CAAD 648/2017-T: Deductibility of Financial Expenses Under Article 23 of the IRC Code

ARBITRAL DECISION (consult complete version in PDF)

The arbitrators José Poças Falcão (arbitrator chairman), Manuel Alberto Soares (arbitrator member) and Américo Brás Carlos (arbitrator member), agree on the following:

1 – REPORT

A..., SA, with the NIPC..., and registered office at Rua ..., nº..., ... -... ..., hereinafter referred to as the Claimant, came, pursuant to the provisions of paragraph a) of no. 1 of article 2 of the Legal Framework for Arbitration in Tax Matters (RJAT) approved by Decree-Law no. 10/2011, of January 20, to request the constitution of a collective arbitral tribunal, having submitted the following claims:

a) Declaration of illegality of the IRC assessment of Group B..., of which the Claimant is the dominant company within the meaning and for the purposes of the Special Tax Treatment Regime for Groups of Companies (RETGS) provided for in articles 69 et seq. of the IRC Code (CIRC), relating to the fiscal year 2012, which, within the scope of the internal inspection procedure determined by service order OI2015..., reflected the non-deductibility for tax purposes of financial charges in the amount of € 2,152,229.19 borne by the Claimant as a company forming part of Group B... arising from the external inspection procedure determined by service order OI2014.... The amount of the disputed assessment is € 112,045.35, with payment deadline of 10.02.2017.

b) Consideration for purposes of calculating the 2012 IRC of the deduction from the tax liability to which the Claimant is entitled under the SIFIDE (Tax Incentive System for Research and Business Development).

The Claimant appointed arbitrator Manuel Alberto Soares pursuant to article 11, no. 2 of the RJAT.

The request for constitution of the arbitral tribunal was accepted by the President of the CAAD and notified to the Respondent, the Tax and Customs Authority (AT).

The AT appointed arbitrator Américo Brás Carlos under no. 3 of article 11 of the RJAT.

In the absence of the agreement provided for in no. 6 of article 11 of the RJAT, the President of the Deontological Council of the CAAD appointed as arbitrator-chairman Judge José Poças Falcão.

The parties, duly notified, accepted the appointments.

The collective arbitral tribunal was constituted on March 5, 2018.

The Claimant requests that the Tribunal declare:

"a) The illegality of the disputed assessment for having used an indirect, presumptive method of allocation of financial charges in disregard of articles 87 to 90 of the LGT, without expressly invoking that the AT that in the specific case there was a place for recourse to an indirect assessment method, which was its responsibility under the provisions of article 74, no. 3 of the LGT.

The illegality of the disregard of the financial charges borne that were transferred in the loans granted to C..., for being deductible charges, under article 23 of the CIRC.

The illegality of the disregard of the financial charges borne for the carrying out of supplementary contributions, for being deductible charges, under article 23 of the CIRC or, subsidiarily, that the transfer pricing regime should have been applied.

The illegality of the disregard of the financial charges borne for the acquisition of equity interests, for being deductible charges, under article 23 of the CIRC.

In the case of there being a partial annulment, the illegality of the assessment for being, in this case, an indivisible act.

That the deduction from the tax liability to which the Claimant is entitled under SIFIDE should be considered for purposes of calculating the tax."

The AT responded within the legally prescribed period, arguing for the total lack of merit of the request for arbitral pronouncement, referring to the tax inspection report (RIT) of service order OI2014... and to the grounds contained therein, summarizing finally that:

"The financial charges whose deduction is disputed relate to foreign capital that was not applied in the operation of A..." (…) "...the financial charges borne do not represent for A..., an expense indispensable for the achievement of the income subject to tax nor for the maintenance of its productive source, being intended only for the possible maintenance of the productive source of its subsidiaries and could only be considered as an expense in these entities."

Furthermore, according to the Respondent:

"There was not, therefore, and did not have to be, on the part of the AT, the use of indirect methods for the calculation of the interest to be disregarded" and

"with respect to the applicability of article 63 of the CIRC (Transfer pricing) to the case at hand (…) the reasonableness of the rates applied compared to those practiced in the market, or any violation of the arm's length principle, was never questioned."

By order of April 20, 2018, the following was determined:

The meeting provided for in article 18 of the RJAT was dispensed with;

A deadline was set for the production of written submissions by the parties;

September 3, 2018 was set as the deadline for rendering and notification of the arbitral decision;

The parties were requested to send copies of the pleadings in Word format.

The parties submitted written submissions within the set deadline.

By order of September 4, 2018, the deadline provided for in article 21, no. 1 of the RJAT was extended by 2 months with good grounds, setting October 4, 2018 as the limit for the arbitral decision.

2 - SANITATION

The Tribunal was regularly constituted and has jurisdiction ratione materiae (cf. articles 2, no. 1, paragraph a) and 5 of the RJAT).

The parties have legal personality and capacity, have standing and are regularly represented (cf. articles 4 and 10, no. 2 of the RJAT and article 1 of Ordinance no. 112-A/2011, of March 22).

The case does not suffer from nullities, and no preliminary issues were raised.

3 – FACTUAL MATTER

3.1 Proven Facts

The following relevant facts for the decision are considered proven:

a) The Claimant, as a company forming part of Group B..., has as its corporate purpose the publishing and marketing of books and distance learning through "e-learning" platforms and, as the dominant company of the Group, is classified within the RETGS provided for in articles 69 et seq. of the IRC Code (CIRC).

b) On September 13, 2010, a contract (Facility Agreement) was signed between the following entities:

D... S.A.R.L., designated as E... or Lender, based in ... in Luxembourg, holding 71.13% of the capital of the Claimant;

F... B.V., based in the Netherlands, designated as Global or Borrower, holding 18.87% of the capital of the Claimant; and

A..., SA, Claimant, NIF ... (previously designated as G..., S.A.), designated as H....

By which,

The entity E..., lender, undertook to finance the entity "F...", through a loan in the "...maximum amount of € 50,000,000.00";

A..., S.A., Claimant, "...will receive from F... part of the amount lent by E... for the realization of its commercial activities."

According to the Claimant's clarification regarding the reason and economic interest of this loan "...the group B... wanted to grow and expand its business in what was the natural market for the achievement of its objective, Brazil, while also wishing to invest in a 3rd area of activity complementary to existing ones: e-learning or distance education through the online channel."(RIT- OI2014..., p. 16);

According to what is described in point 7 of Clause 3 "...the Parties agree that E... must receive an interest rate of 10.85% on the total amount of each Disbursement made (…) since some Disbursements do not bear interest, the interest rate on the elements that contain interest was adjusted to reflect this so that the general interest rate is maintained at 10.85%".

Point 7.7 of Clause 3 of the contract further states that "if the Borrower does not pay any amounts on the Scheduled Reimbursement Date, the Unpaid Amounts should be considered capitalized."

c) On April 26, 2012, a loan contract was signed between the following entities:

A..., SA, Claimant, NIF ...(previously designated as G..., S.A.), as Borrower;

and

F... B.V., based in the Netherlands; D...S.A.R.L., based in ... in Luxembourg; I..., NIF...; J..., NIF...; K..., NIF ... and L..., NIF..., as Lenders.

Under the terms of this contract "The lenders hold together 100% of the borrower's capital. In order to meet the borrower's treasury needs, it requested from its shareholders a loan in the amount of € 4,000,000.00. The loan takes on the nature of contributions";

And, "this is a contributions contract for a total amount of € 4,000,000 with the purpose of reaching Brazil to reinforce the investment in the activity, granted by all shareholders of the Group to A..., where their interest is placed, and followed through subsequent contribution to C... SGPS SA."(RIT- OI2014..., p. 16);

According to Clause 3 "Interest will be calculated on the amounts actually loaned (actual number of days/360) and outstanding under the Loan, at the EURIBOR rate (1 month) plus 3% (three percent)."

d) On January 12, 2011, a contribution contract was signed between the following entities:

A..., SA, Claimant, (previously designated as G..., S.A.), NIF ... and

C...– SGPS, S.A., NIF…,

according to which "the Creditor Entity (A...) will make available a credit for the purposes of covering the financial needs of the Credited Entity (C...-SGPS), intended to be regulated and configured as a contribution…".

Under the terms of clause 1 of this contract "... the creditor opens a credit in favor of the credited entity, in a maximum global amount of € 50,000,000 (fifty million euros), which, once realized, will configure a contribution…".

According to what is described in Clause 4 "The interest rate for contributions will be 10.85%…".

e) On May 28, 2012, an addendum to this contribution contract was signed, revoking clause 4 of the contract and adding the following clause: Clause 4: Interest will be calculated according to the daily balance that is outstanding and will be due at the end of the credit period. The interest rate for contributions will be 3.5%..."

f) According to the accounting elements and the clarifications of the Claimant (pp. 11 to 19 and 153 to 166 of the RIT-OI2014...):

From the loan obtained under the terms of the contract referred to in paragraph b) above, the following amounts of debt and respective interest borne in the 2012 fiscal year resulted:

Loan Obtained - Facility Agreement

From the loans obtained by the Claimant following the contract indicated in paragraph c) above, the following debts resulted in the 2012 fiscal year and, in the same fiscal year, the respective interest borne:

Loan Obtained - Contributions Contract

By which, from the two referred contracts, the following charges resulted in 2012:

a) in accordance with the contract, the average rate on the total loan (remunerated and non-remunerated tranches) stands at 10.85%.

From the amount obtained through these loans, the Claimant made the following allocation:

g) Account 6911000001 – Interest borne from obtained financing[1] in the Claimant's accounting, as well as the extract relating to the loans indicated in paragraphs b) and c) above, reveal an amount of interest of € 6,577,337.86, although the Claimant only provided supporting documentation for the same in the amount of € 6,546,582.99.

h) On the other hand, they are accounted for as financial income, in account 7914000001- Interest obtained from financing to subsidiaries, resulting from the loans granted under the terms of paragraph d) above, in the amount of € 4,425,102.54.

i) Among the financial charges with the loans obtained, reflected in account 691100001 – Interest borne, in the 2012 fiscal year, the amount of € 2,152,229.19 was not accepted for tax purposes in accordance with article 23 of the CIRC, "for not being applied in the actual operation, not being considered charges related to the activity"(RIT-OI2014..., p. 24).

j) This correction to the Claimant's taxable income as an individual entity, in the value of € 2,152,229.19, resulted from the difference between the interest borne by virtue of the contracts mentioned in paragraphs b) and c) above, in the value of € 6,577,331.73, reflected in account 691100001, and the interest, in the amount of € 4,425,102.54, which were received from the subsidiary C..., SGPS, SA following the loan made by the Claimant, reflected in account 7914000001.

k) By virtue of the referred tax correction, the Claimant's taxable income in 2012 changed from a tax loss of € 2,513,394.24 to a tax loss of € 361,165.05; and the Group's taxable base became € 575,027.45, as stated in the RIT-OI2015..., pp. 4 and 13, which concluded:

As stated above, the proposed correction to the algebraic sum of the tax results for the fiscal year 2012 is in the amount of 2,152,229.19 € and the tax losses to be deducted are in the value of 1,725,082.35 €, relating to the companies M..., SA, A..., SA and N..., Lda, which gives rise to a taxable base of 575,027.45 €, as follows:

l) Regarding the claim for deduction from the tax liability under no. 2 of article 90 of the CIRC, corresponding to the tax benefit – SIFIDE, the Respondent acknowledged that "for purposes of calculating the tax, the deduction from the tax liability under no. 2 of article 90 of the CIRC, corresponding to the tax benefit – SIFIDE" (RIT – OI2015..., p. 13) will be taken into account.

3.2 Facts Not Proven

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

3.3 Reasoning for the Establishment of the Factual Matter

The facts given as proven were chosen and selected according to their legal relevance, in the light of the plausible solutions for the legal issues, under the terms of article 596 of the CPC, applicable ex vi article 29, no. 1, paragraph e) of the RJAT, based on the critical analysis of the Administrative Process attached to the records and the documents presented by the parties.

4 - LEGAL MATTER

Each of the alleged illegalities of the disputed assessment shall now be judged.

4.1 The Financial Charges in Question and Article 23, No. 1 and Paragraph c), of the IRC Code

The Claimant requests the "illegality of the disregard of the financial charges borne" for the acquisition of shares, carrying out supplementary contributions and carrying out loans in participating companies.

The first question that needs to be examined and decided concerns the verification of the requirements required by article 23, no. 1 and paragraph c) of the IRC Code, for purposes of tax deductibility of the financial charges in question.

The loans granted to the Claimant thus had the following destinations:

Acquisition of shares in the company O... SGPS, SA.

Carrying out supplementary contributions to company O... SGPS, SA and to company C... SGPS, SA.

Contributions to company C... SGPS, SA.

In light of each of these applications, we have:

a) With respect to the portion of the loans that was used for the acquisition of shares in company O... SGPS, SA, in the amount of € 808,734.00, it was not remunerated. There were therefore no financial charges to influence the Claimant's expense accounts and its taxable income, making this portion irrelevant to the judgment of the issue.

b) With respect to the loans from the shareholders of the Claimant for carrying out supplementary contributions to the participating companies O... SGPS, SA and C... SGPS, SA, in the amounts of € 10,000,000.00 and € 3,500,001.00, respectively, it was demonstrated that they were remunerated and the respective charges were accounted for in the Claimant's expense account and considered deductible for purposes of calculating the taxable income. Note that, in the case sub judice, as the Claimant points out, supplementary contributions do not accrue interest payable by the beneficiary company (art. 210, no. 5 of the CSC). However, the records clarify that the Claimant, the providing entity, bore interest relative to the capital obtained and it is this that is now relevant.

It is therefore necessary to judge its classification under the rules of article 23, no. 1 and paragraph c) of the CIRC. This is done by invoking for discussion the concept of the proven indispensability of the expenses resulting from these provisions, in light of the case law of the superior courts, as follows from article 8, no. 3 of the Civil Code, as well as from article 25 of the RJAT, and the applicable doctrine to the case.

Those provisions of article 23 of the CIRC provided at the time of the facts:

"1 - Expenses shall be considered those which are demonstrably indispensable for the achievement of income subject to tax or for the maintenance of the productive source, in particular:

(…)

(...)

Of a financial nature, such as interest on foreign capital applied in the operation, discounts, premiums, transfers, exchange differences, expenses with credit operations, debt collection and issuance of bonds and other securities, redemption premiums and those resulting from the application of the effective interest rate method to financial instruments valued at amortized cost;

(...)"

The assessment of the proven indispensability of expenses for the achievement of income subject to tax or for the maintenance of the productive source, to which no. 1 of article 23 of the CIRC refers, can first only be made relative to the entity that accounts for and bears them, as results from repeated case law of the STA, of which example is its Decision of 30.05.2012, proc. no. 171/11[2], which concluded: "costs cannot fail to relate to the contributing company itself. That is, for a given amount to be considered a cost of that company, it is necessary that the respective activity be carried out by it itself, not by other companies.", as well as its decision of 10.7.2002, proc. no. 0246/02, which decided: "the costs provided for in article 23 must relate to the contributing company itself", whereby "for a given amount to be considered a cost of that company, it is necessary that the respective activity be carried out by it itself, not by other companies even if in a relationship of control",.

It is therefore clear that, for the said requirement of indispensability to be met, the expense must relate to the contributing entity itself, considered in isolation, and it is evident that the productive source whose maintenance is linked to the expenses in the relationship of "proven indispensability" by virtue of no. 1 of article 23 of the CIRC is that of the participating company that bears the charges and not that of the participating company that benefits from them. As stated in the decision of the TCA-North of 14.3.2013, proc. no. 01393/06.1, "only expenses that were demonstrably indispensable for the achievement of income or gains or for the maintenance of the productive source but of the company itself and not of a third party should be considered costs of the period. That is, costs must be attributed to the activity conducted by the company in question and not by another company."

Now the loans in question were not applied in the company itself that contracted and bore the respective charges, but in commercial companies that, despite being dominated, have distinct legal personalities and tax capacities and are therefore autonomous in the pursuit of their own corporate purposes and in the independent accounting of their income, expenses and other patrimonial variations. It is not clear, therefore, how an expense arising from a financing placed in the legal sphere and at the disposal of another company can be considered indispensable[3]. And, in fact, the Claimant remains as a legal entity with its own legal, tax and autonomous capacities and personalities in relation to the companies associated with it.

On the other hand, the realization of the general clause of indispensability of expenses, although not implying a judgment of opportunity and merit regarding their realization, does not dispense with consideration of the corporate purpose of the respective entity, but rather requires that the assessment of such "indispensability" be made from the point of view "of the interest of the company, given the corporate purpose of the commercial entity in question" (Decision of the STA - plenary no. 049/11, of 15.06.11).

Likewise, the investigation of the proven indispensability of expenses should be based on the idea of proven "necessity" of the same (RUI DUARTE MORAIS, Notes to the IRC, Almedina, 2007, p. 83) "given the corporate purpose of the commercial entity in question" (Decisions of TCA-South of 19.02.2015, proc. no. 8137/14 and 22.01.2015, proc. no. 5327/12.). As the same author states "When it must be concluded that the charge was determined by other motivations (personal interest of partners, administrators, creditors, other companies in the same group, commercial partners, etc. ) then such cost should not be deemed indispensable" (loc. cit., p. 87). And, recall that, it was expressly to enable the development of the activity of other companies in the group that the charges in question were assumed by the Claimant (see financing contracts with the RIT- OI2014...).

Also, in the same sense, to be tax deductible, expenses must be attributed to the "activity of the entity itself delimited by its corporate purpose". (Ac. TCA-South, of 16.10.2007, proc. no. 01276/06). This is because it is a prerequisite for the application of article 23 of the CIRC "the individual consideration of each company or institution, whereby reasoning based on "group" management criteria cannot interfere here or even financings – even if free – from its partners or even the will of these which in this matter is irrelevant, since this is a legal criterion, being only the legal person whose costs are under examination that is relevant" (see Acs. TCA-South of 16.10.2007, proc. no. 01276/06 and 18.12.2008, proc. no. 02515/08).

And, in fact, it is not clear how one can dispense with consideration of the corporate purpose of a company to judge the "proven indispensability" of costs incurred. Commercial companies are legal entities bounded in their activity by the corporate purpose. See article 11, no. 2 of the Commercial Companies Code (CSC): "The corporate purpose should indicate in the contract the activities that the partners propose that the company will conduct" (art. 11, no. 2 of the CSC). Commercial companies have as their purpose the practice of acts of commerce (art. 1, no. 2 of the CSC) and their corporate purpose is a "certain economic activity" that the company will conduct (art. 980 of the Civil Code). This activity, previously determined and specified in sufficiently precise terms, under penalty of nullity of the contract under article 42, no. 1, paragraph b) of the CSC [4]. And, by economic activity, should be understood a series or succession of habitual acts of that nature and not the isolated practice of an act, such as the acquisition of an interest in another company[5]. It results, moreover from the combination of nos. 4 to 6 of article 11 of the CSC, that mere statutory permission to acquire interests in limited liability companies does not constitute an extension of its corporate purpose. The situation will be different for companies engaged in managing a portfolio of equity interests, which is not the case of the Claimant.

The use of the "corporate purpose or scope of the entity" as a decisive parameter for assessing the indispensability of expenses for purposes of article 23, no. 1 of the CIRC, remains very current in the case law of our superior courts in tax matters.

In line, for example, with the Decision of the STA no. 01046/05, of 07.02.07, which considered non-deductible the charges borne by a company to cover the realization of ancillary contributions, for "not being related to the corporate purpose and activity pursued by the company", which was dedicated to "tile manufacturing and not to the management of equity interests or financing of venture companies" and of the Decision of the STA no. 0107/11, which in light of article 23 of the CIRC, decided that costs with interest and stamp duty on bank loans contracted by a company and applied in financing its associated companies were not deductible, despite the total relationship of control[6], the STA, in its recent Decision no. 01206/17, of 28.02.18, reiterated clearly the connection between the concept of indispensability of expenses of a company and its "corporate purpose".

Having in mind that the Claimant is not a Management Company for Equity Interests (SGPS), the conclusions of this Decision no. 01206/2017 are now examined.

The question was whether the financial charges borne by a company (which pursued real estate activity) with loans used for carrying out supplementary contributions in participating companies were deductible under article 23, no. 1 of the CIRC. It was decided in this ruling:

"I - Being true that the appellant is a partner of the participating company and may make supplementary contributions to it, should it meet the legal requirements, which is not in question here, in its legal sphere the decision to make the supplementary contribution is not the exercise of its business activity because it does not have as its purpose, also, the management of equity interests.

II - The shareholders' agreement it concluded and in compliance with which it came to make the supplementary contributions does not alter/extend the corporate purpose of the appellant, and, for not obtaining legal classification in this regard, is not development of the appellant's social activity.

III - It is not a matter of assessing the merit of the management acts carried out by the appellant, but of verifying that, whatever financial operations it may conduct, outside its corporate purpose, are not an act of management of its business activity, whereby it cannot bring to this the costs that this financial operation produces.

IV - The reinforcement of the capital of the participating company through supplementary contributions made by the appellant are not the exercise of the business activity of the appellant, whereby the costs that incur with these or because of the realization of such contributions are not tax-deductible costs under IRC in light of article 23 of the CIRC."

This reasoning is, with due respect, adopted in the present case.

Furthermore, paragraph c) of no. 1 of article 23 of the CIRC also makes the tax deduction of interest on foreign capital depend on the application of these in its operation, which should be understood as "the productive activity of the company." (Decision of the STA no. 0627/16, of 28.06.17). This did not happen with the application that the Claimant made of the capital obtained.

Finally, note that, contrary to what occurs in the acquisition of equity interests, where there is the acquisition of a right to a greater percentage of dividends, to greater capital gains or to a greater value attributed in case of liquidation of the participating company, there is no in the making of supplementary contributions a "proven indispensability" of the expenses inherent to the same under the terms of no. 1 of article 23 of the CIRC, since, in the most favorable scenario, all that the providing company acquires is merely the right to its reimbursement, in the circumstances provided for in the CSC.

Thus, for the requirements of no. 1 and its paragraph c) of article 23 of the CIRC not to be met, it is understood that the financial charges borne by the Claimant for carrying out the supplementary contributions examined in this point cannot be tax-deductible, because there is an absence of a causal nexus between them and its economic activity that allows it to be recognized that such expenses are demonstrably indispensable for the achievement of its income or for the maintenance of its productive source.

The Claimant further states "subsidiarily, that the transfer pricing regime should have been applied."

Now, when the AT intends to carry out any tax correction aimed at a corrective assessment, it is obviously the one that chooses the path leading to it. Then it substantiates it and subjects itself to the scrutiny that taxpayers and courts will make of that option and that course. It is therefore on the tax act practiced and not on what, in the view of the taxable persons, should have been practiced, that the court's judgment falls. And, having the AT supported the said tax correction on article 23, no. 1 of the CIRC, as referred to above, it does not merit the same, for this reason, any judgment of disapproval. In light of the records, the Claimant recognizes the Respondent's reasoning when, in this regard, it rules out the application of the so-called transfer pricing regime, responding: "with respect to the applicability of article 63 of the CIRC (Transfer pricing) to the case at hand (…) the reasonableness of the rates applied compared to those practiced in the market, or any violation of the arm's length principle, was never questioned."

Whereby it is not considered illegal the decision of the AT, based on article 23, no. 1 and paragraph c) of the CIRC, not to consider as expenses of the activity tax-deductible the financial charges arising from the amounts that the Claimant made available to other entities of the group in the form of supplementary contributions.

c) As for the charges arising from obtaining the loans that were used by the Claimant for making contributions to C... SGPS, SA, the argumentation above set forth regarding loans obtained for carrying out supplementary contributions is, mutatis mutandis, equally valid, namely and in summary, that which can be found in the above-cited case law of superior courts in tax matters.

As noted before, the costs with interest and stamp duty on loans contracted by a company and applied in financing its participating companies are not deductible, in light of article 23 of the CIRC, despite the total relationship of control. Decision STA no. 0107/11, of 30.11.2011, also decided this way, where one can read:

"...the costs provided for there cannot fail to relate, first, to the contributing company itself. That is, for a given amount to be considered a cost of that company, it is necessary that the respective activity be carried out by it itself, not by other companies. Were it otherwise, how could the exercise of the activity of another company with which it had some relationship be imputed to a company."

And still regarding the costs borne by the participating company "Such amounts are not, therefore, directly related to any activity of the taxable person inscribed in its corporate purpose which is the purchase and sale of real property (real estate and property management) and not the management of equity interests or financing of venture companies; and also do not relate, even indirectly, to its activity.

On the other hand, neither are we dealing with interest on foreign capital applied in the actual operation, those yes provided for as costs in paragraph c) of no. 1 of article 23 of the CIRC.

And the mere possibility of being able to have in the future gains resulting from the application of these capital in its associated company does not in itself determine that such investments can fit within the concept of tax costs because for that it was necessary that such charges were indispensable for the achievement of income or gains subject to tax or for the maintenance of the productive source.

And such indispensability is far, in this case, from having been demonstrated."

Now, also in the case sub judice, the legal personality and capacity and the activity of the Claimant, lender, do not confuse with those of the borrower company, even if fully held by it.

And, similarly to what was noted for the interest of the financing intended for carrying out supplementary contributions, the costs accounted for by the Claimant with the acquisition of financing intended for carrying out contributions in the participating company also lacked the necessary allocation of the same to its own productive activity for them to be tax-deductible, as required by no. 1 and paragraph c) of article 23 of the CIRC, in the version at the time of the facts.

Recall that the Claimant has as its corporate purpose and develops the activity of publishing and marketing books and distance learning and not the management of equity interests, whereby such financial charges are not directly related to its activity. The possibility that, by virtue of the receipt of the contributions, there is an opportunity for greater capacity for the development of the activity of the borrower company is an advantage that relates solely and demonstrably to it. Using the words of the cited Decision of the STA no. 0107/11, "the mere possibility that (the participating company) may in the future have gains resulting from the application of these capital in its associated company does not in itself determine that such investments can fit within the concept of tax costs."

For them to be deductible in the sphere of the Claimant, it would thus be necessary that such charges were demonstrably indispensable for the achievement of income or gains subject to tax or for the maintenance of its productive source, and were not merely indirectly linked to hypothetical future benefits, not even measurable, dependent on the future maintenance of the current relationship between participating and participated company and resulting from a possible favorable scenario to occur relative to the participating company.

It must be concluded, therefore, that, in the abstract, also in the case of making contributions, the allocation of foreign capital to the operation of another company that did not acquire it from third parties and bore the charges of such financing does not confer on these charges, immediately, the nature of indispensable expenses for the providing company. At the limit, if it were so, it would open the door to the displacement of tax results between companies in pursuit of undue tax advantages. And, in the case, the expenses of the exercise of the activity of the participated company would be imputed to the participating company, even if dominant[7]. What is not accepted as a general principle.

However, the AT considered that, in obedience to a principle of relationship between the expenses borne or incurred and the income obtained, the interest borne by the Claimant should be tax-deductible insofar as they generated income in its sphere. A principle that the Claimant did not contest, since what it contested was the method of calculating the amount of deductible expenses, as will be seen below.

In this circumstance, for calculation of the Claimant's individual taxable income, the AT subtracted from the expenses borne or incurred by virtue of obtaining the foreign capital intended to make the referred contributions and supplementary contributions mentioned above – accounted for in account 691100001 in the amount of € 6,577,331.73 – the interest, in the amount of € 4,425,102.54, accounted for in account 7914000001, which were received from the subsidiary C..., SGPS, SA following the contribution made by the Claimant. That is, it did not accept as a tax expense the component of interest accounted for as expenses that did not have correspondence in the value of interest accounted for as income.

This tax correction does not merit the court's disapproval.

4.2 – Regarding the Alleged Application of an Indirect Method in Disregard of Articles 87 to 90 of the LGT and Article 74, No. 3 of the Same Instrument

The Claimant considers that the AT "used an indirect, presumptive method of allocation of financial charges in disregard of articles 87 to 90 of the LGT", without invoking "the provisions of article 74, no. 3 of the LGT" because "The quantification of non-deductible financial charges was done in an indirect manner, because it resulted from the mere difference between the financial charges of the loans obtained and the financial income from loans to its participating companies."

Let us see whether, as the Claimant argues, there was indirect assessment of the taxable base.

As stated above, the correction under analysis results simply from the non-acceptance for tax purposes of interest borne that exceeds the amount of interest obtained, on the presumption that the granting of non-remunerated loans, in whole or in part, is in no way indispensable for the activity of a company such as the Claimant, which is neither a SGPS nor a venture capital company.

The court understands that this is, in fact, a simple "technical correction" for tax purposes[8] to the value of interest borne stated in the Claimant's IRC return (art. 16, no. 3 of the CIRC) determined by the non-deductibility for tax purposes of part of the interest accounted for as expenses by the Claimant. These are corrections, as indeed literally follows from the final part of article 17, no. 1 of the CIRC "Taxable income (…) is constituted by the algebraic sum of the (…) eventually corrected under the terms of this Code". Such correction was imposed by no. 1 and paragraph c) of article 23 of the CIRC as a result of the duty to control the taxable person's return (art. 16, no. 1 of the CIRC) and correction of the result determined based on accounting (art. 17, no. 1 of the CIRC).

Regardless of whether in the loans obtained as in the financing granted there are remunerated and non-remunerated parts, of the remunerated being at different rates and of there being structural differences in some and others, namely with respect to the capitalization or non-capitalization of interest in the event of non-repayment of capital[9], in fact, what exists is the following reality: the Claimant intended to grant the cited loans and supplementary contributions to the participated companies, and for that, it resorted to financing by foreign capital in the terms mentioned above. There is, therefore, in the 2012 fiscal year, a value of interest borne by virtue of obtaining such financing and a value of interest received by virtue of the contributions made (since supplementary contributions did not accrue interest). The tax correction made had the value of the difference, evidenced in the accounting and in the Claimant's IRC return, between interest payable and interest receivable.

What the AT did was a direct assessment of taxable income. And the AT could not even proceed to its indirect assessment, because it is not a "case nor of the conditions expressly provided by law" for this, as, without room for doubt, article 81, no. 1 of the LGT determines.

As stated in the Decision of the TCA-South of 13.03.2014 (process no. 07216/13) "Resort to the direct assessment method is only legally possible when the determination of the taxable base through technical corrections proves entirely impracticable." Now that was not what occurred.

In the case sub judice, the veracity of the Claimant's accounting was not questioned and there is no doubt that the accounting of the taxable person, when not considered falsified or vitiated, is clearly an element of direct assessment (see art. 88 of the LGT a contrario). It would have been necessary for the AT to have cast doubt on the veracity of the accounting in order for it to be able to resort to indirect assessment. As, lapidarily, RUI DUARTE MORAIS states "the refusal, by the administration, of the tax acceptance of a given cost by invoking that it is unnecessary does not put into question the truth of the taxable person's accounting, but only the qualification made by it (in the seat of self-assessment of income) of that cost (which is accepted to have actually existed). Hence, such non-acceptance does not legitimize the resort to methods of indirect assessment, but only what is normally called "technical corrections" of the declared taxable base."[10]

It was not, therefore, disrespected any of the provisions of the LGT cited by the Claimant, because none of the requirements for their application were met. None of the situations in the universe that permit indirect assessment of the taxable base occurred (see arts. 16, no. 4 and 57 et seq. of the CIRC and arts. 87 to 89 -A of the LGT), nor, naturally, should such have been invoked by the AT.

Also from the point of view of the systematic element of interpretation, it is relevant that article 16, no. 4 of the CIRC provides: "The determination of taxable income by indirect methods can only be carried out under the terms and conditions referred to in section V". Now, the correction in question resulted from the application of no. 1 and paragraph c) of article 23 of the CIRC, which is found in section II – Determination of the taxable base - of the same chapter and, therefore, within the provisions relating to direct assessment of the taxable base.

The method of determination of the taxable base used by the AT was not, therefore, a method of indirect assessment, having instead been based on the accounting elements of the taxpayer and its clarifications, whereby, also here, no illegality in the act practiced is recognized.

4.3 – Regarding the Non-Consideration of the Tax Liability Deduction Granted as a Tax Incentive under SIFIDE

The Claimant requests that "the deduction from the tax liability to which the Claimant is entitled under SIFIDE should be considered for purposes of calculating the tax."

Such deduction had been mentioned, without quantifying it, in the RIT-OI2015... (p. 13), in the following terms "For purposes of calculating the tax, the deduction from the tax liability under no. 2 of article 90 of the CIRC, corresponding to the tax benefit – SIFIDE, will be taken into account."

It now requests recognition of a right to a deduction from the IRC tax liability, which was not exercised by the Claimant in its IRC return for 2012, and therefore was not subject to any correction in the corrective assessment in dispute; to which is added the fact that it is a deduction which, in case of insufficiency of tax in the fiscal year in which the expenses were incurred, the undeducted balance can be so until the 6th immediate fiscal year (art. 4, no. 3 of Law no. 40/2005).

In these circumstances, the court understands that the examination of such claim is not included within the scope of its jurisdiction, which is limited, as it is, to the examination of the legality of the acts referred to in no. 1 of article 2 of the RJIT.

4.4 – Conclusion

It is concluded, therefore:

a) That the alleged illegalities of the disputed assessment are not verified with respect to the disregard of the financial charges borne by the Claimant.

b) It is not within the jurisdiction of this arbitral tribunal to consider the tax liability deduction provided for in SIFIDE, requested by the Claimant.

5. DECISION

In these terms, the Arbitral Tribunal agrees on:

a) To judge the request for arbitral pronouncement to be without merit in the part that intended the tax consideration of the financial charges borne by the Claimant for purposes of determining its taxable income in IRC for the fiscal year 2012, and the assessment carried out under the terms of articles 69 et seq. for the economic group of which the Claimant is the dominant company should be maintained;

b) Not to pronounce on the consideration of the IRC tax liability deduction for the fiscal year 2012, resulting from SIFIDE, because, given no. 1 of article 2 of the RJIT, such judgment is outside the scope of its jurisdiction.

6. VALUE OF THE CASE

The value of € 112,045.35 is set for the case, under the terms of articles 3, no. 2 of the Regulation of Costs in Tax Arbitration Proceedings, 97-A, no. 1, paragraph a) of the CPPT and 306, nos. 1 and 2 of the CPC.

Lisbon, September 19, 2018

The Chairman

José Poças Falcão

The Arbitrator Member

Manuel Alberto Soares
(votes dissenting in accordance with attached statement)

The Arbitrator Member

Américo Brás Carlos

DISSENTING STATEMENT

I do not agree with the decision that prevailed for the reasons which, albeit in summary form, I hereby proceed to explain.

The Claimant is the dominant company of a Group, covered by the RETGS, which, apart from its activity of publishing, distribution and sale of school books, has in its assets equity interests of more than 11 companies, held, directly or indirectly, in their overwhelming majority, at 100%.

We are not dealing with passive investments, that is, mere perception of income, since necessarily, as happens in the generality of groups, the existence of various companies has in its genesis reasons for specialization by area of activity, but exercising the participated companies economic activities with greater or lesser degree of integration or complementarity, they must obey a common strategy, assumed by the dominant company, as indeed demonstrates the financing of the participated companies assumed by the Claimant.

Therefore, the dominant company manages, as with any other asset, its equity interests, participating in general assemblies, influencing management decisions of the participated companies in its operational area, deliberating the strengthening of the equity capital of the participated or the increase of its treasury availability. That is, in fact, it manages these equity interests in the exact framework of the pursuit of its social purpose. This is participation in companies with corporate purpose identical to what the dominant conducts – whereby the references that are made in the decision are revealed to be artificial and do not attend, in my view, to the specificities of commercial law, with respect to the acquisition of interests in companies with corporate purpose identical to what the dominant conducts and the acquisition of interests in companies with another corporate purpose, as follows from nos. 4 and 5 of article 6 of the Commercial Companies Code.

I therefore do not agree with the arbitral decision when it reconducts, in the case of the Claimant, the acquisition of equity interests to the practice of an "isolated act", as if the securities had been acquired, placed in a safe (with dematerialization this can no longer even be done) and nothing else had happened. As appears in the records, it was the Claimant that, at the very least, ensured the external financing of the group, which configures an act of management of its financial interests, and the management of equity interests is not exclusive to SGPSs, as suggested in the decision.

Wherefore, under the terms permitted by the bylaws, the Claimant exercises in fact the management of equity interests and does so in a strategic framework of development of its business which is the editorial activity, that is its social purpose

But even if this did not happen in the restricted sense of its corporate purpose, assumed in the decision, insofar as it follows from article 23 of the IRC Code, in the version at the time of the facts, all expenses and losses incurred or borne by the taxable person are deductible in order to obtain or guarantee income subject to IRC and, under the terms of article 20, income and gains are considered subject those resulting from operations of any nature, as a consequence of a normal or occasional action, basic or merely accessory.

Which means that the IRC Code subjects to tax all income resulting from the activity of the company, whether or not such activity is inscribed in the 3 or 4 lines with which the corporate purpose of a company is traditionally summarized, insists, in a strict sense. Which also means that income from financial interests (dividends or capital gains), whether the company is or is not a SGPS, whether or not it has inscribed in its corporate purpose the management of equity interests, such income is unequivocally subject to tax. And, being subject to tax, the corresponding expenses for obtaining those income are deductible, as clearly follows from article 20 of the CIRC.

In this context, as referred to in the Decision of the STA no. 0627/16, of 28.06.17, cited in the decision, the AT "can only disregard those that are not inscribed within the scope of the activity of the taxpayer and were contracted, not in the interest of the latter, but for the pursuit of alien objectives (when it is to be concluded, in the face of the rules of common experience that it had no potential to generate income)", which is manifestly not the case.

Moreover, this conception that article 20, which deals with income (positive component of income), admits the taxation of any income or gains and that article 23, which deals with expenses (negative component of income) only admits the deduction of those that are comprised in the corporate purpose, transforming, as for this segment the tax on income into a true tax on turnover reveals itself to be an unconstitutional application of article 23 of the IRC Code.

In fact, the IRC fulfills the constitutional goal of taxation of companies enshrined in no. 2 of article 103 of the CRP and one cannot, by way of the artifice of activities comprised in (or supposedly carried out beyond) the corporate purpose, allow its transformation into a tax on turnover, which will be nothing more than taxation of consumption provided for in no. 4 of the same article 103 and which is primarily achieved by VAT.

It is my opinion that such an application of article 23 of the IRC Code constitutes a fiction of income. Now, the establishment of fictions of income is unconstitutional by violation of the principles of actual income and contributory capacity.

Such cases should not be confused with non-acceptance by the legislator of certain expenses for tax purposes, of which an example is the enumeration contemplated in article 23-A of the IRC Code.

There is a duty of interpretation in accordance with the Constitution of the legal provisions that provide for and regulate the determination of taxable income, being inadmissible that expenses of a business nature, such as those which are here at issue, can be disregarded by the fiction which has no legal basis that taxable income of companies corresponds to:

As for activities comprised in the corporate purpose, to the difference between income and gains and the respective expenses or losses;

As for activities not comprised in the corporate purpose, to the income or gains of those activities;

There is no basis in the provision of article 23, nor in any other provision of the IRC Code, for such an interpretation, and it is clear that, in light of the case law, as will be seen below, the limitations imposed by article 23 relate to expenses of a non-business nature and not to artificial issues such as the corporate purpose or the difference between interests in companies with the same corporate purpose and in companies with a different corporate purpose.

In my view, the sense of the decision, by aligning itself with this interpretation, is admitting fictions of income not admitted and which are capable of admitting an application not in conformity with the CRP of article 23 of the IRC Code, whereby, in conscience, I cannot fail to manifest my opposition to such an interpretation.

But the reasons for my disagreement with the sense of the decision are not limited to this issue. In fact,

The Financial Charges in Question and Article 23, No. 1 and Paragraph c), of the IRC Code

In this context, contrary to what follows from the decision that prevailed, we follow the vast case law formed in the CAAD, consisting in particular of recent Decisions in Proceedings nos. 637/2017-T, 466/2017-T and 115/2017-T, as well as of the Decision in Proceedings no. 715/2016-T, in which Judge Dr. José Poças Falcão (Arbitrator Chairman), Dr. Mariana Vargas and Dr. Henrique Fiúza (Arbitrator Members) were Arbitrators. It is recalled that in this Proceeding the reasoning of the Arbitral Decision issued in Proceedings no. 12/2013-T, of the CAAD, in which Tomás Tavares was sole arbitrator, was followed, under the terms of which it was considered that "A company may obtain funds (and pay interest) and then deliver those funds to a subsidiary without any remuneration of consequence and direct – and yet still adequately exercise its activity, within its capacity and lucrative scope: it may effect a capital increase (art. 25 of the CSC), contributions or ancillary contributions without interest (art. 210 and 287 of the CSC) or contributions without interest (art. 243 of the CSC) – and in any of these cases it acts entirely within its capacity for exercise and with a lucrative intent and in the exercise of its activity", which we also subscribe to.

Therefore, we cannot subscribe to the decision that prevailed when it seeks to make the tax deduction of interest on foreign capital depend on the application of these in its operation, understood, in the transcription made of the Decision of the STA no. 0627/16, of 28.06.17, as limited to "the productive activity of the company", when the conclusions of the Decision point in the diametrically opposite direction, accepting the deductibility of an expense (in the case, precisely, a loss on the sale of an equity interest) which "in a judgment relating to the moment in which it was made, be appropriate to the productive structure of the company and to the obtaining of profits, even if it comes to prove to be an unproductive or economically ruinous economic operation" (Bold ours).

Therefore, to consider that "there is no in the making of supplementary contributions a "proven indispensability" of the expenses inherent to the same under the terms of no. 1 of article 23 of the CIRC, since, in the most favorable scenario, all that the providing company acquires is merely the right to its reimbursement, in the circumstances provided for in the CSC" is to require a nexus of causality between costs and income, which infringes with satiety the constitutional primacy of taxation of the actual income of companies, and, as also referred to in the aforementioned Decision already long ago was refused:"... this understanding of indispensability is reduced to the requirement of a necessary and direct causal relationship between costs and income long refused by doctrine and case law."

Furthermore, just as with capital, no. 5 of article 210 of the Commercial Companies Code prohibits supplementary contributions from accruing interest, being a cost of the shareholder, which the Claimant alleged, with the Tribunal omitting any pronouncement on this issue.

But even admitting that tax legislation requires remuneration for what the CSC determines should not be remunerated, the AT would still have to make the direct allocation of financial charges borne to the alleged non-remunerated financings, quantifying the financial charges that the Claimant incurred to finance the supplementary contributions, which it manifestly did not do (underlined ours)

That is, it did not quantify the expenses that should be disregarded, as it based its reasoning on, under the terms of article 23 of the CIRC.

Charges Resulting from Obtaining Loans Used by the Claimant for Making Contributions to C... SGPS, SA

Neither can we agree with the decision when it states that "the argumentation above set forth regarding loans obtained for carrying out supplementary contributions is, mutatis mutandis, equally valid," since, contrary to supplementary contributions, which were made without remuneration, the contributions in question were made with remuneration.

We are therefore dealing with expenses with financing that generated income subject to tax.

And, consequently, the correction to be made under the terms of article 23, in accordance with the reasoning used, should correspond to the totality of the financial charges borne (€ 6,577,331.73) by the Claimant (excluding the portion used for its own financing, which the inspection never quantified).

In fact, article 23 permits the non-acceptance of expenses that are not indispensable for the achievement of income subject to tax or for the maintenance of the productive source (which, it is repeated, would require that the AT disregard, in its view, all financial charges), but it does not establish any alleged "principle of relationship between the expenses borne or incurred and the income obtained," to disregard expenses, resulting, as it argues, from the fact that "manifestly favorable financial conditions were agreed upon," as expressly appears in the Report.

That is, a matter of transfer pricing.

Hence, the Claimant contested the manner of calculation of the correction and the inapplicability of transfer pricing, in my view correctly, given the confused reasoning of the correction.

Inapplicability of Transfer Pricing

In fact, as very well stated in the decision "it is on the tax act practiced that the court's judgment falls." But if the AT sustained the correction poorly, it should merit, for that reason, a judgment of disapproval by the Tribunal.

As noted, article 23 of the CIRC allows substantiation of the non-acceptance of expenses, but with manifest special relationships existing and manifestly favorable financial conditions having been agreed upon, as stated in the Report, with respect to financing, including contributions, then the correction should have been based on article 63 of the CIRC.

The Claimant bore financial charges to finance its participated companies, obtained financial income resulting from the financing made, but manifestly favorable financial conditions were fixed, which means that the question is not one of the indispensability of the expenses (which were borne to obtain income), but the insufficiency of the agreed remuneration, which means the requirements for application of transfer pricing are met.

And, in this case, as was decided in the Decision of the STA, of 21.09.2016, in Proceedings no. 571/13, the Tax Administration cannot exempt itself from the application of the legal regime and reasoning provided for in article 57 (current article 63) of the CIRC and 77, no. 3, of the LGT, shielding itself in the application of article 23 of the CIRC. That is, if we are dealing with the indispensability of an expense it can apply article 23, but if we are dealing with the insufficiency of the remuneration of financing made with remuneration, the correction should correspond to the remuneration that should have been contracted between independent entities in comparable operations, under the terms of article 63 of the CIRC.

Consequently, the disputed assessment suffers from error in the legal assumptions.

The Application of an Indirect Method

Interest is by definition the remuneration of capital, depending on the time during which it was ceded and the rate fixed.

As appears in the proven facts, the Claimant contracted loans over the years 2010 to 2012, which were used to meet its own treasury needs, to acquire financial interests, and, at different moments, to make remunerated contributions at different rates, and non-remunerated supplementary contributions.

If the tax inspection intended to disregard, under the terms of article 23, the financial charges borne related to non-remunerated financing, then, given the different allocation of the loans contracted, it should have determined the amount of interest from loans contracted that were actually channeled for the financing of non-remunerated supplementary contributions, which it did not do. (underlined ours)

In fact, the inspection limited itself to presuming that if the financial income is lower than the financial charges, then the difference corresponds to the financial charges related to non-remunerated supplementary contributions.

And, thus being, with the loans contracted having multiple uses, including its own financing and remunerated financing of the participated companies, the calculation of the disregarded financial charges results from a mere presumption. When it should correspond to the financial charges actually borne corresponding to the loans that were channeled for financing, without remuneration, of supplementary contributions, a relationship that the inspection did not establish in the Report and which would allow, in a direct manner, the determination of the financial charges to be disregarded with alleged basis in article 23 of the CIRC.

It is recalled that, as was decided in the cited Proceedings no. 715/2016-T, in which Judge Dr. José Poças Falcão (Arbitrator Chairman), Dr. Mariana Vargas and Dr. Henrique Fiúza (Arbitrator Members) were Arbitrators, as the failure to indicate the criterion for apportioning the financial charges borne by the Claimant, attributable to the loans granted to the participated companies, leaves well-founded doubts about its quantification, the tax assessment should be annulled (underlined ours): "In the absence of elements that permit the exact quantification of the financial charges borne with the granting of non-remunerated financing to companies of which the Claimant is not a partner, with the Arbitral Tribunal having well-founded doubt about the quantification of the tax fact, the assessment act should, in that part, be annulled."

It is this annulment that is petitioned by the Claimant when it states that "the illegality of the assessment should be declared since it is not for the courts, substituting for the Administration, to determine the interest rate, the capital and the term, corresponding to the financial charges that may be considered non-deductible, under the terms of article 23 of the CIRC", because, as is evident, with the contributions having been remunerated, the question of indispensability could only arise with respect to the non-remunerated financing of the supplementary contributions, whose corresponding financial charges, it is repeated, the tax inspection did not calculate in a direct manner.

And, therefore, with the disregarded financial charges having been calculated in a presumed manner (which does not permit the exact quantification of the financial charges borne with the granting of non-remunerated financing), the Claimant's reasoning is correct and, thus, I do not agree with the decision.

Regarding Non-Consideration of the Tax Liability Deduction Granted as a Tax Incentive under SIFIDE

Neither do I agree with the decision as to the non-consideration of the tax liability deduction of the incentive relating to SIFIDE.

It is a proven fact that the Claimant is entitled to the disputed tax liability deduction and that the inspection itself assumed in the Report that it would take into account this deduction, which, by a possible oversight, ended up not materializing.

It is not because the balance can be deducted until the 6th immediate fiscal year that it should not be considered in the period in which there is IRC tax to which the deduction can be made, as moreover the inspection recognizes.

The corrections favorable to the taxpayer, not materialized in the assessment, also constitute an illegality of the assessment, whereby their examination clearly falls within the jurisdiction of the Tribunal.

The CAAD Arbitrator

Manuel Alberto Gaspar Soares

[1] From the Accounts Chart of the System of Accounting Normalization

[2] In line with multiple previous decisions of this superior court (see Decision of 10.07.2002, proc. no. 246/02; Decision of 12.07.2006, proc. 186/06; Decision of 07.02.2007, proc. no. 1046/05; Decision of 20.05.2009, proc. no. 1077/08; Decision of 30.11.2011, proc. no. 107/2011).

[3] See in the same sense and for a situation of holding 100% of the capital of the participated company, the Decision of the STA of 12