RJAT framework (Article 2) provides broad jurisdiction over tax act legality, enabling comprehensive review of both legal and factual determinations. However, the request must be timely filed, and the taxpayer must demonstrate legitimate interest in the annulment and compliance with formal requirements for arbitration eligibility.
How are exchange rate variations treated under the SNC transitional regime for IRC purposes?
Under the SNC transitional regime for IRC purposes, exchange rate variations receive specific treatment depending on their timing and accounting classification. Previously, under POC section 5.2.2, favorable foreign exchange differences from medium and long-term debts could be deferred (not recognized as revenue) if reasonably expected to reverse, being transferred to income only upon actual payment or receipt. When transitioning to SNC, such deferred amounts required reclassification according to new accounting standards. The Tax Authority's position, reflected in Decree-Law 159/2009 Article 5(1), treats these reclassifications as creating positive net worth changes subject to IRC taxation. Specifically, amounts moved from deferred accounts to equity that were never previously taxed must be recognized ratably over five years (one-fifth annually from 2010-2014). This prevents companies from permanently avoiding taxation on economic gains simply because accounting presentation changed. The methodology requires identifying the total deferred exchange gains at transition, calculating the annual fifth portion, and reporting it in Model 22 field 703 of table 07. This approach balances the policy goals of facilitating accounting modernization while maintaining tax base integrity and preventing windfall benefits from timing differences between old and new accounting frameworks.