VAT on Inventory Losses: Presumption of Onerous Transfer Challenged at CAAD (701/2014-T)

THE PARTIES

Claimant: «A», Tax ID …, with registered office at …

Respondent: Tax and Customs Authority

Subject: VAT - Losses in Inventories and Presumption of Onerous Transfer

ARBITRAL DECISION

I - Subject matter of the application and procedural conduct

On 1 October 2014, the Claimant filed an application for arbitral pronouncement, requesting:

i) Declaration of illegality of the following VAT assessment notices, in the total amount of €38,437.17, relating to 2011:

ii) The consequent annulment of the respective interest compensation assessment notices.

By decision of the President of the Ethics Council (No. 1 of article 6 of the RJAT) the undersigned was designated as sole arbitrator. The single arbitral tribunal was constituted on 3 December 2014.

The Tax and Customs Authority (hereinafter referred to, in abbreviated form, as TA) filed its Reply on 14 January 2015.

The arbitral hearing (article 18 of the RJAT) was held on 9 February. The examination of the 3 witnesses summoned by the Claimant took place on 12 March.

The parties presented successive written submissions.

The Tribunal notified the parties that the arbitral decision would be prepared by 11 May.

The parties possess legal capacity and standing.

The Arbitral Tribunal was regularly constituted and is competent.

The proceedings do not suffer from any nullity. No exceptions were raised by the parties that would prevent consideration of the merits of the case.

II - Factual framework and examination of witnesses

A. Facts determined proven on the basis of the documentation

On the basis of the documents brought into the proceedings, it is established as proven that:

a) The commercial activity of the Claimant consists of the production and sale, on the wholesale market, of bakery products. The finished products are, in their vast majority, packaged for subsequent commercialization. The vast majority of its customers operate in the catering and retail trade markets for food products;

b) The Claimant acknowledges losses and shortages in inventories (raw materials and finished products), which are subject to accounting record through separate accounts «#38 - Inventory Adjustment» and «#684 - Losses in Inventories»;

c) The Claimant submitted a request to the TA (dated 15 September 2012, but received on 8 October), in which it identified the aforementioned causality inherent to the recording of these exceptional devaluations. It also disclosed the constraints resulting from the perishable nature of these inventory goods, in the areas of public health and safeguarding the regular functioning of the factory installations;

d) And, given the obligation of prior communication with a minimum advance notice of 15 days of such exceptional devaluations, it requested (a) the reduction of this period to 5 days and (b) the carrying out of the disposals on Saturday, the day of collection carried out by the Municipal Services of ...;

e) The TA did not request clarification and did not reply to this request;

f) In the fiscal year 2011, the Claimant recorded accounting expenses of €298,627.23 as inventory adjustment, which represents 21.72% of the total initial inventory plus purchases in the fiscal year;

g) The inventory adjustments relate, in the amount of €284,719.25, to losses in inventories and disposal of merchandise. The differential corresponds to donations of merchandise to various social welfare institutions;

h) Based on service order DI…, the TA conducted an inspection at the Claimant's factory installation on 13 October 2012, at 11:00;

i) This inspection resulted from the request submitted by the Claimant on 15 September 2009, "communicating that it would proceed with the destruction of non-usable industrial/food waste and/or the destruction of consumer goods, in accordance with article 80 of the VAT Code and in compliance with the circular office No. … of the VAT Services";

j) It was intended to "verify the destruction of bakery products that had lost their validity, which had manufacturing defects or which were in poor condition";

k) The two TA inspectors verified "the existence at the location of several waste containers", in which were products "indiscriminately mixed, thus making it impossible to match the products and their quantities existing within the plastic containers";

l) In response to the indiscriminate grouping of goods in containers, making "physical counting" impossible, the managing partner who accompanied the inspection stated "that this is how waste is usually gathered so that it can be collected by the Municipal Services, in 1,000-liter containers";

m) The inspectors note that "at the date and time indicated in the disposal communication, the truck of the Municipal Services of... which was supposed to transport the non-usable industrial waste to the sanitary landfill, was not at the company's headquarters";

n) When questioned, this same managing partner replied that "the situation was due to the fact that he could not control the schedule of the Municipal Services truck, further noting that it might possibly be delayed";

o) In its conclusions, the TA refers to the provision of the VAT Code, which establishes the presumption of transfer of goods not found in any of the locations where the taxpayer carries out its activity;

p) Noting that "although there is no legal obligation to request authorization/communicate in advance to the Tax Administration that this destruction or destruction will be carried out, it is advisable to make prior communication of these facts - with indication of the day and hour - so that due control can be exercised"

q) And having not "witnessed the actual destruction of the goods", nor having "witnessed their subsequent removal and removal by the Municipal Services to the sanitary landfill", it becomes "impossible to assess concretely the number and nature of the goods subject to destruction/destruction";

r) The inspectors conclude that the act to which they were present (or the absence of the same) could not be considered as a disposal. This entails its "non-consideration as a tax deduction";

s) From this service order resulted the carrying out of an external inspection for the fiscal year 2011, which took place between 14 March and 16 April 2014;

t) The tax inspection report states that "the taxpayer sent the corresponding disposal notifications to the Tax Service of the area where the disposals would occur, attaching discriminating lists with the quantities and valuation of the goods to be disposed";

u) "However, it was verified that these requests were not made with the minimum advance period of 15 days, as required by article 38 of the Corporate Income Tax Code, nor are they part of the tax documentation process in accordance with article 130 of the Corporate Income Tax Code";

v) The report further states that the Claimant "carried out on average two disposals per month, sending the respective communications with a minimum advance of 5 days". Therefore, it was impossible to verify the corresponding disposals, as well as the actual destruction/destruction of the goods";

w) Concluding the TA in its final report that "given that the requirements established in article 38 of the Corporate Income Tax Code were not met, for such devaluations to be considered as an expense of the taxation period, they must be added to the taxable profit of the fiscal year", in the total amount of €284,719.25;

x) The report adds that "consequently, given that under article 38 of the Corporate Income Tax Code the aforementioned merchandise devaluations cannot be considered an expense of the period, the corresponding VAT should be assessed, in accordance with article 86 of the VAT Code";

Which provides that "save proof to the contrary, goods found in any of the locations where the taxpayer carries on its activities are presumed to have been acquired and goods acquired, imported or produced that are not found in any of such locations are presumed to have been transferred";

y) The inspection report identified, in the fiscal year 2011, a gross profit margin of 64.8%, "a margin which we believe corresponds to reality, given that it is slightly higher than the margin shown in the national ratios for the sector of activity of the taxpayer";

z) The Claimant did not exercise the right to prior hearing;

aa) The TA issued additional VAT assessment notices in the amount of €38,437.17, corresponding to the "tax that should have been assessed with respect to merchandise devaluations/disposals (…) in accordance with articles 19 to 27, 41 and 78 of the VAT Code".

B. Examination of witnesses

The Claimant called three witnesses, who gave their evidence on 12 March 2015.

The witness ... works as an advocate in a business association in the agro-industry sector, which includes the bakery and confectionery sectors in which the Claimant carries out its economic activity.

He stated that:

• Inventory losses in this industry exceed 20%, because we are dealing with fresh products (with no marketing of frozen products);

• Finished products have especially short shelf lives, and companies are subject to frequent phytosanitary and food safety inspections;

• These losses are of normal and predictable occurrence, without exceptional nature and with reduced seasonal effect.

The witness ... has been an employee of the Claimant for 6 years, being responsible for the quality department. She clarified that:

• The factory operates continuously in 3 shifts. And every day there is waste and products eliminated as a consequence of the normal functioning of the production process;

• In each shift, the production manager prepares the list of waste and the reason for its occurrence. The list is signed and sent to the central services, which daily collect the information from the 3 shifts;

• Customers are regular and production is stable throughout the year;

• Waste is placed in containers, located in the factory premises, but segregated from production;

• Works on Saturday mornings, having witnessed several processes of removal of containers by the Municipal Services. Ideally, these goods should be eliminated 2 times per week, due to their rapid deterioration. However, the Municipal Services only ensure removal fortnightly;

The witness characterized the production process clearly and objectively. Identifying, with concrete examples, the reasons inherent to the losses of raw materials, together with the disposal of packaging material.

She further stated that, in addition to losses inherent to the production process, the Claimant operates on the basis of production planning schedules, so as to ensure fulfillment of customers' orders.

However, these orders are not firm, and can only be predicted on the basis of customer history or greater expectation of retail commercialization. A fact that subjects the Claimant to the risk of not fully disposing of planned and completed production, with the consequent destruction of goods produced in excess.

Finally, it was also clarified why raw materials are disposed (e.g. eggs and cream). These are goods involved in the preparation of final products (e.g. semi-frozen products) which, as a result of the non-confirmation of the order by the customer, are destroyed. Therefore, the final product is not even subject to accounting in the finished goods inventory (and, thus, suitable for commercialization).

The witness ... has been an employee of the Claimant for 17 years, performing administrative functions. She clarified that:

• The persons responsible for work shifts prepare lists of destroyed goods, the same happening with the drivers who make delivery of goods and the collection of goods delivered in previous trips that were not sold in retail (as well as those whose delivery is, for various reasons, not accepted by the customer);

• Daily, the witness collects these lists and sends them for management approval. This is an inevitable routine of daily work;

• The Municipal Services of ... collect garbage on Tuesday, Thursday and Saturday. On this last day they also collect destroyed goods, which, unlike garbage, require access to the factory;

• Prepares the letter of prior notifications of disposals to the TA, which it sends within 5 days before each Saturday (fortnightly). The losses recorded in the period between the notification and the following Saturday are considered in the notification and disposals carried out in the following fortnight;

• Once the disposal is carried out (collection of containers by the Municipal Services), a new notification is sent to the TA;

• The witness stated that she was not always able to ensure prior notification of the disposal, which she justified on the basis of the time needed to perform other tasks and the fact that she had temporarily accumulated the functions of a colleague.

C. Facts determined proven by the combination of documentary and testimonial elements

From the combination of the procedural documentation and the examination of witnesses, the facts determined as proven should be expanded in the following terms:

i) The Claimant produces 30 thousand cakes and breads, operating daily;

ii) Loss of raw materials is inherent to the production process, so its occurrence is normal and frequent;

iii) Such losses also result from the nature of food goods produced (fresh and rapidly perishable), together with production planning aimed at ensuring a minimum level of supply, so as to meet customers' orders (since these are not always foreseeable);

iv) The origin of the losses of raw materials lies in leftovers and scraps, in their placement on trays and conveyor belts, in production errors and defects and in the divergence between goods produced and firm customer orders;

v) Losses in finished products result from customer returns, insofar as goods are purchased from the Claimant under a consignment system. Therefore, the Claimant bears the risk of not disposing of its production on the retail market where its customers operate;

vi) Raw materials and finished products, as well as the materials in which they are packaged (e.g. films, cardboard and forms) are rapidly and easily perishable, not allowing for alternative economic use;

vii) Losses are identified through lists and service records filled out by shift supervisors (raw materials) and drivers (finished products). The lists are subject to an approval chain by management bodies, followed by disposal of the goods;

viii) The disposal occurs by collection by the Municipal Services, carried out fortnightly and on Saturdays;

ix) For several years the Claimant has established a procedure of prior notification of these disposals to the TA. It does so by mail communication and with a minimum advance of 5 days, describing the goods to be destroyed and the respective accounting expense;

x) In the fiscal year 2011 the losses amount to 20% of the value corresponding to the sum of initial inventory and purchases. Although the amount appears high in absolute terms, the gross profit margin of the Claimant exceeds the national average of companies operating in this sector. Therefore, the disposals carried out by the Claimant are consistent with the reality of the sector and its value is not unreasonable;

xi) Finally, raw materials and finished products constitute goods from the inventory of the Claimant, being as such reflected in its accounting.

D. Facts not proved

The Claimant did not prove that all disposals carried out in 2011 respected the prior period of 5 days.

Upon comparing the dates contained in the copies of the postal registration records and receipts and the disposal calendar verified throughout the fiscal year, various discrepancies were found between such dates. It was concluded that, at various times, the notification to the TA was sent after the disposal was carried out.

III - Summary of the legal grounds invoked by the parties and final written submissions

A. The Claimant's understanding

The merchandise in question, raw materials and finished products, were subject to real and actual destruction. This makes their subsequent commercialization impossible, and therefore there is no VAT capable of assessment.

The destruction of this merchandise is communicated in advance to the TA, as the TA itself admits in the inspection report. For its part, the Claimant accepts that this prior communication does not comply with the 15-day period established in article 38(3)(c) of the Corporate Income Tax Code. Rather, it is carried out within a period of 5 days in advance.

Non-compliance with the legal period of 15 days does not automatically and necessarily lead to the consideration of disposals as constituting a tax-deductible cost under the Corporate Income Tax regime.

And from this consideration under the Corporate Income Tax regime, the presumption of transferability of goods provided for in article 86 of the VAT Code cannot, without more, flow.

This presumption is refutable by the fact that the merchandise was subject to destruction, as witnessed in person and set forth in disposal records which contain the list of the respective destroyed goods.

This fact is not undermined by the failure to respect the prior communication of 15 days, whose shortening to 5 days is explained by the nature of the goods. These are fresh food products, easily perishable and without subsequent economic use. This does not fit with a previous waiting period of 15 days.

The prior communication of 5 days has been adopted for several years. Verification of this practice is within the knowledge of the TA and is recognized in the inspection report. So much so, that it was the subject of a request made to the TA on 15 September 2009, which was never answered.

But even if the TA had maintained the requirement of prior communication of 15 days, the Claimant would always have been unable to comply with this legal requirement. On pain of repeatedly committing breaches for failure to comply with legal obligations in the area of public health.

In its Circular Office No. 35264, under the heading "Destruction of destroyed, deteriorated or obsolete goods", the VAT Services Directorate considers that there is no legal obligation for prior diligence or notification to the TA, as regards the justification of "shortfalls in the existence of destroyed or destroyed goods".

And in the absence of this obligation, the TA recommends prior notification of this destruction or destruction, so as to allow verification of the integrity of these facts. And taxpayers may "prepare and retain a record of destruction or destruction of goods subject to disposal, witnessed by persons outside or within the company who witnessed that act".

In summary, the economic and substantive reality (destruction) overrides mere formalism of the minimum prior notification period. The non-compliance with Corporate Income Tax rules regarding verification of this period is not extendable to the presumption of transferability of goods. Since, whether or not this period of 15 days was met, they were destroyed.

B. The Respondent's understanding

The external inspection was carried out because, in the context of dispatch DI…, opened to verify the destruction of merchandise, it was found that "it was impossible to assess concretely the number and nature of goods subject to destruction/destruction and it was not possible to witness the disposal of the same".

Between 2008 and 2011 the Claimant declared inventory adjustments whose values range, in each of those fiscal years, between €270,000 and €320,000. This represents between 17% to 24.79% of initial inventory plus purchases.

In the fiscal year 2011, the "accounts #38 and #684" of the Claimant's financial statements record "losses in inventories/inventory adjustment" - disposals - in the amount of €284,719.25. The difference to the balance of said accounts relates to donations of merchandise to social welfare institutions.

Such disposals did not comply with the provisions of article 38 of the Corporate Income Tax Code, "a provision that governs the prior formalities to be observed in a disposal". A fact that made it impossible to verify the corresponding disposals, together with the actual destruction or destruction of the goods.

And having concluded that the exceptional merchandise devaluations cannot be considered as tax-deductible expenses under the Corporate Income Tax regime, the corresponding VAT should be assessed as provided for in article 86 of the VAT Code.

The Claimant operates under an incorrect interpretation of these provisions of the Corporate Income Tax Code and the VAT Code.

Article 38(3)(c) expressly requires that the disposal be communicated with a minimum advance of 15 days, indicating the time and location of its carrying out.

To the letter of the law is allied the underlying ratio legis, based on the possibility of effective verification of the disposal by the TA. Removing the requirement of the 15-day period implies subversion of the meaning and scope of the rule, contrary to the rules of hermeneutics contained in article 11 of the General Tax Law and article 9 of the Civil Code.

In the case at issue, there is no declaration or record from any independent entity, capable of attesting to the end of the validity period of food products and, to that extent, proving that they were not capable of commercialization. Thus justifying the destruction of these goods.

In this sense, it should be emphasized that the notification of disposals is made by the spouse of one of the managing partners and the witnesses who sign the disposal records are invariably the two managing partners.

Moreover, the disposals are carried out with the same frequency (2 disposals per month) and always occur on a non-business day (Saturday).

Focusing attention on the goods listed in the disposal records, it is verified that (i) the quantities and values do not change significantly, (ii) raw materials such as sugars, almonds and flours are destroyed, whose validity period is typically longer than 1 year and (iii) goods used to package and wrap food products are destroyed, such as cardboard boxes and aluminum forms.

Furthermore, it is strange that the consistency of these disposals, insofar as the quantities and value of destroyed goods do not fluctuate throughout the year, i.e. is indifferent to the effects of economic seasonality.

No less difficult to understand is the absence of management measures aimed at reducing these losses.

It is certain that article 38 of the Corporate Income Tax Code frames "exceptional devaluation" situations normatively, so that the fortnightly frequency of disposals carried out by the Claimant evolved from exception to rule.

And, as previously emphasized, the procedure adopted by the Claimant raises serious doubts as to its truthfulness. Because (i) disposals are always carried out on a non-business day, (ii) are prepared on the preceding Monday, (iii) without the presence of any external and independent entity and (iv) always signed by the same two witnesses (without varying with vacation or possible health, personal or family reasons).

Moreover, the 5 business days prior that the Claimant says it observes do not allow verification through the records of CTT (postal services). As is verified in the months of January, February, March, April, June, July, October and November.

For example, in the first January communication, no copy of the signed postal receipt was presented.

In the second January communication, the letter was sent on 25 January and received the next day, but informing of a disposal carried out on 23 January. That is, the communication was subsequent and not prior to the disposal.

Returning to the inspection act carried out in October 2012, it is evident from the same that it could not be verified (i) the nature and quantity of destroyed goods, (ii) the impossibility of commercialization of the same and (iii) the actual destruction due to the lack of attendance, at the date and time set, of the Municipal Services truck.

And when we are faced with the destruction of food products as waste or by-product, the disposal process implies the issuance, respectively, of the waste tracking guide model A and guide model 376 of the Animal and Plant Health Directorate. Therefore, testimonial evidence cannot replace the documentary element.

C. Final submissions

Final written submissions were presented, in which the Parties maintained the essentials of the grounds supporting their positions.

Claimant

It stated that we are not dealing with the concept of "exceptional devaluations" provided for in article 38 of the Corporate Income Tax Code, but rather normal losses of merchandise.

From the testimony of the witnesses it was firmly established that the Claimant regularly needs to dispose and destroy raw materials and finished products. A fact that, as it does not amount to anomalous and sporadic events, justifies the inevitability of the consequent losses recorded as an expense of each fiscal year.

Such losses were recognized through disposals personally witnessed and notified to the competent Finance Service.

The contested assessment notices result from the failure to observe the prior communication period of 15 days. However, since these losses are not within the scope of the regime contained in article 38 of the Corporate Income Tax Code, the applicability of this period is prejudiced.

Without dispensing, it emphasizes the inexecutability of compliance with this 15-day period, due to the perishability of the goods and the need to observe food safety rules.

As for the presumption juris tantum enshrined in article 86 of the VAT Code, the same falls away insofar as its application flows from the aforementioned article 38 of the Corporate Income Tax Code.

Since non-compliance with the 15-day period cannot automatically and without more result in the presumption of transferability of goods. There must be a clear distinction between the Corporate Income Tax and VAT regimes.

This presumption does not apply in the face of the real and actual disposal of the goods. It allocates to the TA a "formal artificiality" (the 15-day period) to achieve the incidence of VAT on transfers that never existed, invoking in its support circular office 35264 of the VAT Services Directorate.

Respondent

The final submissions of the Claimant add nothing new, raising no substantial change to the grounds adduced by the TA in its Reply to the application for arbitral pronouncement.

Nevertheless, it highlights an inconsistency in the Claimant's argumentative reasoning, given the fact that the latter initially supported its disposal procedure on article 38 of the Corporate Income Tax Code, to then, in the context of submissions, argue for the non-applicability of this regime.

It recalls that the origin of the disputed tax acts relates to the inspection action carried out under service order DI…, in which it was found that it was impossible to assess concretely the number and nature of the disposed goods. In addition, it was not possible to witness the disposal operation.

The Tax Inspection Services concluded that, in accordance with article 38 of the Corporate Income Tax Code, the exceptional merchandise devaluations could not be considered as an expense of the fiscal year. The corresponding VAT should be assessed, as provided for in article 86 of the VAT Code.

It is irrefutable from the letter of the law, the imposition of a minimum and prior period of 15 days. The date and time of the disposal should be communicated and a list of the goods to be disposed should be presented.

It maintains the non-existence of verification of the facts that determined the disposal, namely that "there is no declaration/record from any independent entity to attest that these foods, in those quantities, could not be commercialized or used in the production process".

Added to this is the failure to verify internal control procedures in the preparation of the lists in which the goods to be destroyed are identified.

As for the disposal notifications, it again emphasizes their preparation by the same persons (the two managing partners and the spouse of one of them), the carrying out of disposals on Saturday and with the same temporal frequency, together with the lack of control by external entities.

It resumes the fact that perishability is not susceptible to application to all goods listed in the disposal lists. In addition to the fact that they include packaging materials, such as the film that wraps food and whose consumption should be accounted for as a production cost (and not as inventory to be disposed).

It again identifies that, from the analysis of the documents that the Claimant attached to the case file, numerous communications were notified to the TA after the carrying out of the respective disposals. Without observing the 5-day period that the Claimant says it observes.

Finally, it notes that the invoices issued by the Municipal Services do not cover all disposals carried out, in addition to the dates indicated therein not corresponding to Saturdays.

In summary, the goods to be destroyed are piled up in containers. Not allowing their identification and quantification, in the terms as stated in the lists of destroyed goods. And no transport guide or record of diligence was issued by the Municipal Services.

Therefore, the destruction of the goods cannot be proved.

IV - On the law

The crux of the disputed question can be enclosed in the following question: what is the legal-tax framework applicable to the destruction and disposal of goods belonging to the taxpayer's inventory?

This implies the analysis of a series of prior and concurrent questions:

i) Do the destroyed and disposed goods constitute, for accounting purposes, elements of inventory (current assets) or fixed assets (non-current assets)?

ii) Is the tax regime applicable to disposal of inventory goods governed by an autonomous tax rule in relation to the accounting regime?

iii) Does article 38 of the Corporate Income Tax Code establish the tax regime for said destruction of inventory goods?

iv) Does the failure to consider a disposal of inventory goods as constituting a tax-deductible expense under the Corporate Income Tax regime, result in the establishment of the presumption of transferability provided for in article 86 of the VAT Code?

v) What are the requirements to be observed in the recording of losses of inventory goods (raw materials and/or finished products), so as to prove their existence?

vi) What may constitute sufficient evidence to refute the presumption of article 86 of the VAT Code?

In the perspective of the Claimant, the loss of merchandise is inseparable from its sector of activity, as well as from its operating and production conditions. Of regular frequency, these losses are identified in its management process, documented and witnessed, with the goods being removed by a third party.

Non-compliance with the prior notification period does not allow us to conclude that the merchandise is presumed to have been transferred. Since they were actually lost and disposed.

For the Respondent, the tax provision is clear in requiring prior communication of 15 days, and the taxpayer cannot be exempted from compliance with this requirement. The losses appear with particular stability as to value and temporal frequency, not meeting the concept of exceptionality that the tax rule embraces.

And the documentation and testimony, without assessment and control by external entities, are combined in the sense of not evidencing the effectiveness of the losses and subsequent disposals.

Accounting and tax framework of inventory goods

Throughout the proceedings there are abundant references, made indistinctly by the Claimant and the Respondent, to "merchandise", "inventory" and "inventory".

In parallel, the Parties offer a different interpretation and reading of the regime set out in article 38 of the Corporate Income Tax Code (subsequently repealed by Law No. 2/2014, of 16 January), particularly as regards the observation of the minimum and prior period of 15 days and the exceptionality or otherwise of the losses.

Now, the origin of article 38 of the Corporate Income Tax Code dates back to Regulatory Decree No. 2/90, of 12 January, which established the regime of depreciation and amortization of fixed assets.

This legislation established the methods and criteria for recognition of the tax cost resulting from the use of fixed assets used by the taxpayer to generate taxable income.

Depreciation and amortization, respectively, of tangible and intangible assets operates through the calculation of an annual quota. The amount of which may vary depending on the method chosen by the taxpayer (e.g. constant or declining quotas) or depending on the greater or lesser intensity of use of the asset during the useful life period listed in various specific tables by sector of activity and a general scope table.

To this framework of relative constancy of the methods and criteria for recognition of the acquisition cost of fixed assets, the legislator added an exceptional regime.

Intended for the recognition of certain facts or occurrences that, due to their exceptionality, caused the reduction or elimination of the net accounting value (and tax value) of a given fixed asset.

We speak of article 10 of said law. Which, under the heading "exceptional devaluations of fixed assets", empowered the taxpayer to recognize an exceptional depreciation or amortization, i.e. outside the scope of the annual quota resulting from the application of the other rules.

This exceptionality depended on verification of "abnormal causes duly proven", designating "disasters, natural phenomena and exceptionally rapid technical innovations". The taxpayer must obtain the acceptance of the TA, through submission of a properly substantiated request.

By way of example, we could present the case submitted for consideration of the Supreme Administrative Court (decision of 2 November 2011), in which the taxpayer made improvements to a rented building, the value of which is subject to annual depreciation. However, non-renewal of the lease agreement leads to the loss of these improvements. An exceptional devaluation, whose tax deductibility would be conditional on the acceptance of the TA, through a request to be submitted for this purpose (as per the decision of 2 November 2011 of the Supreme Administrative Court).

This rule was subject to substantial amendments introduced by Decree-Law No. 211/2005, of 7 December, among which the flexibility of the requirement of acceptance by the TA stands out.

Specifically, acceptance is maintained when exceptional causes occur in a fiscal year different from the one in which the "physical disposal, dismantling, abandonment or destruction of goods" takes place.

But in cases where the fiscal year coincides with the aforementioned causality, the acceptance of the TA is replaced by a new regime of prior communication. Carried out with a minimum advance of 15 days and identifying "the location, date and time of the disposal, dismantling or destruction and the total net tax value of the goods".

Following the communication, so that "it is verified the physical disposal, dismantling, abandonment or destruction of the goods", the preparation of a "record signed by two witnesses". The record is accompanied by a "discriminating list of the tangible fixed assets in question, containing, for each asset, the description, year and acquisition value, as well as the accounting value and net tax value".

And as backdrop to these requirements, the "facts that originated the exceptional devaluations" must be "identified and verified". All these requirements must be inserted in the tax documentation process provided for in the Corporate Income Tax Code.

Decree-Law No. 159/2009, of 13 July, which adapted the Corporate Income Tax Code to international accounting standards and the National Accounting Standardization System, transported this regime to the Corporate Income Tax Code, by way of the addition of article 35-B (effective for fiscal years beginning after 1 January 2010).

This legal adaptation culminates with Regulatory Decree No. 25/2009, of 14 September, which, also coming into force in fiscal years beginning after 1 January 2010, repeals Regulatory Decree No. 2/90.

Therefore, the exceptional devaluation of tangible and intangible fixed assets (terminology that replaced "tangible and intangible fixed assets") is now part of article 35-B of the Corporate Income Tax Code. Later republished as the current article 38.

It is only important to note that, if there were any doubts, article 38 of the Corporate Income Tax Code, in force from fiscal years 2010 onwards, is applicable to the exceptional devaluation of assets provided for in article 35(1)(c) of the Corporate Income Tax Code.

Which allows the consideration as a tax-deductible expense of "exceptional devaluations occurring in tangible fixed assets, intangible assets, non-consumable biological assets and investment properties".

The coming into force of the so-called Corporate Income Tax Reform confirms this scope of applicability, insofar as it maintains exceptional devaluations (now framed as impairment losses) limited to the recoverable value of fixed assets.

So much so, that the current article 31-B of the Corporate Income Tax Code (by repeal of article 38) is entitled "impairment losses in non-current assets".

It is certain that throughout the amendments to the regime of exceptional devaluations, the legislator maintained the regime established in 2005: (i) the identification and verification of the abnormal causes, (ii) the communication with 15 days in advance and (iii) the disposal record signed by two witnesses and accompanied by a discriminated list of these goods.

And it is within this framework that the Claimant, in 2011, submits to the TA a request for reduction of the prior communication period, from 15 to 5 days.

It does so, undoubtedly, under the exceptional devaluation regime set out in the Corporate Income Tax Code. However, it describes goods from "daily production", which remain "due to manufacturing defects" and by return "from non-sale of consignment products".

But having arrived here, and after a relatively lengthy description of the exceptional devaluation regime, it is necessary to ask whether the issue is correctly framed from a tax perspective. That is, to know whether losses and disposals carried out on inventory goods are governed by the provisions of article 38 of the Corporate Income Tax Code.

The answer is clearly negative.

Because in the case sub judice, we are - without a shadow of doubt - faced with the destruction of current assets. Goods affected by the Claimant's inventory.

Raw material intended for the production of goods. And finished products that were not commercialized.

We are not dealing with goods from the Claimant's tangible fixed assets. Goods from non-current assets. And with respect to which, now yes, the Corporate Income Tax Code establishes a special regime for recognition of expenses resulting from abnormal or exceptional events.

Now, in 2011 the Claimant frames its procedure for disposal of inventory goods in the "regime of exceptional devaluation established in article 38 of the Corporate Income Tax Code" and the subsequent acts carried out - both by the Claimant and by the Respondent - suffered from the same thinking.

Thus, the tax inspection report - which supports the disputed tax acts - emphasizes that the "requests were not made with the minimum period of 15 days in advance".

In the application for arbitral pronouncement the Claimant acknowledges that it "did not observe the fifteen-day period established in article 38 No. 3 article (c)".

In the reply it submitted, the TA transcribes article 38.

In the written submissions both the Claimant and the Respondent maintain article 38 of the Corporate Income Tax Code as the framework and foundation of the grounds of their positions.

But it is important to leave no shadow of doubt: article 38 of the Corporate Income Tax Code is not, in any way, applicable to the disposal of inventory goods.

And it is with these goods that we are dealing in the case at issue.

As appears from Accounting and Financial Reporting Standard (NCRF) 18, which classifies inventory as goods "held for sale in the ordinary course of business activities or in the process of production for such sale".

Inventory also consists of "materials or consumables to be applied in production processes or in the provision of services".

A fact that both the Claimant and the Respondent are not unaware of, since the economic losses are recorded in the accounts «#38 - Inventory Adjustment» and «#684 - Losses in Inventories».

Moreover, the terms "merchandise" and "inventory" permeate all documents brought by the Parties into the case file. Such as the reports of the inspection acts of 2012 and 2014, the application for arbitral pronouncement and subsequent reply by the TA and the final submissions.

Moreover, NCRF 1 classifies such goods as current assets, insofar as they are held for the purpose of trade within an economic cycle of up to 12 months.

This accounting framework is fully accepted by the Corporate Income Tax Code. Which, in its article 17, identifies the taxpayer's accounting as the starting point for the calculation of the taxable profit of the fiscal year, clarifying that it must be organized in accordance with the rules of accounting standardization.

The systematic insertion of the exceptional devaluation regime of article 38 and its reference to the deduction of impairment losses of "tangible and intangible fixed assets" contained in article 35, complements this framework.

Allowing us to conclude that:

• The Corporate Income Tax Code does not contain (now and at the time of the act) a specific regime for recognition of losses in inventory goods;

• The regime provided for in article 38 of the Corporate Income Tax Code is strictly applicable to fixed assets, excluding inventory goods from its scope; and

• Article 38 is not invocable as regards the identification and verification of the facts that originated the economic losses in inventory goods.

Naturally, the disposal of inventory goods must, necessarily and necessarily, be based on criteria that allow assessment of their existence. Verifying its concrete occurrence. And refuting (or not) the presumption of transferability.

But these criteria do not require strict and monopolistic compliance with the regime contained in article 38 of the Corporate Income Tax Code.

In other words, it is necessary to identify the reason for the loss of inventory and verify its quantity and subsequent disposal. But this does not necessarily involve compliance with a minimum and prior period of 15 days. Or the signing of a record by two witnesses.

Note that both Parties cite office No. 35264 of the VAT Services Directorate. Now this administrative interpretation, regardless of restricting its binding to the TA, correctly identifies the absence of an autonomous and specific normative framework for losses of inventory goods.

Indicating a procedure that may be adopted in order to verify the losses and disposals, based on prior communication and the identification of goods in a record signed by two persons.

On the foundation of the disputed tax acts based on the regime stated in article 38 of the Corporate Income Tax Code

Let us not lose sight of the disputed case: the presumption of transferability established in article 86 of the VAT Code.

We have already seen that this article 38 - for what in the disputed case is of interest to us - does not govern the terms and conditions to be observed in the disposal of inventory goods.

The tax inspection report - which supports the tax act whose annulment is requested by the Claimant - begins by identifying the reason for the carrying out of this inspection act: because "it was found that it was impossible to assess concretely the number and nature of the goods subject to destruction/destruction and it was not possible to witness the disposal of the same".

However, it is clear that the inspection act did not take care to analyze the effectiveness of the losses and respective disposal. Having been satisfied with the finding that "the requests were not made with the minimum period of 15 days in advance".

Requests that were nothing more than the "disposal communications to the Finance Service".

Therefore "it was made impossible to verify the corresponding disposals, as well as the actual destruction/destruction of the goods listed in the discriminated lists of goods in question".

Starting from non-compliance with article 38, the inspection report concludes that "since, in accordance with article 38 of the Corporate Income Tax Code, the mentioned merchandise devaluations cannot be considered an expense of the period, the corresponding VAT should be assessed, in accordance with article 86 of the VAT Code".

In summary, despite recognizing the goods as merchandise, the inspection report bases both the failure to verify the disposals and the actual destruction of the goods on the regime of article 38 of the Corporate Income Tax Code. Which, without more, gives rise to the presumption of transferability.

Everything due to non-compliance with the prior and minimum period of 15 days.

But, as we have seen, the disposal of inventory goods is not governed by article 38 of the Corporate Income Tax Code. There is, consequently, no tax rule that requires prior communication of disposals. Or even that this prior act observe a certain minimum number of days.

We conclude, therefore, that the basis of the inspection report, which supports the disputed tax act, has no normative adherence. Since it is based on a regime applicable to disposal of fixed assets, when we are, moreover, dealing with elements of inventory.

It is true that, in the exercise of its Reply, the TA adds other elements. The stability of the values resulting from fortnightly disposals, the consistency of communications being prepared by the spouse of a managing partner, the fact that they invariably act as witnesses or the circumstance that the disposal procedure is not validated by an external entity.

Is this complementary and ex post facto foundation of the tax act admissible?

Once again, the answer is negative, because the elements that support the tax act carried out by the TA are part of the notification made to the taxpayer. Supporting (and circumscribing) the harmful act against which the latter may react.

In the sense of this non-admissibility of foundation after the carrying out of the administrative act, consider the decision of the TCAN of 6 January 2005 (case No. 00439/04) or the decision of the TCAS of 19 March 2015 (case No. 06720/13).

Nevertheless, the question is not entirely closed, since the case at issue - although based on non-compliance with article 38 of the Corporate Income Tax Code - deals with the presumption of transferability of the goods.

This leads us to the next consideration.

On the doctrine of the TA

Article 68-A(1) of the General Tax Law binds the TA to the "generic guidelines contained in circulars, regulations or instruments of identical nature, regardless of their form of communication, aimed at the uniformization of the interpretation and application of tax rules".

This rule arises in the context of the duties of uniform and equal action of the TA before the universe of taxpayers. Binding it to action with parameters of stability, based on the publication of its interpretations. So as to provide guidelines for action to other taxpayers whose operations take place in a framework of factual identity.

This is reinforced by the publication of requests for binding information (No. 17 of article 68 of the General Tax Law), meeting a second need: the safeguarding of legal certainty and security. Relevant for both the TA and taxpayers.

In process A509 2009009, of 29 June 2009, the TA ruled on the issue of "abnormal inventory shortages", in the context of a request for binding information. And which addresses - directly - the disputed question, particularly the exclusion of the presumption of transferability of inventory goods.

The factual framework to which said request relates can be summarized as follows:

• The taxpayer carries out a retail activity (trade in current consumption products, not producing any of the products marketed);

• Records various inventory differences, as a result of (i) merchandise returns, (ii) damaged merchandise, (iii) withdrawal of merchandise for quality reasons, (iv) goods with end-of-sale date defined or unsaleable, (v) damage occurring in the store or in transport and handling and (vi) theft by employees and/or customers;

• There are mechanisms of control and assessment of these shortages;

• There are unidentified deviations, which are due to customer theft (42%), employee theft (35.2%), internal and administrative failures (16.5%) and theft or fraud committed by suppliers (6.3%);

• This is a reality intrinsic to the distribution sector, the solution of which is not within the reach of companies, which can only minimize it; and

• The shortages are within the limits of reasonableness observed for this sector of activity and are indispensable (inevitable) for the generation of taxable income.

In its interpretation the TA, naturally, does not mention article 38 of the Corporate Income Tax Code (or the equivalent rule at the time of the request for information), rather identifying that "the crux of the question is to know, regarding inventory shortages, designated as normal and/or abnormal shortages in the sense of the POC, what conditions constitute sufficient evidence to refute the presumption established in the cited article 86".

To know whether inventory shortages "constitute operations subject to tax or not, considering the factual situation of the inherent circumstances".

And here too the TA starts from a request for information previously submitted in the context of Corporate Income Tax (dispatch of the Director-General of Taxes relating to a request submitted in 2008, with interpretation reflected in Information 986/2008).

In accordance with which, "for unidentified shortages an inventory document must be prepared with stock differences, which must be signed by inventory analysts and the store manager". This document serves as "support for the accounting entries of inventory shortages".

Therefore, "it should dispense with the preparation of destruction and disposal records". It is not required to make "reports to the police for theft against unknown persons". Or even the contracting of insurance policies, as these are thefts "resulting from the normal exercise of activity, not having an extraordinary and unforeseeable nature".

Having the TA concluded that the shortages entail tax-deductible expenses under the Corporate Income Tax regime, given (i) the existence of control systems, (ii) the preparation of lists for identified and unidentified shortages, (iii) the preparation of internal documents that support the accounting records and (iv) the fact that the shortages do not depart from reasonable limits for the distribution sector.

And "being considered an eligible cost for Corporate Income Tax purposes, consequently it appears that the same may be taken into account under the VAT regime".

Although these are decidedly different taxes, this "does not prevent the use of common procedures, namely internal control and to prevent tax evasion, leading to converging decisions in the two tax regimes".

Thus concluding with the exclusion of the presumption established in article 86 of the VAT Code.

Let us recall then that the TA removes the aforementioned presumption of transferability of the goods, even in cases where the shortage is not identified. That is, in cases where there is no actual destruction and disposal of the goods. But only the finding of their disappearance.

Provided there is an internal control system. And internal documents are prepared to identify the shortages, signed by the management bodies. It is not required that any monitoring or validation be carried out by external entities.

All this in a framework of shortages inherent to the activity and which are within the observable limits in the sector of economic activity in which the taxpayer operates.

On the adequacy and sufficiency of the evidence presented by the Claimant

Let us move to the final question: to know whether the process adopted by the Claimant and the documentation produced is capable of refuting the presumption fixed in article 86.

We anticipate that the answer is affirmative.

First, insofar as the Claimant demonstrated, in an objective and concrete manner, that the shortages constitute a normal, inevitable and inherent consequence of its productive activity.

Namely, by the need to maintain a stable level of production, which allows it to manage the needs of its customers, such as large retail commercial surfaces.

Determining a level of production of finished products, without guarantee of their disposal.

Second, given that the production process involves, due to the nature of the goods produced and the raw material used in the preparation process, the recording of losses. Having the witness ... referenced various examples of losses both of raw material (such as flour and cinnamon) as well as finished products and packaging materials.

Third, because the business model is based on a consignment system, with the Claimant assuming the return of products that its customers (retail channel) were not able to commercialize with final consumers.

Fourth, insofar as the Claimant documents and records the losses in the production process and in customer returns. Through documents signed by shift supervisors and drivers, which are approved by the management body. Resulting in the accounting entry of losses and the sending of goods for disposal.

In truth, in any sector of economic activity, the recording of an inventory shortage - with known or unknown origin - is demonstrative of the existence of mechanisms of control, assessment and counting of perishable goods. Under pain of the level of inventory being abnormally high, reflecting a situation not supported by reality (non-existent stock) by manifest absence of control by the taxpayers.

Naturally, the mere recording of losses may indicate situations of evasion or fraud. Nothing preventing some taxpayers from resorting to false and/or fanciful records, so as to dispose of goods and achieve the deduction of their respective costs. Erasing the trail of previous (undeclared and unrecorded) sales of these same goods.

However, nothing indicates the occurrence of these facts in the case at issue.

Even more so, in the fifth place, the inspection report does not allege or identify facts susceptible to indicating the commission of evasive or fraudulent acts. Merely finding that prior communications were not communicated with a minimum advance of 15 days.

As a sixth ground, it is important to highlight the two reasons alleged in the inspection act carried out in October 2012: (i) the impossibility of physical counting due to the fact that goods are indiscriminately placed in 1,000-liter containers and (ii) the fact that the Municipal Services truck did not appear at the time identified in the communication to the Finance Service.

This is the "assessment of the goods subject to destruction and not being able to witness the disposal of the same".

But this in fact indicates an instructional deficiency. Which the TA sought to remedy in the course of the current proceedings, particularly by reference to the stability of values throughout the year, the identity of the witnesses, the absence of external control and the finding that some disposals were not previously communicated.

It is important to recall that the goods are food products, finished or raw material. Products collected from production or returned by customers.

It is not reasonable to impose on the taxpayer the adoption of a process of labeling or isolation of each finished good, of each raw material or even the separation of packaging and food. All with the purpose of carrying out some type of counting or weighing. As a sole condition of "concrete assessment of goods".

It is not reasonable that the verification of shortages should be based on the identification of fresh and perishable goods, as it is not reasonable to expect that these can be maintained in a perfect state of verification and identification. The nature of the goods and their origin (production and collection from customers) must be taken into account in the process of verification of the disposal, under pain of imposing on the taxpayer an excessive burden of proof.

In truth, the products are progressively placed in containers over two weeks. Being subject to decomposition processes. Having the witnesses stated that these are "trash", with the particularity that it cannot be mixed with other goods to which we usually assign such a definition.

And as for the failure of Municipal Services trucks to appear, the 2012 inspection act did not go beyond noting the delay compared to the time indicated in the communication sent by the Claimant.

Having not investigated whether the truck did or did not collect the goods. On that day or any other.

Having the Claimant presented invoices issued by the Municipal Services. A simple exercise of experience allows us to conclude that goods placed in containers must necessarily be subject to removal. And that the removal of these and other industrial waste is, under legal terms, an incumbency entrusted to the Municipal Services.

Recall, further, that the Claimant notified the adoption of this procedure in 2009. The TA carried out, to this procedure, a single inspection act in 2012. This, insofar as the inspection act carried out in 2014 was satisfied by finding the failure to comply with the 15-day period.

An insufficient investigation in time and in depth of analysis. Which contrasts with the fortnightly recurrence of the disposal of goods and description of the origin of inventory shortages, as a result of the continuous operation of the Claimant's production process.

In the seventh place, the presumption of transferability of goods is not consistent with the nature of the disposed goods. Food products resulting from waste from the production process and collection from the retail channel.

Whose special perishability and reduced periods of validity for food consumption do not allow subsequent resale.

Moreover, all this process of identification and subsequent disposal of goods fits, without a shadow of doubt, in the administrative understanding of the TA.

In truth, in 2009 the TA communicated its interpretation regarding the process of disposal of goods resulting from theft. An occurrence in which the good is not even susceptible of presentation for disposal.

Unlike what happens in the case at hand, in which goods are identified and isolated for subsequent disposal.

And not requiring the TA monitoring external to the shortages resulting from theft, identical position must be applied to the shortage of raw material and finished products in the case at hand.

In truth, the requirement of verification - by an external entity - of the destruction of goods and verification of their respective quantities, represents an especially excessive burden of proof. Especially when the law does not impose it, nor does the TA require it in the case of goods subject to theft. Where the burden of proof should be even more demanding, given the manifest non-existence (physical) of the disposed goods.

In the eighth place, although there are various references to the percentage represented by shortages in the value of initial inventory and purchases (between 17% and 24.79%), it is no less true that the TA inspection report, after analysis of the gross margin of 2011 (64.8%), concludes that this is "slightly higher than the margin shown in the national ratios for the sector of activity of the taxpayer".

Meeting the interpretation of the TA of 2009, in which the concern was reflected in verifying whether shortages due to theft were within the limits and percentages of the respective economic sector.

Finally, the receipts of the communications made by the Claimant allow us to conclude that approximately one-third of them were sent to the TA after the disposal.

However, this fact does not allow us to conclude that there was no destruction and subsequent disposal of goods.

In fact, what is at issue is not each of the disposals individually carried out. Rather, it is the credibility of the entire procedure adopted by the Claimant. In the sense of identifying and documenting the disposed goods, obtaining the approval of the management body and contracting the collection from the Municipal Services.

All in an environment of continuous industrial production, shortages inherent to this activity and consignment system in the sale of finished products.

And in a framework of compliance with the administrative doctrine formulated by the TA in 2009, as regards the exclusion of the presumption of transferability of goods in cases of theft. In which, recall, there is not even any record or physical evidence of the goods, all shortages being entirely documented on the basis of internal documents.

Moreover, in 2009 the Claimant anticipated this procedure to the TA. Which devoted a single inspection act to it in 2012.

V - Decision

Applying the above considerations to the case sub juditio, the illegality of the VAT assessments based on the presumption of transferability of goods disposed by the Claimant is immediately evident.

The procedure for recording, documentation, approval and communication of disposals is adequate to the corresponding evidence. It fits within the administrative doctrine applicable to theft. The economic costs of the disposed goods respect the values observed in the economic sector in which the Claimant operates its activity.

And, as a rule, the taxpayer carries out the communication at a moment prior to the disposal, through a procedure brought to the knowledge of the TA in 2009.

Therefore, the Arbitral Tribunal decides:

a) To uphold the application for arbitral pronouncement; and

b) To annul the tax acts of VAT assessment and respective compensatory interest.

The value of the case is set at €38,437.17.

Costs borne by the Respondent in the amount of €1,836.

Notify the parties.

Lisbon, 8 May 2015

The Single Arbitral Tribunal

José Luís Ferreira