IRC Tax Assessment Annulled: Direct Method for Taxable Income Quantification Challenged (CAAD 672/2015-T)

ARBITRAL DECISION

The Arbitrator Raquel Franco, designated by the Deontological Council of the Administrative Arbitration Center (CAAD) to form the singular arbitral tribunal constituted on 18 January 2016, decides as follows:

I. REPORT

1. On 10.11.2015, the company "A…, LDA.", Tax Number … filed a request for constitution of a singular arbitral tribunal, in accordance with the provisions of Articles 2 and 10 of Decree-Law No. 10/2011, of 20 January (Legal Framework for Tax Arbitration, hereinafter, "LFTA"), with the Tax and Customs Authority (TCA) being summoned.

2. The request for constitution of the Arbitral Tribunal was accepted by the Esteemed President of CAAD and automatically notified to the TCA on 13.11.2015.

3. Pursuant to paragraph a) of Article 6, paragraph 2 and paragraph b) of Article 11, paragraph 1 of Decree-Law No. 10/2011, of 20 January, in the wording introduced by Article 228 of Law No. 66-B/2012, of 31 December, the Deontological Council designated the undersigned as arbitrator of the singular arbitral tribunal, who communicated acceptance of the corresponding assignment within the applicable timeframe.

4. On 31.12.2015, the parties were duly notified of this designation and expressed no intention to refuse the arbitrator's designation in accordance with the combined provisions of Article 11, paragraph 1, paragraphs a) and b) of the LFTA and Articles 6 and 7 of the Deontological Code.

5. Thus, pursuant to paragraph c) of Article 11, paragraph 1 of Decree-Law No. 10/2011, of 20 January, in the wording introduced by Law No. 66-B/2012, of 31 December, the arbitral tribunal was constituted on 18.01.2016.

6. In the present case, the Claimant seeks that the Arbitral Tribunal declare the illegality of the act imposing an additional corporate income tax (IRC) liability for the fiscal year 2012, in the amount of € 1,519.06 (assessment No. 2015…, of 20.07.2015).

7. Specifically, the Claimant contests the correction made by the TCA with respect to alleged omitted sales, in the amount of € 33,256.56, while accepting, by contrast, the correction relating to non-accepted depreciation, in the amount of € 2,016.58.

8. The disputed issue concerns the legality, or otherwise, of the method used by the TCA to determine the taxable base for corporate income tax purposes, carried out within the framework of the inspection procedure that preceded the additional assessment.

8.A. The Claimant supports its request, in summary, in the following terms:

· The inspection made no quantification of the omissions or inaccuracies in the accounting elements that would allow the necessary verification and direct and exact quantification of the taxable base, and, accordingly, the requirements for carrying out a direct assessment, as provided for in Article 83 of the General Tax Law (LGT), for determining the real value of income or assets subject to taxation, are not met.

· This omission is exclusively attributable to the TCA, as it was made available with all files and accounting elements so that, within the framework of the procedure, it could determine, through direct assessment, the taxable profit.

· Pursuant to Article 6 of the Supplementary Regulations for Tax Inspection Procedures (RCPITA), the inspection procedure aims at the discovery of material truth, and the tax administration must officially adopt the appropriate initiatives to this end, particularly bearing in mind that, pursuant to Article 74 of the LGT, the burden of proof rests with the TCA.

· In this case, by refraining from quantifying the alleged omitted sales from the computer files, the tax inspection made it impossible to quantify directly and exactly the taxable base, rendering the assessment issued for corporate income tax purposes illegal.

· Pursuant to Article 81 of the LGT, the taxable base is assessed or calculated directly according to the criteria specific to each tax, and the tax administration may only proceed to indirect assessment in cases and under conditions expressly provided by law.

· Indirect assessment is therefore subsidiary to direct assessment and presupposes that it is impossible to quantify the taxable base directly and exactly.

· From the grounds set out in the Inspection Report it follows that the tax inspection called into question the reliability of the Claimant's accounting, with indications being pointed out that it does not reflect the real values of sales and, consequently, of income obtained by the taxpayer, with an alleged omission of sales being attributed to the Claimant, for not converting table consultations issued into invoices and which would correspond to service provisions in an amount that the tax inspection did not determine from the analysis of the files.

· According to the Claimant, the TCA should have identified and quantified exactly those table consultations that did not give rise to any invoice, and, in that manner, without resorting to indicia or presumptions, determined the taxable profit in accordance with the rules enshrined in the Corporate Income Tax Code for direct assessment.

· By contrast, what the TCA did was presume sales on the basis of indicia. Specifically, it made use of the accounting record of advances made in cash, demonstrated through accounting records, and with this indicative fact, it sought to establish another fact – the omission of sales.

· However, the Claimant considers that deeming that the value of the alleged advances is equal to the value of omitted sales is not correct because, although it is true that in certain cases the financial flow corresponding to undeclared sales returns to companies as advances, the relationship between both is not absolutely certain.

· Also according to the Claimant's analysis, the inspection inferred that the recorded advances did not correspond to actual capital contributions by the partners, proceeding from their periodicity and from the fact that, in their absence, the cash account would have a negative balance, but this inference is not necessarily correct because one of the possible purposes of loans made by partners to companies is precisely to cover treasury shortfalls, so in their absence, the cash account would always have a negative balance.

· The Claimant further adds that, even if effective advances had not been made, the amount corresponding to them thus evidenced in the accounting could constitute an indicium of sales not realized, but nothing more than that.

· In summary, the Claimant alleges that the TCA, under the guise of technical corrections, corrected and altered declared values, improperly using indirect methods, without observing the procedure thereof, which is subject to special duties, namely of substantiation, and which attribute specific rights and guarantees to taxpayers, in the first place, the review request, provided for in Article 91 of the LGT, which constitutes the means of defense, par excellence, for discussing, from a quantitative perspective, the erroneous determination of taxable profit. Not having observed the procedure corresponding to an indirect assessment method, actually used, it considers that the impugned corporate income tax assessment is tainted with illegality.

8.B. In its Response, the TCA invoked, in summary, the following:

· The Claimant was subject to an inspection action, directed at taxpayers identified as users of the IECR billing program, certificate No. …, resulting in the seizure of the "dongle pen" with serial number T… at the Claimant's premises.

· During the inspection action that took place, the entries made in the Claimant's accounting were analyzed, which have as support the documents filed in the respective folders, the inspection services verifying that (i) in sales and service provisions carried out by the Claimant, receipt is made through cash or debit card (ATM terminal); (ii) receipts from clients made in cash are deposited in the bank, receipts through debit card being automatically transferred to the Claimant's bank account; (iii) the accounting record of these receipts is made by debiting the bank account (account 12) and by crediting cash (account 11); (iv) at the end of the month the monthly closing is withdrawn from the billing system, that is the monthly accounting of sales recorded in that month; (v) these values are recorded in the accounting, with the cash account (account 11) being debited by credit of sales or service provision accounts (71/72) and VAT payable (account 2433).

· Because the Claimant did not record all products sold, the amounts deposited in the bank are greater than the declared sales values, so the cash account has a credit balance. Subsequently, an entry is made, which has as support an internal document, in which it is transferred from this cash account to the partners' account, account 268 (cf. annex 2 of the ITR), the value corresponding to the value of omitted sales.

· In the year 2012, the Inspection Services identified two distinct situations that have the same origin, that is, two accounts in which movements are recorded that are intended to conceal unregistered sales. One first situation refers to the cash account (account 11) as already explained, another situation is the account for remuneration payable (account 2311). Specifically, remuneration for corporate bodies is processed and paid monthly, but the financial flow corresponding to these payments is not recorded in the accounting (annex 2), being made only at the end of the year. The Inspection Services verified that, similarly to what is done for workers, whose remuneration is processed monthly and who are paid in cash, as evidenced, for example, by entries Nos. …, … and…, of 31/01/2012, 29/02/2012 and 30/06/2012, respectively, all from journal 5, corporate bodies are also paid in this manner, which is assumed at the end of the year, as per internal entry of the total amount. Thus, the Inspection Services concluded that these payments corresponded to values received from the only known source of income, namely from sales realized, which are not deposited, being used to cover the remuneration payable to corporate bodies.

· In this manner, they verified the existence of omissions of income, a fact reflected in internal account transfer entries, debit of account 11 - cash by offset of account 26 – shareholders (annex 3), and reinforced by the results of the audit of data stored in the "dongle/pen" with serial number T….

· Given the foregoing, and taking into account that receipts occurred over time, the Inspection Services determined the following values, divided by period, for the fiscal year 2012 (cf. annex 2, page 1 and annex 4 of the ITR):

· In these terms and in accordance with that described in point III.1 of the ITR, the Inspection Services determined, for the year in question (2012), the following omission of recording of sales/service provisions: € 33,256.56, value to be added to taxable profit, pursuant to paragraph a) of Article 20, paragraph 1 of the CIRC.

· As to the grounds invoked by the Claimant for the illegality of the impugned assessment, the TCA responds in the following terms:

• The records found in the inspection action evidenced that there was an attempt to conceal every trace of the presence in the Claimant's database of consultation documents that did not give rise to invoice issuance through their frequent deletion at the moment of "cash closing".

• The Claimant understands that the inspection services should have reconstructed the volume of business of the taxpayer, identifying the table consultations that did not give rise to invoicing.

• At the beginning of the inspection procedure, i.e., 08-04-2015, the Inspection Services requested from the Claimant, in order to verify the irregularities detected, the following elements:

• SAF-T accounting file (2013 and 2014);

• SAF-T billing file (2013 and 2014).

• Subsequently the SAF-T accounting file for the fiscal year 2012 was requested (billing file, mandatory since January 2013, pursuant to Decree-Law 198/2012).

· The inspection action took place at the Claimant's premises, where the supporting documents for the accounting of the years 2012 to 2014 were made available.

· On the basis of the SAF-T accounting file, from which trial balances were extracted (cf. annex 1 of the ITR) and account statements, the Inspection Services analyzed the documents supporting the accounting.

· The documentary analysis focused on the records of the following accounts:

• Purchases;

• Tangible fixed assets;

• Supplies and external services;

• Personnel expenses;

• Income.

· From the above-mentioned accounts, the Inspection Services proceeded to analyze the extracts and the most relevant sub-accounts, having verified the supporting documents, namely associated costs, invoice requirements and their issuers.

· Having analyzed all files and the audit of stored data, the TCA concluded that the Claimant carried out service provisions/sales without being accompanied by invoice issuance, that is, it was thus proven that, through the IECR billing software, certain consultation documents were issued that did not give rise to invoice issuance, and that the same translated into actual transactions.

· The TCA further concluded that, from the analysis of the accounting, which constitutes an objective criterion, it was possible to infer the real value of income, with the ITR containing the criteria used and the weighing of the factors that influenced the determination of its result.

· The accounting thus made it possible to discern the direct and exact quantification of the taxable base, resulting from the analysis of the accounts and the entries made, with no presumption on the part of the tax inspection in the quantification of income.

· Given the foregoing, contrary to what is advocated in item 41 of the initial statement, there was no inference on the part of the tax inspection in the present case, given that from the accounting it resulted that the alleged advances, with the exception of some that were not disregarded, resulted from omission of sales, a fact reflected in the internal account transfer entries, debit of account 11 - cash, by offset of account 26 – shareholders.

· It is also worth mentioning that pursuant to Article 63-C, paragraph 2, of the LGT "all movements relating to advances, other forms of loan and capital contributions of partners, as well as any other movements to or in favor of taxpayers shall be made through the account referred to in paragraph 1", which did not occur, bearing in mind that all movements considered have internal supporting documentation and did not go through account 12 – bank account.

· Thus, there was no indirect assessment in the inspection action in question, all corrections made resulted from the accounting presented by the Claimant, accounting that is demonstrative and representative of the facts, from which the correction sub judice resulted.

· In this manner, the TCA considers having proven the existence of omissions of income, fact reflected in the internal account transfer entries, debit of account 11 - cash by offset of account 26 – shareholders (annex 3), and reinforced by the results of the audit of data stored in the "dongle/pen" with serial number T…, for which reason it sees no reason for censure of the technical corrections proposed by the Inspection Services, and consequently the act of impugned assessment, which translates the tax correction of income in the amount of € 33,256.56, pursuant to paragraph a) of Article 20, paragraph 1 of the CIRC.

III. DISMISSAL OF PRELIMINARY ISSUES

1. The Tribunal is competent and regularly constituted, pursuant to Articles 2, paragraph 1, paragraph a), 5 and 6, all of the LFTA.

2. The parties have legal personality and capacity, are legitimate and are legally represented, pursuant to Articles 4 and 10 of the LFTA and Article 1 of Ordinance No. 112-A/2011, of 22 March.

3. The case is not affected by vices that would invalidize it.

IV. FACTS

Before entering into the examination of the legal issues, it is necessary to present the factual matter relevant for its understanding and decision, which, having examined the documentary evidence and the administrative file (AF) attached to the record and taking into account the facts alleged, is established as follows:

IV.1. Established Facts

A. The Claimant was subject to an inspection action, directed at taxpayers identified as users of the IECR billing program, certificate No. …, resulting in the seizure of the "dongle pen" with serial number T… at the Claimant's premises.

B. The inspection action had general scope, having covered the years 2012, 2013 and 2014.

C. During the inspection action that took place, the entries made in the Claimant's accounting were analyzed, which have as support the documents filed in the respective folders.

D. Having analyzed the files and conducted an audit of stored data, the TCA concluded that the Claimant carried out service provisions/sales without being accompanied by invoice issuance.

E. The inspection action proved that consultation documents were issued, through the IECR billing system, that did not give rise to invoice issuance, and that the same translated into actual transactions.

F. Through the records, the TCA concluded that there was an attempt to conceal records of this type of documents from the database, through their deletion at the moment of cash closing.

G. In sales and service provisions carried out by the taxpayer, receipt is made through cash or debit card (ATM terminal).

H. Receipts through debit card are automatically transferred to the bank account;

I. As for cash receipts, the TCA considered, in the inspection report, that they are deposited in the bank.

J. At the end of each month, the monthly closing is withdrawn from the billing system, that is, the monthly accounting of sales recorded in that month.

K. These values are recorded in the accounting, with the cash account (account 11) being debited by credit of sales or service provision accounts (71/72) and VAT payable (account 2433).

L. In the year 2012, remuneration for corporate bodies was processed and paid monthly, but the financial flow corresponding to these payments is not recorded in the accounting (annex 2), being made only at the end of the year.

M. The Inspection Services verified that, similarly to what is done for workers, whose remuneration is processed monthly and who are paid in cash, corporate bodies are also paid in this manner, which is assumed at the end of the year, as per internal entry of the total amount.

N. The Inspection Services concluded that these payments corresponded to values received from the only known source of income, namely from sales realized, which are not deposited, being used to cover remuneration payable to corporate bodies.

O. The corrections made by the Inspection Services for the year 2012 in terms of income omissions were € 33,256.56.

P. The TCA issued an additional corporate income tax assessment, referring to the fiscal year 2012, in the amount of € 1,519.06.

Q. Pursuant to the statement of account reconciliation, the amount payable by the taxpayer for the fiscal year 2012 was € 180.89.

R. The Claimant was notified, pursuant to Article 60 of the RCPITA, to exercise the right to prior hearing regarding the Project of Corrections to the Inspection Report.

S. The notification was received on 16.06.2015.

T. The Claimant did not submit any response in this regard.

IV.2. Unestablished Facts

There are no facts relevant to the decision that have been deemed unestablished.

V. THEMA DECIDENDUM

The issue to be decided in the present case concerns the manner in which the TCA quantified the taxable income of the Claimant following the inspection action it carried out, in this case, for the fiscal year 2012. Specifically, it is necessary to ascertain whether, as the Claimant states, the TCA proceeded to an indirect assessment of the taxable base under the guise of technical corrections or whether, as the Respondent argues, the TCA merely quantified, using elements available in the Claimant's accounting, the actual taxable base.

VI. LEGAL REASONING

The inspection of the Claimant's accounting records revealed that it carried out, during the fiscal year 2012, uninvoiced sales. Instead of issuing an invoice for each transaction carried out, the Claimant issued, at times, another type of document that allows the respective client to know how much is being paid for the consumption realized and that allows it – the Claimant – not to record the value of the sale as income for taxation purposes.

The TCA concluded that the formulas used by the Claimant, in 2012, to achieve this effect by accounting for unregistered receipts in two ways: (i) through the falsified recording of advances and (ii) through the payment of remuneration with the credit balance of the cash account. Thus, it assumed that the values recorded in internal account transfer entries, debit of account 11 – cash by offset of account 26 – shareholders, correspond to sales realized without invoice issuance (except in some cases, in which it did not alter the accounting record made by the Claimant) and that the payments of remuneration to corporate bodies are made with money from the credit balance of the cash account.

Through the internal documents contained in annexes 2, 3 and 4 to the inspection report, the TCA concluded that the values of omitted income resulting from the cash account credit balance and the remuneration payable account credit balance amounted to € 33,256.56[1], having therefore added this value to taxable profit pursuant to paragraph a) of Article 20, paragraph 1 of the Corporate Income Tax Code.

Thus, the TCA proposed the corrections, namely for corporate income tax purposes for the fiscal year 2012, taking into account documents and values contained in the Claimant's accounting, to which it gave an interpretation different from that given by the Claimant in the determination of accounting and taxable profit. Now, accounting records are only that: records of facts relevant to the determination of profit from the activity of the entity in question, which also serve, pursuant to the provisions of the Corporate Income Tax Code, to determine the tax owed. However, they are not immune to manipulation in so far as they result from human activity. Thus, it is possible to create accounting documents to support facts that did not occur in the manner the record suggests, namely, documents that record advances that were not actually made. On the other hand, it is possible to create accounting documents that provide support for facts that would otherwise have no accounting support, such as, for example, remuneration payments based on money that "remains" in the cash closing because no corresponding invoice was issued.

The creation of accounting documents A, B and C to record accounting for the supposed facts X, Y and Z does not mean that these facts become reality; they are only so within that accounting. What it means, in turn, is that they can be called into question as real facts and not merely as accounting facts.

The Claimant understands that what the TCA did was resort to indicia and presumptions to establish the value of the taxable base and that, consequently, the procedures for determining the taxable base were indirect and not direct. It does not appear to us that it is correct.

Pursuant to Article 83 of the LGT, "direct assessment aims at the determination of the real value of income or assets subject to taxation", while "indirect assessment aims at the determination of the value of taxable income or assets based on indicia, presumptions or other elements available to the tax administration".

In the present case, notwithstanding the TCA qualifying in a different manner from the Claimant the values recorded in its accounting, it is effectively the values recorded in the accounting that were taken into account in determining the taxable base. That is, the TCA did not make use of indicia or presumptions to determine the real value of income subject to taxation, rather it made use of the values contained in the Claimant's accounting, although qualifying them differently and, as such, generating the levy of tax where the Claimant had not levied it.

This different qualification of the values recorded in the accounting does not translate into an indirect assessment of income subject to taxation, on the contrary: it was the values recorded by the taxpayer itself in its accounting that served as the basis for determining the taxable base and, consequently, the tax owed. Using the words of Diogo Leite de Campos/Benjamim Silva Rodrigues/Jorge Lopes de Sousa, "the assessment was made on the basis of evidence of the real value of the assets or taxable income and, therefore, aims to determine exactly this value" (cf. General Tax Law – Annotated and Commented, 4th edition, 2012, p. 739).

The fact that the TCA altered the qualification that the taxpayer gave to the facts described in certain accounting movements does not make the assessment indirect, since the determination of taxable income continues to be carried out on the basis of evidence of the real value of such income. In the case under analysis, there was no impossibility of verifying and quantifying directly and exactly the taxable base through elements contained in the taxpayer's accounting, which is why the TCA effectively resorted to these same elements.

Thus, the Claimant is not correct when it says that the tax inspection did not determine the real value of income subject to taxation and when it argues that the TCA resorted to indicia and presumptions in proceeding to correct the values qualified accounting as credit balance of remuneration payable and as advances by converting them to declared sales. Moreover, it is important not to forget that the Claimant had the opportunity, in the prior hearing stage and in this arbitration, to contest the qualification carried out by the TCA, as well as to explain why the operations disregarded should not have been and did not do so, choosing only to call into question the legality of the method of assessment of the taxable base carried out by the tax inspection.

VII. DECISION

In accordance with that set out above, it is decided:

(i) To dismiss the request for arbitral decision and, consequently, to maintain in the legal order the impugned assessment act;

(ii) To condemn the Claimant to pay the costs of the proceedings.

Value: In accordance with Article 315, paragraph 2 of the Code of Civil Procedure, combined with paragraph a) of Article 97-A of the Tax Procedure Code and paragraph 2 of Article 3 of the Regulations of Costs in Tax Arbitration Proceedings, the value of the case is fixed at € 1,519.06 (corresponds to the value of assessment No. 2015…, of 20.07.2015).

Costs: Pursuant to Article 22, paragraph 4, of the LFTA and in accordance with Table I attached to the Regulations of Costs in Tax Arbitration Proceedings, the amount of costs is fixed at € 306.00, to be borne entirely by the Claimant pursuant to Articles 12, paragraph 2, and 22, paragraph 4, both of the LFTA, and Article 4, paragraph 4, of the said Regulations.

Be it registered and notified.

Lisbon, 15 May 2016

The Arbitrator,

Raquel Franco

[1] The TCA determined the values contained in the cash account credit balance and the remuneration payable account credit balance, having arrived at the taxable base taking into account the proportion of sales at the VAT rate of 6% and at the VAT rate of 23%.