Process: 666/2016-T

Date: April 18, 2017

Tax Type: IRC

Source: Original CAAD Decision

Summary

Process 666/2016-T addresses critical issues regarding the IRC taxation of a German company's Portuguese permanent establishment. The case involves A..., a German entity operating through a Portuguese branch (B...) that participated in a construction project via an Economic Interest Grouping (ACE D...). The Tax Authority corrected the taxable income by €672,946.38 for fiscal year 2012, resulting in an additional IRC assessment of €188,225.58. The dispute centers on whether expenses allocated from the German head office to the Portuguese branch qualify as deductible for IRC purposes, and the proper application of the Portugal-Germany Double Taxation Convention. Key issues include: (i) the qualification of the Portuguese branch as a permanent establishment under Article 5 of the Convention; (ii) the deductibility of expenses charged by the head office under Article 7, which allows only expenses genuinely incurred for the permanent establishment's activities; (iii) the taxpayer's burden of proof to demonstrate that expenses were effectively incurred and properly documented under Article 75 of the IRC Code and Article 123 of CPPT; and (iv) the correct attribution of profits to the permanent establishment following the arm's length principle. The arbitration was constituted under CAAD jurisdiction, with the applicant challenging both the factual assumptions and legal interpretation applied by the Tax Authority. This decision has significant implications for foreign companies with Portuguese branches regarding expense allocation methodologies and documentation requirements under double taxation treaties.

Full Decision

ARBITRAL DECISION

The Arbitrators Counsellor Jorge Lopes de Sousa, Dr. Jorge Carita and Prof. Doctor José do Vale Marçal, designated by the Deontological Council of CAAD to form the Arbitral Tribunal, constituted on 19-01-2017, agree as follows:

1. Report

A... with tax identification number in Germany DE... in Portugal..., and with a branch in Portugal with tax identification number..., with address in Portugal at..., ... –..., ...-... Lisbon (A..., or applicant), designated in the assessment here in question as B... – Branch in Portugal, came to request, under the provisions of articles 2nd, no. 1, paragraph a), and 10th, nos. 1 and 2, both of Decree-Law no. 10/2011, of 20 January ("RJAT") and articles 1st and 2nd of Order no. 112-A/2011, of 22 March, the constitution of a Collective Arbitral Tribunal.

The Applicant intends that, in these terms, the illegality of the partial dismissal of the voluntary complaint no. ...2015..., the illegality of (i) the corrections by the tax inspection to the taxable matter in the amount of €672,946.38, (ii) the illegality of the additional IRC assessment and consequent surcharges that followed it, no. 2014..., relating to the fiscal year 2012 of A..., and (iii) the illegality of the corresponding interest, with its consequent annulment, in the amount (tax and interest) of €188,225.58, due to error in the factual assumptions and violation of law and the principle of legality, with all legal consequences, namely the reimbursement of the amount of €188,225.58, and payment of compensatory interest on this amount counted from 27 November 2014 until full reimbursement.

The respondent is the TAX AUTHORITY AND CUSTOMS AUTHORITY (AT).

The request for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax Authority and Customs Authority on 18-11-2016.

Pursuant to the provisions of paragraph a) of no. 2 of article 6th and paragraph b) of no. 1 of article 11th of RJAT, the Deontological Council of CAAD designated as arbitrators of the collective arbitral tribunal the signatories, who communicated their acceptance of the task within the applicable period.

Pursuant to and for the purposes of the provisions in no. 7 of article 11th of RJAT, the President of CAAD informed the Parties of this designation on 04-01-2017.

Thus, in accordance with what is provided in no. 7 article 11th of RJAT, after the period provided in no. 1 of article 13th of RJAT elapsed without the Parties saying anything, the Collective Arbitral Tribunal was constituted on 19-01-2017.

The Tax Authority and Customs Authority submitted a Response, in which it defended the lack of merit of the application.

By order of 23-02-2017, the holding of the meeting provided for in article 18th of RJAT was dispensed with and it was decided that the proceedings would continue with successive written pleadings.

The Parties submitted pleadings.

The Arbitral Tribunal was regularly constituted and is competent and no obstacles were raised to the assessment of the merits of the case.

The parties have legal personality and capacity and are legitimate (articles 4th and 10th, no. 2, of the same statute and article 1st of Order no. 112-A/2011, of 22 March) and are duly represented.

The proceedings do not suffer from any nullities.

2. Factual Matter

2.1. Proven Facts

• The Applicant is the German legal entity A..., whose tax identification is DE..., hereinafter referred to as A..., obtained in Portugal, on 03-03-2009, the NIPC..., corresponding to a non-resident entity without permanent establishment, for the performance of an isolated act, identified as "Acquisition of social participation" (document no. 9 attached with the request for arbitral ruling, whose content is given as reproduced);

• The Applicant has as a branch B... – Branch in Portugal registered with the NIPC..., obtained on 07-04-2009 (document no. 10 attached with the request for arbitral ruling, whose content is given as reproduced);

• The A... constituted, on 17-04-2009, a Grouping of Economic Interest (ACE), jointly with C... SA, in the proportions, of generic contribution to the charges thereof, of 15% and 85%, respectively, designated by "D...", with the NIPC..., hereinafter designated as D... (Report of the Tax Inspection which is document no. 6 attached with the request for arbitral ruling, whose content is given as reproduced);

• This ACE has the objective of carrying out the contract for the expansion work of the terminal of E..., owned by F..., SA, NIPC..., with which it celebrated the respective contract on 08-05-2009, for the amount of €158,743,766.06 (Report of the Tax Inspection);

• For the constitution of the ACE, A... used the NIPC..., corresponding to a non-resident entity without permanent establishment (Report of the Tax Inspection)

• On 04-05-2009, the ACE D... celebrated two sub-contracting contracts of the work owned by F... in question, with two entities designated by its two members, B... and C... SA, with which it celebrated the respective contracts (Report of the Tax Inspection);

• For tax purposes, the Applicant declared the commencement of activity on 13-04-2009, as a non-resident taxpayer with a permanent establishment, and developing "engineering and related technical activities", which corresponds to CAE 71120 (Report of the Tax Inspection);

• The Tax Authority and Customs Authority carried out an inspection action on the Applicant, under Service Order no. OI2013..., relating to the fiscal year 2012;

• In this inspection a Report of the Tax Inspection was drawn up, a copy of which is document no. 6 attached with the request for arbitral ruling, whose content is given as reproduced, in which the following is mentioned, among other things:

II.3.5. PREVIOUS INSPECTIVE PROCEDURES

The taxpayer was the subject of an action for analysis and collection of elements developed by the Division of Fraud Investigation and Special Actions (DIFAE), with temporal incidence in the fiscal years 2009 to 2011, for collection and cross-referencing of information, in view of the detection of significant differences between the values declared by the taxpayer in their periodic VAT declarations and the values declared, for VIES purposes, by various community operators, both regarding intra-community acquisitions of goods and regarding the provision of services, and, also, in view of invoicing issued to its client – D... ACE, not reflected in the income declarations delivered.

In the course of this action, the taxpayer replaced the periodic VAT declarations for the periods of the fiscal years 2010 and 2011, with divergences still remaining in relation to the values contained in VIES, but which proved to be materially irrelevant, given that no prejudice was verified for the State.

Those services also concluded that the taxpayer did not apply the provisions of article 19th of CIRC, that is, did not apply the criterion of the percentage of completion, for purposes of recognition of income in the respective fiscal years. Still in the course of that action, it presented the calculations for determining income based on that criterion, and reflected them accounting-wise.

The taxpayer was also subject to inspective procedures, carried out by these tax inspection services, in the fiscal years prior to 2009 to 2011, within which it proceeded with the delivery of periodic IRC income declarations, with the values relating to income determined in accordance with the aforementioned criterion. Within the scope of these procedures, corrections were also made in the area of VAT and IRC, as well as relating to withholdings on income tax paid to non-resident entities in the national territory.

(...)

III.1. ANALYSIS WITHIN THE SCOPE OF THE CORPORATE INCOME TAX

III.1.1. CORRECTIONS TO TAXABLE PROFIT • NON-FISCALLY ACCEPTED EXPENSES

III.1.1.1. CHARGES FOR WHICH THIRD PARTIES ARE RESPONSIBLE - CHARGED BY ACE D...

In the analysis of the accounting documentation, it was found that debit notes issued by ACE D..., concerning expenses borne by it and attributed to the taxpayer, as "distribution of common costs of the ACE", in the proportion of 64.29%, were recorded, in the same way as in the previous inspective procedures.

It is important to note that ACEs are subject to the special regime of fiscal transparency provided for in no. 2 of article 6th of CIRC, by means of which the profit or loss determined by them, in each economic exercise, is attributed to its members, in the proportion stipulated in the respective constitutive act, integrating itself in their taxable income, for purposes of taxation in IRC. Therefore, the charges borne by the ACE should not be charged directly to its members, but should be recognized for purposes of determining the respective fiscal profit or loss, to be attributed to its members, in the proportions established in the respective constitutive contract.

In the case under analysis, it is found that the ACE contract was presented to the Commercial Register Office on 2009.04.17, as already mentioned, and provides for generic contribution to the charges of ACE D... of 15% by part of A... and 85% by the other member (cf. annex II). And, on the other hand, the "agreement and internal regulation" of that entity, stipulates the distribution of obligations/liabilities, among its members, in the proportion of 64.29% for A... and 35.71% for the other member (cf. annex V). Therefore, there is always a matter of distribution of results or charges among the members of the ACE.

But, in the specific case, it is to be noted another particularity: the taxpayer under analysis does not correspond to any of the members of the ACE in question – D... -. It is the very German legal entity, with registration in the national territory as a non-resident without permanent establishment - NIPC... - that is part of the ACE in question (annex II). It is also noted the fact that on the date of constitution of the ACE - 2009.04.17 - the German legal entity A..., had already constituted a branch (permanent representation) in this territory, without, however, having used the respective NIPC for the constitution of the ACE in question. Therefore, it could be concluded that it was the option of A... to have used the NIPC of non-resident without permanent establishment.

In this regard, it is noted that, within the scope of the previous inspective procedures, and in view of the insistence by the taxpayer that there is the existence of two NIPCs for the same entity - one attributed upon the constitution of the ACE as "non-resident without permanent establishment", and another attributed with the awarding of the performance of the construction work as "non-resident with permanent establishment" -, the taxpayer requested, from the Directorate of Services for Registration of Taxpayers (DSRC), as to the possible way to overcome this impasse and associate the two NIPCs, by allegedly referring to being the same entity (cf. annex VI).

This Directorate of Services informed that it was not possible to associate the two NIPCs as intended, given that they are two autonomous and distinct entities, and that only the National Register of Legal Entities (RNPC) could resolve the matter.

Thus, knowing the information from DSRC, still in the course of the previous inspective procedures, a visit was made to the premises of RNPC, for clarification of the situation, and, later, the same information was requested via e-mail. And these services also consider these to be two autonomous entities, whose NIPCs cannot be associated (cf. annex VII).

Therefore, being considered by those entities, and even by DIFAE itself, when analyzing the taxpayer under analysis, previously to the inspective procedures on the previous fiscal years, that these are two independent and autonomous records of legal entities, namely:

– one corresponding to the mere registration of the non-resident entity without permanent establishment A..., for the performance of an isolated act - acquisition of social participation – NIPC...,

– and another registration, NIPC..., that of a branch - permanent establishment of that non-resident entity, for purposes of developing an activity in the national territory,

the charges attributed to that other entity (parent company) as a member of the ACE cannot be fiscally accepted, as expenses of the fiscal year of the permanent establishment of a non-resident entity, whose purpose is the performance of a work, even though under its guidance, even if it is considered, under article 5th no. 9 of CIRC, that the income that this entity obtains in this capacity are obtained through a permanent establishment located in the national territory, but another one, given that it did not identify the taxpayer under analysis as such.

It is pointed out to the fact that, although the ACE D... is considering the NIPC of the taxpayer under analysis (...), for purposes of attribution of profit/loss of the ACE and withholdings made, this situation was not recognized by itself, in its tax declarations. And it could not have been, given that the taxpayer under analysis is not a member of that ACE, that is, its NIPC was not used for the constitution of the same and nor is any alteration in its composition known in that sense.

Considering, thus, that the taxpayer is not legally authorized to bear those charges charged by ACE D..., (whose copies of the respective debit notes are attached as annex VIII), as title of common costs, and which are the responsibility of third parties, the same are not fiscally accepted, under the terms of article 45th of CIRC, in the amount of €633,212.43, as is calculated below. For the reason, as previously mentioned, not only the taxpayer under analysis is not a member of the ACE, but also for the fact that being the ACE an entity with headquarters or effective management in the national territory, which was constituted and functions according to the legal terms, and with organized accounting, the expenses and income of the same should, under the terms of article 17th of CIRC, allow the determination of the profit or loss of the exercise, and this yes, attributable to its respective members in the proportion of their participation, under the terms provided in no. 2 of article 6th of CIRC.

It is noted that with respect to the charges charged by ACE D... to the taxpayer under analysis, we only accept as deductible from the net result of this period, the charges charged by means of the debit note with accounting number …/…, in the total amount of €2,275.50, referring to the transfer of a maritime container, which, for the fact that the analyzed documentation does not show that it is a debit of common costs of the ACE, was not considered in the values determined in the table inserted above.

It is pointed out the fact that given the voluntary regularization carried out by the taxpayer, by means of delivery of IRC model 22 income declaration, as described in chapter VI, it subjected to autonomous taxation expenses that we now propose to disrecognize. Therefore, that autonomous taxation will be analyzed/adjusted in its own point.

III.1.1.2. CHARGES FOR BANK GUARANTEES INVOICED BY A...

From the documentary analysis carried out in the course of the inspective acts, it was verified the recording of charges for bank guarantees, with origin in three different entities, for the same economic reality: the parent company A..., the ACE D... and the bank itself G..., as can be concluded from the table presented below.

Within the scope of the previous inspective procedures the taxpayer, after notification for that purpose, presented a contract for the constitution of ACE D... - "Shareholders Agreement and International Regulations regarding the operation of the ... ACE" -, although it did not attach a copy of the respective annexes, which in its chapter V - "Guarantees", provides for guarantees to be provided by each respective member and by the ACE to the work owner, in the amount of 5% of the total value of the contract - €158,743,766.06 x 5% = €7,937,188.30.

As previously stated, as it is considered that the taxpayer under analysis does not correspond to any of the members of the ACE, the charges for bank guarantees borne by this and re-charged to that, in the amount of €33,122.87, is not fiscally deductible from its taxable profit, under the terms of article 45th of CIRC, having already been subject to analysis and correction in point III.1.1.1.

In the construction contract itself celebrated between the ACE and the taxpayer, nothing is specifically mentioned regarding the provision of (bank) guarantee - see annex III.

Therefore, and given that charges for bank guarantees were recorded, based on notes issued by bank G... to the taxpayer under analysis (cf. annex IX), whose beneficiary is the work owner, and similarly to what was verified in the previous procedures, only these will be accepted as fiscally deductible under the terms provided in article 23rd of CIRC, given that the amount to be guaranteed at the beginning of the guarantee was €15,308,455.08, corresponding to 10% of the total value of the contract, which is equivalent to double what was stipulated in the ACE constitution contract mentioned.

Thus, in view of the above stated, the charges relating to bank guarantees charged by A... (cf. annex X), will not be fiscally accepted as deductible from the taxable profit, as well as for not having been proven the occurrence and indispensability of the same for the realization of the tax-subject income of the taxpayer, under the terms of article 23rd of CIRC.

Therefore, the amount of €39,733.95 will be added to the net result of the period.

(...)

• Following the inspection, the IRC assessment no. 2014... and the compensatory interest assessment no. 2014... were issued, whose copies are document no. 1 attached with the request for arbitral ruling, whose content is given as reproduced, in which, among other things, the aforementioned corrections were considered;

• On 27-03-2015, the Applicant filed a voluntary complaint against the aforementioned assessments, which had the number ...2015... (document no. 2 attached with the request for arbitral ruling, whose content is given as reproduced);

• By order of 03-08-2016, the voluntary complaint was dismissed as to the corrections mentioned in points III.1.1.1. and III.1.1.2. of the Report of the Tax Inspection, which manifests agreement with an information, whose content is given as reproduced, in which the following is mentioned, among other things (document no. 3 attached with the request for arbitral ruling):

2 - Charges for which third parties are responsible - Charged by ACE D...

The correction to the taxable profit in question concerns charges attributed by ACE D..., as title of "distribution of common costs of the ACE", not accepted fiscally under the terms of article 45th of CIRC for being the responsibility of third parties, the taxpayer not being legally authorized to bear those charges.

As mentioned in the report, and also by the complainant, A... was assigned the NIPC..., corresponding to a non-resident entity without

permanent establishment.

The now complainant, permanent representation in Portugal of that company, in the form of a branch, was constituted on 07-04-2009 (fl. 417-verso), and was assigned the NIPC.... For tax purposes, it commenced activity on 13-04-2009 (fl. 395), appearing in the AT database as a permanent establishment of a non-resident entity.

On 17-04-2009 the ACE D... was constituted by A... and C..., S.A. As noted in the report, it is not the branch in Portugal (now complainant) that appears as a member of the ACE, but A....

On 04-05-2009, the branch in Portugal (now complainant) celebrated with the ACE a contract designated "No. …/…" (fls. 422 to 435) for the performance of the work corresponding to the part of A... (hereinafter referred to as A...).

Given that the branch (now complainant) is not one of the members of the ACE, the conclusion in the report seems correct that the charges attributed as title of common costs of the ACE do not apply to it, and are not deductible in the calculation of its taxable profit.

Pursuant to no. 2 of article 6th of CIRC, the groupings of economic interest attribute to their respective members the taxable profit determined, and are therefore not taxed in IRC based on that profit. In the case where one of the partners or members of an ACE is a non-resident entity, that attribution is to be considered made to a permanent establishment located in Portugal (no. 9 of article 5th of CIRC).

However, in the present case it is not a matter of attribution of the taxable profit of the ACE, but of charges of the ACE itself.

Thus, it seems that the correction made to the taxable profit should be maintained.

3 - Charges for bank guarantees invoiced by A...

The correction object of complaint concerns charges for guarantees charged by A... to the branch in Portugal (the documents supporting the accounting appear in annex X of the Report of the Tax Inspection - fls. 475 and 480 of the present records).

As new documents (docs. no. 5 to 9 - fls. 113 to 133), the complainant attaches various banking documents originating from Bank G... relating to guarantees related to the work of the D... ACE.

These documents do not contain any mention of guarantee costs or which entities bore those costs.

Given that, as mentioned in point III.1.1.2. of the report (cf. point II-1-a above) the charges for guarantees charged by G... were accepted and, on the other hand, because the documents now presented do not lead to the conclusion that the complainant should bear charges for these guarantees via A... or other entities, it seems appropriate to maintain the correction to the taxable profit object of complaint.

• On 27-11-2014, the Applicant paid the sum assessed above (document no. 4 attached with the request for arbitral ruling, whose content is given as reproduced);

• On 04-11-2016, the Applicant filed the request for constitution of the arbitral tribunal that gave rise to the present proceedings.

2.2. Unproven Facts

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

2.3. Reasoning of the decision on the factual matter

The facts were given as proven based on the documents attached with the request for arbitral ruling and on the administrative proceedings, with no controversy over them.

3. Legal Matter

The German legal entity A..., with tax identification DE..., hereinafter referred to as "A...", obtained in Portugal, on 03-03-2009, the NIPC..., corresponding to a non-resident entity without permanent establishment.

On 07-04-2009, the branch of the said German legal entity was registered in Portugal, B... – Branch in Portugal, to which the NIPC... was assigned, as a permanent establishment of that German legal entity.

On 17-04-2009, the German legal entity, using the first identification number, constituted a Grouping of Economic Interest, jointly with C... SA, in the proportions, of generic contribution to the charges thereof, of 15% and 85%, respectively, designated by "D..., for execution of a construction contract in Portugal.

On 04-05-2009, the ACE D... celebrated two sub-contracting contracts of the work in question, one of them with the aforementioned branch and another with C... SA, being agreed upon the reciprocal benefits between the branch and the ACE and that the latter should charge to the sub-contractors, in the agreed proportions of 64.29% for A... and 35.71% for the other member.

In the execution of the contract, the ACE indicated in the debit notes it issued to charge costs to the branch the tax identification number thereof.

The active operations of the ACE are constituted (by way of subcontracting), by the active operations of the branch and of the other company forming part of the ACE, these having invoiced to the ACE the entirety of the income that this invoiced to the work owner.

The Applicant understands, in summary, that there is no legal obstacle to the ACE charging to the branch the costs in which it incurs.

3.1. Question of the "charges for which third parties are responsible" charged by the ACE

The Tax Authority and Customs Authority, on the basis of what is referred to in point III.1.1.1. of the Report of Tax Inspection, made a correction to the taxable profit of the branch of the Applicant (NIPC..., corresponding to a permanent establishment) ([1]) in the amount of €633,212.43 concerning the charges charged by ACE D... in the course of the fiscal year 2012.

The corrected charges concern the issuance of debit notes issued by ACE D..., referring to expenses borne by it and attributed to the branch of the Applicant, as title of distribution of common costs of the ACE, in the proportion of 64.29%, in the same way as in the previous inspective procedures.

The Tax Authority and Customs Authority justified the correction in the following terms, in summary:

a) ACEs are subject to the special regime of fiscal transparency provided for in no. 2 of article 6th of CIRC, by means of which the profit or loss determined by them, in each economic exercise, is attributed to its members, in the proportion stipulated in the respective constitutive act, integrating itself in their taxable income, for purposes of taxation in IRC;

b) the charges borne by the ACE should not be charged directly to its members, but should be recognized for purposes of determining the respective fiscal profit or loss, to be attributed to its members, in the proportions established in the respective constitutive contract (…)";

c) the charges in question cannot be attributed to the member of the ACE "(…) for the fact that being the ACE an entity with headquarters or effective management in the national territory, which was constituted and functions according to the legal terms, and with organized accounting, the expenses and income of the same should, under the terms of article 17th of CIRC, allow the determination of the profit or loss of the exercise, and this yes, attributable to its respective members in the proportion of their participation, under the terms provided in no. 2 of article 6th of CIRC.";

d) the taxpayer under analysis does not correspond to any of the members of the ACE in question – D... . It is the very German legal entity, with registration in the national territory as a non-resident without permanent establishment – NIPC... – that is part of the ACE in question (annex II). It is also noted the fact that on the date of constitution of the ACE - 2009.04.17 - the German legal entity A..., had already constituted a branch (permanent representation) in this territory, without, however, having used the respective NIPC for the constitution of the ACE in question. Therefore, it could be concluded that it was the option of A... to have used the NIPC of non-resident without permanent establishment."

e) the taxpayer under analysis [NIPC associated with the recognition of a permanent establishment] is not a member of that ACE, that is, its NIPC was not used for the constitution of the same and nor is any alteration in its composition known in that sense;

f) not only the taxpayer under analysis is not a member of the ACE, but also for the fact that being the ACE an entity with headquarters or effective management in the national territory, which was constituted and functions according to the legal terms, and with organized accounting, the expenses and income of the same should, under the terms of article 17th of CIRC, allow the determination of the profit or loss of the exercise, and this yes, attributable to its respective members in the proportion of their participation, under the terms in no. 2 of article 6th of CIRC.

g) considering, thus, that the taxpayer is not legally authorized to bear those charges charged by ACE D..., (whose copies of the respective debit notes are attached as annex VIII), as title of common costs, and which are the responsibility of third parties [of the first NIPC obtained in Portugal], the same are not fiscally accepted, under the terms of article 45th of CIRC, in the amount of €633,212.43"

It is to be recalled that, in the terminology of the Report of the Tax Inspection, the "taxpayer" to which reference is made is the branch and not A..., Applicant in the present proceedings (as can be understood from the expressions "the taxpayer under analysis [NIPC associated with the recognition of a permanent establishment] is not a member of that ACE" and "not only the taxpayer under analysis is not a member of the ACE").

3.1.1. Regime of taxation of ACEs in IRC

The ACEs – Groupings of Economic Interest -– were introduced into Portuguese law by Law no. 4/73, of 4 June, regulated by Decree-Law no. 430/73, of 25 August, with a view to allowing, above all, cooperation between small and medium enterprises, in order to improve the conditions of exercise or result of their economic activities (no. 1 of Base 1 of Law no. 4/73 and Preamble of Decree-Law no. 430/73).

ACEs cannot have as their principal purpose the realization and sharing of profits and shall be constituted with or without their own capital (no. 1 of Base II of Law no. 4/73).

They can only have the realization and sharing of profits as an accessory purpose when expressly authorized by the constitutive contract (article 1st of Decree-Law no. 430/73), which, in this case, was not imposed by the constitutive contract of the ACE.

ACEs are subject to a regime of fiscal transparency, by virtue of what is provided in art. 6th, no. 2 of CIRC, so they are not taxed in IRC (article 12th of CIRC), being "the profits or losses of the exercise, determined under the terms of this Code (...) directly attributable to the respective members, integrating itself in their taxable income".

From this rule it follows that, when this regime is applicable, the profits or losses of ACEs must be determined under the terms of CIRC, being attributed to the members those profits or losses (and not the underlying income or expenses and other positive or negative components of taxable profit). No. 3 of article 6th of CIRC, in establishing that the attribution of profits or losses is made to the members of the ACE on the terms resulting from the constitutive act of the entities mentioned there or, in the absence of elements, in equal parts, confirms that, when this regime is applicable, it is not discretionary the determination of profits or losses within the scope of the ACE, as if it were, it would not justify the suppletory provision of the regime of attribution of profits or losses to the members of the ACE in equal parts, for cases in which the terms of attribution do not appear in the constitutive act.

In light of these rules, the charges relating to the activity of the ACE should constitute, in a 1st phase, expenses of the ACE and only then, in a 2nd phase, would the profits or losses that were determined be attributed to its members.

In the case at hand, this regime was not applied, as D... did not determine any accounting result, because it re-charged to its members, in full, the charges incurred with the project, as previously contractualized in the construction contracts established with the respective members.

For this reason, if this regime were applicable, one would be faced with an irregular procedure, even if the results could be similar, which is not demonstrated.

3.1.2. Regime of taxation in IRC of German companies, in light of the Tax Treaty between Portugal and Germany

However, in the case at hand, being faced with the activity of a German company in Portugal, one must take into account the norms of the Convention between the Portuguese Republic and the Federal Republic of Germany for the Avoidance of Double Taxation with Respect to Taxes on Income and Capital approved for ratification by Law no. 12/82, of 3 June (hereinafter "CDT"), which, by virtue of what is provided in article 8th, no. 2, of the CRP, and articles 26th and 27th of the Vienna Convention on the Law of Treaties, approved for ratification by Resolution of the Assembly of the Republic no. 67/2003, of 7 August, prevail over the norms of internal law.

This CDT provides a specific regime for taxation of the profits of companies, in its article 7th, which establishes, among other things, the following:

ARTICLE 7

Profits of enterprises

1 - The profits of an enterprise of a Contracting State may only be taxed in that State, unless the enterprise carries on business in the other Contracting State through a permanent establishment situated there. If the enterprise carries on business in this manner, its profits may be taxed in the other State, but only insofar as they are attributable to that permanent establishment.

2 - Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated there, there shall be attributed, in each Contracting State, to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions, and dealing wholly independently with the enterprise of which it is a permanent establishment.

3 - In determining the profits of a permanent establishment, it is permitted to deduct expenses which have been incurred for the purposes of the permanent establishment, including executive and general administrative expenses incurred in connection with the permanent establishment, whether incurred in the State in which the permanent establishment is situated or elsewhere.

As results from this article, the CDT does not provide that the profits of a German company are taxed in Portugal through the attribution of the results of an ACE and the percentage of participation provided for in the contract that constitutes it.

In fact, from no. 1 of article 7th it results that the profits of a German company may only be taxed in Portugal when it carries on business through a permanent establishment and "only insofar as they are attributable to that permanent establishment" and not to an ACE.

Under the terms of no. 2 of the same article 7th, the profits which it might be expected to make shall be attributed, in Portugal "to that permanent establishment if it were a distinct and separate enterprise engaged in the same or similar activities" and not the profits which can result from the percentage of participation in an ACE.

Furthermore, under the terms of no. 3 of this article 7th, "in determining the profits of a permanent establishment, it is permitted to deduct expenses which have been incurred for the purposes of the permanent establishment", from which it results from the CDT that the determination of taxable profit is carried out directly, with attribution to the permanent establishment of the charges related to the pursuit of its purposes and not with attribution to this of a percentage of the profits or losses of an ACE.

Thus, this CDT does not provide any regime identical to that which results from nos. 1 and 2 of article 6th of CIRC, relating to the attribution of profits and losses after being determined within the scope of the ACE, providing instead the direct determination of the profit of the permanent establishment, with a specific regime of attribution of expenses.

Thus in light of the CDT, the profits that the German company that is the Applicant in the present proceedings may have obtained from its activity in Portugal may be taxed "only insofar as they are attributable to that permanent establishment", being the determination of its taxable profit carried out directly, namely with direct attribution of the expenses that have been incurred for the purposes of its activity.

Thus, the permanent establishment, which is the form of taxation of the taxpayer that is the Applicant, may deduct from its taxable profit the expenses made for the purposes of its activity, therefore, by bearing the charges that were re-charged to it by the ACE it is not bearing charges that should be incurred by third parties, charges which the taxpayer is not legally authorized to bear, but, on the contrary, by virtue of the CDT, must be attributed to it, in the context of the determination of its taxable profit.

For this reason, it is erroneous the understanding adopted by the Tax Authority and Customs Authority underlying the assessment challenged, according to which, by virtue of article 45th of CIRC [it is inferred that the Tax Authority and Customs Authority are referring to paragraph c) of its no. 1, as the norm of article 45th is not expressly indicated to which it refers] "the taxpayer is not legally authorized to bear those charges charged by the ACE Projesines", "in the amount of €633,212.43".

In fact, only expenses could not be attributed to the permanent establishment if they were not "incurred for the purposes of the permanent establishment", which has not been demonstrated.

For this reason, the assessment challenged suffers from illegality due to a defect of violation of law which justifies its annulment, under the terms of article 163rd, no. 1 of the Code of Administrative Procedure, subsidiarily applicable, by virtue of paragraph c) of article 2nd of the LGT.

Furthermore, there is no legal basis for the disregard of expenses for the reason that the Applicant A... used its NIPC of non-resident without permanent establishment to constitute the ACE and that the debit notes were issued by the ACE in the name of the branch and with use of the NIPC thereof.

In fact, as regards the constitution of the ACE it is obvious that only A... could intervene, as ACEs can only be constituted by entities with legal personality ("natural or legal persons" and "companies", in accordance with article 1st, no. 1, of Law no. 4/73), and branches do not have legal personality, being merely a local form of representation of the company that creates it (article 13th, no. 1, of the Code of Commercial Companies).

On the other hand, the creation of a branch constituted for the Applicant the fulfillment of a duty, imposed by article 4th of the Code of Commercial Companies, which establishes that "the company which does not have its effective seat in Portugal, but wishes to carry on business here for more than one year, must establish a permanent representation and comply with what is provided in Portuguese law on commercial registration".

And it is the norms of commercial registration, in particular articles 10th, 40th, 46th and 70th of the Code of Commercial Registration, that imposed that branches have a NIPC (tax identification number), which is also the tax identification number (article 3rd, no. 1, of Order no. 386/98, of 3 July, currently revoked by Decree-Law no. 14/2013, of 28 January).

Thus, in accordance with the provisions of the aforementioned article 4th of the Code of Commercial Companies, the branch of the Applicant in Portugal is merely a form of representation of the Applicant A..., therefore, when attributed to this the expenses charged to the branch, with the respective NIPC, they are being attributed to A....

The existence of a permanent establishment of a non-resident company, embodied in the branch, which has autonomy for tax purposes, does not alter this legal reality that the non-resident entity is the subject to taxation, as results from article 4th, nos. 2 and 3, of CIRC.

It is relevant to cite here the arbitral award handed down in proceedings no. 1/2013-T:

"The permanent establishment is reconducted to an autonomous patrimony, for purposes of tax law, but the autonomy for these purposes is embodied only in the subjection of a mass of assets to a unitary tax treatment. "The patrimonial autonomy of Tax Law – and which is commonly referred to as "assimilation to independent enterprise" – reveals itself while the law subjects to independent taxation the profits that are directly attributable to it, rather than taxing the legal person as a whole or taxing analytically the foreign resident on each of the isolated income that it obtains, through withholding at source". ([2]) "(...) Among us, the patrimonial autonomy of establishments did not lead to the attribution of legal personality, for tax purposes, so that the taxpayer continues to be the foreign resident, only that taxed in the country where the branch is located through a methodology identical to that of legal entities resident there. In fact, article 13th, no. 1, of CIRS, and article 2nd of CIRC, consider the subject to taxation, not the permanent establishment, in itself considered, but natural or legal persons, foreign residents, who are its holders". ([3]) (emphasis ours).

This doctrine has explicit support in paragraph c) of no. 1 of article 2nd of CIRC, in which it is established that subjects to taxation are "entities, with or without legal personality, which do not have their seat or effective management in Portuguese territory and whose income obtained there is not subject to IRS". ([4])

It shall, therefore, be the foreign resident who holds the permanent establishment and not the permanent establishment itself that is taxed, as, as seems clear in light of what is provided in no. 2 of article 4th of CIRC, for which the initial part of no. 3 of the same article refers (...), the permanent establishment, despite being treated as an autonomous patrimonial mass for purposes of determining the amount of profits taxable in Portugal, does not have autonomous tax personality, being solely a specially relevant presence of the foreign resident: "legal entities and other entities which do not have their seat or effective management in Portuguese territory (that) become subject to IRC only as regards income obtained there".

The IRC Code itself, in the various provisions that refer to the permanent establishment, always considers it as being linked to the foreign resident and not as an autonomous entity [articles 3rd, no. 1, paragraph d), and 55th no. 1, among other articles of CIRC] with distinct tax personality from the non-resident company or entity of which it forms part".

Thus, it is concluded that, contrary to what the Tax Authority and Customs Authority understood, the fact that it was A... that intervened in the contract for the constitution of the ACE (using its NIPC..., as could not fail to be), is not an obstacle to the profits and losses being attributed to the branch (using its NIPC... of permanent establishment, as should be).

For this reason, also for these reasons, the rule of non-deductibility of the charges that incur on third parties which the taxpayer is not legally authorized to bear, which appears in paragraph c) of no. 1 of article 45th of CIRC, does not apply in this scope.

Consequently, it is not correct the understanding of the Tax Authority and Customs Authority that the "taxpayer", the branch, "is not legally authorized to bear those charges charged by ACE D..., (whose copies of the respective debit notes are attached as annex VIII), as title of common costs, and which are the responsibility of third parties [of the first NIPC obtained in Portugal]", as A... (first NIPC obtained in Portugal) is not a third party in relation to its branch.

On the other hand, given that it is not questioned, in the case at hand, that the branch constitutes a permanent establishment of A... and that all the activity to which the charges refer is attributable to the activity that was exercised in Portugal through this permanent establishment, this activity must be treated unitarily for purposes of IRC, through a methodology identical to that of legal entities resident here.

For this reason, contrary to what was concluded in the Report of the Tax Inspection, "those charges charged by ACE D..., (whose copies of the respective debit notes are attached as annex VIII), as title of common costs" are not "the responsibility of third parties [of the first NIPC obtained in Portugal]", having to be attributed to the permanent establishment, as they were.

Thus, in the context in which the Tax Authority and Customs Authority invokes article 45th of CIRC, which is that the branch cannot bear charges attributable to the member of the ACE A..., it is erroneous the position assumed in the Report of the Tax Inspection: one is not faced with charges that should be attributed to the "first NIPC obtained in Portugal" (in the terminology used in the Report of the Tax Inspection), as A... is taxed in Portugal by the activity of the permanent establishment through the methodology of entities resident here and, for that reason, the charges attributable to the activity developed through the permanent establishment should be borne by this (although indirectly, through the attribution of profits or losses of the ACE). ([5])

It is concluded, thus, that the correction in question also suffers from a defect of violation of law, by erroneous application of article 45th, no. 1, paragraph c), of CIRC.

3.2. Question of the charges for guarantees

The Tax Authority and Customs Authority made a correction in the amount of €39,733.95 concerning the charges for bank guarantees charged by A..., which it understood not to be fiscally accepted as deductible from the taxable profit for not having been proven the occurrence and indispensability of the same for the realization of the tax-subject income of the taxpayer (referring to the branch).

In chapter V - "Guarantees", of the "Shareholders Agreement and International Regulations regarding the operation of the ... ACE" (document no. 15 attached with the request for arbitral ruling), guarantees to be provided by each member and by the ACE to the work owner are provided for, in the amount of 5% of the total value of the contract - €158,743,766.06 x 5% = €7,937,188.30.

In annex X to the RIT are included copies of the invoices issued by A... with the values of the bank guarantee of €14,628.09, €14,550.06 and €10,555.80, which total the amount of €39,733.95, this amount corresponding to the bank guarantees borne by A....

The Tax Authority and Customs Authority understood, referring to the branch, that

(...) given that charges for bank guarantees were recorded, based on notes issued by bank G... to the taxpayer under analysis (cf. annex IX), whose beneficiary is the work owner, and similarly to what was verified in the previous procedures, only these will be accepted as fiscally deductible under the terms provided in article 23rd of CIRC, given that the amount to be guaranteed at the beginning of the guarantee was €15,308,455.08, corresponding to 10% of the total value of the contract, which is equivalent to double what was stipulated in the ACE constitution contract mentioned.

Thus, in view of the above stated, the charges relating to bank guarantees charged by A... (cf. annex X), will not be fiscally accepted as deductible from the taxable profit, as well as for not having been proven the occurrence and indispensability of the same for the realization of the tax-subject income of the taxpayer, under the terms of article 23rd of CIRC.

The provision of guarantees was provided for in the agreement celebrated between A... and C... relating to the operation of the ACE and were required in the public tender notice for the performance of the construction work for which the ACE was intended.

The Tax Authority and Customs Authority accepted the deductibility of the charges for bank guarantees referred to in the notes issued by bank G... to the branch of the Applicant, but not those that were re-charged to the branch by the Applicant itself, which appear in annex X to the Report of the Tax Inspection (part "PA14" of the administrative proceedings, pages 1 to 8), "for not having been proven the occurrence and indispensability of the same for the realization of the tax-subject income of the taxpayer, under the terms of article 23rd of CIRC".

What is at issue, in this correction, is the lack of proof that the guarantees referred to are related to the activity of the permanent establishment.

And, in fact, there are doubts as to the documents referred to, as those which appear in the aforesaid Annex are issued by the Applicant, A..., without being accompanied by documents issued by banking entities that prove that it bore the costs that it re-charged to the branch and that they are connected with the activity of this.

On the other hand, the Applicant attached with the voluntary complaint other documents relating to guarantees related to the work of the D... ACE (documents with nos. 5 to 9 attached to the voluntary complaint, which appear in parts "PA4.pdf" and "PA5.pdf" of the administrative proceedings), but none of them contains any mention of guarantee costs or who bore them.

Article 23rd, no. 1, and its paragraph c), of CIRC, invoked by the Tax Authority and Customs Authority, establishes, in the wording in force in 2012, that "expenses are considered those which are demonstrably indispensable for the realization of income subject to taxation or for the maintenance of the source of production, namely (...) of a financial nature", therefore the deductibility is dependent on the proof of expenses and their relationship with the activity potentially generating income or with the maintenance of its source.

In the case at hand, in light of the evidence produced, the Tax Authority and Customs Authority could not give these requirements of deductibility as proven.

For this reason, it cannot be considered demonstrated that the correction in the amount of €39,733.95 suffers from illegality.

Consequently, the request for arbitral ruling is not upheld, in this part.

4. Reimbursement of the amount paid and compensatory interest

The Applicant paid the assessed amount and requests reimbursement of the amount of €188,225.58, relating to IRC, municipal and state surcharges and compensatory interest proportionally corresponding to the corrections challenged.

The Applicant further requests compensatory interest.

In accordance with the provisions of paragraph b) of art. 24th of RJAT, the arbitral decision on the merits of the claim, which is not subject to appeal or challenge, binds the Tax Administration from the expiration of the period provided for appeal or challenge, having to this, in the exact terms of the procedure of the arbitral decision in favor of the taxpayer and until the expiration of the period provided for the spontaneous execution of the sentences of the tax courts, "restore the situation that would have existed if the tax act that is the subject of the arbitral decision had not been performed, adopting the necessary acts and operations for that purpose", which is in line with what is provided in art. 100th of LGT [applicable by virtue of the provisions of paragraph a) of no. 1 of art. 29th of RJAT] which establishes that "the tax administration is obliged, in case of total or partial success of a complaint, judicial challenge or appeal in favor of the taxpayer, to the immediate and full restoration of the legality of the act or situation that is the subject of the litigation, including the payment of compensatory interest, if applicable, from the expiration of the period for execution of the decision".

Although art. 2nd, no. 1, paragraphs a) and b), of RJAT uses the expression "declaration of illegality" to define the jurisdiction of the arbitral tribunals that function at CAAD, not making reference to condemnatory decisions, it should be understood that its jurisdiction includes the powers that in judicial challenge proceedings are attributed to tax courts, being this the interpretation that is in line with the sense of the legislative authorization on which the Government based itself to approve RJAT, in which it proclaims, as the first directive, that "the tax arbitral proceeding must constitute an alternative procedural means to the judicial challenge proceeding and to the action for the recognition of a right or legitimate interest in tax matters".

The judicial challenge proceeding, although it is essentially a proceeding for the annulment of tax acts, admits condemnation of the Tax Administration in the payment of compensatory interest, as can be understood from art. 43rd, no. 1, of LGT, in which it is established that "compensatory interest is due when it is determined, in a voluntary complaint or judicial challenge, that there was error attributable to the services as a result of which the tax debt was paid in an amount greater than that legally due" and from art. 61st, no. 4 of CPPT (in the wording given by Law no. 55-A/2010, of 31 December, which corresponds to no. 2 in the original wording), that "if the decision that recognized the right to compensatory interest is judicial, the period for payment is counted from the beginning of the period for its spontaneous execution".

Thus, no. 5 of art. 24th of RJAT, when it says that "payment of interest, regardless of its nature, is due, under the terms provided in the general tax law and in the Code of Procedure and Tax Process", must be understood as allowing the recognition of the right to compensatory interest in arbitral proceedings, as well as the reimbursement of the amount paid, which is the basis for calculating interest.

It is therefore necessary to assess the request for reimbursement of the amount unduly paid, plus compensatory interest.

In the case at hand, it is manifest that, following the partial illegality of the assessment act, there is a place for reimbursement of the tax paid, under the heading of IRC, state and municipal surcharges and compensatory interest, in the proportional part to the value of the correction of €633,212.43 challenged in the present proceeding, which is the only one whose illegality is declared.

In fact, by virtue of the aforementioned arts. 24th, no. 1, paragraph b), of RJAT and 100th of LGT, the reimbursement is essential to "restore the situation that would have existed if the tax act that is the subject of the arbitral decision had not been performed".

As regards compensatory interest, it is also clear that the illegality of the assessment act is attributable to the Tax Administration, which, on its own initiative, performed it without legal support.

Consequently, the Applicant has the right to compensatory interest, under the terms of art. 43rd, no. 1, of LGT and 61st of CPPT, with respect to the amount that is to be reimbursed.

The compensatory interest will be paid from the date on which the Applicant made the payment until the full payment of the amount that should be reimbursed, at the legal suppletory rate, under the terms of articles 43rd, no. 4, and 35th, no. 10, of LGT, article 61st of CPPT, article 559th of the Civil Code and Order no. 291/2003, of 8 April.

As rightly argued by the Tax Authority and Customs Authority in its Response, the calculation of the amount to be reimbursed, on which compensatory interest is charged, should be carried out in execution of judgment, under the terms of the aforementioned article 24th, no. 1, paragraph b), of RJAT, 100th of LGT and 61st of CPPT.

5. Decision

In these terms, the members of this Arbitral Tribunal agree to:

a) Render partial judgment in favor of the application for arbitral ruling, in the part corresponding to the correction in the amount of €633,212.43;

b) Annul the order dismissing the voluntary complaint no. ...2015..., the IRC assessment (which includes that of state and municipal surcharges) no. 2014... and the compensatory interest assessment no. 2014..., in the part corresponding to the correction in the amount of €633,212.43;

c) Condemn the Tax Authority and Customs Authority to reimburse the Applicant the amount of IRC, municipal and state surcharges and compensatory interest corresponding to the aforementioned correction in the amount of €633,212.43;

d) Condemn the Tax Authority and Customs Authority to pay the Applicant compensatory interest calculated on the basis of the amount to be reimbursed, from the date of payment until the date on which the reimbursement is made;

e) Render judgment not in favor of the application for arbitral ruling as to the correction in the amount of €39,733.95, and absolve the Tax Authority and Customs Authority of the requests connected with it.

6. Value of the proceeding

In accordance with the provisions of art. 306th, no. 2, of CPC and 97th-A, no. 1, paragraph a), of CPPT and 3rd, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings the proceeding is assigned a value of €188,225.58.

7. Costs

Under the terms of art. 22nd, no. 4, of RJAT, the amount of costs is set at €3,672.00, under the terms of Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, charged to the Applicant in the percentage of 6.27% and charged to the Tax Authority and Customs Authority in the percentage of 93.73%.

Lisbon, 18-04-2017

The Arbitrators

(Jorge Manuel Lopes de Sousa)

(Jorge Carita)

(José do Vale Marçal)

[1] In the Report of the Tax Inspection, the references to the "taxpayer" refer to the entity with NIPC..., which is the branch of the now Applicant A..., NIPC....

[2] ALBERTO XAVIER, International Tax Law, 2nd edition, page 326.

[3] Author and Work Cited.

[4] In this sense, see the judgment of the Supreme Administrative Court of 7-5-2008, proceeding no. 0200/08, whose case law was followed in the judgments of 21-5-2008, proceeding no. 0191/08, and of 24-9-2008, proceeding no. 0199/08. (...).

[5] In any case, by virtue of the provisions in no. 3 of article 3rd of CIRC, even the other income obtained in Portuguese territory, arising from activities identical or similar to those performed through the permanent establishment, of which A... was the holder would be attributable to the permanent establishment.

Frequently Asked Questions

Automatically Created

What qualifies as a permanent establishment (estabelecimento estável) for IRC purposes under the Portugal-Germany Double Taxation Convention?
Under the Portugal-Germany Double Taxation Convention, a permanent establishment (estabelecimento estável) for IRC purposes is defined in Article 5 of the Convention. It requires a fixed place of business through which a German enterprise wholly or partly carries on its business in Portugal. In this case, the German company A... established Branch B... in Portugal on 07-04-2009, registered with Portuguese tax authorities as a non-resident taxpayer with permanent establishment, developing engineering and technical activities (CAE 71120). The branch participated in a construction contract through ACE D... for the expansion of a terminal. The key criteria include: (i) a fixed physical location in Portugal, (ii) permanence or intended duration exceeding certain thresholds, (iii) the enterprise's disposal over the location, and (iv) business activities carried on through that location. The Portuguese Tax Authority recognized the branch as a permanent establishment when it commenced activity on 13-04-2009, which is crucial because it subjects the branch to IRC taxation in Portugal on profits attributable to Portuguese activities under Article 7 of the Convention.
Can a German company's Portuguese branch deduct expenses (gastos) allocated from its head office for IRC tax purposes?
A German company's Portuguese branch can deduct expenses allocated from its head office for IRC purposes, but only if specific conditions are met under both Portuguese domestic law and the Portugal-Germany Convention. Article 7 of the Convention provides that only expenses genuinely incurred for the purposes of the permanent establishment are deductible. Under Article 23 of the IRC Code (CIRC), expenses are deductible if they are: (i) indispensable for generating taxable income or maintaining the income source, (ii) properly documented with invoices or equivalent supporting documents under Article 23-A CIRC, and (iii) effectively borne by the permanent establishment. In Process 666/2016-T, the Tax Authority challenged €672,946.38 in expense deductions, apparently relating to charges allocated by the head office. The burden is on the taxpayer to prove that expenses were real, necessary, and properly allocated using acceptable methods such as direct attribution, cost allocation keys based on revenue, personnel, or other reasonable criteria. Transfer pricing rules under Article 63 CIRC also apply, requiring that expense allocations follow the arm's length principle, meaning they must reflect what independent parties would charge under comparable circumstances.
What burden of proof applies to expense deductions claimed by a permanent establishment in Portugal?
The burden of proof for expense deductions claimed by a permanent establishment in Portugal follows Article 74 of the General Tax Law (LGT) and Article 75 of the IRC Code. The general principle is that the Tax Authority bears the burden of proof for facts that constitute tax liability, while the taxpayer bears the burden of proving facts that support tax benefits, deductions, or exemptions. Regarding expense deductions, Article 75(1) CIRC specifically provides that proof of expenses rests with the taxpayer. This means the Portuguese branch must demonstrate: (i) that expenses were effectively incurred through proper documentation (invoices, contracts, payment evidence), (ii) that expenses are indispensable and directly related to income-generating activities, (iii) proper accounting records under SNC (Sistema de Normalização Contabilística), and (iv) compliance with transfer pricing documentation requirements for transactions with related parties. In Process 666/2016-T, the Tax Inspection found issues with expenses charged by ACE D... and potentially by the German head office, suggesting insufficient documentation or proof of their necessity. Article 123 of the Tax Procedure Code (CPPT) reinforces that taxpayers must provide all documents and clarifications requested by tax authorities. Failure to adequately prove expenses results in their exclusion from deductibility and addition to taxable income.
How does the Portugal-Germany Convention for the Avoidance of Double Taxation affect IRC assessments on branch profits?
The Portugal-Germany Convention for the Avoidance of Double Taxation significantly affects IRC assessments on branch profits by limiting Portugal's taxing rights and establishing profit attribution rules. Article 7 (Business Profits) provides that profits of a German enterprise are only taxable in Portugal if attributable to a permanent establishment situated there, and only to the extent of profits that the permanent establishment would have made if it were a distinct and independent enterprise. This requires: (i) separate accounting for the Portuguese branch, (ii) arm's length pricing for transactions between the branch and head office, (iii) deduction only of expenses genuinely incurred for the branch's activities. Article 23 (Elimination of Double Taxation) requires Germany to eliminate double taxation by allowing credit for Portuguese taxes paid or exempting Portuguese-source income. In Process 666/2016-T involving fiscal year 2012, the application of the Convention meant that the €672,946.38 correction to taxable matter must respect Convention limitations. If the Tax Authority's corrections violate Convention provisions, the taxpayer can challenge them. The Convention's provisions prevail over domestic law under Article 8(2) of the Portuguese Constitution. The separate entity approach under Article 7 is crucial because it permits expense deductions that a standalone Portuguese company would have, but disallows artificial allocations that don't reflect genuine economic substance.
What is the procedure to challenge an IRC additional tax assessment through CAAD arbitration in Portugal?
The procedure to challenge an IRC additional tax assessment through CAAD (Centro de Arbitragem Administrativa) arbitration in Portugal follows the Regime Jurídico da Arbitragem em Matéria Tributária (RJAT - Decree-Law 10/2011). In Process 666/2016-T, the applicant followed these steps: (i) First, submitted a voluntary complaint (reclamação graciosa) no. ...2015... to the Tax Authority, which was partially dismissed; (ii) Within 90 days of notification of the dismissal, filed a request for constitution of an arbitral tribunal under Articles 2(1)(a) and 10(1)(2) RJAT; (iii) The request must identify the contested act (IRC assessment no. 2014... for fiscal year 2012), state grounds for illegality (error in factual assumptions, violation of law and legality principle), quantify the amount disputed (€188,225.58), and attach supporting documents; (iv) Paid the arbitration fee calculated under Portaria 112-A/2011; (v) CAAD's President accepted the request on 18-11-2016 and automatically notified the Tax Authority; (vi) The Deontological Council appointed three arbitrators who accepted by 04-01-2017; (vii) The tribunal was constituted on 19-01-2017 after the challenge period elapsed; (viii) The Tax Authority submitted a Response defending the assessment; (ix) Written pleadings were exchanged; (x) The tribunal will issue a decision within 6 months (extendable), which has the same effects as a court judgment and is enforceable. CAAD arbitration provides a faster alternative to tax courts for challenging IRC assessments.