Reverse Merger Financing Costs Deductibility Under Article 23 CIRC | CAAD 729/2016-T

TRANSLATION

The arbitrators José Baeta de Queiroz (chairman arbitrator), Tomás Cantista Tavares and Américo Brás Carlos (arbitrators), designated, respectively, by the CAAD (in the absence of agreement among the arbitrators nominated by the parties), by the Claimant and by the Respondent to form the Arbitral Tribunal, agree as follows:

1. Report

A…, SA, NIPC…, with registered address at Av…, …, Lisbon (hereinafter A… or Claimant), filed an application for constitution of a collective arbitral tribunal, in accordance with the combined provisions of Articles 2, no. 1, lit. a), and 6, no. 2, lit. b) of Decree-Law no. 10/2011, of 20 January (Legal Regime for Arbitration in Tax Matters, hereinafter RJAT), in which the Tax and Customs Authority (hereinafter AT) is respondent, with a view to declaring the illegality of the following assessment, relating to the year 2009, of Corporate Income Tax (2013…) and compensatory interest (2013… to 2013…) – statement of account adjustment 2013…, in the total amount of 1,121,231.12€.

The application for constitution of the arbitral tribunal was accepted by the President of the CAAD and followed its normal procedure, in particular with notification to the AT. All arbitrators communicated their acceptance within the applicable period. The parties did not manifest any intention to refuse the appointment of the arbitrators.

The collective arbitral tribunal was constituted on 6/3/2017.

The AT responded, arguing that the application should be judged unfounded.

By Order, with the agreement of the parties, the meeting provided for in Article 18 of the RJAT was not held – the claimant waiving the examination of the witnesses it had called; written submissions were filed.

The arbitral tribunal was properly constituted and has material competence, as provided in Articles 2, no. 1, lit. a) and 4, both of the RJAT.

The parties have legal personality and capacity, are legitimately constituted and are represented (Articles 4 and 10, no. 2, of the same legal instrument and Articles 1 to 3 of Administrative Order no. 112-A/2011, of 22 March).

The proceedings do not suffer from any nullities and there is no obstacle to the consideration of the merits of the case.

2. Statement of Facts

2.1. Proven Facts

The following facts, relevant to the decision, are considered proven:

a) The Claimant is engaged in the marketing of piped gas, as well as in the installation, assembly and technical assistance of piped gas networks;

b) Fund B… (and its subsidiaries) is a venture capital entity for qualified investors, whose assets are intended to be invested in the acquisition of shareholdings in entities with high growth and appreciation potential.

c) Fund B… established company C…, wholly owned by it, to lead investments in the activities of production, marketing and distribution of gas, fuels and their derivatives.

d) On 13/5/2009, C… established company D…, wholly owned by it, whose corporate purpose was, in essence, the development of activities of production, marketing and distribution of gases and other fuels.

e) Also in 2009, D… acquired the share capital of A… (a mature entity already engaged in this business of piped gas marketing, with assets and customer portfolio).

f) To consummate this acquisition (and, to a much lesser extent, to develop operational activity), D… became indebted to banks (in the amount of 28 million euros) and to its shareholders in the amount of 15,240,000.00€.

g) Also in 2009, effective 1/7/2009, D… merged with A… in a reverse merger operation, justified for the following reasons: 1) requirement of financing banks (see financing agreement, clause 2, no. 10 and clause 14, no. 3); 2) cost rationalization; 3) the merger is reverse because A… had licenses and permits (for conducting the activity), name, brand and market reputation – and if the merger were not reverse, the permits and licenses would be revoked and there was commercial risk to customers.

h) Following the merger, the Claimant (acquiring company) assumed (i) all the debts of D… and (ii) bore the financial charges (interest) incurred by D… with the banks and shareholders.

i) In the venture capital activity (as conducted by group E…) it is customary for the purchase of shares of the company being acquired to be carried out by a vehicle company established for that purpose (D…) and subsequently to promote a merger with the operational entity (A…) – normal or reverse – in order to (i) effect a reduction of administrative costs and (ii) at the requirement of the banks (place the debt in the same legal entity that owns the assets).

j) D… incurred charges with external legal counsel related to the merger operation, in the total amount of 85,091.85€, itemized as follows: specialized work "closing costs – merger"; and specialized work "costs – diameter merger";

l) The AT does not accept that A…, in 2009, may deduct 3,763,838.20€ in tax terms: 3,678,747.35€, relating to financing interest originally contracted by D… for the acquisition of A… and assumed by it as a result of the merger; 85,091.85€, relating to legal services contracted by D… for the completion of the merger.

m) The AT bases its claim on Article 23 of the Corporate Income Tax Code (CIRC), considering that such financial charges are allegedly not indispensable for obtaining income or for maintaining the source of production and, consequently, carries out the Corporate Income Tax assessments that are the subject of this arbitral process.

n) The Claimant filed a timely Administrative Review (Reclamação Graciosa) against this Corporate Income Tax assessment of the year 2009 – and based on the express dismissal of the Administrative Review, it then filed a timely hierarchical appeal, which, following its express dismissal, gave rise to the present arbitral judicial process.

o) The Claimant paid the assessments contested in this process: on 20/12/2013, 625,227.10€ under RERD (Decree-Law no. 151-A/2013), with waiver of payment of corresponding compensatory interest (and default interest); on 16/9/2014, it paid the remainder.

p) The Claimant provided a bank guarantee to suspend enforcement proceedings (before payment), having incurred expenses for providing the guarantee in the amount of 23,712.29€.

2.2. Unproven Facts

There are no facts with relevance to the consideration of the merits of the case that have not been proven.

2.3. Grounds for Determination of Facts

The proven facts are based on documents presented by the parties (which are essentially documents issued by the Tax Authorities, regarding the merger and financing), on the agreement of the parties (also regarding the documents, values and dates of payments) and on official information attached to the proceedings.

3. Legal Matters

3.1. Question to be Decided

As accepted by the parties, the question that arises in the present case concerns only the tax treatment to be given to the interest and other charges borne in 2009 by A… relating to legal services and loans (from shareholders and third parties) for the purchase of its own share capital and which the claimant bears by virtue of and as a result of the merger with its shareholder D… which originally contracted these debts.

In the opinion of the AT, such interest and charges would not be tax deductible under Article 23 of the CIRC (as worded and numbered at the date of the facts) because they are not indispensable for obtaining income or maintaining the source of production. For the Claimant, conversely, such interest and charges would be tax deductible by meeting the requirements inherent in Article 23 of the CIRC.

3.2. Applicable Laws

According to Article 23 of the CIRC (as worded and numbered at the date of the facts), the following are considered costs or expenses:

"1. […] those which are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the source of production, in particular:

(…)

c) Of a financial nature, such as interest on borrowed capital applied in operation […], expenses with credit operations […]";

On the other hand, with the merger of companies "the incorporated companies are extinguished […], and their rights and obligations are transferred to the incorporating company" (Article 112, lit. a), of the Commercial Companies Code).

3.3. The Arguments of the Parties

The justification for the assessments (and response of the Respondent and other statements by the AT throughout the proceedings, in particular in the decision on the Administrative Review and hierarchical appeal) invokes, in summary, that the interest borne by A… following the completion of the merger (and as a result of this operation) relating to financing originally contracted by D… directly for its own acquisition of the capital of A… (and legal services also for the merger) do not merit the character of being indispensable for the income or maintenance of the source of production: after the merger they no longer finance the acquisition of shareholdings; there would have to be, in each year in which interest is recorded, a balancing between the financial charges borne and the income and existence of assets; such interest would not be linked with the claimant's normal activity and the associated asset does not exist and will not contribute to taxable income in the future.

The Claimant argues, conversely, that the interest borne in 2009 by A… is indispensable for the income or maintenance of the source of production, and is therefore qualified as a tax cost under Article 23 of the CIRC. The interest and legal expenses are borne by A… in the exercise of its activity; the interest (and legal expenses), when originally incurred (by D…), were indispensable to income and maintenance of the source of production – and if they were at the initial moment, they must be forever, whatever subsequent modifications occur (even with the merger); the merger, among its normal effects, leads to the economic and tax result in the case; the merger is an operation permitted by commercial and tax law and the AT, in justifying the act, does not invoke any alleged abuse of the merger operation, preceded by the acquisition, under Article 38, no. 2, of the General Tax Law (LGT).

3.4. Decision

The arbitrators have analyzed all the rhetoric raised by the parties (in their written pleadings, documents and arguments), as well as the argumentation and consideration of earlier arbitral decisions on the subject, always bearing in mind the minor variations of the case ("each case is a case").

Indeed, several arbitral awards (for example, in proceedings 14/2011-T and 87/2014-T) rejected the tax deduction of interest borne by the acquiring company post-merger, relating to financing contracted by the acquired company pre-merger for the purpose of acquiring the share capital of the future acquiring company. By contrast, arbitral awards 101/2013-T, 42/2015-T (here in a non-reverse merger, but the considerations are the same), 92/2015-T and 93/2015-T, 88/2016-T, 491/2016-T, 537/2016-T and 560/2016-T pronounce themselves in the opposite sense, accepting the deduction of such financial charges, by considering them manifestly indispensable for obtaining income or for maintaining the source of production.

Moreover: the arbitrators have already pronounced themselves in other proceedings on the same subject (proceedings 88/2016-T and 491/2016-T), composed of the same exact panel – and decided, by majority, in the sense of accepting the tax deduction of such financial charges, even after the merger. In this proceeding, they reconsidered all the factual and legal arguments contained in this case and the content of the earlier arbitral decisions – also in proceedings 88/2016-T and 491/2016-T, to confirm whether they maintained or changed their sense of decision.

After all that consideration, they decide, by majority, to annul the assessments challenged and to consider that this interest and charges (legal services) borne by the Claimant are indispensable for the income and maintenance of the source of production of A…, based on the consideration and decision of the arbitral award in proceedings 93/2015-T, to which they adhere and to which they reproduce the operative part next, adopted also in this proceeding (which was also done in proceedings 88/2016-T).

(Beginning of citation of Award in Arbitral Proceedings 93/2015-T)

"[…] exclusively at issue are interest charges on borrowed capital, it is therefore considered that the starting point of the decision-making process in the dispute that now must be resolved lies within the framework of Article 23, no. 1, c) of the CIRC.

Such rule provides, among other things and insofar as it is relevant to what matters now, that 'The following shall be considered expenses (…) in particular: c) interest on borrowed capital applied in operation.'

Thus, and before proceeding to determine whether the aforementioned norm results, or not, in a limitation of the deductibility of interest on borrowed capital to its application in operation, or whether, as concluded in Award 42/2015-T, interest on borrowed capital applied to other purposes shall be deductible within its scope, it is necessary to determine whether, in this case, that, or not, is the situation that occurs.

In making such an assessment, and without prejudice to better judgment, four aspects should be taken into account as decision-making reference points, in addition to what has already been properly addressed, which are considered fundamental, namely:

• The first […] is the circumstance that the shareholdings in the acquiring company, which formed part of the assets of the acquired company, do not exist in the patrimony of the company resulting from the merger process;

• The second, which is considered as inescapable as the former, is that the 'borrowed capital' to which the interest borne and whose deductibility is questioned relate are found, at a moment prior to the merger, already fully applied;

• The third, far less evident, but equally inescapable and relevant, is that the company resulting from the merger process does not materially identify itself (from the perspective of economic reality) with the company benefiting from the merger, as it was configured prior to the same;

• The fourth, which is equally not contestable, it is that the shares attributed, in the merger process, to the shareholders of the acquired company, shall be the consideration, not for the capital obtained by it through financing whose interest has its deductibility in issue, but, as has already been seen, for the shares of that same acquired company and which, by force of the merger process, are extinguished.

In light of these reference points, it is considered that, effectively, in this case the preconditions of the aforementioned lit. c) of no. 1 of Article 23 of the CIRC are met, for the expenses with interest in question correspond to borrowed capital that has been applied in the operation of the entity that bears them.

This statement, which at first glance may appear counter-intuitive, will be understandable if the third of the fundamental decision-making criteria listed above is properly borne in mind.

Indeed, and as was written in the Award of the Administrative Supreme Court of 13-04-2005, rendered in proceedings 01265/04:

'Merger by incorporation, although it entails that only the company in which the others are incorporated survives with its own legal personality, does not have as a consequence, in the field of economic and business realities, the disappearance of the merged companies. Some commercial law doctrine – see PINTO FURTADO, PINTO COELHO and PUPO CORREIA in the places cited in the judgment under appeal – points out that the merged company, losing its legal personality, nonetheless persists, modified, forming a whole with others, in conditions different from those that occurred before the merger. But it is undeniable that the same economic reality continues to exist, the same set (now integrated in another more extensive one) of means devoted to a productive activity, which the partners, moreover, intended to enhance with the merger.

That is, with a merger by incorporation a transformation of the company occurs, but not an extinction, the integration does not result in its disappearance, but in its alteration, although it entails the loss of legal personality.'

Also in the Award of the Court of Appeal (Southern Circuit) of 17-04-2012, rendered in proceedings 04172/10, it was written that 'the merger of companies is the act by which two or more companies combine their economic forces to form, with the partners of all of them, a single collective entity, a new economic and legal subject.

Hence it can be stated, as A… appears to have done, that the merger is, as a general rule, and the situation under analysis does not constitute an exception, recommended by interests common to the companies involved in it, and not merely to one of them.'

And further: 'It is true that it could be argued that the merged company, losing its legal personality, nonetheless persists, modified, forming a whole with others, in conditions different from those that occurred before the merger; however, it is also true that the same economic reality continues to exist, the same set (now integrated in another more extensive one) of means devoted to a productive activity, which the partners, moreover, intended to enhance with the merger.

In another formulation, it can be stated that with a merger by incorporation a transformation of the company occurs, but not an extinction, the integration does not result in its disappearance, but in its alteration, although it entails the loss of legal personality.'

Understood in this way, it will then be understandable the statement that the expenses with interest in question correspond to borrowed capital that has been applied in the operation of the entity that bears them. Indeed, properly understood the post-merger reality (not fraudulent), it should be accepted that the entity resulting from it, although contained in the legal 'shell' of the acquiring company, does not correspond to it as it was configured before the aforementioned corporate reorganization process, but is rather a synthesis between the acquired and the acquiring company.

Citing the jurisprudence that precedes, it continues to 'exist the same economic reality', the 'same set (now integrated in another more extensive one) of means devoted to a productive activity', in the operation of which the borrowed capital whose interest expenses come to have their deductibility questioned have been applied, since the integration did not result in its disappearance, but in its alteration, albeit with the loss of legal personality.

Thus, in light of this understanding of the effects of a merger by incorporation – including the reverse – one cannot come to any other conclusion but that the preconditions of the aforementioned lit. c) of no. 1 of Article 23 of the CIRC are met.

It becomes thus understandable the passage of Award 42/2015-T cited above, according to which 'the merger maintains in the Claimant the financing by means of which it paid interest, and had as a patrimonial consequence the joining, in the same balance sheet, of the assets that such debt financed and continued to finance. Not financial assets, but its real translation into assets and liabilities of an operational nature'. Indeed, the perspective of the award in question, which will be unquestionable in cases of merger by incorporation 'ordinary' (not reverse or upstream), where it is evident that the acquiring company exchanges the shareholdings it holds for the economic reality into which the company it owns translates, should equally be considered valid in cases of reverse merger, since the material post-merger reality (the 'economic reality', the 'set (…) of means devoted to a productive activity'), shall be, at least insofar as they constitute aspects relevant to the issue under discussion, precisely the same.

This conclusion is not invalidated by the fact that, as is stated in Arbitral Award 87/2014-T, 'the tax deduction of financial charges incurred (…) must be assessed in the context of the Claimant's own business, in light of the normative criteria resulting from no. 1 of Article 23 of the CIRC', and that 'in order to proceed to apply to the case at hand the requirement of indispensability of costs, it is decisive to ascertain (…) the actual and concrete allocation of the financing of which the borne interest is the remuneration or, in other words, it is important to verify the destination or use of the funds obtained in relation to which the taxpayer claims to deduct tax, for the purposes of determining its taxable profit, the interest and other associated charges it has borne'.

Quite the contrary. Understood that the Claimant, as it presents itself post-merger, is no longer the same center of interests that existed before that process, but a different one that has synthesized with the acquired company and that, therefore, the business context of the Claimant incorporates also the economic reality previously embodied autonomously by the company incorporated in it, one shall then – truly – be assessing the 'normative criteria resulting from no. 1 of Article 23 of the CIRC' 'in the context of the Claimant's own business'.

On the other hand, and as has been referred to already, there is also no evidence that any alteration has occurred in the '(…) actual and concrete allocation of the financing of which the borne interest is the remuneration', or deviation in the 'destination or use of the funds obtained in relation to which the taxpayer claims to deduct tax, for the purposes of determining its taxable profit, the interest and other associated charges it has borne', since, on the one hand and as has been seen, the financing was fully applied at a moment prior to the merger, and on the other and as has equally been seen already, the product of that application was not even diverted to a third party, notably to the shareholder (before the acquired and thereafter the acquiring), insofar as the shares of the acquiring company of which it became owner derive, not from the financing whose interest is in question, but from the shares of the acquired company which it held, and which were extinguished by the merger process.

The position adopted is equally compatible with the assertion that can be read in the same award just referred to, according to which 'the fact that certain financial charges were previously tax deductible in the context of determining the taxable base of a certain company does not in itself mean that they necessarily are on the same terms in the context of the company that, by merger, incorporated that one'.

Indeed, and as Professor Teixeira Ribeiro already referred to, in light of the Code of Industrial Contribution (CCI), the literate clauses of no. 1 of Article 23 of the CIRC cannot be understood in any other way than that when costs or losses are specifically listed in Article 23, the essential nature thereof is presumed, and consequently the taxpayer is relieved of the corresponding proof, which is precisely the purpose of the enumeration (derived, among other things, from the use of the expression 'in particular').

The fulfillment, in this case, of lit. c) of no. of Article 23 of the CIRC does not mean that the AT cannot question the general requirement of deductibility of expenses contained in the body of the article, demonstrating that, despite a literate clause of the same being met (in this case lit. c)), the merger was carried out for interests not being the business interests of the companies party to it.

Similarly, the AT could demonstrate that, despite fulfilling a literate clause of no. 1 of Article 23, and that the merger was determined by interests proper to the companies party thereto, the same was carried out in a fraudulent context, so as not to produce tax effects, as prescribed by Article 38, no. 2 of the General Tax Law (LGT).

However, in this case, neither of these avenues was taken by the AT, and therefore it is not for the Tribunal to assess their merit.

It is not considered, finally, that the circumstance, also identified above, that, at the moment when the interest is borne, the assets in which the borrowed capital has been applied do not already form part of the legal sphere of the company resulting from the merger, is relevant.

Indeed, where borrowed capital has been applied in operation (a situation different from the 'diversion' of part of the capital for applications outside business interests, which, as has already been seen, does not occur in this case), it is considered that it would nonetheless be possible to refuse the tax deductibility of the corresponding financial charges, by demonstrating (and thus eliminating the presumption of deductibility resulting from lit. c) of no. 1 of Article 23 of the CIRC, detected following Professor Teixeira Ribeiro), that the product of that application – and not the borrowed capital itself – would have been diverted for extra-business purposes.

What has just been stated will be easily understood by resorting to the example of a company which, using borrowed capital, acquires a vehicle, which it allocates, from the outset, to operation within the scope of its activity, but which, from a given moment on, allows the use of the same exclusively in the interest of third parties (e.g.: shareholders; other companies).

In this situation, it is considered that the presumption of indispensability of financial charges borne with the acquisition of the vehicle, resulting from the application of borrowed capital in the operation of the company in question, will be defeated, and therefore the deductibility of such charges should be refused. However, once again, that is not the situation in this case.

Rather, what happens in the situation at hand is that, by means of the merger operation carried out, there was a disappearance of the object of the application of the borrowed capital. That is: such object, which existed, no longer exists (which is different and, it is repeated once more, is not what happens in the situation sub iudice, of continuing to exist in the sphere of third parties).

Returning to the example of the vehicle, the situation will be the same as would occur in the case where, by means of a business decision, it becomes unusable before the period of payment of the financial charges related to its acquisition ends (e.g.: its use in an advertising campaign that destroys it). Still, it is believed, those charges will remain deductible, notwithstanding the disappearance – by means of a business decision – of the object in which the borrowed capital that remunerates them was applied. This would only not be the case, following what has just been stated, if it were demonstrated that the decision that caused the disappearance of such object was motivated by interests alien to the company or, then, that it was abusive. Which – once again – is not what is at issue in the present proceeding.

Finally, it shall be stated that it is considered that it will not invalidate either the decision-making reference points from which one started, nor the conclusions that have been drawn, the regime relating to the prohibition of financial assistance to the acquisition of own shareholdings essentially regulated in Articles 322, no. 1 of the CSC, and 23 of the Second Directive 77/91/CEE of the Council, of 13 December 1976.

Notwithstanding such question having been neither a ground of the tax act that is the subject of the present arbitral action, nor raised by the parties themselves, it shall always be stated, to the credit of the integrity of the decision, that there is no evidence that any act has been committed that, concretely, can be pointed out as having occurred in violation of the aforementioned prohibition.

In fact, Article 23, no. 1 itself of the Second Directive 77/91/CEE of the Council, of 13 December 1976, in force at the date of the tax fact, and in light of which the provision of Article 322, no. 1 of the Commercial Companies Code (CSC) should be read in this case, considers financial assistance the advance of funds, the granting of loans or the provision of guarantees, and it is certain that, in this case, there is no evidence that any of these situations has occurred.

In fact, the funds used for the acquisition of the shareholdings of the Claimant were provided by banking entities, and not advanced or extended on credit by the Claimant, and this, so far as can be determined, did not provide any guarantee to the creditors of the financing used for the acquisition of such shareholdings, so that, unless fraud has occurred, it cannot be considered that, in this case, the Claimant has provided financial assistance, proscribed by the aforementioned norms.

That is, and in summary: there is no doubt that no funds were advanced, credit extended or guarantees provided by the Claimant, with a view to the acquisition of own shares. If – and in this case, it is considered, this is a discussion that will not need to be pursued, and therefore will not be relevant whether this is questionable or unquestionable – the same results were obtained by other non-prohibited means, we would then be in the presence of fraudulent conduct, to be treated as such.

For it to be considered that any violation of the prohibition on financial assistance has been verified, the same would have to be drawn from the combination of all the legal acts carried out by the Claimant, and from the intention – in that case, fraudulent – of, by that means, obtaining a result that the law prohibits.

Indeed, a conclusion of violation of the prohibition on financial assistance by the Claimant will – it is believed – always have to rest on the combination of the complex of acts carried out, from the organization of the group corporate structure initially instituted, to the completion of the reverse merger by incorporation, passing through the financing operation carried out, it being certain that all such acts, considered in themselves, will appear as lawful and proper to the various business entities involved therein, and only a fraudulent purpose and result actually demonstrated shall be capable of removing the mantle of legality that covers them.

Now, in the opinion submitted, each of the various legal acts carried out by the different participants in the complex transaction at issue in the present proceeding being lawful and business-related, the proper means of carrying out the aforementioned demonstration, and drawing the proper tax effects from it, shall be by means of the anti-abuse clause.

This conclusion shall not, it is believed, be capable of being affected by the consideration – moreover not effected by the AT itself – of the prohibition on financial assistance in the context of densifying the general criterion of indispensability of Article 23, no. 1 of the CIRC, not least because it is understood that not only would it be necessary, previously, to demonstrate an actual (and not merely generic or potential) violation of such prohibition, but also that, being at issue – in the concrete case, as has been stated – overall fraudulent conduct, the use of the general criterion of indispensability would constitute – with all due respect and, so to speak – itself a 'fraud on the law', insofar as it would be a expedient means of depriving the taxpayer of the protections that the law intended to confer on him, in cases where the AT understands that the legal forms used by him do not correspond to the economic reality pursued.

In any event, it is further noted that there being no doubt that in the case a so-called 'leveraged merger' ('merger leveraged buy-out', mLBO) took place, it is equally certain that such figure is known, from a date that can be considered long ago, by the legislator, which – to date – has understood not to draw from such knowledge either its illegalization in general (there being no record, moreover, that this has occurred in any community legal system), nor any other effects on the tax level.

Moreover, in regimes, such as the Italian one, where mLBO operations have already been regulated, the regulation instituted insists especially on reporting and audit obligations, thus showing that the operation in itself is not intrinsically unlawful and/or fraudulent, but that it merely contains within itself a potential for unlawfulness/fraud higher than normal. Being thus the case, it is considered that the mere occurrence of a leveraged merger operation will not, in itself, be capable of being considered fraudulent and, still less, anti-business.

Finally, it shall be stated that the application to the case, by means of the general criterion of indispensability of expenses, of the prohibition on financial assistance to the acquisition of own shares, on the argument that all the acts and contracts performed were characterized by the purpose that it be the patrimony of the Claimant to bear the cost of the acquisition of its own shareholdings, will equally encounter the finding that that same result would be obtained if the merger by incorporation had been carried out in the opposite direction.

In conclusion, and as Professor Saldanha Sanches referred, if 'Spin-off and merger operations are an area where attempts to obtain tax savings through abusive practices are very frequently verified, which motivates the legitimate concerns of the legislator', one cannot start from an 'incurable mistrust (…) in relation to the reverse merger, as if this operation could only be carried out to circumvent tax law or were, in itself, an abusive operation'.

Thus, considering that, in the case, the preconditions of Article 23, no. 1, c) are met, namely, that the borrowed capital to which the financial charges whose deductibility is questioned by the AT relate have been actually applied in the operation of the Claimant, as it presented itself at the date when it bore those charges (post-merger), at issue in the present proceeding, and that it is not demonstrated (nor does such fact even constitute a ground of the tax acts that are the subject of the present arbitral process) that the merger operation, from which resulted the disappearance of the shareholdings in which the aforementioned borrowed capital had been applied, has been exclusively or primarily motivated by interests outside business, or fraudulent, the entirety of the annulment arbitral applications formulated shall proceed.

(End of citation of Award in Arbitral Proceedings 93/2015-T)

For the sake of truth, it should be noted that the matter of financial assistance is not properly a subject to be decided, as it was never invoked by the AT during the proceeding (nor in subsidiary form). It is addressed only as a mere note suggested by the subject, as indeed occurred in proceedings 93/2015-T.

With the tenor of the decision on the essential question – to the effect of annulling the assessments challenged, as not violating Article 23 of the CIRC – the pronouncement on the other defects pointed out by the claimant becomes moot (alleged insufficiency of the justification of the assessment acts, breach of essential legal formality [failure to notify for prior hearing], lack of justification [inconsistency and lack of clarity] of the tax inspection report itself).

The argumentation regarding the tax deduction of financial charges equally applies to the tax deduction of expenses incurred with external legal counsel for legal support to the merger operation. Such charges are linked to the activity and operation of D… (purchase of shareholding and merger), something permitted and regulated in commercial law legislation. These charges are not incurred outside the interests of the company that bears them. They are not intended to benefit solely the shareholders. And they are transferred, via merger, in accordance with the specific rules of that institution. And for these reasons, as has been argued at length regarding the interest – and which are here reproduced – such charges are deductible from income, even as a result of the merger, under Article 23 of the CIRC.

The Claimant also requested that, in addition to the annulment of the assessment in question, the AT be condemned to return the tax paid plus compensation interest as provided by law.

Article 43, no. 1, of the LGT provides that compensation interest is owed to the taxpayer when it is determined in judicial challenge (and arbitral action is included in this legal dictate, for coherence and unity of the legal system) that there was error attributable to the services resulting in payment of a tax debt greater than that owed.

Now, that is what occurs in this case. The AT, by introducing additional Corporate Income Tax assessments – now annulled – resulted in payment of tax by the taxpayer, which was ultimately unwarranted and exacted only by error attributable to the AT's services (which demanded assessment of illegal taxes).

Whereby, the requirements of Article 43 of the LGT being met, the AT must proceed to pay compensation interest, at the legal rate, from the moment of payment by the taxpayer until full reimbursement to the taxpayer of the tax paid by him.

The claimant further requests that the AT be condemned to pay the expenses incurred with the provision of a bank guarantee to suspend the enforcement proceedings relating to the assessment in question – because the claimant did not pay the assessment immediately, but only later, in two tranches, in an option of management not open to challenge – quantifying the costs of such guarantee (23,712.29€), in a document issued by a banking entity and not contested by the respondent.

According to Article 53, no. 2, of the LGT, the taxpayer is entitled to be indemnified for an unwarranted guarantee, even when it has maintained it for a period less than 3 years, when it is verified, in judicial challenge – and must be read also, in tax arbitration, in an updated reading of the law and integrated in its systemic unity – that there was error attributable to the services in the assessment of the tax. Now, as was stated above regarding the interest, the finding of the illegality of the additional assessment promoted by the AT has as a consequence that it underlies an error attributable to the services – which carried out an illegal assessment (and subsequent requirement of an unwarranted guarantee). For this reason, the claimant is entitled to be indemnified for the costs of the unwarranted guarantee, the exact value of which must be determined spontaneously by the Tax Authority (or if this does not happen, in execution of the judgment), bearing in mind the limits and procedures described in nos. 3 and 4 of Article 53 of the LGT (whose exact data are not contained in the present proceeding).

5. Decision

In accordance with the above, the arbitrators in this Arbitral Tribunal agree to:

Find the application for a declaration of illegality of the 2009 assessment in question, for Corporate Income Tax (2013…) and compensatory interest (2013… to 2013…), in the total amount of 1,121,231.12€, to be well-founded.

And in consequence:

Order the return to the claimant of the Corporate Income Tax and compensatory interest paid by her;

Condemn the AT to pay compensation interest to the Claimant, from the dates of payment of the tax (on the amounts paid on 20/12/2013 and on 16/9/2014) until full reimbursement.

Grant to the claimant the right to indemnification for unwarranted guarantee, to be assessed spontaneously by the services of the Tax Authority or, in the absence of voluntary compliance, in execution of the Judgment.

6. Value of the Proceeding

In accordance with the provisions of Article 97-A, no. 1, lit. a), of the Code of Tax Procedure and Process (CPPT) and 3, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of the proceeding is fixed at € 1,121,231.12€.

Notify accordingly

Lisbon, 30 June 2017

The Arbitrators

José Baeta de Queiroz (chairman arbitrator)

Tomás Cantista Tavares (arbitrator)

Américo Brás Carlos (arbitrator – dissenting as per declaration attached, which forms an integral part of the present decision)

DISSENTING OPINION

I dissented, disagreeing with the Award in the part relating to the tax deductibility of charges relating to the financing contracted by D… (acquired company), on the following grounds:

1. Not attending to the jurisprudence of the Administrative Supreme Court (STA) and the Courts of Appeal (TCA) – rather basing its argument on decisions of the Tax Arbitration Tribunal – disregards the conforming role of the jurisprudence of those superior courts and is susceptible to appeal under no. 2 of Article 25 of the RJAT.

2. The assessment of the 'demonstrated indispensability of expenses for the realization of income subject to tax or for the maintenance of the source of production' referred to in no. 1 of Article 23 of the CIRC can only be made in relation to the entity that accounts for and bears them, as is moreover admitted in the transcription of ff. 12 of the Award and results from repeated jurisprudence of the STA of which its Award of 30.05.2012, proceedings no. 171/11, is an example, which concluded: 'costs cannot but relate to the taxpayer company itself'. Which taxpayer company is in the case sub judice, the Claimant, undeniably the only person – the only center of imputation of rights and duties – that after the merger survived in the legal system, including the part thereof relating to taxation.

3. In the case of payment of charges with loans, I understand that it is the use of the assets acquired with the funds thus obtained that determines the characterization and regime that applies – indispensability and tax deductibility, or not – to the concomitant interest.

4. The investigation of the demonstrated indispensability of expenses, although it should not involve prior judgments of value on the correctness or incorrectness of the company's management decisions, should be based on the idea of demonstrated 'necessity' of the same, 'given the corporate purpose of the business entity in question'.

5. Moreover, the exercise of assessment of the demonstrated indispensability or the demonstrated necessity of expenses cannot also fail to be sustained in a judgment based on a vision of normality or verisimilitude (as is common in any assessment for purposes of legal judgment) in light of the expense in itself, but also in light of all the circumstances that determined that the same be incurred in the circumstances in which they were. As was decided in the Award of the Court of Appeal (Southern Circuit) of 16.10.2014, proceedings no. 6754/13, a cost is indispensable when there is 'a causal nexus with the income or gains explained in terms of normality, necessity, congruence and economic rationality'.

6. Now in the case of the proceedings, the factual sequence of the entire operation was:

• On 12.05.2009, a Venture Capital Investment Fund (B…) establishes a company C… (C…), remaining owner of 100% of its capital;

• On 13.05.2009, the company C… establishes the company D (D…), remaining owner of 100%, and this with the same administrators as C…, who were also the top management responsible for the Venture Capital Investment Fund. The company D… was established with a corporate purpose similar to that of the company A… (A…) already pre-existing and at the time legally independent of Companies C… and D…, as well as of the Fund.

• On 18.05.2009, three banks made available to company D… a loan of 28 million euros intended to enable the acquisition of the shares of company A…, with credit institutions imposing the obligation for company A… to incorporate by merger company D…, within a maximum period of one year. Note that company D… never had operational activity, did not acquire the licenses and permits necessary for its exercise and had no assets to satisfy the guarantee requirements imposed by banking creditors (see ff. 3 and 4 of the award).

• On 30/12/2009 the total merger of D… (parent company) was completed into Claimant A… (acquiring company), with effects dated 30/6/2009.

1. As, with meridian clarity becomes apparent, the entire operational sequence is subordinated to the following objective: acquisition of all the share capital of the Claimant by group E… (as is the nature of Venture Capital Funds) and placement of the debt resulting from such financing in the acquired company itself – the Claimant – the only entity with relevant operational activity and with income that, as has been stated, allow the tax deduction of charges borne as a result of debts contracted by a third party for the acquisition of its own shares.

2. All the steps of the operation are inserted within the same 'unit of intention and action' and are, from the beginning, solely directed to the business purpose referred to in the preceding number. An objective foreign to the business interest of the Claimant, the financing and payment of the concomitant charges not being necessary to its activity, nor indispensable for the pursuit of its specific business interest embodied in the production of its income subject to tax or in the maintenance of its generator source. The obligation to pay the charges under analysis was never, from the outset, contracted in the business interest of the Claimant, and could not, after the merger, come to be considered such financing to be indispensable to it for purposes of no. 1 of Article 23 of the CIRC.

3. And the noted 'unit of intention and action' in which the facts referred to above are inserted makes all the difference in relation to the situation of continued payment and deduction of interest beyond the existence of an asset whose acquisition generated charges, which the Award used to, by exemplifying, support its decision. In the example used there, the subsequent vicissitude that determines the disappearance of the asset – a vehicle that is withdrawn from the assets – does not fall within the 'line of intention and action' that determined its acquisition with recourse to credit. The unity of action that results from the factuality contained in the proceedings, noted above, equally calls into question the touchstone of the Award which rests on the idea of making relevant the fact that the purchase of the shares of the Claimant took place, entirely, before the merger.

4. And not far from this line of assessment of the indispensability of expenses in light of the ultimate business objective (or commercial objective or business purpose) will be the judicious doctrinal reference of Tomás Cantista Tavares 'the legal notion of indispensability is thus delimited, based on an economic-business perspective, by direct or indirect fulfillment of the ultimate motivation of contributing to the obtaining of profit'.

5. In my view, an interpretive effort cannot segment the acts of a chain of logically inter-related acts and ignore the whole which, in that relationship, reveals the business purpose.

6. It shall be stated that it is also in the consideration of business purpose that one can 'attend to the economic substance of the tax facts', as required by no. 3 of Article 11 of the LGT.

7. In consequence, bearing in mind the above, the charges relating to those loans, borne by the Claimant, do not meet the requirement of indispensability referred to in no. 1 of Article 23 of the CIRC, because, in summary:

a) They do not relate to the activity developed by it (Award STA, proceedings 171/11);

b) The expenses corresponding to the interest borne by an acquiring company by virtue of the acquisition of borrowed capital by the acquired company for the acquisition of 100% of the shares of the first are not indispensable for this company (acquiring company), because they were not constituted in its business interest, not being thus necessary for the pursuit of its corporate purpose (Award STA, proceedings 164/12 and Awards Court of Appeal (Southern Circuit), proceedings no. 5327/12 and proceedings no. 8137/14);

c) There is no causal nexus between those expenses and its income or gains, explained in terms of normality, necessity, congruence and economic rationality (Award Court of Appeal (Southern Circuit), proceedings no. 6754/13);

1. And these reasons would suffice for such charges not to be tax deductible.

2. But the impossibility of tax deduction of such charges is further prescribed by lit. c) of no. 1 of Article 23 of the CIRC.

3. Such consequence is not prevented by the exemplary enumeration formed by the set of literate clauses of such number. As a whole, the literate clauses of no. 1 form an exemplary enumeration because it is accepted that there may be other expenses in which a company may incur. However, this does not mean that within some of these literate clauses the law has not included binding provisions, such as those resulting from part of its lit. c) and of lit. j).

4. The fact that in lit. c) of no. 1 of Article 23 of the CIRC the legislator has imposed for financial charges a limitation (and also did so for expenses relating to some financial instruments, including in the norm some instruments and excluding others, according to its measurement method) which he did not wish to repeat in relation to other expenses referred to there (discounts, premiums, transfers, exchange differences, etc.). The norm exists and the interpreter cannot act as if it does not exist, considering it useless (see no. 3 of Article 9 of the Civil Code).

5. In the provision of lit. c) of no. 1 of Article 23 of the CIRC, the law, within the general framework of financial charges, establishes for interest the following rule: 'interest on borrowed capital applied in operation is tax deductible'. And, from its combination with the requirement of demonstrated indispensability referred to in such no. 1, given the criteria of normality, necessity, congruence and economic rationality, I adhere to the understandings of MARIA DOS PRAZERES LOUSA and RUI MARQUES, to conclude that, in the case of borrowed capital, this must be applied in operation by the company that bears it, for the corresponding charges to be tax deductible. Which is not the case in the proceedings.

6. The Award also brought to bear the problematic of the 'prohibition on financial assistance', to conclude that this does not apply in the present case, because the Claimant did not proceed to the 'advance of funds, the granting of loans or the provision of guarantees'. Without prejudice to considering this subject relevant because it touches on the principle of indispensability of costs, I also disagree here, because, in my opinion, it is the Claimant which through its payments of the debt contracted by the acquired company is 'furnishing the funds' to a third party so that it holds shares representative of its capital. This directly contends with the provision of no. 1, of Article 322 of the Commercial Companies Code (CSC).

7. And these prohibited acts of financial assistance are sanctioned by no. 3 of the same Article 322, with the strongest of the negative values reserved for illegal acts – nullity.

8. Combining the provision of nos. 1 and 3 of Article 322 of the CSC, with no. 1 of Article 23 of the CIRC, an act that the legal system 'sanctions' with nullity cannot be considered indispensable or necessary for tax purposes. This would be the negation of the principle of unity of the legal system.

For all these reasons the tax act under analysis should be upheld; and therefore I record this dissenting vote.

Lisbon, 30 June 2017

Américo Brás Carlos

(Document drawn up by computer, in accordance with Article 131, no. 5 of the Code of Civil Procedure, made applicable by reference from Article 29, no. 1, lit. e) of the Legal Regime for Tax Arbitration)