IRC Additional Assessments 2010-2011: Inventory Adjustments, Guarantees and Business Expense Deductibility at CAAD

ARBITRAL COURT DECISION (CAAD)

The members of this Arbitral Court hereby decide:

I. REPORT

I.1. A…, UNIPESSOAL, LDA., holder of the tax identification number and registration number at the Commercial Registry Office…, with registered office at Rua…, …, …, …-… …, hereinafter referred to as "Claimant" or "A…", pursuant to the provisions of paragraph a) of Article 2(1) and Articles 10 et seq., all of the Legal Regime for Tax Arbitration ("RJAT"), in conjunction with Article 102(1) of the Tax Procedure and Process Code ("CPPT"), applicable by virtue of paragraph a) of Article 10(1) of the RJAT,

has requested the constitution of this Tribunal to rule on the illegality and consequent partial annulment of the tax acts consisting of the additional assessment of Corporate Income Tax ("IRC") no. 2013…, relating to fiscal year 2010, and additional assessment of IRC no. 2013…, assessment of compensatory interest no. 2013…, and assessment of default interest no. 2013…, all relating to fiscal year 2011, as well as annulment of the decisions rejecting the administrative appeal and the hierarchical appeal that upheld them.

It alleged in summary:

On 30 May 2012, the Claimant submitted a periodic income statement (Form 22) replacing the IRC for fiscal year 2010, in which zero taxable income was declared due to the determination of tax losses in that fiscal year, which amounted to €2,748,675.26 (document number 1).

On 31 May 2013, the Claimant presented a periodic income statement (Form 22) replacing the IRC for fiscal year 2011, in which taxable income of €1,466,281.08 was declared as a result of deducting from the taxable profit determined in fiscal year 2011 (€4,214,956.34) the amount of tax losses determined in fiscal year 2010 (i.e., €2,748,675.26) (document number 2).

The Claimant was subject to an external tax inspection of general scope, relating to fiscal year 2010, conducted by the Tax Inspection Services ("SIT") of the Tax Directorate…, undertaken pursuant to service order no. OI2012…, due to the high tax loss and the decrease in gross profit margin over cost (compared to the prior fiscal year) from 86% to 20%.

In the course of the aforementioned tax inspection, the SIT made the following adjustments:

The Claimant was notified to exercise the right to prior hearing regarding the draft Tax Inspection Report, but did not exercise it, whereby the adjustments proposed above were entirely maintained in the Final Tax Inspection Report ("Inspection Report"), of which the Claimant was notified on 24 April 2013 (document number 3).

Based on the adjustments referred to in the preceding paragraph, the Tax and Customs Authority ("TA") made the following additional assessments, which reflect the adjustments resulting from the inspection:

· Additional IRC assessment no. 2013…, dated 2 May 2013, relating to fiscal year 2010, and account reconciliation statement no. 2013…, dated 6 May 2013, in which the TA maintained the value of the tax credit to be refunded to the Claimant (€6,130.72), since, despite the adjustments made by the SIT, the Claimant's tax position, with reference to fiscal year 2010, remained negative (document number 4);

· Additional IRC assessment no. 2013…, dated 12 June 2013, relating to fiscal year 2011, in the amount of €311,489.42, account statement for compensatory interest assessment no. 2013…, in the amount of €12,459.57, and default interest assessment no. 2013…, in the amount of €1,139.16, and account reconciliation statement no. 2013…, dated 21 June 2013, resulting in a total balance payable of €325,088.15 (document number 5), which the Claimant paid on 27 August 2013¹ (document number 6).

Disagreeing with the adjustments (and their respective grounds) set forth in sections III.1.2 (redisallowance of warranty costs), III.1.4 (impairments – inventory adjustments), and III.1.5 (inventory write-downs/disposals) of the Inspection Report, which totaled €2,137,826.21 and which also served as the basis for the assessments identified above, the Claimant filed an administrative appeal on 17 July 2013 (document number 7).

On 29 January 2014, the Claimant filed a hierarchical appeal of the decision dismissing the administrative appeal, which had been notified to it on 2 January 2014 (document number 8).

The hierarchical appeal was entirely dismissed by decision dated 26 June 2015, having been communicated to the Claimant by registered mail with return receipt received on 27 July 2015 (document number 9).

Considering that the costs and losses incurred in fiscal year 2010 with (i) inventory adjustments, (ii) warranties provided to customers, and (iii) inventory write-downs were indispensable for generating taxable income or for maintaining the source of income, and also considering that such costs are properly documented, the Claimant cannot accept the additional IRC assessments issued by the TA, nor the tenor of the decisions issued by the TA maintaining them, which constitute a clear violation of the principles of taxpayer capacity and taxation based on actual profit. In the Inspection Report, the SIT argued that the cost resulting from inventory adjustments cannot be accepted fiscally under Article 28 of the CIRC because:

(i) The supporting documents presented by the Claimant "(…) do not meet the requirements defined in paragraph a) of Article 123(2) of the CIRC, namely in that they are justificatory (…)", as stated on page 25 of the Inspection Report;

(ii) The cost "(…) is supported by an internal document (and not by an external document), which does not justify, establish the cause, nature and amount (…), whereby (…) it constitutes an improperly documented expense", as stated on page 25 of the Inspection Report; and

(iii) The supporting documents presented by the Claimant "(…) do not demonstrate, whether in whole or in part, compliance with the conditions provided in Article 28 of the CIRC and Article 26(4) of the CIRC, namely because:

•      It recorded, as suggested by the entry, adjustments in raw materials "…up to the limit of the difference between the acquisition or production cost of inventories…", Article 28(1) of the CIRC;
  

•      It does not demonstrate that inventories are recorded at the lower of cost or net realizable value;
  

•      They do not demonstrate what the net realizable value is and whether it complies with what is established in Article 26(4) of the CIRC (…)", as stated on page 28 of the Inspection Report.
  

The TA concluded that the Claimant failed to prove the existence of double taxation (that is, at the time of constitution and at the time of reversal of inventory adjustments), in that it failed to prove "in which taxation period(s) the reversal of the impairments constituted in 2010 occurred, nor (…) what amounts were reversed in each of those periods".

The Claimant further argues that the documentation it presented is (and was) sufficient, under law, to prove the tax deductibility of a loss determined irremediably by the Company in the course of a failed project – the "…" Project –, and that the amounts written off are documented within the practical, real, and business logic of a multinational company of the Claimant's size.

It therefore requests the annulment of the adjustment made, accepting that the Company indeed incurred a cost resulting from the write-off of inventories, which should be fiscally accepted, in that, in addition to having actually been borne by the Company, it is amply demonstrated.

I.2. The request for constitution of the arbitral tribunal was accepted by the President of the CAAD and notified to the Tax and Customs Authority (hereinafter referred to as TA or "Respondent").

I.3. The Claimant did not designate an arbitrator and, consequently, by decision of the President of the Ethics Council of the CAAD, issued pursuant to Articles 6 and 11, both of the RJAT, the signatories were designated as arbitrators to integrate the present collective arbitral tribunal, having communicated their acceptance within the legal period.

I.4. The Tribunal was constituted on 4 January 2016, as per the communication of the President of the Ethics Council of the CAAD, which is attached to the file.

I.5. The Claimant requests (i) the declaration of illegality, for violation of law, due to error regarding factual and legal premises, of the tax act of additional IRC assessment no. 2013…, relating to fiscal year 2010, and its annulment to the extent that the amount of €2,137,826.21 was disregarded as tax losses, as well as annulment of the decisions rejecting the administrative appeal and hierarchical appeal that upheld it; (ii) the declaration of illegality, for violation of law, due to error regarding factual and legal premises, of the tax acts of additional IRC assessment no. 2013…, compensatory interest assessment no. 2013…, and default interest assessment no. 2013…, all relating to fiscal year 2011, and their consequent annulment to the extent that the amount of €2,137,826.21 was disregarded as deductible tax losses, as well as annulment of the decisions rejecting the administrative appeal and hierarchical appeal that upheld them; (iii) a judgment condemning the Respondent (TA) to reimburse the Claimant for the tax paid in excess as a result of the partial annulment of the aforementioned assessments; (iiii) without prejudice, in the event that, with respect to the adjustments made to the taxable income for fiscal year 2010, the request for annulment is denied in the part relating to inventory adjustments, "(…)then, alternatively (…)", it requests "(…) the official correction of inventory reversals taxed in fiscal years 2011, 2012, 2013, and 2014; and in the part relating to warranty costs, then, alternatively, official correction of fiscal year 2007 should be ordered for acceptance of the cost in question (…)"; (iiiii) it further requests a judgment condemning the Respondent to pay the Claimant indemnity interest "(…) due, under Article 43(1) of the LGT and Article 61 of the CPPT, calculated at the supplementary legal rate on the tax paid in excess as a result of the partial annulment of the aforementioned assessments, calculated from 27 August 2013 until full reimbursement of said amount (…)".

I.6. Having been notified for that purpose, pursuant to Article 17 of the RJAT, the TA filed its Answer and attached the administrative file.

Response of the TA

I.7. In its Response, the TA contested the request and its grounds, alleging, in summary:

1.7.1 By way of exception:

a) The material incompetence of this Arbitral Tribunal, based on the fact that, allegedly, the requests formulated exceed the scope of the cognitive powers of the arbitral tribunal, since they do not concern the illegality of the tax acts under scrutiny here, as provided in paragraph a) of Article 2(1) of the RJAT ("arbitral tribunals are competent to declare the illegality of acts assessing taxes, self-assessment, withholding at source, and payment on account").

Therefore, the Arbitral Tribunal could not determine official corrections of inventory reversals for fiscal years 2011, 2012, 2013, and 2014, and that, regarding the part on warranty costs, "(…) official correction to fiscal year 2007 be ordered (…)".

Thus and with respect to the request formulated by the Claimant to have official corrections determined for subsequent years, it is established that the Arbitral Tribunal is materially incompetent to rule on such request, reason for which the exception is invoked for all legal purposes as a dilatory exception preventing knowledge of the merits of the case, pursuant to Article 576(1) and (2) and Article 278, both of the CPC as amended by Law 41/2013 of 26 June.

b) By way of exception: the unsuitability of the procedural means

The Claimant argues that the procedural means – request for arbitral ruling – does not constitute the appropriate procedural means for the tribunal to determine the making of official corrections in subsequent years.

Specifically: if the Claimant intends that official corrections be made – following the inspection conducted on fiscal year 2010 – for the subsequent fiscal years, the appropriate procedural means to assert such claim by the Claimant will be either the request for official review established in Article 78 of the LGT (administrative review) or through the intimation for a course of action provided in Article 147 of the CPPT (contentious review).

The intimation for a course of action constitutes the most appropriate procedural means to ensure protection of the desired result, that is, the determination of official corrections in subsequent years for costs not accepted fiscally in fiscal year 2010.

Therefore, the request for arbitral ruling having as its object the annulment of the disputed assessments does not constitute the procedural means to trigger the making of official corrections in subsequent fiscal years.

It is thus axiomatic that the request for arbitral ruling does not constitute the procedural means to determine the making of official corrections in the years, but rather the intimation for a course of action.

All the more so since the request for ruling addresses exclusively the legality of the assessments in fiscal years 2010 and 2011 and not the determination of official corrections in subsequent years due to the non-acceptance of costs in fiscal year 2010.

C) By way of objection on the merits

Notwithstanding the exceptions invoked above, the Claimant disputes "(…) the arguments put forth by the Claimant regarding the merits (…)".

It alleges in particular that it disallowed the tax cost relating to inventory adjustments in the amount of €268,121.96, basing its understanding on the fact that the supporting documents presented did not meet the requirements established in paragraph a) of Article 123(2) of the CIRC, with the cost being supported by an internal document that does not justify or evidence the cause and nature of the amount, not constituting a properly documented expense; furthermore, the documents do not demonstrate compliance with Articles 28 and 26(4), both of the CIRC, because it recorded up to the limit of the difference between the acquisition or production cost of inventories; "(…) it is also noted that the Claimant does not demonstrate that inventories are recorded at the lower of cost or net realizable value, nor do they demonstrate what the net realizable value is and whether it complies with what is established in Article 26(4) of the CIRC (…)".

In fact, the Claimant considered as an expense in sub-accounts 6521000 – Losses from impairment of raw materials and 6523000 – Losses from impairment of finished goods the amounts of €149,769.97 and €118,351.99, respectively.

According to the Respondent, the supporting documents relating to such losses are internal documents, listings with headers (when present, in German), references and amounts, and additionally a set of slides in English ("Stocktake valuation – Preparation") was presented which suggests corresponding to a manual of procedures for stock valuation.

At the accounting level, the Accounting and Financial Reporting Standard contained in the Accounting Normalization System approved by Decree-Law 158/09 of 13 July (NCRF) 18 – Inventories – provides that, as a general rule, inventories are measured at cost or at net realizable value (NRV), whichever is lower.

And it further provides that, if at the end of the period, the cost exceeds the NRV, an adjustment is made.

The NRV is defined as the estimated selling price in the ordinary course of business activity less estimated completion costs and estimated costs necessary to effect the sale.

The recognition of losses from impairment of inventories (inventory adjustments) depends on the identification of the causes contributing to a loss in value and a process of quantifying the loss through estimates of net realizable value.

And continuing in this line of argument, the Respondent concludes that the official corrections that the Claimant advocates cannot be made automatically, always requiring the identification of the specific assets to which the reversals relate, their origins, and the years in which they were recorded, in order to determine when there is double taxation.

On the other hand, the disallowance of the tax deductibility of costs relating to warranties provided to customers resulted in a positive adjustment to taxable profit in the amount of €96,708.14, on the ground of failure to comply with Article 23(1) regarding documentary proof of the expenses, Articles 123(1) and (2), and also the principle of exercise specialization provided in Article 18(1), all of the IRC Code.

The so-called recharge made by B… to the Claimant and recorded by it in 2010 related to warranty costs that C… had erroneously charged to B….

The documents supporting the accounting record of these costs consist of the debit note no. 2007… dated 17.09.2007, issued by C… (…), in the amount of 153,099.46 USD and the document "Intercompany Recharge Debit Note" no. …, dated 07.07.2010, issued by B…, in the amount of 79,054 pounds, relating to warranty claim proceedings and activation of guarantees by customers, thus relating to warranty costs/repair costs for the period between 01.10.2005 and 31.12.2006.

Meeting of the Tribunal with the parties and investigative measures

On 17-6-2016 a meeting of the Tribunal with the parties took place and the requested evidence was presented [statements of parties and examination of witnesses called], where the Tribunal deliberated, with the agreement of the parties or without their opposition: (a) to extend the period for the final decision pursuant to Article 21(2) of the RJAT; b) that final written arguments be submitted; and c) to defer to the final decision the ruling on the exceptions [See respective minutes].

Subsequently, by order dated 30 August 2016, 15-9-2016 was set as the probable date limit for the issuance and notification to the parties of the final arbitral decision.

The parties submitted their final arguments.

Arguments/Conclusions of the Claimant:

The Claimant submitted the following conclusions:

a) The inventory adjustments made by the Claimant were validated by an independent entity and could only be supported by internal documentation, with external documentation not being required.

b) The Claimant did not tax the inventory adjustments supported at the time of their constitution, going on to tax the reversals of such adjustments in subsequent fiscal years (2011, 2012, 2013, and 2014), as provided for in Article 28 of the IRC Code.

c) Therefore, the adjustment made by the Respondent in this regard should be annulled.

d) Alternatively, in the scenario where the relevant adjustment to fiscal year 2010 subsists, it should be recognized that symmetric, official, and automatic correction is due to the tax result of the fiscal years in which there were reversals of such adjustments (2011, 2012, 2013, and 2014).

e) The accounting record of the debit note issued by C… should be attributed to fiscal year 2010, as it was manifestly unknown to the Claimant before that fiscal year.

f) The costs with warranties that the Claimant had to incur with respect to that entity should therefore be accepted as tax expenses.

g) Therefore, the adjustment made by the Respondent in this regard should be annulled.

h) Without conceding, in a scenario where the relevant adjustment to fiscal year 2010 subsists due to violation of the principle of exercise specialization, it should be recognized that symmetric correction is due to the tax result of the fiscal year to which the costs should relate (2007), pursuant to Administrative Circular 14/93 of 23 November of the IRC Services Directorate.

i) The production of spindle pieces is supported within the scope of the Claimant's activity.

j) The failure in the development of this product entailed significant costs for the Claimant.

k) There should be no doubt that the spindle pieces that became unusable went to scrap.

l) With the cost associated being properly supported and the destination of the goods unambiguously defined.

m) Therefore, the adjustment made by the Respondent in this regard should also be annulled.

Arguments/Conclusions of the Respondent (TA):

i) The Claimant submits to the Arbitral Tribunal's consideration the illegality and consequent partial annulment of the tax acts of additional IRC assessment no. 2013…, relating to fiscal year 2010, and additional IRC assessment no. 2013…, compensatory interest assessment no. 2013…, and default interest assessment no. 2013…, relating to fiscal year 2011, as well as the legality of the decision to dismiss the administrative appeal and hierarchical appeal, further requesting that, without prejudice to the failure of the adjustments advocated for fiscal year 2010, in the part referring to inventory adjustments, official correction of the reversals of inventories taxed in fiscal years 2011, 2012, 2013, and 2014 be ordered, further seeking that in the part relating to warranty costs, official correction to fiscal year 2007 be ordered for acceptance of the cost in question, together with the payment of indemnity interest at the legal rate;

ii) Regarding the request formulated by the Claimant to have official correction of inventory reversals taxed in fiscal years 2011, 2012, 2013, and 2014 ordered, and regarding the part on warranty costs, official correction to fiscal year 2007 be ordered for acceptance of the cost in question, it is important to note that the Arbitral Tribunal is not competent to know of such requests, first and foremost because the requests formulated exceed the scope of the cognitive powers of the arbitral tribunal, since they do not concern the illegality of the tax acts under scrutiny here, and violate the provision in paragraph a) of Article 2(1) of the RJAT which provides that arbitral tribunals are competent to declare the illegality of acts assessing taxes, self-assessment, withholding at source, and payment on account;

iii) Therefore, the material scope of tax arbitration outlined by the aforementioned paragraph corresponds to that established in Article 97(1)(a) of the CPPT, being in situations where one or more tax assessment acts are contested, and in that endeavor, the Arbitral Tribunal cannot determine that official corrections of inventory reversals be made for fiscal years 2011, 2012, 2013, and 2014, and regarding the part on warranty costs, official correction to fiscal year 2007 be ordered;

iv) It is established that the request formulated by the Claimant far exceeds the scope of the material competence established in paragraph a) of Article 2(1) of the RJAT, the Arbitral Tribunal being materially incompetent to rule on such request, reason for which for all legal purposes the dilatory exception is invoked preventing knowledge of the merits of the case, pursuant to Article 576(1) and (2) and Article 278, both of the CPC as amended by Law 41/2013 of 26 June;

v) In the same vein, the request for arbitral ruling does not constitute the appropriate procedural means for the tribunal to determine the making of official corrections in subsequent years, because if the Claimant intends that official corrections be made – following the inspection conducted on fiscal year 2010 – for subsequent fiscal years, the appropriate procedural means to assert such claim by the Claimant will be either the request for official review established in Article 78 of the LGT (administrative review) or through the intimation for a course of action provided in Article 147 of the CPPT (contentious review);

vi) Indeed, the intimation for a course of action constitutes the most appropriate procedural means to ensure protection of the desired result, that is, the determination of official corrections in subsequent years for costs not accepted fiscally in fiscal year 2010;

vii) Therefore, the request for arbitral ruling having as its object the annulment of the disputed assessments does not constitute the procedural means to trigger the making of official corrections in subsequent fiscal years, all the more so because the request for ruling addresses exclusively the legality of the assessments in fiscal years 2010 and 2011 and not the determination of official corrections in subsequent years due to the non-acceptance of expenses in fiscal year 2010;

viii) It is axiomatic that the request for arbitral ruling does not constitute the procedural means to determine the making of official corrections in the years, but rather the intimation for a course of action, reason for which the use of an improper procedural means constitutes a dilatory exception preventing knowledge of the merits of the case, pursuant to Article 576 of the new CPC applicable by virtue of paragraph e) of Article 2 of the CPPT, which prevents knowledge of the request and the dismissal of the defendant from the proceedings pursuant to Article 278, both of the CPC, applicable ex vi paragraph e) of Article 2 of the CPPT;

ix) Regarding inventory adjustments, the Claimant considered as an expense in sub-accounts 6521000 – Losses from impairment of raw materials and 6523000 – Losses from impairment of finished goods the amounts of €149,769.97 and €118,351.99, respectively, as results from the file, the supporting documents relating to such losses are internal documents, listings with headers (when present, in German), references and amounts, additionally a set of slides in English ("Stocktake valuation – Preparation") was presented which suggests corresponding to a manual of procedures for stock valuation;

x) In accordance with Article 28(2) of the CIRC, net realizable value is obtained from the estimated selling price, deducted from necessary completion and selling costs, understanding by selling price those contained in (i) official sources; or (ii) those last practiced in normal conditions by the taxpayer; or also (iii) those which, at the end of the taxation period, are current in the market, provided that in any case they are considered suitable or of unambiguous control;

xi) In tax matters, the CIRC provides that, in case of inventory devaluation, inventory adjustments may be fiscally deductible in determining taxable profit within the limit of the difference between the acquisition or production cost of inventories and the respective net realizable value referred to the balance sheet date, when this is lower than that (Article 28 of the CIRC on this subject refers to CARLOS ALBERTO DA SILVA CUNHA in Taxation in the transition from POC to SNC, OROC magazine no. 116 November 2009 pages 43-45 "... the tax law thus aligns with accounting standards by admitting net realizable value as a method for valuing inventories");

xii) Thus, from the tax and accounting regulations, it is apparent that the recognition of losses from impairment of inventories (inventory adjustments) depends on the identification of causes contributing to a loss in value and a process of quantifying the loss through estimates of net realizable value, or as stated by J.A. PINHEIRO PINTO, "The problems anticipated regarding inventory adjustments – because they already existed regarding provisions for depreciation of inventories – stem from proof as to market prices.";

xiii) Naturally, the proof of adjustments is made with documents whose content must provide clear information on the origin, nature, estimates of prices considered relevant, and quantification of inventory adjustments (already ROGÉRIO FERNANDES FERREIRA taught that "(...)documentation constitutes the basis on which entries in books and accounting records rest, (...) every fact to be recorded must be supported by a justificatory document", since this is a basic principle to be observed in the preparation and execution of regularly organized accounting);

xiv) The Claimant presented a document entitled "Stocktake valuation", having been considered by the Respondent that such document does not meet the formal requirements for purposes of Article 23(1) and paragraph g) of Article 45(1), both of the CIRC, raising in points 53 to 61 of the request for arbitral ruling amazement at such requirement, arguing that "the accounting record ("entry") of a provision/entry in inventories derives from a management decision of internal Companies, which cannot be supported by other documents besides internal documents" and having corroborated such argument by the witnesses during examination;

xv) However, the question will be asked, will the burden of proof vary depending on the corporate purpose pursued by the taxpayers?;

xvi) Or will it be that depending on a certain corporate object, the rules contained in the accounting and tax standards are set aside and without application?;

xvii) Moreover, how is it compatible, under penalty of violation of the principle of equality and taxpayer capacity, to require of a certain taxpayer the proof of inventory adjustments in external documents - and in accordance with accounting and tax standards established by law and the fulfillment of the requirements established in Article 23(1) and paragraph g) of Article 45(1), both of the CIRC –, and to accept of the Claimant the demonstration of such adjustments with mere internal documents, under the cover of the specificity of the automobile sector?;

xviii) And given the argumentative rationale established by the Claimant, how could such proof regarding inventory adjustments not be extended to other equally complex market areas, such as the pharmaceutical industry, cutting-edge technology, etc?;

xix) Indeed, the proof of inventory adjustments can never – under penalty of being contrary to Article 23(1) and paragraph g) of Article 45(1), both of the CIRC, and to the constitutional principles of equality and taxpayer capacity – be made through a mere internal document, as the Claimant did;

xx) And all the less is it permissible to allege that given the specificity of the automobile market and the group of companies in which the Claimant is inserted, such proof could only be made through mere internal document;

xxi) Indeed, while it is true that estimates of net realizable value and the calculation of the amount of adjustments must be made in internal documents created in the company itself, it is undeniable that they must be supported in external documents, in this case, purchase invoices (raw materials), sales invoices (finished goods), contracts, estimates on completion and selling costs, or other suitable elements capable of justifying both the necessity of recognizing expenses for inventory adjustments and their quantification, as well as to make known the events and circumstances capable of determining the determination of a potential loss in value in the inventories;

xxi) Moreover, the administrative doctrine constructed based on the opinion of the CEF no. 3/92 of 06.01.1992 indicates that "An internal document lacks additional means of proof that unambiguously demonstrate the materiality of the operation underlying it." and identical understanding has TOMÁS CANTISTA TAVARES (in On the relationship of dependence between accounting and tax law in determining the taxable income of legal entities, some reflections at the level of costs, Science and Tax Technique, 396 pages 123 et seq.) on the notion of justificatory document is broader than the notion of invoice, being able to encompass any external form of representation of the operation without specific invoice solemnities "provided that it explicitly sets forth clearly the main characteristics of the operation (the parties, the price, the date, and the object of the transaction");

xxiii) Now, these are the additional elements that lead to understanding the causes of inventory depreciation and the parameters that serve as reference for its quantification, which the Claimant failed to present, whereby in accordance with the provision in Articles 23 and paragraph g) of Article 45(1), both of the CIRC, the documents presented by the Claimant "Stocktake valuation" cannot be considered as documents justifying the costs for purposes of determining taxable profit, since these are only tax deductible when being properly proven, will be indispensable for generating profits or for maintaining the source of production, whereby the absence of requirements implies non-consideration of the costs (see F. Pinto Fernandes and Nuno Pinto Fernandes, Corporate Income Tax Code annotated and commented, Rei dos Livros 5th Edition, 1996 pages 206 et seq.);

xxiv) Therefore, the documents presented by the Claimant "stocktake valuation" do not meet the requirements as to their content sufficiency, as well as to their origin, capable of proving the net realizable value of raw materials (replacement price) and finished goods (selling price less completion and selling costs) and the events that determined the potential loss in value expressed by the losses from impairment;

xxv) Finally, taking into account that reversals of inventory adjustments can be determined by write-off, sale, or (cf. no. 33 of NCRF) or when the circumstances that previously resulted in adjustment to the value of inventories cease to exist or when there is clear evidence of an increase in net realizable value due to change in the circumstances initially considered, the non-deductibility of inventory adjustments recorded in 2010 will imply that the reversals that contributed to the calculation of taxable profit in subsequent fiscal years be subtracted from taxation, making it necessary to establish the necessary correspondence between the amounts adjusted in 2010 and the amounts and origin of the reversals recorded in 2011 and subsequent years;

xxvi) Thus, taking into account that losses from impairment expressed by inventory adjustments are calculated, regarding raw materials and finished goods, and within each group, element by element, any eventual corrections to be made to the reversals in 2011 and subsequent years cannot be triggered automatically, because it becomes necessary to identify the specific assets to which the reversals relate, their origins and the years in which they were recorded, in order to determine when there is double taxation;

xxvii) Hence, in addition to the exceptions invoked regarding the request formulated, the official corrections that the Claimant advocates cannot be made automatically, always being necessary the identification the assets to which the reversals specifically relate, their origins and the years in which they were recorded, in order to determine when there is double taxation, whereby the arguments invoked by the Claimant fail summarily;

xxviii) The disallowance of the tax deductibility of costs relating to warranties provided to customers resulted in a positive adjustment to taxable profit in the amount of €96,708.14, on the ground of failure to comply with Article 23(1) regarding documentary proof of the expenses, Articles 123(1) and (2), and also the principle of exercise specialization provided in Article 18(1), all of the IRC Code, with the so-called recharge having been made by B… to the Claimant and by it recorded in 2010 relating to warranty costs that C… had erroneously charged to B…;

xxix) The documents supporting the accounting record of these costs consist of the debit note no. 2007… dated 17.09.2007, issued by C… (…), in the amount of 153,099.46 USD and the document "Intercompany Recharge Debit Note" no. …, dated 07.07.2010, issued by B…, in the amount of 79,054 pounds, relating to warranty claim proceedings and activation of guarantees by customers, thus relating to warranty costs/repair costs for the period between 01.10.2005 and 31.12.2006;

xxx) Notwithstanding the Claimant's explanation that the outcome of the warranty process only came to its knowledge in 2010, for reasons not attributable to it, it does not cease, however, to recognize that there was a long process of negotiation with the services of C… about the claimed amounts, whereby the provision of Article 18(2) of the IRC Code cannot be applied, whereby it appears that the Claimant had already accepted the expenses, as denoted by the entries in the document dated 17.09.2007, and on the other hand, the internal control procedures instituted for claims lead to believe that the Claimant would have had to have actual knowledge of its responsibilities regarding the warranties provided and of the respective amount;

xxxi) Indeed, it is considered strange that, having spent a long process of negotiation and analysis whose responsibility was of the warranty department of A… in Coventry (United Kingdom) and the debit note of C… having been issued in 2007, that it only came to the Claimant's knowledge in 2010, through the endorsement of B… to the Claimant of the cost relating to warranty costs of fiscal year 2007, because it understands that the debit note issued by C… was wrongly addressed to it;

xxxii) Leaning once more on the arguments ventured by the Claimant and the testimonial evidence produced, it is extracted that it is the legal system that must adapt to the requirements and complexity of the automobile sector and not the reverse;

xxxiii) That is, the observance of the principle of exercise specialization, provided in law will – in the understanding of the Claimant – have to be readjusted depending on the specificities of the market and the group of companies in which the Claimant is inserted – since the costs with warranties provided should have been attributed to taxable profit in the fiscal year to which they related – 2007, year in which their responsibilities were determined and the debit note was issued by C… – and not in the year 2010, that is, about 3 years later;

xxxiv) Regarding the disallowance of costs in the total amount of €1,772,996.11, relating to write-offs of raw materials, work-in-progress and finished goods, considered as scrap, mainly originating from deficiencies and imperfections that caused various quality problems and re-engineering in the production line of the spindle project for automobiles, such records are supported by internal documents that the Respondent entity did not qualify as valid to prove the effectiveness of the losses suffered, as required by Article 23(1) of the IRC Code, because they do not evidence the cause, nature, and amount relating to each of the elements that were subject to write-off;

xxxv) The internal documents presented by the Claimant comprise: the accounting movement journal, with accounts moved and amounts and two emails, one written in English and another in Spanish, and an extract from the account…, on the other hand, in the external documents presented by the Claimant, namely the Model A guides from the Ministry of the Environment, Spatial Planning and Regional Development, the descriptions evidence generic designations (Metals, Plastic scrap, Clean iron scrap), or there is no designation whatsoever, and discrepancies were also detected both between the value of the costs considered and the kilos/m3 contained in the guides, when compared monthly, as well as between the dates of the guides and the dates of the write-off in inventories;

xxxvi) The guides do not allow identification of the class in which the goods are integrated (raw materials, work-in-progress or finished goods) but only the nature of the materials, namely plastic material, steel, wood and aluminum, with no invoice or equivalent document having been issued relating to the written-off materials, pursuant to Article 36 of the VAT Code, regarding the scrap sent to the economic operator that develops activity in that domain;

xxxvii) It must be concluded that the documents that served as support for the accounting record of the write-offs, both internal and external, do not allow unambiguous control of their values and nature of the written-off goods nor of their true destination and, consequently, are not capable of proving the respective costs, as required by Article 23(1) of the IRC Code, which combined with paragraph g) of Article 45(1) of the same Code implies the disallowance of these costs for determining taxable profit.

II. CASE MANAGEMENT

Material Competence of the Tribunal

The Respondent argues, to substantiate the exception of material incompetence of the Tribunal, that the Claimant, in view of the failure of the adjustments advocated for fiscal year 2010, in the part relating to inventory adjustments, requests that the Tribunal determine official correction of inventory reversals taxed in fiscal years 2011, 2012, 2013, and 2014, and that regarding the part on warranty costs, likewise determine official correction to fiscal year 2007 for acceptance of the cost in question.

The Respondent concludes that the requests formulated exceed the scope of the cognitive powers of the arbitral tribunal, since they do not concern the illegality of the acts of assessment here under scrutiny in light of the provision in Article 2(1)(a) of the RJAT, that is, "(...)as regards the request formulated by the Claimant to have official corrections determined for the making of corrections in subsequent years, it is established that the Arbitral Tribunal is materially incompetent to rule on such request, reason for which the dilatory exception is invoked for all legal purposes preventing knowledge of the merits of the case, pursuant to Article 576(1) and (2) and Article 278 of the CPC as amended by Law 41/2013 of 26 June (...)".

Let us see:

The Claimant comes requesting the Tribunal [formulation of the request] to:

a) Declare illegal, for violation of law, due to error regarding factual and legal premises, the tax act of additional IRC assessment no. 2013…, relating to fiscal year 2010, ordering its annulment to the extent that the amount of €2,137,826.21 was disregarded as tax losses, as well as annulment of the decisions rejecting the administrative appeal and hierarchical appeal that upheld it;

b) Declare illegal, for violation of law, due to error regarding factual and legal premises, the tax acts of additional IRC assessment no. 2013…, compensatory interest assessment no. 2013…, and default interest assessment no. 2013…, all relating to fiscal year 2011, ordering their annulment to the extent that the amount of €2,137,826.21 was disregarded as deductible tax losses, as well as annulment of the decisions rejecting the administrative appeal and hierarchical appeal that upheld them;

c) Order the reimbursement to the Claimant of the tax paid in excess as a result of the partial annulment of the assessments under the terms requested in a) and b) above;

d) Without prejudice, in the event (which must be considered) that with respect to the adjustments made to the taxable income for fiscal year 2010, the request for annulment is denied:
d.1.) in the part relating to inventory adjustments, then, alternatively, official correction of inventory reversals taxed in fiscal years 2011, 2012, 2013, and 2014 should be ordered;
d.2.) in the part relating to warranty costs, then, alternatively, official correction of fiscal year 2007 should be ordered for acceptance of the cost in question;

e) Order the payment to the Claimant of indemnity interest due, pursuant to Article 43(1) of the LGT and Article 61 of the CPPT, calculated at the supplementary legal rate on the tax paid in excess as a result of the partial annulment of the assessments under the terms requested in a) and b) above, and calculated from 27 August 2013 until full reimbursement of said amount.

Now it is clearly evident that the exception is raised not regarding the principal request but rather regarding the subsidiary request formulated in point d).

This alone is sufficient to assess the question only insofar as the Tribunal must assess such subsidiary request.

The Tribunal is thus competent (at least and for now, to assess the principal request) and is regularly constituted, pursuant to Articles 2(1)(a), 5, and 6, all of the RJAT. The parties have legal personality and capacity, are legitimate and are legally represented, pursuant to Articles 4 and 10 of the RJAT and Article 1 of Ordinance no. 112-A/2011 of 22 March.

Unsuitability of the Procedural Means

The Respondent equally excepts to the procedural means used by the Claimant, considering it unsuitable for the tribunal to determine the making of official corrections in subsequent years.

Being such matter equally the object of a subsidiary request opportunely and if such be the case, such exception will be assessed.

There are no defects that invalidate the proceedings. It is now necessary to assess the merits of the request.

III. GROUNDS FOR DECISION

III.1. Proven Facts

It must be noted preliminarily that the judge (or arbitrator) does not have the duty to rule on all the matters alleged, having instead and only the duty to select the (factual matters) that are relevant to the decision, taking into account the cause (or causes) of action that sustain the request(s) formulated by the plaintiff (see Articles 596(1) and 607(2) to (4) of the CPC as amended by Law no. 41/2013 of 26/6, applicable ex vi Article 29 of the RJAT) and to establish whether it considers it proven or not proven (see Article 123(2) of the Tax Procedure and Process Code).

In this light, the following are the facts considered proven by the Tribunal:

1. The Claimant is a company incorporated under Portuguese law whose capital belongs entirely to the German company D… GMBH;

2. The Claimant's main activity is the production, assembly, and sale of locking systems for the automobile industry;

3. The automobile industry is characterized by strong specificities, among which the following stand out:

   a. A small number of automobile manufacturers (referred to as OEM – Original Equipment Manufacturer, such as C…, E… or F…) and a substantial number of independent suppliers to whom the OEM subcontract significant portions of production (as is the case of the Claimant);

   b. Logic of anticipation, on the part of OEM, who order components for the production of vehicles to be sold a relatively extended period of time thereafter;

   c. The locking systems for automobiles produced by the Claimant are conceptually developed by the central engineering department of Group G…;

   d. Such locking systems are customized for a specific series of a specific model of a vehicle of an OEM;

   e. After the insertion of a locking system into the automobile model of each OEM, industrial property of such system is held by the OEM;

   f. The locking systems produced for a given OEM in no circumstance can be utilized by the Claimant, either for another OEM or for any after-sales service;

4. The locking systems that the Claimant produces are customized for a unique and clearly delimited market;

5. The locking systems produced by A… can only be used by the specific OEM that ordered them, and cannot be adapted for any other function or use;

6. In the particular case of the Claimant, the values considered for purposes of the adjustments are referenced by the central services of the Group, since it is the department responsible for the tender and negotiation of the order portfolio with the OEM;

7. The Claimant presented a document entitled "Stocktake valuation", having been considered by the Respondent entity that such document does not meet the formal requirements for purposes of Article 23(1) and paragraph g) of Article 45(1), both of the CIRC;

8. The adjustments (impairments) in inventories made by the Claimant in 2010, in the total amount of €268,121.96, are supported by internal documentation;

9. In the production by the Claimant of locking systems there is a technical factor that it is obliged to consider: of the thousands of parts it will produce, the Claimant estimates, based on its experience, that a certain percentage (technical factor) of production will result in defective parts, establishing thus a ratio (defective parts/parts produced) and this ratio will constitute the technical factor to apply;

10. Any part claimed by customers with multinational expression is subject to prior validation by one of the central departments of Group G… for collection and analysis of guarantees – B… or H… (cf. statements of parties);

11. These central departments analyze the reports with the claims, conduct tests on the claimed materials, presenting their arguments to reduce the amount of the warranty to be provided (process called "Field…");

12. After this process is completed, the same departments proceed to redistribute the claims by the concrete production units of the Group whose responsibility was defined and determined;

13. In this case, group C… made in 2007 a claim with B…;

14. ... which in 2010 B… recognized that part of the claimed amounts related to the Claimant and only then did B… inform the Claimant of the claim made by C… and of the respective amount of responsibility that was attributed to it, whereby only in 2010 did the Claimant come to know of the claim made by C…;

15. The Claimant recorded the responsibility that was attributed to it in the fiscal year in which it came to know of the claim, that is, in 2010;

16. The part or article called spindle is a new product developed by the engineering department of A… and that relates to the manufacture of springs for car trunks;

17. The spindle was introduced in 2010 and constituted a novelty compared to the type of production of A… at that time;

18. The spindle was produced to be later incorporated in high-end vehicles;

19. During the vehicle production process, serious problems were reported with the trunks, and failures were identified in said spindle product;

20. And those parts sent by the Claimant became unusable;

21. And the parts that were being produced and those that had just been produced and ready for shipment also became immediately unusable;

22. In an attempt to solve the problem, the central engineering department of A… kept determining successive changes to the spindle design, which had to be automatically adopted by the Claimant;

23. As the engineering department introduced changes to the spindle design, the components produced by the Claimant up to that point (and in their most varied versions) became immediately unusable;

24. Unable to be applied anywhere else, because they constitute intellectual property of the OEM, the defective spindle products went to scrap (see the proof of the registration of the defective spindle products on the SIRAPA platform - "Integrated System for Registration of the Portuguese Environment Agency – Integrated Waste Registration Map" –, with indication of the types of waste and respective tonnage);

25. On 30 May 2012, the Claimant submitted a periodic income statement (Form 22) replacing the IRC for fiscal year 2010, in which zero taxable income was declared due to the determination of tax losses in that fiscal year, which amounted to €2,748,675.26 (document number 1);

26. On 31 May 2013, the Claimant presented a periodic income statement (Form 22) replacing the IRC for fiscal year 2011, in which taxable income of €1,466,281.08 was declared as a result of deducting from the taxable profit determined in fiscal year 2011 (€4,214,956.34) the amount of tax losses determined in fiscal year 2010 (i.e., €2,748,675.26) (document number 2);

27. The Claimant was subject to an external tax inspection of general scope, relating to fiscal year 2010, conducted by the Tax Inspection Services ("SIT") of the Tax Directorate…, undertaken pursuant to service order no. OI2012…, due to the high tax loss and the decrease in gross profit margin over cost (compared to the prior fiscal year) from 86% to 20%;

28. In the course of the aforementioned tax inspection, the SIT made the following adjustments:

1. The Claimant was notified to exercise the right to prior hearing regarding the draft Tax Inspection Report, but did not exercise it, whereby the adjustments proposed above were entirely maintained in the Final Tax Inspection Report ("Inspection Report"), of which the Claimant was notified on 24 April 2013 (document number 3).

2. Based on the aforementioned adjustments, the Tax and Customs Authority ("TA") made the following additional assessments, which reflect the adjustments resulting from the inspection:

· Additional IRC assessment no. 2013…, dated 2 May 2013 (compensation no. 2013… – nil), relating to fiscal year 2010, and account reconciliation statement no. 2013…, dated 6 May 2013, in which the TA maintained the value of the tax credit to be refunded to the Claimant (€6,130.72) (document number 4);

· Additional IRC assessment no. 2013…, dated 21 June 2013 (compensation no. 2013… - €325,088.15), relating to fiscal year 2011, in the amount of €311,489.42, account statement for compensatory interest assessment no. 2013…, in the amount of €12,459.57, and default interest assessment no. 2013…, in the amount of €1,139.16, and account reconciliation statement no. 2013…, dated 21 June 2013, resulting in a total balance payable of €325,088.15 [compensation no. 2013…] (document number 5), which the Claimant paid on 27 August 2013 (document number 6);

1. Disagreeing with the adjustments (and their respective grounds) set forth in sections III.1.2 (redisallowance of warranty costs), III.1.4 (impairments – inventory adjustments), and III.1.5 (inventory write-downs/disposals) of the Inspection Report, which totaled €2,137,826.21 and which also served as the basis for the aforementioned assessments, the Claimant filed an administrative appeal on 17 July 2013 (document number 7);

2. On 29 January 2014, the Claimant, having had the appeal dismissed, filed a hierarchical appeal of such dismissal decision and which had been notified to it on 2 January 2014 (document number 8);

3. The hierarchical appeal was entirely dismissed by decision dated 26 June 2015, having been communicated to the Claimant by registered mail with return receipt received on 27 July 2015 (document number 9);

4. The aforementioned impairments in inventories, recorded as an "expense" in sub-accounts 6521000 ("Losses from impairment of raw materials" and 6523000 ("Losses from impairment of finished goods") by the amounts of €149,769.97 and €118,351.99, respectively, result from the adoption in the Claimant of the stocktake valuation that it receives from the central department of A…;

5. These entries were justified by an internal document of the Claimant;

6. On 27-8-2013 the Claimant made the payment of €325,088.15 (additional IRC assessment no. 2013…, compensatory interest assessment no. 2013…, and default interest assessment no. 2013…) – See document 6, accompanying the request for arbitral ruling.

III.2 Unproven Facts

It was not demonstrated:

• That there were no reliable documentary supports for the measurement of impairments in inventories, recorded as an "expense" in sub-accounts 6521000 ("Losses from impairment of raw materials" and 6523000 ("Losses from impairment of finished goods") by the amounts of €149,769.97 and €118,351.99, resulting from the adoption in the Claimant of the stocktake valuation that it receives from the central department of A….

III.3 – Grounds

According to the principle of free assessment of evidence, the Tribunal bases its decision, regarding the evidence produced, on its intimate conviction, formed from the examination and evaluation it makes of the means of evidence brought to the proceedings and in accordance with its experience of life and knowledge of people (see Article 607(5) of the Civil Procedure Code as amended by Law 41/2013 of 26/6). Only when the probative force of certain means is pre-established in law (e.g., full probative force of authentic documents – see Article 371 of the Civil Code) is the principle of free assessment of evidence not dominant in the assessment of the evidence produced.

In this case and for the proof of the facts, the statements given by I…, mechanical engineer by training, general director and manager of the Claimant – who testified in the capacity of a party – and by the witnesses called by the Claimant, J…, employee of the Claimant and responsible for quality control and K…, economist and tax consultant of the staff of the audit company "L…, SA", with headquarters in Porto that provides services to the Claimant in the area of taxation, were taken into account, combined, and analyzed critically. These statements were globally considered credible and demonstrated knowledge, particularly technical, within the scope of their respective activities and specifically in relation to the specific matter at issue in the proceedings.

The administrative investigative file was also relevant to the formation of the Tribunal's conviction regarding the evidence, and in particular the report of the Tax Inspection Services as well as the other documents attached to the file and that the Tribunal analyzed critically in combination with the positions of the parties reflected in their respective pleadings and arguments.

IV – THE LAW

IV.1. Issues to be Decided

The following are the adjustments made by the TA to the tax losses for fiscal year 2010 summarized in the following table:

· Concretely and equally questioned are the adjustments referred to in sections III.1.2 [€96,708.14 – redisallowance of warranty costs], III.1.4 [€268,121.96 - impairments inventory adjustments] and III.1.5 [€1,772,996.11 - inventory write-downs/disposals] and the consequent additional IRC assessments [no. 2013…, dated 2 May 2013 (compensation no. 2013… – nil), relating to fiscal year 2010 (document number 4) and additional IRC assessment no. 2013…, dated 21 June 2013 (compensation no. 2013… - €325,088.15), relating to fiscal year 2011, in the amount of €311,489.42 with account statement for compensatory interest assessment no. 2013…, in the amount of €12,459.57, and default interest assessment no. 2013…, in the amount of €1,139.16, and account reconciliation statement no. 2013…, dated 21 June 2013, resulting in a total balance payable of €325,088.15 [compensation no. 2013…] (document number 5), which the Claimant paid on 27 August 2013 (document number 6)].

Thus and regarding each of the questioned and described adjustments, the analysis is to determine whether the operations and respective accounting entries comply or obey the rules imposed by the CIRC as the Claimant intends or whether, on the contrary, the adjustments made by the TA are in harmony with the technical standards provided in the Law so as not to be affected by violation of the Law the tax acts in question.

More concretely: the Respondent understood that the costs/adjustments made by the Claimant and now in question [sections III.1.2, III.1.4, and III.1.5 of the Tax Inspection Report (RIT)] were supported by mere internal documents, which do not justify or evidence the cause and nature of the amount, not constituting a properly documented expense.

On the other hand and according to the Respondent, such documents do not demonstrate compliance with Articles 28 and 26(4), both of the CIRC, because the Claimant recorded up to the limit of the difference between the acquisition or production cost of inventories, it is also noted that the Claimant does not demonstrate that inventories are recorded at the lower of cost or net realizable value, nor do they demonstrate what the net realizable value is and whether it complies with what is established in Article 26(4) of the CIRC.

IV.2 – Framework

It should be noted that the Courts do not have to assess all the arguments formulated by the parties – this is what has been repeatedly affirmed, for a long time, by jurisprudence [See inter alia, Decision of the Plenum of the 2nd Section of the STA, of 7 June 95 (case 5239, in DR – Appendix of 31 March 97, pages 36-40) and Decision of the STA – 2nd Section – of 23 April 97 (DR/Appendix of 9 October 97, page 1094), but have only the duty to assess and decide the questions raised by the parties, in addition to those of which they must take official cognizance.

Let us see then.

IV.3 - General Considerations

In order to allow for the determination of taxable profit according to the concept established in Article 17(1) of the CIRC/2010, the accounting must be organized in accordance with accounting normalization and other legal provisions in force for the respective sector of activity, without prejudice to the specificities provided in the CIRC and must reflect all operations carried out by the taxpayer so that the results of operations and patrimonial variations subject to IRC can clearly be distinguished from the remainder [See nos. 3-a) and b) of the CIRC].

All accounting entries must be supported by justificatory documents, dated and capable of presentation whenever necessary [Article 123(2)(a) of the CIRC].

On the heading "Inventories", corresponding to subsection II of section XII of chapter III of the CIRC, Article 26 – Inventories provides:

1 — For purposes of determining taxable profit, the income and costs of inventories are those that result from the application of methods using:

a) Acquisition or production costs;

b) Standard costs determined in accordance with appropriate accounting techniques;

c) Selling prices reduced by normal profit margin;

d) Selling prices of products harvested from biological assets at the time of harvest, reduced by estimated costs at the point of sale, excluding those for transport and others necessary to place the products on the market;

e) Special valuations for inventories considered basic or normal.

2 — Where inventories require a period exceeding one year to reach their condition of use or sale, the acquisition or production costs include the costs of borrowed funds obtained that are directly attributable to them in accordance with the applicable accounting normalization.

3 — Whenever the use of standard costs results in significant variations, the General Tax Directorate may make appropriate corrections, having regard to the field of application thereof, the amount of sales and final inventories, and the degree of inventory rotation.

4 — Selling prices are those appearing in official sources or those last practiced in normal conditions by the taxpayer or those which, at the end of the taxation period, are current in the market, provided that in any case they are considered suitable or of unambiguous control.

5 — The method referred to in paragraph c) of no. 1 is only accepted in sectors of activity where the calculation of acquisition or production cost becomes excessively burdensome or cannot be determined with reasonable accuracy, and the normal profit margin, in cases where it cannot be easily determined, may be replaced by a deduction not exceeding 20% of the selling price.

6 — The use of special valuations provided in paragraph e) of no. 1 requires prior authorization from the General Tax Directorate, requested in a petition stating the methods to be adopted and the reasons justifying them.

Regarding adjustments in inventories, Article 28 of the CIRC provides:

1 — Deductible in determining taxable profit are adjustments in inventories recognized in the taxation period up to the limit of the difference between the acquisition or production cost of inventories and the respective net realizable value as of the balance sheet date, when the latter is lower than the former.

2 — For purposes of the above, net realizable value means the estimated selling price in the normal course of the taxpayer's activity according to no. 4 of Article 26, less the necessary costs of completion and sale.

3 - The reversal, partial or total, of the adjustments provided in no. 1 contributes to the formation of taxable profit. (Amended by Rectification Decree no. 67-A/2009 - 11/09)

4 — For taxpayers engaged in publishing activity, the annual accumulated amount of the adjustment corresponds to the loss in value of publishing funds consisting of works and supplementary elements, provided that two years have elapsed after the date of their respective publication, which for this purpose is considered to coincide with the date of legal deposit of each edition.

5 — The devaluation of publishing funds must be evaluated based on elements contained in the records evidencing the movement of works included in the funds.

IV.4 – The Facts and Their Subsumption

According to the Respondent (TA), the supporting documents presented by the Claimant did not meet the requirements established in paragraph a) of Article 123(2) of the CIRC.

We do not see that this is the case in that the proven facts reveal that the value of the inventory adjustments made by the Claimant and supported only by internal documentation was calculated in an appropriate manner, taking into account the specificities of the market in which the Claimant operates, and nowhere in the Law is it expressly or implicitly excluded, proof by internal documentation, provided that the same be convincing and appropriate and perhaps accompanied by other means of proof that consolidate and make it credible. In summary or synthesis: the documents comply with the formal requirements required for purposes of Article 23(1) and paragraph g) of Article 45(1), both of the CIRC (proper documentation of expenses).

On the other hand, the Claimant had no effective way of coming to know in 2007 of the claim made by C… with B… (see above, in "proven facts", points 13 and 14), and the amounts recorded accounting as write-offs actually resulted from losses caused by the spindle project and were destined for scrap in the absence of any other alternative for the reasons that emerge from the proven facts (see above, "proven facts", points 22 to 24).

It should be noted that extraordinary breakage of inventories through depreciation in value, adjustments or write-offs, are losses that are demonstrably indispensable for maintaining the source of production and are therefore costs with tax effects, pursuant to Article 23 of the CIRC.

Reason for which the fiscal acceptance of losses resulting from write-off, adjustments or regularization of inventories duly recorded in the accounting does not depend on the observance of any legal formalities, particularly regarding the form or nature of the document that serves as support for the respective entries [the legal requirement is only of a justificatory document without specifying its origin or nature – see Article 123(2)(a) of the CIRC]

IV.5 - Further Development of the Question of Impairments:

The expression "impairment loss" was introduced by the Accounting Normalization System (SNC).

The concept is regulated in a general manner in Accounting and Financial Reporting Standard 12 (NCRF 12) - Impairment of Assets, which is based on International Accounting Standard IAS 36 - Impairment of Assets, adopted by the original text of Commission Regulation (EC) no. 1126/2008 of 3 November. It corresponds to the English expression "impairment" and was inspired by international accounting standards (IAS/IFRS) issued by the IASB.

The term "impairment", although existing in Portuguese dictionaries, was not part of the accounting language previously disclosed.

It is defined as "impairment loss" the excess of the carrying amount (recorded) of an asset, or a cash-generating unit, in relation to its recoverable amount.

NCRF 12 - Impairment of Assets aims to establish the procedures that an entity must apply to ensure that its assets are carried at no more than their recoverable amount. An asset is carried at more than its recoverable amount if its carrying amount exceeds the amount to be recovered through use or sale of the same. If this is the case, the asset is described as impaired and the Standard requires that the entity recognize an impairment loss. The Standard also specifies the circumstances in which an entity must reverse an impairment loss and establishes disclosure requirements.

However, it contemplates different solutions when applied in the accounting treatment of asset impairment, namely those identified in its §2, including those relating to Inventories (NCRF 18) and Receivables (NCRF 27).

Impairments in inventories are one of the exceptions to the treatment of NCRF 12 - Impairment of Assets, this issue being addressed in NCRF 18 - Inventories.

The practice of reducing the cost of inventories (write down) to net realizable value is consistent with the view that assets should not be carried at amounts exceeding those that would presumably result from their sale or use.

Inventories are generally reduced to their net realizable value item by item, and in some circumstances, it may be appropriate to group similar or related units.

Impairment losses on inventories are calculated by the difference between the purchase cost, or production cost, and its net realizable value, when the latter is lower.

The cost of inventories may not be recoverable if those inventories are damaged (it can be affirmed that this will be the case in the proceedings), if they become partially or totally obsolete, or if their selling prices have decreased. The cost of inventories may also not be recoverable if estimated completion costs or estimated costs to be incurred to realize the sale have increased.

Given this, the problem then lies in determining net realizable value, that is, in defining the conditions of its calculation.

According to §§ 30 and 31 of NCRF 18 - Inventories, estimates of the net realizable value that inventories are expected to realize should be based on the most reliable evidence available at the time the estimates are made. These estimates should take into account variations in prices or costs directly related to events occurring after the end of the period, insofar as such events confirm conditions already existing at the end of the period.

Estimates of net realizable value should also take into account the purpose for which the inventory is held.

At the end of each reporting period, the net realizable value must be reassessed, and when the circumstances that previously resulted in adjustment to the value of inventories cease to exist, or when there is clear evidence of an increase in net realizable value due to change in circumstances, the amount of the adjustment must be reversed, so that the new carrying amount is the lower of the cost and the revised net realizable value.

Thus it is that, in light of accounting rules, companies in general, and the automobile sector in particular, must measure, on a permanent basis, existing inventories by the lower of two amounts: their acquisition cost or their net realizable value. At all times the exercise is carried out of knowing whether inventories (i) are saleable and, if so, (ii) at what value, so as to prevent the value of inventories, and consequently of the balance sheet, from being overstated. From the exercise of permanent evaluation of the net realizable value of existing inventories may result the accounting entry of negative adjustments (the aforementioned impairments) to the value of inventories, whenever the historical cost is superior to net realizable value, that is, in cases where companies will not – presumably – be able to recover with the sale of inventories the amount they paid when acquiring them.

The problem in the specific case is the determination and proof of net realizable value.

According to the Claimant (see arguments), "the values considered for purposes of the adjustments are referenced by the central services of the Group, since it is the department responsible for the tender and negotiation of the order portfolio with the OEM, as explained by the manager of the Claimant in the statements of the party. Indeed, and with particular emphasis on the automobile sector, the measurement of the net realizable value of inventories and the consequent measurement of an impairment can only be determined through an internal evaluation process, since the automobile components are destined for a specific OEM and a concrete automobile series. (…) In any sector of activity, in any Company, the accounting record ("entry") of an impairment in inventories can only result from a management decision internal to Companies, because only these can assess, at each moment, whether the net realizable value of inventories (i.e., its recoverable value) proves to be lower than the amount at which they are accounted for – which should determine the entry of an impairment for the difference. Being, unequivocally, a management decision internal to Companies, the entry of an impairment in inventories cannot be supported by documents other than internal documents.

Furthermore, in this case, the accounting entry of the adjustment was audited by the Official Auditor of the Claimant, an entity that performs its functions in a regime of complete functional and hierarchical independence. As a result of the exercise of its functions endowed with public faith, the Official Auditor issued a Legal Certification of Accounts on the financial statements of the Claimant, having expressed no reservations regarding the adjustments made by the Claimant in fiscal year 2010. Given the foregoing, the Claimant subjected such impairments to the tax regime specifically provided in Article 28(1)(3) of the IRC Code. As such, the Claimant did not tax the inventory adjustments at the time of their constitution (2010). However, it...

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