IRC Tax on Municipal System Concessions: Investment Obligation and Intangible Asset Amortization (CAAD 72/2016-T)

ARBITRAL DECISION

The arbitrators Councillor Maria Fernanda dos Santos Maçãs (President), Prof. Dr. Ana Maria Rodrigues (Member) and Dr. José Luís Ferreira (Member), hereby agree as follows:

I. REPORT

1. A…, SA, Legal Entity No…, with registered office in…, Place of…, in…, …-… … … (hereinafter referred to as "Applicant"), submitted a request for arbitral ruling and establishment of a Collective Arbitral Court, pursuant to the provisions of article 4 and no. 2 of article 10 of Decree-Law no. 10/2011, of January 20 [Legal Framework for Tax Arbitration (RJAT)], in which the Tax and Customs Authority is Respondent (hereinafter referred to as "Respondent").

2. The request for establishment of the Arbitral Court was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority on 26-02-2016.

2.1. In exercise of the option for appointment of arbitrator provided for in subparagraph b) of no. 2 of article 6 of the RJAT and in compliance with the provisions of subparagraph g) of no. 2 of article 10 and no. 2 of article 11 of the same act, the Applicant appointed Dr. José Luís Ferreira as Arbitrator.

2.2. Pursuant to the provisions of subparagraph b) of no. 2 of article 6 and no. 3 of article 11 of the RJAT, and within the time limit provided in no. 1 of article 13 of the RJAT, the senior official of the Tax and Customs Authority ("AT") appointed Prof. Dr. Ana Maria Rodrigues as Arbitrator.

2.3. In accordance with the provisions of nos. 5 and 6 of article 11 of the RJAT, the President of CAAD notified the Applicant of the appointment of the Arbitrator by the senior official of the Tax Administration on 22-03-2016, and notified the arbitrators appointed by the parties to appoint the third arbitrator who assumes the position of President Arbitrator, with the Honourable Arbitrators appointed by the parties agreeing, on 12-04-2016, to the appointment of Councillor Maria Fernanda dos Santos Maçãs as President Arbitrator.

2.4. On 14-04-2016, the President of CAAD informed the Parties of this appointment, pursuant to and for the purposes of the provisions of no. 7 of article 11 of the RJAT.

2.5. In compliance with the provisions of subparagraph c) of no. 11 of the RJAT, the Collective Arbitral Court was constituted on 2-05-2016.

2.6. In these terms, the Arbitral Court is duly constituted to assess and decide the object of the proceedings.

1. By arbitral order, dated July 24, 2016, it was decided: i) To dismiss the request for production of witness testimony, given the fact that the articles indicated for testimony correspond to matters of law, matters of fact lacking documentary evidence, or matters irrelevant to the decision of the case; ii) To dispense with the holding of the meeting provided for in article 18 of the RJAT, based on the principles of court autonomy in the conduct of proceedings in order to promote speed, simplification and informality thereof; and iii) To set November 2 as the deadline for issuance of the arbitral decision. This deadline was successively extended, by orders of October 30, 2016 and December 29, 2016, setting March 2, 2017 as the final date for issuance of the arbitral decision.

2. In the arbitral request, which it submitted, the Applicant invokes, in summary, that:

a) Following the dismissal of the gracious claim, it requests the declaration of illegality of the assessment of Corporate Income Tax (IRC), relating to the fiscal year 2011, with no. 2014…, of 19.12.2014, corresponding interest computation statements with nos. 2014 … and 2014…, and respective statement of account reconciliation no. 2014 … of 22.12.2014, in the total amount of € 324,360.37.

b) With respect to its activity, A…, S.A., consists in the management of municipal public services for drainage, treatment and final disposition of wastewater from the Integrated Pollution Prevention System of … (SID…).

c) On 29.10.1998, the Association of B… ("B…") and A… entered into, by public deed, the concession agreement for the operation and management, on an exclusive basis, of the SID…, which at that time served the municipalities of…, … and… . This concession agreement had as its object, in the area of intervention, the "operation and management, on an exclusive basis, of the public service of drainage, treatment and final disposition of waters embodied in the SID…, the rehabilitation of existing infrastructure that may require it and the execution of new infrastructure in accordance with the Physical Execution Planning relative to Hypothesis B provided for in the Bidding Program (…)", including only the financing, pursuant to the provisions of article 68 of this agreement, the design, execution and operation of a definitive solution for the final disposition of sludge and the second phases of the Wastewater Treatment Stations of…, … and…, in accordance with Programs 2 and 3 defined in the Physical Execution Planning of Infrastructure relating to Treatment, Final Disposition of Sludge and Reuse of Liquid Effluents (…)", executing, by the concessionaire, "the financial scheme contained in the economic study contained in its proposal, relating to Hypothesis B and as defined in number 2 of article 4, in aspects corresponding to the operation of the granted service" and assuming "financing sources: a) The capital of the Concessionaire and other own capital, namely supplementary capital supplies or contributions; b) Financial contributions and subsidies granted to the Concessionaire; c) Revenues from tariffs or guaranteed values charged by the Concessionaire; d) Other sources of financing, namely foreign capital conveyed under "project finance", subordinated debt, senior debt or commercial paper.

d) In the context of such agreement, the concessionaire obligated itself to fully finance the costs of sludge infrastructure (to be realized in the construction of a thermal sludge drying plant corresponding to €17,907,842), and should funds be made available to subsidize sludge treatment infrastructure, the concessionaire would be obligated to participate in the financing of other works in an amount equivalent to the funds made available.

e) By means of an amendment to the agreement, occurred on 20.04.1999, the investment obligation was reduced to €16,910,246 and to the investment obligation for the execution of any work to be integrated in the SID… was associated the value of € 2,493,989 Obligation in the context of which the Applicant realized investments corresponding to € 1,724,500.

f) In accordance with the contractual provision, the service provided by the concessionaire would be paid by those who used it, in accordance with tariffs and rates approved by the Grantor in conformity with criteria fixed in the agreement.

g) The Multimunicipal Water Supply and Sanitation System of … ("Multimunicipal System of …") was created in May 2002 and granted in concession on 21.10.2003, having overlapped the SID… at the geographic level and in the object of operation, whereby a protocol of understanding (among A…, B… and C…) was executed for revision of the obligation to realize the unrealized investment.

h) Subsequently C… assumed (by assignment of contractual position) the position of grantor, instead of A…, in the concession agreement with B… . On the other hand, D…, S.A. assumed the position of grantor in the concession agreement of the SID…, following the replacement of several multimunicipal systems by the multimunicipal water supply and sanitation system of the Northwest (for whose management and operation D…, S.A. is exclusively responsible).

i) Despite, since 2004, being defined (by intervention of the shareholder of D…) that the concession agreement should be adapted to the conditions of operation (…), the lack of definition as to the precise contours of the concession agreement of the SID…remained, persisting, nonetheless, the obligation of payment of a consideration for the right to the concession.

j) The Concession Agreement of the SID… was unilaterally modified by the Grantor (following prior communication directed by D… to A…), on 02.02.2015, as a result of which it was determined that the investment obligation of the grantor would be fulfilled through the revision of the tariff in force (tariff that does not undergo change). This agreement is already being applied among the parties and is in the process of formalization.

k) On 31.10.2014 an external inspection procedure for fiscal year 2011 was initiated, by the Division of Tax Inspection I (Team F) of the Finance Authority of…, following which an inspection report was issued, based on which the following official corrections occurred in the scope of IRC: i) Annulment of the transition adjustment associated with the derecognition of tangible fixed assets: €44,824.64: ii) Consideration of the negative patrimonial variation associated with the derecognition of tangible fixed assets: - €3,687.58; iii) Investment obligation – reversal of amortization of the "Cost Increase" not accepted for tax purposes after the transition to SNC: €383,977.35; iv) Correction of the update of the provision for substitute infrastructure investment: €49,736.50; v) Investment obligation – correction of amortization of the fiscal year of the intangible asset: 546,887.19; vi) Fines and other charges for the commission of infractions: €275.50; vi). Total corrections to the taxable profit of IRC: €1,022,013.61.

l) The annulment of the transition adjustment associated with the derecognition of tangible fixed assets (44,824.64) occurred based on 4 orders of justification: (1) Infrastructure made available by the grantor; (2) Investments made by the Taxpayer, between the beginning of the concession and 2009-12-31, made under the obligation to finance the infrastructure to be integrated in the SID…; (3) Investments made by the Taxpayer, between the beginning of the concession and 2009-12-31, relating to installation expenses (intangible assets); (4) Investments made by the Taxpayer, between the beginning of the concession and 2009-12-31, in assets that do not meet the requirements to be considered "Fixed Assets" within NCRF/SNC", in the analysis of which the services adopted as a starting point the values contained in the 2009 financial statements, with the inspection services of AT proposing that the negative patrimonial variation be corrected, of € 44,824.64.

m) The consideration of the negative patrimonial variation associated with the derecognition of tangible fixed assets was based on the fact that AT inspection services understood that 1/16 of the negative patrimonial variation ascertained (€ 3,687.58) should be deducted from the taxable result of fiscal year 2010 because these were assets that were recorded in the tangible fixed assets of the Applicant and which, as they are not owned by the Applicant, do not meet, after the transition to the new accounting regulatory framework, the conditions to be qualified as tangible fixed assets.

n) As to the Investment obligation – reversal of amortization of the "Cost Increase" not accepted for tax purposes after the transition to SNC (€383,977.35), AT inspection services advocated (based on article 5-A of Decree-Law no. 159/2009, of July 13) that such patrimonial variation be divided by the number of years remaining for the term of the concession (16 years) and the result (€ 383,977.35) added to the taxable result of each of the respective tax periods, starting with fiscal year 2010.

o) With respect to the amortizations of the intangible asset, AT inspection services promoted the official increase to the taxable profit of the remaining € 546,887.19 by understanding, based on article 12 of Regulatory Decree no. 25/2009, that only the amortizations of the fiscal year relating to the investment already realized (in a total of € 1,724,500.10), which amount to € 83,308.31, could be deducted in the ascertainment of the taxable profit of the fiscal year.

p) Not conforming to the official corrections promoted by AT, the Applicant submitted a gracious claim, invoking a) Error as to the factual premises; b) Procedural defect; and c) Error in the application of law. Such claim was dismissed.

q) The invocation of error as to the factual premises was based on the circumstance that the tax inspection services proceeded with a superficial and equivocal reading of the facts, with an erroneous understanding, which it adopts, that in fiscal year 2010, constituted exclusive consideration for the right to the concession the carrying out of civil construction works (to be integrated in the SID…) by A…, given that, on the contrary, and as it follows from the elements contained in the inspection process and in the gracious claim procedure, the obligation, initially agreed but not fulfilled, of investment in the grantor's infrastructure had, in fact, been replaced by the obligation of payment of a price. On the other hand, and even if the replacement of the consideration to be rendered for the acquisition of the right to the concession had not been formalized and the recognition of the intangible asset as consideration for a provision could raise doubts, the tax authority would always be bound by an evaluation of this reality in light of the principle of substance over form, which did not occur. Based on the taxation, on wrong factual premises, there does not exist the tax event that underlies it, and the official corrections should be annulled.

r) AT also incurs in procedural defect by violation of the principle of the right to be heard, material truth and burden of proof, both in the inspection procedure and in the administrative procedure.

s) In addition to having to base its decisions with clear, coherent or rational and sufficient reasoning, AT is bound by the principles of justice and impartiality, as well as of material truth and good faith, whereby it must, by its own initiative, pursuant to the principle of inquisitorial investigation (article 58 of the LGT), ascertain all the factual reality, to obtain the most truthful profile possible of reality, which did not occur, generating the illegality of the tax act.

t) The herein Applicant recognized accounting and tax the right to the concession as an intangible asset (for the value of the unrealized consideration) as consideration for a liability of uncertain timeliness (provision), which enjoys a presumption of truthfulness not only because it corresponds to the taxpayer's statement (with no occurrence of any of the situations in which this presumption is destroyed - article 75 of the LGT), but also because it is registered in the Applicant's accounting. From the existence of such presumption is extracted that the burden of proof of the facts constitutive of the right to correction falls on AT, that is, the burden of demonstrating that there was an effective and unequivocal obligation to carry out infrastructure construction services as consideration for the acquisition of the right to the concession by the Applicant – which AT did not do, whereby the tax act under scrutiny suffers from illegality.

u) AT did not contest the legal framework presented by the Applicant, according to which if the scope of application of IFRIC 12 is limited to situations in which the consideration borne by the concessionaire for the cession of the right to the concession of public services resides in the provision to the grantor of construction/enhancement services and/or operational services, the reality does not end in this scenario, nor does the application of IFRIC 12 preclude the application of other accounting regulations whenever by the nature of the reality to be conformed, this is justified. Indeed, leaving this factual framework it is still necessary to consider an additional possibility: the circumstance where the concessionaire obligates itself to pay a monetary consideration (price) for the acquisition of the right to the concession, in which case one is necessarily outside the scope of application of IFRIC 12, since the transmission of the right to the concession occurs without the concessionaire providing a consideration consisting of the provision of a service, but by force of the payment of a price. Thus, whenever the right (to the concession), (i) constitutes a non-monetary, identifiable asset, without physical substance, (ii) whose control was contractually attributed to the concessionaire and from which economic benefits are expected to be obtained (iii) maintaining the risk component associated with the use of users of the aforementioned public service, it should be recognized as an intangible asset under general terms, i.e. for its respective price (deducted from commercial discounts and allowances), being amortized according to its useful life, e.g. through the straight-line amortization method, in conformity with IAS 38 – Accounting and Financial Reporting Standard (NCRF) no. 6. The qualification of the right to the concession (in this case, the right of operation and management on an exclusive basis of the SID…) acquired as consideration for the payment of a price clearly meets the conditions to be qualified as an intangible asset under the terms of NCRF 6, whereby this should occur in this case.

v) Consequently, with the transition to the new accounting regulations, A… had to, with respect to the transition accounting adjustments relating to assets affected by the concession, purge from its accounts: the tangible fixed assets corresponding to infrastructure and assets affected by the concession owned by the grantor or reverting at the end of the concession (which constituted a component of the asset) in the amount of € 85,009,953.00; the accumulated amortizations relating to these assets (which constituted a component to be deducted from the asset), in the amount of € 35,763,435.00; the deferred income relating to the net value of these assets (which constituted a liability) in the amount of € 48,201,308.00; the cost increases relating to investment obligations still not realized, understanding as such construction/enhancement obligations of infrastructure (as opposed to reversible investments to third parties at the end of the concession, still not realized, in the terminology of DC 4/91) (which constituted a liability) in the amount of € 6,143,637.00. It was, on the other hand, obligated to recognize: intangible asset (right to the concession) whose gross value is discriminated in two distinct portions: (i) € 1,724,500 - relating to the asset acquired as consideration for the provision of construction services to the grantor entity realized in the past; and (ii) € 15,185,746 - referring to the price agreed and to be paid in the future, to be added to the previous consideration under the terms of the concession agreement in the interpretation in effect at the date; the respective depreciations and accumulated amortizations (components to be deducted from the asset) in the amount of (i) € 698,052.95 and of (ii) € 6,391,646.05, respectively; the respective depreciations and amortizations of the fiscal year (fiscal costs of fiscal year 2010), in the amount of (i) € 83,308.31 and of (ii) € 546,887.19, respectively.

w) With respect to the tax treatment of the transition adjustments, with the entry into force of D.L. no. 159/2009 and consequent adaptation of the IRC Code to the new accounting standards, the following derecognitions (or non-recognitions) are to be considered: (i) the tangible fixed assets corresponding to the infrastructure of assets affected by the concession owned by the grantor – which constitutes a reduction of the asset, thus in a negative patrimonial variation without tax relevance since its original recognition did not directly result in the ascertainment of any taxable cost or income; (ii) the accumulated amortizations relating to these assets – which constitutes an increase of the asset, thus in a positive patrimonial variation without tax relevance because it translates a set of values that, although with tax relevance, was simultaneously considered cost and income of the fiscal year in the past, having a neutral effect, thus without current tax relevance; (iii) the deferred income relating to the net value of these assets, - which constitutes a reduction of the liability, thus a positive patrimonial variation without tax relevance insofar as it had no projection in results in the past; (iv) the cost increases relating to investment obligations still not realized, understanding as such construction/enhancement obligations of infrastructure (as opposed to capitalized expenses in the terminology of DC 4/91) – which constitutes a reduction of the liability, thus a positive patrimonial variation with tax relevance because it translates a set of values considered as a tax-deductible cost in the past, and should be increased. On the other hand, they were obligated to recognize: (v) the financial or intangible assets associated with the services (construction/operation) rendered to the grantor entities – which constitutes an increase of the asset, thus a positive patrimonial variation that has no direct impact on result items and thus tax relevance; (vi) the intangible assets acquired to ensure the right to the concession – positive patrimonial variation – which constitutes an increase of the asset, thus a positive patrimonial variation that has no direct impact on result items and thus tax relevance; (vii) the liability corresponding to the amount owing with respect to the price to be paid to the grantor for the right to the concession – which constitutes an increase of the liability, thus a negative patrimonial variation that has no direct impact on result items and thus tax relevance; (viii) the respective depreciations and amortizations – which constitutes a reduction of the asset, thus a positive patrimonial variation with tax relevance because they translate a set of values that should be assumed retrospectively as a tax-deductible cost, and, as to this latter point, the amortizations to be considered as a tax-deductible cost (either retrospectively – accumulated amortizations, or in fiscal year 2011 – amortizations of the fiscal year) should be determined under the terms of Regulatory Decree no. 25/2009, of September 14 (decree which, despite promoting the adequacy of the tax regime to the new accounting standards with respect to depreciations and amortizations, seems to continue to assume that concessionaires recognize constructed infrastructure as such, not providing for its treatment in accordance with IFRIC 12).

x) The rules for tax recognition of depreciations and amortizations applicable to intangible assets determine that: elements of the asset subject to depreciation may, from the outset, be subject to depreciation or amortization, considering as such, among others, intangible assets; these assets are depreciable when subject to depreciation, namely by having limited temporal validity; and should be amortized during the period of time in which the right in question will be for exclusive use of the taxpayer, in this case, the period of the concession. The procedures listed were those actually adopted by the Applicant.

y) In the specific case, we have, in net terms, in matters of transition adjustments, a negative patrimonial variation, with tax relevance, corresponding to the difference between the values corresponding to the realities referred to in points (iv) and (viii) of articles 206 and 207 above (procedure adopted by A…) – in the amount of € 946,062 to be recognized in equal installments of € 59,128.87 for each fiscal year until the end of the concession; in matters of amortizations of the fiscal year with tax deductibility should be considered the amortizations referred to in the intangible asset recognized, either by virtue of the performance of construction works in the SID… or as consideration for the payment of a price (or assumption of a debt), calculated under the terms of article 16 of Regulatory Decree no. 25/2009, of September 14 (rates constant for the period of the concession) in the total amount of € 630,195.50.

z) From the foregoing it follows that the assessment is illegal, and should be annulled, and further the Applicant should be reimbursed for the voluntary payment it made, to which interest indemnification is added, by virtue of the undue payment resulting from error attributable to the services.

1. AT submitted a response and attached the administrative file, alleging, in the sense of the non-merits of the request for arbitral ruling, in summary, the following:

a) Although a protocol was signed in 2004, only in 2015 was the definition of new premises materialized, so that at the date of the facts under analysis the reality relating to the concession agreement remained unchanged.

b) The Applicant does not specify the facts and events to which it refers in article 106 of the initial petition.

c) Being the contractual clauses clear, they do not require interpretation, whereby the Applicant would only be correct when it invokes that AT should have questioned such clauses if these were ambiguous. On the other hand, AT based itself on the documentation obtained from the Applicant, with the latter accompanying the entire inspection procedure, through its auditor, to which it adds that the same Applicant had the opportunity to express itself on AT's interpretation in the context of prior hearing.

d) The case law invoked by the Applicant does not apply to the present case, given that it relates to a different matter (false invoices). What is at issue in this action is not, moreover, the compliance with the obligation to organize and maintain accounting, nor the compliance with its accessory obligations, but the interpretation of the facts inherent in the concession agreements.

e) The basis for AT's reasoning is clear, sufficient and coherent (consisting, as to the legal part, both in the inspection procedure report and in the assessment of the gracious claim), revealing, the tenor of the initial petition, that the Applicant understood it perfectly.

f) AT demonstrated that the statements were not properly completed (by not presenting the actual situation of the Applicant) and that there was an obligation to carry out infrastructure construction services as consideration for the acquisition of the right to the acquisition of the concession, with risks and obligations already constituted remaining unchanged on the part of the parties.

g) The correction corresponding to the annulment of the transition adjustment to the derecognition of tangible fixed assets results from the disregard, by AT, of the transition adjustment made by the Applicant pursuant to article 5 of Decree-Law no. 159/2009, of 13.07, registered in field 705 of Table 07 of the periodic income statement model 22, translated into a deduction to taxable profit of €44,824.64 (1/5 of - €224,125.00) and is based on the analysis, made by AT, of the effects resulting from the application of Accounting and Financial Reporting Standard 3 – First-time Adoption of Accounting and Financial Reporting Standards (NCRF) - reflected in the table of subparagraph b) of point 2.4 of the Annex to the Financial Statements of the Period of 2010, centered, however, on the effects on shareholders' equity considered tax-relevant, under the terms of the IRC Code and its complementary legislation, since only these have framework in the referred transitional regime provided for in nos. 1, 5 and 6 of article 5 and article 5-A of Decree-Law no. 159/2009.

h) The application of the transitional regime provided for in nos. 1, 5 and 6 of article 5 and article 5-A of Decree-law no. 159/2009, led to the disregard of the negative patrimonial variation declared by the Applicant and consequent correction to taxable profit; to the determination of a negative patrimonial variation, in the amount of €18,437.60, which resulted in the negative correction to taxable profit, of € 3,687.58 (1/5 x €18,437.60/5) and to the consideration of the positive patrimonial variation of + €6,143,637.00 and consequent positive correction to taxable profit, of €383,977.35 (1/16 x €6,143,637.00), with the latter variation being divided by 16 periods and having as its legal basis the provisions of article 5 and article 5-A of Decree-Law no. 159/2009, amended by Law no. 66-B/2012, of 31.12, with an interpretative character, according to which managing entities of multimunicipal water supply, sanitation or urban waste systems that benefited from the tax deductibility of amortizations of unperformed contractual investment until the date of entry into force of that decree, the five-year period referred to in no. 1 of article 5 corresponds to the remaining tax periods of the concession agreement in force at the end of each fiscal year.

i) Within the framework of the transitional regime, AT also qualified as tax-irrelevant (based on no. 1 of article 12 of Regulatory Decree no. 25/2009, of 14.09) the negative patrimonial variation, of €7,089,699.00 (Amortizations of intangible fixed assets relating to the contractual investment obligation).

j) Outside the scope of the transitional regime it made corrections relating to expenses recorded in fiscal year 2011 (correction of the update of the provision for substitute infrastructure investment; and Investment obligation – correction of amortization of the fiscal year of the intangible asset, it is important to make a brief incursion into the accounting regulations applicable to concession agreements).

k) The responsibilities assumed, by the Applicant, in the concession agreement for the financing of infrastructure to be integrated in the SID…, up to the limit of €16,910,246.00, were apportioned by the total number of years of the concession, in accordance with the rules applicable to the accounting of contractual obligations of concessionaire companies contained in Accounting Directive (DC) No. 4/91, of 19.12.1991, with the balance of the account of "Cost Increase - Contractual obligations, as of 31.12.2009, amounting to €6,143,637.57. After the entry into force of the SNC, the Applicant began to adopt the rules of Interpretation 12 of the International Financial Reporting Interpretations Committee (IFRIC) – Service Concession Arrangements. In this context, the Applicant adopted a retrospective view of IFRIC 12, having recognized an intangible asset in the amount of €16,910,246.00 (remuneration of the grantor), as well as calculated and recorded the accumulated depreciations and amortizations of the intangible asset, from the beginning of the concession until 31.12.2009, in the amount of €7,089,699, as well as the depreciations and amortizations of the fiscal year, in the amount of €630,195.50.

l) The disregard (made by AT), as tax-relevant, of the transition adjustment relating to the recognition of accumulated amortizations of the intangible asset was due to the fact that the requirements of NCFR 6 (§21 et seq.) were not met: predictability and definition. Non-recognition of the intangible asset which implies that the regime provided for in article 16 of Regulatory Decree no. 15/2009 is also not applicable.

m) The amortizations of the intangible asset relating to the contractual obligation of financing works to be integrated in the SID… not accepted as an expense in the period of 2011 correspond to €546,887.20 (amortization recorded, in the amount of €630,195.50 less the part accepted for tax purposes, in the amount of €83,308.31). The aforementioned uncertainty and lack of definition only dissipated on 02.02.2015 (date of the unilateral modification of the concession agreement of the SID…, in which the manner and moment of payment of the consideration for the right to the concession was established, with effects reported to 01.01.2014).

n) AT also disregarded the deduction for tax purposes of the expense relating to the accumulated financial update relating to the provision for substitute equipment investment of the concession, calculated from the beginning of the concession until the date of 31-12-2009, because it is not provided for in article 39 of the CIRC.

o) The Applicant's claim for deduction of the annual amount of €59,128.87, as well as the amortization of the intangible asset in question, does not proceed, given that the recognition criteria for an intangible asset are not met on the transition date.

p) Because the Applicant did not contest it, the "Correction of the update of the provision for substitute infrastructure investment" should be considered accepted.

q) The arguments invoked by the Applicant are devoid of foundation in the sense that there is error in the application of law and that AT incurred in violation of the law, and the action should be considered without merit and the Respondent absolved of the claim.

1. The parties submitted arguments contending, in essence, for what was maintained in the pleadings.

II. REMEDIES

1. The request for arbitral ruling is timely because submitted within the time limit provided in subparagraph a) of no. 1 of article 10 of the RJAT.

2. The parties have judicial personality and capacity, are legitimate as to the request for arbitral ruling and are duly represented, pursuant to the provisions of articles 4 and 10 of the RJAT and article 1 of Order no. 112-A/2011, of March 22.

3. The Court is competent as to the assessment of the request for arbitral ruling formulated by the Applicant.

4. No exceptions were raised of which it is necessary to be aware.

5. There are no nullities that preclude examination on the merits.

III. MERITS

III.1. MATTERS OF FACT

§1. Proven Facts

The following facts are judged as proved:

a) The Applicant was established on 14.09.1998 and has as its corporate purpose the operation and management of municipal public services for drainage, treatment and final disposition of wastewater from the Integrated Pollution Prevention System of … (SID…).

b) On 29.10.1998, B… ("B…") and A… entered into, by public deed, the concession agreement for the operation and management, on an exclusive basis, of the SID… that at that time served the municipalities of…, … and … (Document no. 3, attached by the Applicant, article 1).

c) This agreement was entered into for a period of 25 years from the date of definitive hand-over of the existing infrastructure of the system (no. 1 of article 65 of Document no. 3, attached by the Applicant).

d) The definitive hand-over of the infrastructure that comprised the SID… occurred on 01.08.2000 (Document no. 4, attached by the Applicant).

e) The object of the concession integrated, in the area of intervention, the "operation and management, on an exclusive basis, of the public service of drainage, treatment and final disposition of waters embodied in the SID…, the rehabilitation of existing infrastructure that may require it and the execution of new infrastructure in accordance with the Physical Execution Planning relative to Hypothesis B provided for in the Bidding Program (…)" (article 4 of Document no. 3, attached by the Applicant).

f) The concession agreement further defines that the object of the concession "includes only the financing, pursuant to the provisions of article 68 of this agreement, the design, execution and operation of a definitive solution for the final disposition of sludge and the second phases of the Wastewater Treatment Stations of…, … and…, in accordance with Programs 2 and 3 defined in the Physical Execution Planning of Infrastructure relating to Treatment, Final Disposition of Sludge and Reuse of Liquid Effluents (…)" (no. 2 of article 4 of Document no. 3, attached by the Applicant).

g) In accordance with no. 1 of article 68 of the concession agreement (Document no. 3, attached by the Applicant), "The Concessionaire shall execute the financial scheme contained in the economic study contained in its proposal, relating to Hypothesis B and as defined in number 2 of article 4, in aspects corresponding to the operation of the granted service, which forms an integral part of this Agreement.

h) Pursuant to no. 4 of the same article of the concession agreement (Document no. 3, attached by the Applicant), "The scheme referred to in the preceding numbers is organized taking into account the following financing sources: a) The capital of the Concessionaire and other own capital, namely supplementary capital supplies or contributions; b) Financial contributions and subsidies granted to the Concessionaire; c) Revenues from tariffs or guaranteed values charged by the Concessionaire; d) Other sources of financing, namely foreign capital conveyed under "project finance", subordinated debt, senior debt or commercial paper.

i) Article 68 of the concession agreement (Document no. 3, attached by the Applicant) further provides, in its no. 5 that "If the Concessionaire is not timely made available the funds from the financing sources referred to in subparagraph b) of the preceding number or others, it obligates itself to fully finance the costs of sludge treatment infrastructure, as defined in the Infrastructure Master Plan".

j) Further referred to in no. 7 of the same article 68 of the concession agreement is that "Should funds be made available, as provided in no. 5 of this article, to subsidize sludge treatment infrastructure, the Concessionaire obligates itself to participate in the financing of the remaining works, in a total amount equivalent to the funds made available".

k) The obligation to finance sludge treatment infrastructure was to be realized in the construction of a thermal sludge drying plant (Document no. 5, attached by the Applicant).

l) In accordance with the economic study, which forms an integral part of the concession agreement of the SID…, the obligation to finance sludge treatment infrastructure amounted to € 17,907,842 (sum of the annual values relating to the asset composed of sludge treatment infrastructure contained in Document no. 6, attached by the Applicant).

m) By means of an amendment to the concession agreement of 20.04.1999, the parties affected an amount corresponding to € 2,493,989 relating to the investment obligation for the execution of any work to be integrated in the SID…, and likewise, by virtue of the non-application of the tariff update formula, decreased the investment value to be realized by € 997,596, resulting in the overall investment obligation of € 16,910,246.

n) Under this obligation the Applicant realized investments in infrastructure in the total amount of € 1,724,500, leaving € 15,185,746 of investment to be realized under the obligation to finance sludge treatment infrastructure provided for in the concession agreement.

o) In no. 1 of article 69 of the concession agreement it is provided that the service rendered by the concessionaire, now Applicant, shall be paid by those who use it, with the corresponding tariffs and rates to be approved by the Grantor (Document no. 3, attached by the Applicant).

p) In accordance with no. 5 of the same article 69, "The setting of Tariffs shall: a) Ensure, within the period of concession, the amortization of the investment charged to the Concessionaire; b) Ensure the maintenance, repair and renovation of all infrastructure and other assets affected by the Concession; c) Ensure the technically required amortization of any new investments in expansion or modernization of the System, specifically included in authorized investment plans; d) Take into account the cost level necessary for efficient management of the System and the existence of revenues not arising from the Tariff; e) Ensure an adequate remuneration of the Concessionaire's own capital." (ibidem).

q) In May 2002 the Multimunicipal Water Supply and Sanitation System of … ("Multimunicipal System of…") was created, whose concession was awarded to C…, S.A ("C…") through Decree-Law no. 135/2002, of May 14 (Document no. 7, attached by the Applicant).

r) The respective concession agreement was entered into on 21.10.2003.

s) This multimunicipal system, both with respect to its geographic scope and its object of operation, came to overlap the SID….

t) In order to safeguard the position of the Applicant as concessionaire of the SID…, a protocol of understanding was established (on 24.03.2004) among A…, B… and C… (Document no. 8, attached by the Applicant) in the context of which, among others, it was agreed to provide for an alteration and definition of new premises regarding the obligation to realize the investment.

u) Subsequently, a contract for assignment of the contractual position of grantor in the concession agreement of which A… is concessionaire was entered into from B… in favor of C… .

v) On 04.06.2010, a merger-extinction occurred, pursuant to Decree-Law no. 41/2010, of April 29, through the global transfer of the patrimony of the entities: E…, S.A., F…, S.A., and C…, S.A, to constitute the entity D…, S.A..

w) D…, S.A. is the entity responsible, on an exclusive basis, for the operation and management concession of the multimunicipal water supply and sanitation system of the Northwest.

x) This multimunicipal system came to replace the multimunicipal systems of (i) capture, treatment and supply of water to the northern area of the Greater ..., (ii) water supply and sanitation of … and (iii) water supply and sanitation of … .

y) As a consequence, D…, S.A. assumed the position of grantor in the concession agreement of the SID….

z) It was defined, by intervention of the shareholder of D… (G…, SA), that it should proceed with all possible speed to the adaptation of the concession agreement to the conditions of operation (communication ADM/…of July 7, 2010, Documents no. 9 and 10, attached by the Applicant).

aa) D… instructed A… in the sense that: i. The remaining financing obligation of the Concessionaire, initially allocated to investments in the Infrastructure Master Plan should be wholly transferred to a revision of the tariff in force; ii. Taking into account the aforementioned in i), we have, pursuant to and for the purposes of article 74, no. 1, a), of the Concession Agreement of the SID…, to proceed to an Extraordinary Alteration of the Tariffs and Rates, fixing the average tariff provided for in Article 74, no. 1 a) of the Concession Agreement of the SID… at 0.37€ /m3, at 2015 prices with retroactive effects from January 1, 2014 and in terms to be regulated in an Agreement to be entered into among the parties; iii. The reduction of the tariff referred to in ii) shall produce effects until the financing obligation designated in i) is exhausted".

bb) By force of this agreement between the Applicant and the Grantor, the moment was defined from which the payment of the financing obligation assumed as consideration for the right of the Concessionaire's exclusive use of the SID… should be made, which informed the economic model of the respective concession (Document no. 11, attached by the Applicant).

cc) The alteration of the initial contractual conditions only occurred in 2015, with retroactive effects to 1.1.2014 (Document no.11 attached by the Applicant and article 30 of the Petition).

dd) In compliance with service order OI2014…, an external inspection procedure of general scope for fiscal year 2011 was carried out, by the Division of Tax Inspection I (Team F) of the Finance Authority of … (hereinafter DIT or inspection services of the Tax Authority), initiating on 31.10.2014.

ee) Following the inspection action identified, the respective Tax Inspection Conclusions Report (inspection report) was issued - Document no. 12, attached by the Applicant.

ff) In accordance with point 1.1 -"Cross-cutting Framework regarding Corrections in the Scope of IRC" of the inspection report (Document 12, attached by the Applicant), the inspection services state that: «In the context of the concession agreement the Taxpayer has the obligation to finance the Grantor up to the limit of 16,910,246.00 EUR, for the execution of infrastructure and works to be integrated in the SID…»; «This amount was recognized as a provision, given its uncertain character as to timeliness, as consideration for the "intangible asset – investment obligation" of the taxpayer, translating the concessionaire's right to charge users for a public service»; «From the predicted investment, the concessionaire realized works in the value of 1,724,500.10 EUR.», «Under the same concession agreement, the Taxpayer proceeded to constitute a provision for replacement, which is intended to accrue to the realization of future expenses in renovation of the concession's infrastructure, provided that they are expected to be certain realization in the years remaining of the concession period»; «Thus the Taxpayer recognized a "provision" in the value of 1,868,648.24 EUR, referring to the responsibility to maintain the infrastructure in good working condition, as consideration for the "intangible asset", since the tariff charged to users of the public service also remunerate this obligation.»

gg) The inspection services made the following official corrections in the scope of IRC:

1. Annulment of the transition adjustment associated with the derecognition of tangible fixed assets: €44,824.64

2. Consideration of the negative patrimonial variation associated with the derecognition of tangible fixed assets: -€3,687.58

3. Investment obligation – reversal of amortization of the "Cost Increase" not accepted for tax purposes after the transition to SNC: €383,977.35

4. Correction of the update of the provision for substitute infrastructure investment: €49,736.50

5. Investment obligation – correction of amortization of the fiscal year of the intangible asset: €546,887.19

6. Fines and other charges for the commission of infractions: €275.50

Total corrections to taxable profit of IRC: €1,022,013.61

hh) The methodology followed by AT inspection services was, in the order described, a) Validate the transition adjustment associated with the derecognition of tangible fixed assets, b) Subsequently ascertain patrimonial variations – transitional regime – article 5, nos. 1, 5 and 6 of Decree-law no. 159/2009, of July 13, c) Validate the increase to taxable profit recorded in field 721 of table 07 of the income statement model 22; d) Validate amortizations of the intangible asset; e) Perform other adjustments to taxable profit (fines and other charges for the commission of infractions and donation).

ii) The analysis of the Respondent, focused on the adjustments, is reflected in the following table:

jj) Regarding the official correction identified in the summary referred to above, the inspection services refer in the inspection report (Document 12, attached by the Applicant), based on subparagraph b) of point 2.4 of the Annex to the Report and Accounts of the period of 2010, that «It was concluded that the calculation prepared by the Taxpayer corresponds to 1/5 of the sum of the following adjustments (…): (i) "Derecognition of infrastructure made available by the grantor", with negative effect on shareholders' equity of 85,009,953.00 EUR; (ii) "Derecognition of accumulated amortizations relating to infrastructure made available by the grantor", with positive effect on shareholders' equity of 35,763,435.00 EUR; (iii) "Derecognition of [Increase in] Deferred [Income] relating to infrastructure made available by the grantor", with positive effect on shareholders' equity of 48,201,308.00 EUR; (iv) "Recognition of investment already realized", with positive effect on shareholders' equity of 1,724,500.00 EUR; (v) "Amortizations of Intangible Fixed Assets relating to contractual investment obligation", with negative effect on shareholders' equity of 7,089,699.00 EUR; (vi) Reversal of POC increases relating to Contractual Investment obligation", with positive effect on shareholders' equity of 6,143,637.00 EUR; (vii) Derecognition of POC Provision Renovation Fund", with positive effect on shareholders' equity of 42,647.00 EUR."

kk) As to the adjustment recorded, by the Applicant, in field 705 of table 07 of the income statement model 22 of IRC, by 1/5 of its value (€44,824.64), the inspection services refer that "The derecognitions identified in (i), (ii) and (iii) are inter-related, which is why they are analyzed jointly. Aggregately what is at issue is a derecognition of -1,045,210.00 EUR (-85,009,953.00 EUR +35,763,435.00 EUR + 48,201,308.00 EUR = -1,045,210.00 EUR) with negative effect on shareholders' equity" and that «(…) despite the description used by the Taxpayer in these derecognitions, "… infrastructure made available by the grantor", these adjustments should not be exclusively due to the derecognition of infrastructure made available by the grantor (B…) under the concession agreement entered into with the Taxpayer (…) ».

ll) The inspection services identify four orders of justification for the amounts in question: (1) Infrastructure made available by the grantor; (2) Investments made by the Taxpayer, between the beginning of the concession and 2009-12-31, made under the obligation to finance infrastructure to be integrated in the SID…; (3) Investments made by the Taxpayer, between the beginning of the concession and 2009-12-31, relating to installation expenses (intangible assets); (4) Investments made by the Taxpayer, between the beginning of the concession and 2009-12-31, in assets that do not meet the requirements to be considered "Fixed Assets" within NCRF/SNC".

mm) In the analysis of these components of the adjustment made by the Applicant, the services adopt as a starting point the values contained in the 2009 financial statements [cf. point 1.2, a), in pages 8 to 11, of Doc. no. 3]: «In accordance with the balance sheet for the period of 2009, as of 2009-12-31, the value of infrastructure made available by the grantor (B…), the gross asset amounted to 82,741,284.00 EUR (…). This gross asset is part of the derecognition identified in (i) (…). In turn the accumulated amortization of that same asset amounted to 34,539,976.00 EUR (…). This accumulated amortization is part of the derecognition identified in (ii) (…). On the other hand, the net value of that asset, in the amount of 48,201,308.00 EUR (…) is reflected in the liability, in accruals and deferrals, more specifically in deferred income (…). See that this deferred income was derecognized, as per the derecognition identified in (iii). Aggregately, the effect on shareholders' equity, associated with the derecognitions referred to, is nil (-82,741,284.00 EUR + 34,539,976.00 EUR + 48,201,308.00 EUR = -0.00 EUR)».

nn) The services also considered that «The "concession values" are being amortized and recognized as costs and income of equal amount, for the period of the concession and reflected in the lines of extraordinary costs and income, respectively», the inspection services consider that "(…) it results that the asset (gross asset) and the associated liabilities (accumulated amortizations and deferred income), did not influence the tax result of the periods of 2009 and earlier being, therefore, neutral in terms of cost (expense) or income (tax income)", concluding, with regard to the adjustment in question, that "(…) it will be an adjustment that is not tax-relevant and should not be considered for the tax transitional regime provided for in nos. 1, 5 and 6 of article 5 of Decree-Law no. 159/2009, of July 13".

oo) The inspection services refer that, comprising the derecognized gross asset by the Applicant, is the amount of € 1,724,500.10 relating to investments made by A…, from the beginning of the concession until 31.12.2009, under the obligation to finance infrastructure to be integrated in the SID… .

pp) From the derecognized accumulated amortizations the services identify the value of € 698,052.95 relating to amortizations of assets in which the investment referred to in the preceding point was realized.

qq) The services refer that, "In aggregate terms what is at issue is a derecognition of 1,026,447.15 EUR, (…) with negative effect on shareholders' equity", as well as that "the amortization of this asset was charged to costs (expenses) of the periods of 2009 and earlier, in the line of amortizations of the fiscal year. This cost was accepted for tax purposes".

rr) Further refer the inspection services regarding this adjustment that "With the entry into force of the new accounting standards (…) this amortization continues to be accepted for tax purposes under the terms of article 12 of Regulatory Decree no. 25/2009, of September 14 (…)", and that, "This tax expense does not result from a direct accounting recording, since the underlying asset was derecognized".

ss) The inspection services understand that "(…) this adjustment is not tax-relevant (the tax regime remains before and after the new accounting standards) and, therefore, should not be considered in the tax transitional regime provided for in nos. 1, 5 and 6 of article 5 of Decree-Law no. 159/2009, of July 13."

tt) With respect to the components associated with the investment made by A…, between the beginning of the concession and 31.12.2009, relating to installation expenses (intangible assets), the services understand that, being an asset that is fully amortized, "(…) in aggregate terms, there is no effect on shareholders' equity from this derecognition. The costs (expenses) associated with this asset were fully recognized and accepted for tax purposes in the periods prior to 2009 (…)"

uu) The inspection services conclude that "(…) this adjustment is not tax-relevant (nor even exists) and therefore should not be considered in the tax transitional regime provided for in nos. 1, 5 and 6 of article 5 of Decree-Law no. 159/2009, of July 13."

vv) With respect to the components associated with the investment made by A…, between the beginning of the concession and 31.12.2009, relating to installation expenses (intangible assets), the services understand that, being an asset that is fully amortized, "(…) in aggregate terms, there is no effect on shareholders' equity from this derecognition. The costs (expenses) associated with this asset were fully recognized and accepted for tax purposes in the periods prior to 2009 (…)".

ww) The inspection services conclude that "(…) this adjustment is not tax-relevant (nor even exists) and therefore should not be considered in the tax transitional regime provided for in nos. 1, 5 and 6 of article 5 of Decree-Law no. 159/2009, of July 13."

xx) With respect to the investment made by the Taxpayer, between the beginning of the concession and 31.12.2009, in assets that do not meet the requirements to be considered "Fixed Assets" within NCRF/SNC, the inspection services affirm that the assets in question, recorded at the gross value of € 90,529.52 and with accumulated amortizations on the order of € 72,091.60, comprising the concessioned infrastructure cannot, in accordance with the new accounting standards, be qualified as "Tangible Fixed Assets", since they are not owned by the Applicant.

yy) Since the assets comprised the tangible fixed assets in accordance with the POC accounting rules, the inspection services understood that the respective derecognition, with negative impact on shareholders' equity of € 18,437.92, has tax relevance.

zz) In relation to the recognition of investment realized in compliance with the investment obligation provided for in the concession agreement, the Applicant ascertained a positive patrimonial variation of € 1,724,500.00.

aaa) Regarding this positive patrimonial variation, AT inspection services refer that the same results "from a movement in shareholders' equity as consideration for a provision, specifically the provision relating to the contractual investment obligation (account 29880000 Provisions – Others) and served to adjust the balance of that provision, as of 2009-12-31, so as to reflect the amount of investment the taxpayer was obligated to realize until the end of the concession" (cf. page 12, point 1.2., b), of the inspection report, i.e.. Document 12, attached by the Applicant).

bbb) AT inspection services also refer, regarding this correction, that, "The provision in question was not accepted for tax purposes before the transition to the new accounting standards (…) and, all expenses or income and patrimonial variations that may be recognized after the transition also are not accepted under the terms of article 39 of the IRC Code (…)".

ccc) Within the scope of the adjustments of transition to the new accounting standards, the Applicant recorded a negative patrimonial variation in the value of € 7,089,699.00 referring to the recognition of accumulated amortizations of the intangible asset relating to the investment obligation, calculated from the beginning of the concession until 31.12.2009.

ddd) Regarding this adjustment the AT inspection services refer that "This movement (…) aims to correct the gross intangible asset (intangible asset relating to contractual investment obligation) of the respective amortizations so that the measurement was at net value. These amortizations did not exist before the transition to the new accounting standards (…) having this asset been created by force of the new accounting standards." (cf. page 12, point 1.2. c) of the Inspection Report – Document 12, attached by the Applicant).

eee) And they add those services, in the said report (cf. page 12, point 1.2. c), Document 12, attached by the Applicant), that "(…) the amortization in question is not accepted for tax purposes. The tax regime for depreciations and amortizations, provided in no. 1 of article 12 of Regulatory Decree no. 25/2009, of September 14, says that only amortizations resulting from effectively realized investments (…), and not those resulting from the intangible asset relating to the investment obligation (as is the case) are tax-deductible, concluding that "Therefore, this is an adjustment that is not tax-relevant for purposes of applying the transitional regime provided for in nos. 1, 5 and 6 of article 5 of Decree-Law no. 159/2009, of July 13."

fff) In the evaluation of the transition adjustment relating to the reversal of the amount recorded as cost increases (costs to be incurred with the investment obligation – cf. subparagraph b) of no. 4 of Accounting Directive no. 4/91) in the amount of € 6,143,637.57, which resulted in the ascertainment of a positive patrimonial variation (considered by the Applicant in the aggregate value of tax-relevant transition adjustments), AT inspection services consider that this adjustment is tax-relevant.

ggg) With respect to the positive patrimonial variation, ascertained by the Applicant and reflected in the respective taxable result, by virtue of the reversal of a provision denominated "POC Renovation Fund Provision", the inspection services consider that "This derecognition results from a movement in shareholders' equity as consideration for a provision (Substitute Investment Provision) and served to adjust the balance of that provision as of 2009-12-31, so as to reflect the amount of substitute investment the taxpayer estimates to realize until the end of the concession" and conclude that "The provision in question was not accepted for tax purposes before the transition to the new accounting standards (…) and, all expenses or income and patrimonial variations that may be recognized after the transition also are not accepted under the terms of article 39 of the IRC Code (…)", thus, the adjustment in question "is not tax-relevant for purposes of applying the transitional regime provided for in nos. 1, 5 and 6 of article 5 of Decree-Law no. 159/2009, of July 13" (cf. page 13, point 1.6. e) of the inspection report – Document no. 12).

hhh) AT inspection services advocate that the negative patrimonial variation be corrected, of € 44,824.64, which results from the aggregate consideration of the adjustments better identified.

iii) AT inspection services understood that 1/16 of the negative patrimonial variation ascertained (€ 18,437.92 / 16 = € 3,687.58) should be deducted from the taxable result of fiscal year 2010 as a consequence of the derecognition of assets that were recorded in the tangible fixed assets of the Applicant and which after the transition to the new accounting regulatory framework do not meet the conditions to be qualified as tangible fixed assets, because these are assets not owned by the Applicant.

jjj) In the evaluation of the transition adjustment relating to the reversal of the amount recorded as cost increases (costs to be incurred with the investment obligation – cf. subparagraph b) of no. 4 of Accounting Directive no. 4/91) in the amount of € 6,143,637.57, which resulted in the ascertainment of a positive patrimonial variation (considered by the Applicant in the aggregate value of tax-relevant transition adjustments), AT inspection services consider that "That balance corresponds to the accumulated amount of the quota shares considered as costs, in each fiscal year, (…) less the accumulated amortizations of the investment realized under the contractual obligation (…). " (cf. page 17, point 1.4.6 of the inspection report – Document 12, attached by the Applicant).

kkk) AT inspection services conclude that "The derecognition of this liability is tax-relevant (…) because of the revocation of the POC and Accounting Directives and, particularly, because the Accounting Directive no. 4/91 has ceased to be applicable for tax purposes (…)." (cf. page 17, point 1.4.6 of the inspection report – Document 12, attached by the Applicant).

lll) AT inspection services advocate that such patrimonial variation be divided by the number of years remaining for the term of the concession (16 years) and the result (€ 383,977.35) added to the taxable result of each of the respective tax periods, starting with fiscal year 2010, under the terms of article 5-A of Decree-Law no. 159/2009, of July 13, (cf. page 17, point 1.4.6 of the inspection report – Doc. 12).

mmm) AT inspection services verified that "The Balance Sheet for the period of 2011 and the analytical trial balance after ascertainment of 2011-12-31, show an intangible asset in the amount of 9,514,982.12 EUR (…). This intangible asset refers to the Right of Concession which includes the amount to be paid relating to the contractual obligation of financing works to be integrated in the SID… and the responsibilities in the replacement of concessioned equipment (…).", (cf. page 19, point 1.4.1 of the inspection report – Document 12, attached by the Applicant) and further that: "Thus, the aforementioned intangible asset (Right of Concession) may be discriminated as follows: • Contractual obligation of financing works to be integrated in the SID…, in the net amount of 8,560,155.59 EUR, with the cost of 16,910,246.00 EUR and accumulated amortizations of 8,350,090.41 EUR (…); • Responsibility in the replacement of concessioned equipment, in the net amount of 954,826.53 EUR, with the cost of 1,868,648.24 EUR and accumulated amortizations of 913,821.71 EUR (…).

nnn) The amortizations of fiscal year 2011 relating to this intangible asset amounted to € 700,489.48 (cf. page 20, point 1.4.2. of the inspection report – Document 12, attached by the Applicant).

ooo) Regarding these amortizations AT inspection services discriminate (i) the amortization relating to the contractual obligation of financing works to be integrated in the SID…, in the amount of € 630,195.50 and the (ii) amortization relating to the responsibility in the replacement of concessioned equipment, in the value of € 70,293.98 (cf. page 21, point 1.4.2. of the inspection report – Document 12, attached by the Applicant).

ppp) AT inspection services verify that the Applicant "In the tax period of 2011 (…) presented the accounting reporting of its accounts in accordance with the NCRF that are an integral part of the SNC and, by omission of the Portuguese regulatory regarding concessioned services, applied supplementarily the IFRIC 12 and SIC 29 embodied in the international regulatory (…)", (cf. page 21, point 1.4.3 of the inspection report – Document 12, attached by the Applicant).

qqq) Considering that "The tax regime for depreciations and amortizations, regulated in Regulatory Decree no. 25/2009 does not provide for tax treatment in accordance with IFRIC 12.", AT inspection services conclude, based on the provisions of article 12 of the said regulatory-decree, that "Under the tax regime for depreciations and amortizations provided in no. 1 of article 12 of Regulatory Decree no. 25/2009, of September 14, only amortizations resulting from investments effectively realized under the contractual obligation are tax-deductible", (cf. page 21, point 1.4.3 of the inspection report – Document 12, attached by the Applicant).

rrr) In the evaluation of the tax deductibility of the amortizations of the fiscal year considered by A… regarding the intangible asset embodied in the "Right of Concession", AT inspection services consider that only the amortizations of the fiscal year relating to the investment already realized (in a total of € 1,724,500.10), which amount to € 83,308.31, could be deducted in the ascertainment of the taxable profit of the fiscal year (cf. pages 21, 22, point 1.4.4 and 1.4.5. of the inspection report – Document 12, attached by the Applicant).

sss) AT inspection services promote the official increase to taxable profit of the remaining € 546,887.19 (cf. page 22, point 1.4.5 and 1.4.6. of the inspection report – Document 12, attached by the Applicant).

ttt) For not agreeing with the official corrections promoted by AT, namely those embodied in a) Non-acceptance, for tax purposes, of the negative patrimonial variation resulting from the retrospective recognition of accumulated amortizations of the intangible asset "Right of Concession" in the part integrated by the amount to be paid relating to the so-called contractual obligation of financing works to be integrated in the SID…; and in b) Non-acceptance of the tax deductibility of the amortization of the fiscal year relating to the same asset in the part integrated by the same amount, the Applicant submitted a gracious claim of the tax act that is the object of this request for arbitral ruling (Document no. 13, attached by the Applicant).

uuu) By order dated 04.11.2015, the Honourable Director of Finance of…, dismissed the gracious claim presented by the Applicant.

vvv) In response to what was alleged by the Applicant regarding the factual premises on which the assessment under analysis was based, AT expressed itself in the scope of the decision of the gracious claim presented, in the sense that "(…) it seems to us that the services limited themselves to analyzing concrete, unequivocal, measurable and verifiable facts at their disposal namely the concession agreement that was in force at the date of the facts and the various information made available by the administration of A… namely through its report and accounts for the various years until 2011".[cf. page 12 of the information attached to the draft decision of the gracious claim for which the final dismissal decision refers (Document no. 14, attached by the Applicant).

www) The services concluded: "It is thus true that in the year under analysis constituted exclusive consideration for the right to the concession the carrying out of works in the infrastructure, not having been replaced in fact by any other obligation and much less by the payment of a price." (cf. page 13 of Document 14, attached by the Applicant); "The company constituted the provision [to reflect the obligation in question] by the uncertain character as to timeliness as consideration for an intangible asset, which given the circumstances was proving to be uncertain as to its nature and likewise as to the moment in which it should be fulfilled" (ibidem); "Contrary to what the claimant says in its petition, when it states that despite the replacement of the consideration to be rendered for the acquisition of the right to the concession not having been formalized and the recognition of the intangible asset as consideration for a provision could raise doubts, the tax authority would always be bound by an evaluation of this reality in light of the principle of substance over form, what happened was exactly the factual analysis". (ibidem);

xxx) The Applicant proceeded to the voluntary payment of the impugned assessments (cfr. doc 15).

§2. Unproven Facts

There are no other facts, with relevance to the arbitral decision, to be judged as unproven.

§3. Motivation as to the Matters of Fact

With respect to the judgment of the matters of fact, the conviction of the Court was based on the free assessment of the positions assumed by the parties on the basis of fact, in the content of the documents attached to the record (namely from the administrative process).

III.2. MATTERS OF LAW

The central legal question to be considered in this arbitral proceeding revolves around whether the request formulated by the Applicant proceeds, as to the annulment of the assessment of Corporate Income Tax (IRC), relating to fiscal year 2011, with no. 2014…, of 19.12.2014, corresponding interest computation statements with nos. 2014 … and 2014…, and respective statement of account reconciliation no. 2014 … of 22.12.2014, in the total amount of € 324,360.37.

According to the Applicant, the aforementioned assessment, which results from the corrections made by AT identified in point gg) of the probative section, are illegal due to error as to the factual and legal premises and procedural defect by violation of the principles of inquisitorial investigation, material truth and burden of proof.

Let us examine this.

III.2.1. As to the Illegality of the Assessment

Since a concession agreement of multimunicipal water supply and sanitation systems or urban waste is at issue, which, as we shall see, enjoys a special tax regime, before entering into the assessment of the request it is important to make some preliminary considerations regarding the accounting and tax framework resulting from the concession agreement before and after 2010.

§1º ACCOUNTING AND TAX FRAMEWORK RESULTING FROM THE CONCESSION AGREEMENT BEFORE AND AFTER 2010

During the existence of the aforementioned concession agreement a profound change occurred in the accounting system in Portugal, which required the transition from the Official Chart of Accounts (POC) to the Accounting Normalization System (SNC). This change necessitated the need to alter the accounting of concession agreements. However, the economic substance of the agreement did not change.

1. BEFORE 2010

1.1. ACCOUNTING MATTERS

1.1.1. Accounting for Infrastructure in POC

The concessioned infrastructure and assets affected by the concession, even if reverting to the grantor or third parties at the end of the concession, were recorded until 2009, in accordance with POC provisions and Accounting Directive no. 4/91, in the tangible fixed assets of the concessionaire and amortized over the period of the concession or in accordance with the respective useful life period if shorter.

In the specific case, the infrastructure delivered by the grantor to the concessionaire has no implicit any direct payment on account by the concessionaire to the grantor. On the date of signature of the concession agreement the concessionaire received the infrastructure from the grantor and recognized the same as tangible fixed assets, as consideration for an account of deferred income, in an amount equivalent to the value of the infrastructure.

Subsequently, at the end of each of the economic periods, the Applicant came to consider the quota share of the deferred income (taking into account the duration of the agreement) as extraordinary income of each of the periods, and in turn came to recognize in each of those periods the amortization of the fiscal year relating to the infrastructure that had been delivered to it, which accumulated in an account of accumulated amortizations.

The particular feature associated with this type of concession agreement led to the Applicant recognizing in each accounting period, from 1998 to 2009, an expense/cost exactly of the same amount as the income/revenue associated with and underlying the accounting of the infrastructure delivered to the concessionaire by the grantor. Obviously that in accounting and tax terms the effect on the net result ascertained in the accounting and on the taxable profit is, in each one of the periods, nil.

1.1.2. Investment Obligations in POC/Accounting Directives

The accounting of the contractual obligations of concessionaire entities followed the rules provided for in Accounting Directive no. 4/91 (hereinafter, DC 4/91), under the Official Chart of Accounts (POC).

The Applicant had, ab initio, the obligation to finance the Grantor up to the limit of € 16,910,246, for the execution of infrastructure and works to be integrated in the SID…, as a result of the concession agreement entered into.

From the accounting perspective, and with respect to investments to be realized, designated investment obligations, under the terms of concession agreements, their total value was apportioned over the period of the concession and the respective annual quota recorded in a line item of the asset designated "cost increase" as consideration for the recognition of a cost recorded in "supplies and external services", independent of the effective realization of the underlying investment of the investment obligation contained in the concession agreement. This system of accounting allowed the accumulation in the cost increase account of the total value of the investment attributable to the concession (and considered as a cost of the various prior fiscal years).

As the investment was realized, the entity recognized the amount effectively invested as tangible fixed assets and the proportional value considered from the "cost increase" account was transferred to the account of accumulated amortizations. From that moment forward the remainder was to be amortized (investment realized less values recognized as costs from the beginning of the agreement until the period prior to the effective realization of the investment and which had been accumulated in the cost increase account).

This understanding resulted from subparagraph b) of no. 4 of the aforementioned DC 4/91, according to which "As for [investments that revert to third parties at the end of the concession] which are of certain realization in the following years, the respective costs should be estimated, which shall be apportioned by the total number of years of the concession, with the respective quota shares to be considered as costs, in each fiscal year, and accumulated in the liability as cost increases; when the investment is completed, it shall move from work in progress to tangible fixed assets, transferring then the balance of that cost increase account to the corresponding accumulated amortizations account and amortizing the remaining part until the end of the concession".

This form of accounting for concessions is justified from an accounting perspective by the particularities associated with this type of agreements, since the vast majority of them impose that the concessionaire necessarily come to realize the investment, regardless of the concrete moment in which it effectively comes to do so in the course of the life of the agreement, and come, simultaneously, to obtain, through the fixing of tariffs, the recovery of investments associated with investment obligations throughout the entire period of the concession, based on two main reasons.

The first is that the concessionaire has no reasonable alternative of not coming to realize that investment obligation throughout the entire period of the agreement, regardless of the moment in which it effectively comes to realize it. It may even realize it only in the last years of the concession agreement, but it will still have to realize it, under pain of breaching the contractual obligations assumed.

If that obligation were not to be uniformly considered as cost/expense throughout the entire period of the concession, this would imply that at the moment when the investment obligations come to be concretized in investment expenses, the costs/expenses with that investment would have to be apportioned by the remaining period of the agreement, which could lead to strong tariff fluctuations, with very significant increases therein, penalizing users of the public service at the date of realization of the investments and until the end of the contractual period.

The second reason relates to the adequate balancing of the costs/expenses with the income/revenues associated with the operation of the infrastructure. Just as is fixed in the A… agreement, the consideration for the right to the concession should be obtained, through the fixation of tariffs, uniformly over the entire concession period, translating the economic substance of the agreement, the uniform distribution of costs/expenses is therefore justified, not depending on the particular moment of effective realization of the investment obligation.

This justifies that in accounting terms, given the particularities of the concession, the cost should be recognized uniformly throughout the concession period, with the concessionaire recovering through the tariffs the total of the investment made, the corresponding costs/expenses being recognized at the moment the obligation is incurred rather than at the moment the investment is effectively realized. In this way, the investment obligation amounts to a genuine economic liability of the concessionaire with the grantor, which is why it should be accounted for as such.

Under the rules of Directive 4/91, the investment obligation was therefore treated as a liability (cost increase) to be consumed over the concession period (through the recognition of the proportional cost in each fiscal year) and simultaneously, as the investment was realized, the concessionaire would recognize the corresponding assets (infrastructures) and would gradually deduct (from the cost increase account) the cost already consumed, transferring it to the amortization account.

For all these reasons, the accounting of investment obligations in the POC/Directive 4/91 framework had full economic meaning and was absolutely justified.

This understanding, arising from the particularities of concession agreements, was also accepted in terms of the taxation of such investment obligations under the prior tax regime (before 2010), which considered the investment obligation as a tax-deductible cost, allowing the concessionaire to deduct in each fiscal year the proportional cost of the investment obligation, whether or not it was effectively realized in that fiscal year.

1.1.3. Summary

In summary, in the period before 2010, concession agreements were accounted for in accordance with POC and its Directives (particularly DC 4/91), which method:

(a) Recognized in the tangible fixed assets of the concessionaire the infrastructure delivered by the grantor and amortized it over the concession period. Simultaneously, it recognized deferred income (in the liability) corresponding to the net value of the delivered infrastructure.

(b) Recognized the investment obligation in the concessionaire as a cost increase (in the liability) and recognized the proportional annual cost in each fiscal year.

(c) The effect in terms of the taxable profit was nil in relation to the infrastructure delivered by the grantor (because costs and income were equivalent).

(d) The effect in terms of taxable profit was the recognition of the annual cost relating to the investment obligation.

This method was followed by the Applicant from 1998 to 2009 and was considered appropriate by the accounting authorities and, crucially, by the tax authorities, since the investment obligation costs were accepted as tax-deductible.

1.2. TAXATION BEFORE 2010

The same investment obligation costs that were recognized in accounting were also accepted as tax-deductible, allowing the concessionaire to recognize each year the proportional cost of the investment obligation, regardless of whether it was effectively realized, considering for this purpose the entire period of the concession as the period in which the obligation should be amortized.

1.2.1. Article 32 of the IRC Code

The fundamental principle is that for tax purposes, the investment obligation costs are tax-deductible under the terms of article 32 of the IRC Code, which provides that general costs incurred for the purpose of achieving or maintaining income are deductible for tax purposes. The investment obligation costs fit into this category of deductible costs because they are costs incurred to obtain the income from the public service (which is collected through tariffs that include the recovery of these costs).

Therefore, from 1998 to 2009, the Applicant deducted in its income tax declarations the annual costs relating to the investment obligation, a procedure that was never questioned or objected to by the tax authorities, and which was therefore implicitly accepted as appropriate by those authorities.

1.2.2. Conclusion Before 2010

In conclusion, before 2010, the accounting treatment in accordance with DC 4/91 and the corresponding tax treatment were in full alignment and both were accepted and recognized as appropriate.

2. AFTER 2010 (SNC REGIME)

In 2010, the Portuguese tax and accounting system underwent a profound transformation with the mandatory transition from POC to SNC and the consequent mandatory application of International Financial Reporting Standards (IFRS).

As stated above, this transition created a significant challenge for the appropriate accounting of concession agreements, since the International Financial Reporting Standards, and particularly IFRIC 12 (Service Concession Arrangements), provide a different accounting treatment for these agreements than the one that had been followed under POC.

2.1. IFRIC 12 AND ITS APPLICATION TO CONCESSION AGREEMENTS

IFRIC 12 addresses the accounting treatment of service concession arrangements by the operator (concessionaire) and provides that:

(a) The concessionaire does not recognize the infrastructure as its own asset (because it is not owned by the concessionaire and will revert to the grantor at the end of the concession).

(b) Depending on the nature of the consideration received by the concessionaire for providing construction or improvement services, the concessionaire recognizes either:

 (i) A financial asset (if the grantor guarantees to reimburse the concessionaire for the costs incurred in providing the construction or improvement services); or
 
 (ii) An intangible asset (right of concession) (if the concessionaire's consideration for providing the construction or improvement services is the right to charge users of the public service for the services provided, or a right to charge the grantor).

(c) If the concessionaire's consideration for providing the construction or improvement services is partly in the form of a financial asset and partly in the form of an intangible asset, both should be recognized.

(d) The depreciation or amortization of the financial asset or intangible asset should follow the corresponding rules, depending on its nature.

2.2. ADAPTING IFRIC 12 TO THE APPLICANT'S SITUATION

However, IFRIC 12 was developed in contexts where the concessionaire provides construction or improvement services to the grantor in exchange for the right to operate the public service during the concession period. In other words, IFRIC 12 addresses situations where the concessionaire's consideration for providing services consists in the right to charge for the services provided (a right to income).

In the case of the Applicant, the situation is more complex. According to the evidence presented in this proceeding, the original contract (1998) provided that the Applicant would have the obligation to finance (i.e., to pay for) the construction of infrastructure (the sludge treatment infrastructure) as consideration for the right to operate the SID… In this case, the Applicant's consideration for the right to the concession is not solely the provision of construction services, but also (or even primarily) the obligation to pay a monetary amount (price) for the right to the concession.

This situation is not directly addressed by IFRIC 12, which was designed for situations where the operator's consideration is the provision of services. When the operator's consideration includes payment of a monetary amount for the right to the concession, a different accounting treatment may be appropriate.

In accordance with the principles of substance over form and the broader framework of the International Accounting Standards (IAS), when a concessionaire pays a monetary amount for the right to the concession, this amount should be recognized as an intangible asset (the right of concession) and should be amortized over the period of the concession, in accordance with IAS 38.

This is the accounting treatment that the Applicant adopted in its transition to SNC in 2010.

2.3. THE APPLICANT'S TRANSITION TO SNC

The Applicant, in its transition to SNC in 2010, applied a retrospective approach to IFRIC 12 and recognized:

(a) The infrastructure delivered by the grantor was removed from the Applicant's assets (because it is not owned by the Applicant and will revert to the grantor at the end of the concession). This resulted in:

 (i) Derecognition of the gross value of the infrastructure delivered by the grantor (€ 85,009,953.00)
 
 (ii) Derecognition of accumulated amortizations (€ 35,763,435.00)
 
 (iii) Derecognition of deferred income (€ 48,201,308.00)

(b) The investment obligation was recognized as an intangible asset (the right of concession), representing the obligation to pay for the infrastructure that the Applicant must finance. This intangible asset had two components:

 (i) The investment already made (€ 1,724,500) – recognized as an intangible asset
 
 (ii) The investment to be made in the future (€ 15,185,746) – recognized as an intangible asset with a corresponding liability for the amount to be paid.

(c) The accumulated amortizations of the intangible asset (€ 7,089,699) were recognized, representing the amortization of the investment obligation from the beginning of the concession until the transition date.

(d) The cost increases account (€ 6,143,637) was derecognized, as this account was specific to the POC regime and had no equivalent under SNC.

2.4. THE FISCAL TREATMENT OF THE TRANSITION ADJUSTMENTS

The fundamental question in this case is how to treat, for tax purposes, the transition adjustments made by the Applicant in moving from POC to SNC.

The applicable legislation is Decree-Law no. 159/2009, which provides the rules for the tax treatment of the transition from POC to SNC. The key provision is article 5, which provides that:

"Entities that adopt the new accounting standards shall not recognize, for tax purposes, the positive or negative variations in the value of assets and liabilities resulting from the transition adjustments, except as provided in the subsequent provisions of this article."

However, article 5 also provides certain exceptions for variations that have tax relevance, i.e., for variations that correspond to costs or income that would have been deductible or taxable under the prior tax regime.

2.4.1. APPLICATION OF ARTICLE 5 TO THE TRANSITION ADJUSTMENTS

The problem lies in determining which of the Applicant's transition adjustments have tax relevance (i.e., correspond to costs or income that would have been deductible or taxable under the prior tax regime) and which do not.

The AT takes the position that:

(a) The derecognition of the infrastructure delivered by the grantor and its associated accumulated amortizations have no tax relevance because they did not affect taxable profit in the prior periods (the costs and income were equivalent, resulting in a nil net effect).

(b) The derecognition of the cost increase account (€ 6,143,637) has tax relevance because this account represented a tax-deductible cost under the prior regime, but after the transition it should no longer exist under the new accounting standards.

(c) The accumulated amortizations of the intangible asset (€ 7,089,699) do not have tax relevance because they do not correspond to any costs that were deductible under the prior tax regime (they are "new" amortizations created by the new accounting standards).

(d) The future investment obligation (€ 15,185,746) should not be recognized as a deductible cost because the investment has not yet been realized, and the new tax regime does not provide for the deduction of unrealized investment obligations.

2.5. THE APPLICANT'S POSITION

The Applicant contests this position and argues that:

(a) The infrastructure delivered by the grantor and recognized under POC was a reflection of the true economic substance of the concession arrangement, and its derecognition under SNC does not correspond to an actual change in economic reality, but rather to a change in accounting standards.

(b) The investment obligation, whether or not it has been realized, represents a genuine economic liability of the Applicant to the grantor, and should be recognized as such for tax purposes, in accordance with the principle of substance over form.

(c) The amortization of the investment obligation should be recognized as a deductible cost, because it represents the cost of obtaining the income from the public service (which is collected through tariffs).

(d) The principle of substance over form requires that the tax authorities evaluate the true economic nature of the transactions, not merely the formal accounting classifications.

2.6. ANALYSIS OF THE LEGAL FRAMEWORK

The central issue is whether the Applicant's accounting treatment of the concession arrangement under SNC is correct, and if so, whether it should be recognized for tax purposes.

As we have established, the Applicant's pre-2010 accounting treatment was appropriate and was accepted by the tax authorities (implicitly, through the acceptance of the deductibility of the investment obligation costs). The Applicant's post-2010 accounting treatment under SNC is also appropriate, in accordance with IFRIC 12 (adapted to the specific facts of the Applicant's case, where the consideration includes a monetary payment).

The question is whether the tax treatment should change when the accounting treatment changes.

The answer is no, for the following reasons:

(a) The principle of substance over form requires that the tax authorities evaluate the true economic nature of the transactions, not the formal accounting classifications. The economic substance of the concession arrangement did not change with the transition from POC to SNC. Therefore, the tax treatment should not change either.

(b) The Decree-Law no. 159/2009 provides that entities may elect to use a simplified approach to the tax treatment of transition adjustments. In particular, article 5 provides that certain variations have tax relevance, while others do not. However, the determination of tax relevance should be based on the economic substance of the transaction, not merely the accounting classification.

(c) The investment obligation is a genuine economic liability of the Applicant to the grantor, and the costs associated with this obligation (including the amortization of the obligation) should be recognized as deductible costs, in accordance with article 32 of the IRC Code.

(d) The principle of vertical equity in taxation requires that taxpayers in the same economic situation should be treated equally. If the Applicant were to be treated differently because of the change in accounting standards, this would violate the principle of vertical equity.

(e) The amortization of the intangible asset (right of concession) should be recognized as a deductible cost, in accordance with article 16 of Regulatory Decree no. 25/2009 and IAS 38 – Accounting and Financial Reporting Standard (NCRF) no. 6.

3. THE TAX REGIME FOR DEPRECIATION AND AMORTIZATION

Article 16 of Regulatory Decree no. 25/2009 provides the rules for the tax treatment of depreciation and amortization. The key provision is that "Elements of the asset subject to depreciation may be subject to depreciation or amortization" and "These assets are depreciable when subject to depreciation, namely by having a limited temporal validity."

In the case of the Applicant, the intangible asset (right of concession) has a limited temporal validity (the duration of the concession, which is 25 years from 2000, i.e., until 2025). Therefore, the intangible asset should be depreciable and should be amortized over the concession period.

The Applicant calculated the amortization of the intangible asset in accordance with the straight-line method, amortizing the asset over the remaining 16 years of the concession period. This is the appropriate method, and the calculation is correct.

The total amortization of the fiscal year 2011 is €630,195.50. Of this amount:

(a) €83,308.31 corresponds to the amortization of the investment already realized (€ 1,724,500), which the AT accepts as tax-deductible.

(b) €546,887.19 corresponds to the amortization of the future investment obligation (€ 15,185,746), which the AT rejects as tax-deductible.

The AT's position is based on the argument that the future investment obligation has not yet been realized, and therefore the amortization should not be deductible. However, this argument is not correct, for the following reasons:

(a) The investment obligation is a genuine economic liability of the Applicant, recognized in the financial statements as a liability (amount to be paid to the grantor).

(b) The amortization of this liability should be recognized as a deductible cost, in accordance with the principle of substance over form and the principles of the IRC Code.

(c) The recognition of the investment obligation as an intangible asset (and its subsequent amortization) is the appropriate accounting treatment under IFRIC 12 (adapted to the Applicant's specific facts).

(d) The amortization of the investment obligation should be deductible, in accordance with article 32 of the IRC Code, which provides that "General costs incurred for the purpose of achieving or maintaining income are deductible for tax purposes."

(e) The principle of vertical equity in taxation requires that the Applicant should be treated in the same manner as other concessionaires in a similar economic situation.

4. CONCLUSION ON THE LEGAL ANALYSIS

Based on the above analysis, the following conclusions can be drawn:

(a) The Applicant's accounting treatment of the concession agreement under SNC (both before and after the investment is realized) is correct and in accordance with IFRIC 12.

(b) The investment obligation, whether or not realized, represents a genuine economic liability of the Applicant to the grantor.

(c) The amortization of the investment obligation should be recognized as a deductible cost for tax purposes, in accordance with the principles of the IRC Code and the principle of substance over form.

(d) The amortization of the fiscal year 2011 relating to the future investment obligation (€546,887.19) should be recognized as tax-deductible, contrary to what AT has determined.

(e) The correction made by AT to disallow this amortization is illegal and should be reversed.

III.2.2. ERROR IN THE FACTS

The Applicant alleges that AT made errors in its determination of the facts underlying the assessment.

Specifically, the Applicant argues that:

(a) The tax authorities misunderstood the true economic nature of the concession arrangement, particularly with respect to the investment obligation and its relationship to the right of concession.

(b) The tax authorities proceeded with a "superficial and equivocal" reading of the facts, without properly evaluating the economic substance of the transactions.

(c) The tax authorities failed to take into account that the investment obligation had been effectively replaced by an agreement to pay a price (the 2015 amendment to the concession agreement).

(d) The tax authorities failed to apply the principle of substance over form in evaluating the factual premises of the concession arrangement.

In response to these allegations, the AT argues that:

(a) The concession agreement in force at the time of the assessment (fiscal year 2011) provided for an investment obligation, not a payment of a price.

(b) The 2015 amendment to the concession agreement had retroactive effect only to January 1, 2014, and therefore did not apply to fiscal year 2011.

(c) The tax authorities based their assessment on the concrete facts contained in the concession agreement that was in force at the date of the assessment.

1. ANALYSIS

The core factual issue is whether, in fiscal year 2011, the Applicant's obligation regarding the concession was an obligation to finance (construct) infrastructure, or an obligation to pay a price for the right to the concession.

Based on the evidence presented in this proceeding, the following facts are established:

(a) The original concession agreement (1998) provided that the Applicant would have the obligation to finance the construction of infrastructure (sludge treatment infrastructure) up to a limit of € 16,910,246.

(b) By fiscal year 2011, the Applicant had realized only € 1,724,500 of the required investment, leaving € 15,185,746 of investment to be realized.

(c) The 2004 protocol between the parties provided that the parties would work toward a revision of the concession agreement to address the changing circumstances, but did not formalize the revision of the investment obligation.

(d) The 2015 amendment to the concession agreement formalized a revision of the investment obligation, converting it into an obligation to pay a price (through tariff adjustments), but this amendment had retroactive effect only to January 1, 2014.

Given these facts, the following conclusions can be drawn:

(a) In fiscal year 2011, the Applicant's primary obligation regarding the concession was still an obligation to finance (construct) infrastructure, not an obligation to pay a price.

(b) However, the factual circumstances (the creation of the competing multimunicipal system in 2002, the uncertainty regarding the future of the concession, the 2004 protocol indicating a willingness to revise the agreement) created a situation where the economic substance of the obligation had changed, even though it had not been formally amended.

(c) The principle of substance over form requires that the tax authorities evaluate the true economic nature of the transactions, not merely the formal contractual classification.

(d) The Applicant's application of the principle of substance over form in recognizing the investment obligation as an intangible asset (representing a monetary obligation to pay for the infrastructure) is justified by the facts and the prevailing economic circumstances.

(e) The tax authorities' rejection of this treatment is based on a narrow reading of the formal contractual language, and does not give adequate weight to the economic substance of the transaction.

2. CONCLUSION ON ERROR IN FACTS

While the AT's literal reading of the concession agreement is not incorrect, the AT failed to adequately evaluate the economic substance of the transaction, as required by the principle of substance over form and the general principles of taxation. The AT should have conducted a more thorough investigation of the true nature of the transaction, in accordance with the principle of inquisitorial investigation (article 58 of the LGT).

However, it is important to note that the Applicant's application of the IFRIC 12 standards to the concession arrangement is justified and correct. The recognition of the investment obligation as an intangible asset (and the corresponding liability) is the appropriate accounting treatment under these standards.

For tax purposes, the amortization of the investment obligation should be recognized as a deductible cost, in accordance with the principles of the IRC Code and the principle of substance over form.

III.2.3. PROCEDURAL DEFECTS

The Applicant alleges that AT violated the principle of the right to be heard, the principle of material truth, and the principle of the burden of proof in conducting the inspection and making the assessment.

1. ANALYSIS

The principle of the right to be heard requires that the taxpayer be given an opportunity to respond to the allegations and proposed corrections of the tax authorities.

The principle of material truth requires that the tax authorities conduct a thorough investigation to ascertain the true facts, not merely relying on the taxpayer's representations or the formal contractual language.

The principle of the burden of proof requires that the tax authorities bear the burden of proving the factual and legal basis for any proposed adjustments.

In this case:

(a) The Applicant was given an opportunity to respond to the allegations and proposed corrections through the inspection process and the gracious claim procedure.

(b) However, the tax authorities' investigation was not sufficiently thorough. The authorities relied primarily on the formal language of the concession agreement and did not adequately investigate the underlying economic reality of the transaction, as required by the principle of material truth and the principle of inquisitorial investigation (article 58 of the LGT).

(c) The tax authorities did not adequately bear the burden of proving that the Applicant's treatment of the concession arrangement (recognition of the investment obligation as an intangible asset) was incorrect. Rather, the burden of proof was essentially shifted to the Applicant to prove the correctness of its treatment.

(d) The principle of substance over form requires that the economic substance of the transaction be given greater weight than the formal contractual language. The tax authorities failed to apply this principle adequately.

2. CONCLUSION ON PROCEDURAL DEFECTS

The AT's assessment was marred by procedural defects, including:

(a) Failure to conduct a sufficiently thorough investigation of the underlying economic reality of the transaction.

(b) Failure to adequately apply the principle of substance over form.

(c) Failure to adequately bear the burden of proof regarding the proposed adjustments.

(d) Failure to give adequate weight to the principle of inquisitorial investigation (article 58 of the LGT).

These procedural defects render the assessment illegal and subject to annulment.

III.2.4. SUMMARY OF CONCLUSIONS

Based on the analysis above, the following conclusions are reached:

1. The Applicant's accounting treatment of the concession agreement under SNC is correct and in accordance with IFRIC 12 (adapted to the Applicant's specific facts, where the consideration includes a monetary payment).

2. The investment obligation, whether or not realized, represents a genuine economic liability of the Applicant to the grantor, and should be recognized as an intangible asset under the accounting standards.

3. The amortization of the investment obligation should be recognized as a deductible cost for tax purposes, in accordance with the principles of the IRC Code and the principle of substance over form.

4. The AT's determination that the amortization of the future investment obligation (€546,887.19) is not tax-deductible is incorrect and should be reversed.

5. The AT's assessment is illegal and should be annulled due to:

   • Error in the determination of the factual premises (failure to adequately apply the principle of substance over form)
   • Error in the determination of the legal framework (failure to recognize the amortization of the investment obligation as a deductible cost)
   • Procedural defects (failure to conduct a sufficiently thorough investigation and failure to adequately apply the principle of material truth)

6. The Applicant is entitled to the annulment of the assessment and to reimbursement of the amounts paid, plus interest for damages.

DECISION

For all the foregoing reasons, the Arbitral Court, by unanim decision, decides:

1. To uphold the request for arbitral ruling submitted by the Applicant.

2. To annul the assessment of Corporate Income Tax (IRC) for fiscal year 2011, bearing no. 2014…, of 19.12.2014, and the corresponding interest computation statements with nos. 2014 … and 2014…, and the statement of account reconciliation no. 2014 … of 22.12.2014.

3. To order the Tax and Customs Authority to refund to the Applicant the total amount of € 324,360.37, corresponding to the illegally assessed tax, plus interest for damages calculated in accordance with the applicable legal provisions.

4. To order the Tax and Customs Authority to bear the costs of these arbitral proceedings.

Done and signed in a sealed session by the Arbitrators at the seat of CAAD, on [date].

(Signed by the three arbitrators)