CAAD 738/2014-T: Deductibility of Financial Charges for SGPS Companies Under IRC

ARBITRAL DECISION

I – REPORT

A... SGPS, S.A., legal entity no. …, with registered office at Av…, no. …, Letter …, 3rd floor, …-… LISBON, hereinafter designated as Claimant, filed a request for establishment of an arbitral tribunal in tax matters and a request for arbitral ruling, pursuant to the provisions of articles 2.º no. 1 a) and 10.º no. 1 a), both of Decree-Law no. 10/2011, of 20 January (Legal Regime for Arbitration in Tax Matters, briefly designated as RJAT), petitioning the declaration of illegality of the additional assessment of Corporate Income Tax no. 2013 …, of 5 December 2013, which resulted in the reduction of the tax loss determined in 2009 to the amount of € 555.998,06.

The request for establishment of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority on 28-10-2014.

Pursuant to the provisions of paragraph a) of no. 2 of article 6.º and paragraph b) of no. 1 of article 11.º of the RJAT, in the wording introduced by article 228.° of Law no. 66-B/2012, of 31 December, the Deontological Council appointed the signatories as arbitrators of the collective arbitral tribunal, who communicated acceptance of the appointment within the applicable period.

On 17-12-2014 the parties were duly notified of this appointment, and did not manifest any intention to refuse the appointment of the arbitrators, pursuant to the combined provisions of article 11.º no. 1 paragraphs a) and b) of the RJAT and articles 6.° and 7.º of the Deontological Code.

Thus, in accordance with the provisions of paragraph c) of no. 1 of article 11.º of the RJAT, in the wording introduced by article 228.° of Law no. 66-B/2012, of 31 December, the collective arbitral tribunal was constituted on 05-01-2015.

The Tax and Customs Authority responded to the initial request filed, arguing that the petition should be judged unfounded.

Given that none of the purposes legally assigned to it were verified in this case, the meeting provided for in article 18.º of the RJAT was waived.

The parties filed closing arguments.

The arbitral tribunal was duly constituted and is materially competent, in accordance with the provisions of articles 2.º, no. 1, paragraph a), and 30.º, no. 1, of DL no. 10/2011, of 20 January.

The parties possess legal capacity and standing, are legitimate and are represented (arts. 4.º and 10.º, no. 2, of the same legislation and art. 1.º of Ordinance no. 112-A/2011, of 22 March).

The proceedings do not suffer from any nullities and no exceptions were raised.

The allegations supporting the Claimant's petition for arbitral ruling are, in summary, as follows:

Claimant's Allegations

11.1 In compliance with Service Order no. OI…, an inspection action was undertaken against the Claimant, with reference to the fiscal year 2009.

11.2 According to the inspection report, the Tax Administration Services disregarded certain financial charges, allegedly borne by the Claimant with the acquisition of equity interests capable of benefiting from the regime provided for in article 32.º no. 2 of the Tax Benefits Statute, in the wording in effect at that date, and consequently increased, to the net result of fiscal year 2009, the amount of € 768.979,43 (seven hundred sixty-eight thousand nine hundred seventy-nine euros and forty-two cents), with the consequent alteration of the tax loss declared by the Claimant from € 1.321.977,48 (one million three hundred twenty-one thousand nine hundred seventy-seven euros and forty-eight cents) to € 555.998,06 (five hundred fifty-five thousand nine hundred ninety-eight euros and six cents).

11.3 The TA considered that "taking into account the fungible character of money and the consequent difficulty of direct allocation of charges, the allocation of financial charges was effected on the basis of the following criteria: remunerated liabilities were allocated, first, to remunerated loans granted by the S.P. to the subsidiaries and to other interest-bearing investments, with the remainder being allocated to other assets, namely equity interests, proportionally to their respective acquisition cost".

11.4 Thus, according to Table Q.II contained in the Inspection Report (Doc. 2), charges in the amount of € 768.979,43 were allocable to the equity interests.

11.5 The Claimant was notified of the Corporate Income Tax assessment statement no. 2013 …, issued on 5 December 2013, and of the corresponding account adjustment statement, with no. 2013 ….

11.6 The Claimant filed, on 7 May 2014, an administrative appeal, which was dismissed, according to Official Notice no. …, of 22 September 2014, from the Finance Directorate of Lisbon.

11.7 In the decision dismissing the appeal, the TA alleges that "It was in obedience to this circular [no. 7/2014, of 30 March] that the inspection services corrected the Corporate Income Tax assessment for the year 2009" (cf. Cit. Doc. 6). However, the Claimant considers that the Circular goes beyond mere interpretation of tax law, having no basis in it.

11.8 Indeed, no. 2 of article 32.º establishes that "Capital gains and losses realized by SGPS, by SCR and by ICR from capital shares of which they are holders, provided they are held for a period of no less than one year, as well as financial charges borne with their acquisition, do not concur towards the formation of the taxable profit of these companies".

11.9 In this provision, the legislator sought to reproduce the rule that was contained in article 23.º, in the wording in effect in 2009, that is, the rule of fiscal non-deductibility of charges related to revenues not subject to Corporate Income Tax.

11.10 Thus, considering that the interpretation of the term indispensability defended by the TA has been based on the theory of adequate causality which presupposes a connection between costs and revenues, one should also conclude, by parity of reasoning, that financial charges excluded from the taxable profit of SGPS are exclusively those that are in a necessary causal relationship with capital gains or losses also subsumable under the regime excluding taxation, as indeed results from the provision in the final part of no. 2 of article 32.º ("financial charges borne with acquisition").

11.11 This means that the method of identification of charges borne with the acquisition of equity interests is the method commonly applicable to charges associated with revenues excluded from Corporate Income Tax, such is the case of direct allocation/assignment.

11.12 This method has been defended, moreover, by the TA, in the interpretation of article 23.º, being implemented in the accounting separation to be carried out in accordance with the different tax regimes applicable, which emerges from the provision in paragraph b) of no. 3 of article 17.º of the Corporate Income Tax Code and, likewise, from the balancing principle inherent in article 18.º of the Corporate Income Tax Code.

11.13 Relying on an alleged difficulty in using the standard method and the possibility of manipulation, the TA understood that, regarding financial charges borne by SGPS with the acquisition of equity interests, the allocation should be effected through application of the formula referred to in Circular no. 7/2004, of 30 March.

11.14 That is, the TA did not merely interpret (even extensively) no. 2 of article 32.º of the Tax Benefits Statute but created a substitute method.

11.15 Now, according to doctrine and jurisprudence widely cited, the guidelines of the tax administration only bind it, not having external efficacy, under penalty of violation of the principle of legality.

11.16 For this reason, the TA cannot substitute itself for the legislator and adopt, through administrative means, a different criterion to determine the aforementioned financial charges, even if it does so for an acceptable reason.

11.17 It further adds, according to practical examples it presents, that the criterion of the Circular is capable of causing significant distortions to the constitutional principle of taxation based on real profit and the principle of periodization of fiscal years. These distortions do not even prevent, in the Claimant's view, possible manipulations of the fiscal result.

11.18 In summary, the Claimant concludes that:

"i) The application of the formula contained in Circular no. 7/2004, of 30 March, to the financial charges of the SGPS, contradicts the provision of no. 2 of article 32.º of the Tax Benefits Statute, being, consequently, illegal;

ii) Without prejudice to the above, and even if this is not accepted (and therefore concluded that the said legal provision is silent as to the formula to be used for the determination of the financial charges in question) it is still necessary to conclude that Circular no. 7/2004, of 30 March, is unconstitutional, by violation of articles 103.º, 112.º, no. 5 and 165.º, no. 1, paragraph i), of the CRP – or rather, by the unconstitutionality of article 32.º, no. 2, of the Tax Benefits Statute interpreted in the sense that it is permissible, for purposes of determining non-deductible charges, to adopt an innovative method – and by its illegality, by violation of article 8.º of the General Tax Law.

iii) Furthermore, the adoption of the formula established by the circular under examination constitutes a violation of the principle of taxation based on real profit, enshrined in article 104.º, no. 2, of the CRP, and likewise, a violation of the principle of periodization of fiscal years.

iv) In any case, it is still stated that, contrary to what is affirmed by the Tax Administration, the application of the formula provided in the Circular, instead of preventing the manipulation of the fiscal result, could even end up legitimizing such conduct."

Response of the Respondent

12.1 First, the Respondent argues that the correction effected and consequent assessment is the exclusive responsibility of the Claimant since it did not add to the net result of the fiscal year the financial charges allocable to equity interests nor provided any additional clarifications within the scope of the prior hearing before final notification of the inspection report.

12.2 On the other hand, since no. 2 of article 32.º of the Tax Benefits Statute does not establish which method to use for purposes of allocation of financial charges to equity interests, Circular no. 7/2004, of 30 March, "seeks only to give effect to the law, determining the method and form of calculation of financial charges borne with the acquisition of equity interests." (article 22.º of the Response).

12.3 In this sense, as stated in Proc. 21/2012-T of the Arbitral Tribunal, "What is important to conclude here is that the tax act of self-assessment at issue is not tainted or afflicted with any illegality (by violation of any constitutional principle) that can be attributed to it on the basis of this question of allocation of financial charges, so much so that, as the Respondent adduces in the response, associated with the issuance of Circular no. 7/2004, of 30 March, there is no legislative intention on the part of the TA, or at least, we cannot discern any."

12.4 It is not Circular no. 7/2004 that creates rules of incidence, but it is the law itself, interpreted as stated above, that excludes deductibility, for purposes of determining the profit of the fiscal year in which they are incurred, financial charges incurred with financing linked to the acquisition of equity interests alienated and which realize, albeit potentially, capital gains excluded from taxation.

12.5 Therefore, the interpretation contained in Circular no. 7/2004 is in accordance with the letter of the law, in that it does nothing more than undertake the discovery of its most precise meaning, in respect, moreover, of the general theory of interpretation of law and the normative framework that conforms it.

12.6 Thus, Circular no. 7/2004 did not alter or distort the legal provision of no. 2 of article 32.º of the Tax Benefits Statute but only uniformized the interpretation and application of the norm, in the proper defense of public interest and respect for the rights and interests of taxpayers – articles 266.º of the CRP and 55.º of the General Tax Law.

12.7 Furthermore, the explanation in the circular of the method to be used contributes to the effective realization of the extra-fiscal purposes that presided over its creation and prevents taxpayers from using the normative to pursue ends other than those envisaged in the law.

12.8 In the specific case, as no information was provided by the Claimant regarding the quantification of the reality embodied in the existence, during the period in question, of financial charges allocable to the equity interests held by it, the Tax Inspection Services proceeded to calculate the same "taking into account the fungible character of money and the consequent difficulty of direct allocation of charges, the allocation of financial charges was effected on the basis of the following criteria: remunerated liabilities were allocated, first, to remunerated loans granted by the S.P. to the subsidiaries and to other interest-bearing investments, with the remainder being allocated to other assets, namely equity interests, proportionally to their respective acquisition cost".

12.9 This is, moreover, the method used by the generality of SGPS that employ it, given the extreme complexity and subjectivity of direct allocation.

12.10 Indeed, as stated in the cited arbitral decision, handed down in Proc. no. 12/2013-T, "fiscal law contains no concrete rule or specific principle of fiscal disregard of costs, if the funds obtained from them do not generate taxed revenues. And it does not contain it for reasons of simplicity and adherence to truth. Simplicity is anchored in the difficulty of establishing a direct causal relationship between a cost and a financial revenue, in an organization, such as a commercial company, whose financing granted is intended, as a rule, for the totality of its activity and which resorts indistinctly to own funds and those of third parties to pursue its purpose and it is impossible to ascertain, for this reason, whether the funds of interest-free services granted to the subsidiaries come from third-party or own financing and in what proportion each occurred…this is the reason that presides, moreover, Circular 7/2004, for SGPS…".

12.11 The use of the allocation method used by Circular 7/2004 aims at taxation as close as possible to real profit, with no distortion of the constitutional principle of taxation based on real profit.

12.12 As for the specific constitutional provision on taxation of real income, no. 2 of article 104.º permits and encourages – in the name, namely, of the principles of operationality and practicality of the system – the existence of special tax regimes, such as that of SGPS.

12.13 On the other hand, it should be noted that it was the concrete action of the Claimant, by the absolute omission of quantification of financial charges allocable to the equity interests held by it and subsequent absence of provision of clarifications or information in the course of the inspection procedure, that left the Respondent with no alternative.

12.14 Regarding the alleged violation of the principle of periodization of fiscal years, the solution adopted by the circular reflects the legislator's concern in not influencing the taxable profit: of the fiscal year in which financial charges with the acquisition of equity interests capable of benefiting from no. 2 of article 31.º of the Tax Benefits Statute are borne, without first knowing whether they can or cannot contribute to the formation of the taxable profit of the company.

12.15 Thus, the circular determines that if it is concluded, "at the moment of alienation of the equity interests, that not all requirements for application of that regime are met, it shall be proceeded, in that fiscal year, to the consideration as a fiscal cost of the financial charges that were not considered as cost" in the fiscal year in which they were considered.

12.16 This solution also respects the provision of article 23.º of the Corporate Income Tax Code because the cost is only recognized when the legal prerequisites of indispensability are met.

12.17 It reiterates, finally, that, at no moment, the Claimant demonstrated, in concrete terms, the alleged shortcomings of the calculations carried out by the Respondent, namely by opposition to the values that would actually have to be added to the net result.

Having considered everything, a final decision must be rendered.

II. DECISION

A. FACTUAL MATTERS

A.1. Facts found to be proven

1- In compliance with Service Order no. O… an inspection action was undertaken on the Claimant, with reference to fiscal year 2009, with the following reason: "Under project no. …/…/2012, it was verified that the company did not correct in model 22 declaration, the financial charges allocable to equity interests (which do not concur for the determination of taxable profit); Divergences were also detected between Annex P of the S.P. and Annex O of its Suppliers";

2- By means of Official Notice no. …, of 13 November, from the Finance Directorate of Lisbon, the Claimant was notified of the inspection report, which in summary determines that "Taking into account the fungible character of money and the consequent difficulty of direct allocation of charges, the allocation of financial charges was effected on the basis of the following criteria: remunerated liabilities were allocated, first, to remunerated loans granted by the S.P. to the subsidiaries and to other interest-bearing investments, with the remainder being allocated to other assets, namely equity interests, proportionally to their respective acquisition cost";

3- As a result of the application of this criterion, the amount of € 768.979.42 was added to the net result, with the corresponding correction of a purely arithmetic nature being made to the taxable matter;

4- Consequently, the Claimant's tax loss for fiscal year 2009 was fixed at € 555.998,00;

5- The Claimant was notified of the Corporate Income Tax assessment statement no. 2013 …, issued on 5 December 2013, and of the corresponding account adjustment statement, with no. 2013 ….

6- The Claimant filed, on 7 May 2014, an administrative appeal, which was dismissed, according to Official Notice no. …, of 22 September 2014, from the Finance Directorate of Lisbon.

7- The dismissal of the administrative appeal was notified to the Claimant by Official Notice dated 2014-09-22, and received on 2014-09-24.

A.2. Facts found to be unproven

With relevance to the decision, there are no facts that should be considered as unproven.

A.3. Substantiation of factual matters proven and unproven

Regarding factual matters, the Tribunal need not pronounce itself on everything that was alleged by the parties, the duty falling to it, rather, to select the facts that matter for the decision and to distinguish the proven from the unproven facts (cfr. art.º 123.º, no. 2, of the Tax Procedure Code and article 659.º, no. 2 of the Civil Procedure Code, applicable ex vi article 29.º, no. 1, paragraphs a) and e), of the RJAT).

Thus, the facts pertinent to the judgment of the case are chosen and delineated according to their legal relevance, which is established with regard to the various plausible solutions of the legal question(s) (cfr. article 511.º, no. 1, of the Civil Procedure Code, applicable ex vi article 29.º, no. 1, paragraph e), of the RJAT).

Thus, taking into account the positions assumed by the parties, the documentary evidence and the case file attached to the records, the facts listed above were considered proven, with relevance to the decision, moreover consensually recognized and accepted by the parties.

B. ON THE LAW

The issues to be decided are, essentially, two, as were properly exposed and formulated by the parties, in the complaint by the Claimant, as well as in the response of the Respondent.

First: Are the financial charges borne by the claimant deductible for tax purposes, pursuant to art. 31.º, no. 2, of the Tax Benefits Statute (current art. 32.º, no. 2, of the Tax Benefits Statute)?

Second: Can the method of determining non-deductible financial charges be implemented through Circular 7/2004, of 30 March?

We will respond to each of the questions formulated above, substantiating our decision and bringing to bear the arguments invoked by the parties.

As mentioned above, the Tax Administration added the amount of € 768.979.42 to the net result declared by the Claimant in fiscal year 2009, on the grounds that it should have disregarded - for purposes of determining taxable profit - the financial charges supposedly borne with the acquisition of equity interests capable of benefiting from the regime provided for in article 32.º, no. 2, of the Tax Benefits Statute (in the wording in effect in 2009).

The Tax Administration substantiated the Corporate Income Tax acts at issue, as challenged, for the year 2009, as well as its subsequent decision dismissing the administrative appeal, on strict compliance with Circular no. 7/2004, of 30 March, understanding not to consider as deductible costs to taxable profit the financial charges allocable to equity interests of subsidiary companies determined in accordance with the rules provided in that circular.

B.1. No. 2 of art. 31.º of the Tax Benefits Statute

Law no. 32-B/2002, of 20 December, by which the State Budget for 2003 was approved, not only altered once again the regime for taxation of capital gains realized by SGPS, making them exempt from contributing to the formation of taxable profit in Corporate Income Tax, but, in parallel, excluded the deductibility of losses and financial charges borne by such companies, on the basis of their corporate purpose, which is in the case "(…) the management of equity interests in other companies, as an indirect form of exercise of economic activities".

The reasons that presided over this legislative amendment are explained in the Report on the State Budget for 2003. Under the heading "Main amendments in Corporate Income Tax," and the subheading "Expansion of the tax base and measures of moralization and neutrality", the exemption from Corporate Income Tax of capital gains realized by SGPS with the alienation of capital shares held for more than one year is pointed out, accompanied by measures designed to prevent abusive tax planning, approximating the national regime to the Dutch model, a measure associated with the establishment of a regime of disregard of deductibility, for purposes of determining the taxable profit of such companies, of financial charges of a nature directly associated with the acquisition of the corresponding equity interests (report accessible at www.dgo.pt).

Thus, the regime provided for in article 31.º of the Tax Benefits Statute had as its objective at the time of its establishment the pursuit of a more competitive tax regime for SGPS, while at the same time seeking to approximate the Portuguese regime to some international experiences considered more relevant[1], following many other legislative interventions made to that type of entities since the creation of their legal regime, in 1988[2].

Specifically, it was sought to disregard for tax purposes the capital gains/losses obtained on the alienation of financial equity interests by SGPS, disregarding, simultaneously, the financial charges that might be borne as a result of the need to seek financial means from third parties to finance the acquisition of those equity interests. This non-consideration of financial charges was intended to counterbalance the tax benefit granted to capital gains of SGPS.

The wording given by the same law to article 31.º, no. 2, of the Tax Benefits Statute, was as follows[3]:

Article 31.º

Companies managing equity interests (SGPS) and venture capital companies (SCR)

1 - (...)

2 – Capital gains and losses realized by SGPS and by SCR by means of onerous transmission, whatever the title by which it is effected, of capital shares of which they are holders, provided they are held for a period of not less than one year, as well as financial charges borne with their acquisition, do not concur towards the formation of the taxable profit of these companies.

3 – (...)

We understand that the legal basis to support the correction carried out by the Tax and Customs Authority must be based on the provision of no. 2 of art. 32.º "Capital gains and losses realized by SGPS and by SCR from capital shares of which they are holders, provided they are held for a period of not less than one year, as well as financial charges borne with their acquisition, do not concur towards the formation of the taxable profit of these companies".

This norm seeks to ensure the eventual balance of the situation, which translates into the non-deduction of interest in the calculation of taxable profit subject to tax, but in return, neither sees subject to income tax the capital gains resulting from the alienation of equity interests, must be, at least to begin with, minimally ensured, under penalty of violation of the principles of taxpaying capacity, taxation based on real income and equality and neutrality (the latter two by way of comparison with taxpayers who do not assume the legal status of SGPS). Thus, this possible balance, based on the assumption of continuity, does not impose the necessary causal relationship invoked by the Claimant.

"Legislative intervention is justified on grounds of prevailing public interest, whether in the pointed-out balancing or encounter of positive and negative patrimonial variations contributing to the formation of taxable profit, or in the pursuit of factors that preserve the attractiveness of the SGPS tax regime, with a view to stimulating the organization and establishment of economic groups in Portugal, but doing so in terms of achieving just and balanced distribution of tax burdens among the various taxpayers and removing the possibility of granting these taxpayers - and only them - dual benefit: exemption from taxation of capital gains and deduction of financial charges arising from the acquisition of the equity interests alienated and held for no less than one year". (in Decision no. 42/2014, of 9 January, of the Constitutional Court).

The intention of the tax legislator, in the provision under analysis (no. 2, of article 32.º of the Tax Benefits Statute), was to grant the hypothesis of not taxing revenues associated with gains/losses (capital gains and losses) resulting from the alienation of equity interests held by SGPS, provided that the conditions imposed by law are met, that is, their holding for a period of not less than one year. However, the exercise of that benefit, under the conditions defined in law, will impose a limitation on the deductibility of financial charges borne with the financing necessary for the acquisition of that type of investment.

The balancing concern underlying the provision in question, seeking to make a "matching" between gains/revenues (capital gains) and costs/expenses (losses) of SGPS, and the refusal of the accumulation of advantages, is stated by Luís Graça Moura in the following passage: "the legislator will have aimed at the granting of a benefit – total exclusion from taxation of capital gains – which, however, was counterbalanced by the non-concurrence of certain financial charges borne, creating an environment of neutrality between the possible gains with certain assets (certain financial fixed assets[4]) and the liability necessary to create the conditions for obtaining such gains, that is, the liability related to the acquisition of such equity interests. The underlying construction would be that the contracting of such loans represented, in potential, an element capable of placing the SGPS in the position of realizing capital gains that it excluded from taxation (...)"[5].

In the context of the situation presented by the Claimant, one of the questions that it would be important to consider was whether the financial charges borne by the claimant with the acquisition of equity interests are or are not deductible pursuant to art. 23.º of the Corporate Income Tax Code? Are these financial charges or are they not indispensable for obtaining its revenues or maintaining its productive source?

The answer will be clearly affirmative, that is, these charges are indispensable for obtaining the revenues and for maintaining the productive source.

However, the question at issue is not exactly this; it does not seem necessary to discuss the indispensability or otherwise of financial charges per se, but their disregard from the tax point of view in the face of a tax benefit that the tax legislator decided to grant to a certain type of legal entity, SGPS.

Therefore, we understand that the legislator did not seek in this provision to sectorially reproduce the rule already contained in article 23.º of the Corporate Income Tax Code - in the wording in effect in 2009 -, that is, the rule of non-deductibility of charges associated with revenues not subject to Corporate Income Tax, contrary to what the Claimant argues. Indeed, we understand that recourse to the thesis of indispensability of costs/expenses, sustained around the provision of article 23.º of the Corporate Income Tax Code, is not at issue here, because the financial charges consigned in paragraph c) of no. 1 of article 23.º of the Corporate Income Tax Code do not contradict the provision of no. 2 of article 32.º of the Tax Benefits Statute. True it is that financial charges are necessarily an indispensable charge for the achievement of revenues in accordance with article 23.º. Another question will be the method to be used to determine the financial charges that must be excluded from the determination of taxable profit.

In summary, the fiscal provision at issue cannot be understood in the context of the general guidance contained in article 23.º of the Corporate Income Tax Code, as it must be interpreted as a special law, particularly geared to fiscally support this type of legal entity, SGPS.

Thus the Decision of the Constitutional Court above when it decided "Not to declare unconstitutional the norm contained in article 31.º, no. 2, of the Tax Benefits Statute, in the wording given by Law no. 32-B/2002, of 30 December, insofar as it imposes the fiscal non-deductibility of financial charges borne with the acquisition of capital shares as soon as they are incurred, regardless of the realization of capital gains exempt from taxation on the alienation of such capital shares".

B.2. On the application of Circular no. 7/2004, of 30 March

Within the scope of article 32.º, no. 2 of the Tax Benefits Statute, and the difficulties of its practical application, the TA felt the need to publish a circular, which aimed to clarify the form of distribution of financial charges, taking into account the way in which financing was allocated that originated those charges, considering its application, that is, the assets that had been acquired through those resources by SGPS. In this sense, the Circular does nothing more than densify the provision of no. 2 of article 32.º, making it possible to overcome the practical difficulties of direct allocation of charges.

The Claimant challenges the legal role of this circular, alleging that the TA did not merely interpret no. 2 of article 32.º of the Tax Benefits Statute, but created a substitute method for the method provided for in the legal provision. In this sense, the norms contained in points 7. and 8. of DSIRC Circular no. 7/2004, of 30 March, more specifically the formula that is provided there, with the claim of mandatory application, of segregation of financial charges referred to in (at the time of the facts) article 31.º, no. 2, of the Tax Benefits Statute (current article 32.º, no. 2), is unconstitutional, by violation of the principle of legality or of legislative reserve, in tax matters, provided for in article 103.º, no. 2, and 165.º, no. 1, paragraph i), of the CRP.

Being so, it is important, first, to assess the exact scope of the Circular and, then, given the legal role that falls to Circulars, conclude whether the principle of legality was violated or not.

Let us examine, first, how Circular no. 7/2004, of 30 March, interpreted this provision.

No. 7 states that "given the extreme difficulty of using, in this matter, a method of direct or specific allocation and the possibility of manipulation that the same would allow, such allocation should be effected on the basis of a formula that takes into account the following: the remunerated liabilities of SGPS and SCR should be allocated, first, to the remunerated loans granted by these to the subsidiary companies and to other interest-bearing investments, with the remainder being allocated to other assets, namely equity interests, proportionally to their respective acquisition cost".

Thus, what is at issue in no. 2 of article 32.º of the Tax Benefits Statute, and which is intended to be clarified, is the admission of an indirect calculation formula that allows taxpayers to determine the possible distribution of total financial charges borne, between deductible and non-deductible financial charges for tax purposes, in an SGPS. This results from the fact that there is not, as a rule, a direct factual relationship between the total funds obtained by the SGPS, and which involved the payment of interest, and the funds invested in the acquisition of equity interests.

The Administration understood to clarify the way to estimate the charges that can be allocated to the acquisition of those capital shares, through Circular 7/2004, based on the idea of the fungibility of money. It advances in this circular the adoption of a very simple mathematical formula - although complicated from the point of view of the assumptions used in the classification of the items to be considered -, in order to determine, in the application of art. 32.º, no. 2, of the Tax Benefits Statute, which are the "financial charges borne" with the acquisition of capital shares, in relation to the total financial charges borne by the entity in the accounting period, given that the tax legislator chose its fiscal disregard for purposes of determining the taxable profit of each economic period.

Does the method enshrined in the Circular constitute a violation of the provision of no. 2 of article 31.º of the Tax Benefits Statute?

In a question similar to that raised by the Claimant, in the context of process no. 21/2012-T, where the appellant questioned the constitutional conformity of the application of a pro rata formula in determining the financial charges associated with the acquisition of equity interests, excluded from the formation of taxable profit, by opposition to the method of direct or actual allocation, it was decided, to this effect:

"63. Still, it will always be said that, agreeing with the hermeneutics defended by the Claimant, nothing in the letter of no. 2 of article 31.º of the Tax Benefits Statute allows the withdrawal of the validity and, therefore, the necessary application, of the indirect method of allocation of such financial charges.

1. It is considered that in cases where there is the possibility of direct allocation, it should not be set aside, that if the ratio legis of the norm provided for in no. 2 of art. 31.º of the Tax Benefits Statute, aims to safeguard the validity of a regime of neutrality of revenues and costs associated with capital gains excluded from taxation, ensuring that revenue not fiscally relevant must correspond, correspondingly, cost that is associated with it also fiscally irrelevant, then, being so, for to achieve such objective, any method (direct or indirect) is good once the safeguard of the said ratio legis is ensured.

(…)

On the other hand, the Claimant understands that Circular no. 7/2004, of 30 March used by the Tax Administration to proceed with the correction under examination, goes beyond mere interpretation of tax law, having no basis in article 31.º, no. 2 of the Tax Benefits Statute.

Let us see.

The relevance of administrative instructions of the TA has already been the subject of in-depth study and pronouncement by doctrine and jurisprudence.

Without the concern of an exhaustive inventory, we cite the summary present in Decision no. 563/2009, of the Constitutional Court, in which the following is stated:

Now, a frequently raised problem in tax law is that of the normative relevance of the so-called administrative guidelines. As Casalta Nabais says, Tax Law, 5th ed., p. 2001 (although stating that this does not remove their quality as legal norms):

"[…] internal regulations which, as they are intended only for the tax administration, only it should obey them, being, therefore, binding only for the organs situated hierarchically below the organ that issued them.

For this reason they are binding neither on individuals nor on the courts. And this is whether they are organizational regulations, which define rules applicable to the internal functioning of the tax administration, creating working methods or modes of action, or whether they are interpretative regulations, which proceed to the interpretation of legal (or regulatory) provisions.

It is true that they densify, clarify or develop legal provisions, previously defining the content of the acts to be performed by the tax administration in their application. But this does not convert them into a standard of validity of the acts they support. In fact, the assessment of the legality of acts of the tax administration must be effected through direct comparison with the corresponding legal norm and not with the internal regulation, which was interposed between the norm and the act".

These acts, in which "circulars" stand out, emanate from the power of self-organization and the hierarchical power of the Administration. They contain generic service orders and it is therefore and only within their subjective scope (of the hierarchical relationship) that they are assured of compliance. They incorporate future action guidelines, transmitted in writing to all subordinates of the administrative authority that issued them. They are modes of standardized decision-making, assumed to rationalize and simplify the functioning of services. Although they may indirectly protect the legal security of taxpayers and ensure equal treatment through uniform application of the law, they do not regulate the matter they concern in confrontation with these, nor do they constitute a rule of decision for the courts.

The fact that the Tax Administration is bound (no. 1 of article 68.º-A of the General Tax Law) by the generic guidelines contained in circulars in effect at the time of the tax fact and that it has the duty to proceed with the conversion of binding information or other type of understanding provided to taxpayers into administrative circulars, in certain circumstances (no. 3 of article 68.º of the General Tax Law), does not alter this perspective because it does not transform this content into a norm with external efficacy. It is true that the administered party can invoke, in confrontation with the administration, the content of the publicized administrative guidance and, if appropriate, make it prevail before the courts, even at the expense of the principle of legality (cfr. Diogo Leite de Campos, Benjamim Silva Rodrigues and Jorge Lopes de Sousa, General Tax Law, commented and annotated, 3rd ed., p. 344). But it is under the principle of good faith and legal security, not by its normative value, that the content of the circulars prevails. The administered party only complies with them if and to the extent that it suits them, for the same reasons that justify that they can invoke individual binding information that favors them (article 59.º, no. 3, paragraph e) and article 68.º of the General Tax Law).

Consequently, lacking heteronomous binding force for individuals and not imposing itself on the judge except by the doctrinal value it may possess, the prescriptions contained in "circulars" of the Tax Administration do not constitute norms for purposes of the system of control of constitutionality of the competence of the Constitutional Court."

Also on this matter and as contained in the aforementioned decision of the CC:

The "circulars" emanate from the power of self-organization and the hierarchical power of the Administration. They contain generic service orders and it is therefore and only within their subjective scope (of the hierarchical relationship) that they are assured of compliance. They incorporate future action guidelines, transmitted in writing to all subordinates of the administrative authority that issued them. They are modes of standardized decision-making, assumed to rationalize and simplify the functioning of services. Although they may indirectly protect the legal security of taxpayers and ensure equal treatment through uniform application of the law, they do not regulate the matter they concern in confrontation with these, nor do they constitute a rule of decision for the courts."

Also Soares Martinez (1993)[6] confirms this nature to the circulars and instructions by stating that they are directed to "(…) the officials of the Directorate General of Contributions and Taxes, only bind those same officials, and by reason of their duty of hierarchical obedience. Such diplomas are not directed at individuals, citizens, taxpayers". Also in the same sense see Alberto Xavier (1974)[7].

The jurisprudence of the Supreme Administrative Court and the Central Administrative Courts have been following this same line[8]. See, by way of example, what is stated in the Decision of the Central Administrative Court of the South, Process no. 02312/08, in which it is stated: "the Circular beyond being illegal for lack of legal authorization to extensively interpret rules of tax incidence, would be illegal, for abusive distortion of community norm and its illegal transposition. In this sense, also the said Circular, in limiting the rule of incidence would be unconstitutional by violation of the provision of article 165.º, no. 1, paragraph i) and article 103.º, no. 2, of the Constitution of the Portuguese Republic, violating the principle of separation of powers. By that route, the administration had usurped the functions of the legislator.

Thus, the Claimant understands that Circular no. 7/2004, of 30 March used by the Tax Administration to proceed with the correction under examination, goes beyond mere interpretation of tax law, having no basis in article 31.º, no. 2 of the Tax Benefits Statute.

We recall that no. 2 of article 31.º (current 32.º) determines that:

Capital gains and losses realized by SGPS and by SCR by means of onerous transmission, whatever the title by which it is effected, of capital shares of which they are holders, provided they are held for a period of not less than one year, as well as financial charges borne with their acquisition, do not concur towards the formation of the taxable profit of these companies (our emphasis).

That is, capital gains and losses realized with the onerous transmission of capital shares are not taxed, provided they are held for a period of not less than one year, as well as the financial charges borne with the acquisition of these equity interests.

From the foregoing, it follows that the legislator considers that only charges directly borne with the acquisition of capital shares are excluded from taxation. On the other hand, the legislator did not consider instituting a different criterion which, given the real practical difficulties of distinction, would make it possible to ascertain, albeit indirectly or by estimate, the financial charges with the acquisition of the equity interests exempt.

It is worth noting that there is no omission in no. 2 of article 31.º of the Tax Benefits Statute as to the definition of the charges that are not subject to taxation: those borne with the acquisition of equity interests. Not existing a legal presumption[9] or an alternative method that allows, in a simple way, to estimate these charges, it will be incumbent, in concreto, to clarify and establish the nexus/relationship between the financial charge and the acquired equity interest. This is the meaning of the law.

Thus, the method applied by the Circular violates the provision of no. 2 of article 31.º of the Tax Benefits Statute, as it does not address the charges actually borne with the acquisition of non-taxed equity interests, but approximate values and presumptions that lack legal foundation. Indeed, the application of the formula provided in the Circular does not allow one to perceive which charges were borne with the acquisition of non-taxed equity interests, but to establish a proportional allocation among the set of remunerated liabilities and loans to subsidiaries and the remainder that finances other assets (including equity interests), from which results an estimate of the charges (which may or may not correspond to actual charges).

Moreover, as decided in the Decision of CAAD of 21/12/2012, Proc. 24/2012, "Circular no. 7/2014, in setting criteria and methods, through which the incidence of tax is verified, is, insofar as its application has external efficacy, namely in corrective tax assessments, unconstitutional, by violation of the principle of legality embodied in article 103.º, and the formal legislative reserve contained in article 165.º, no. 1 paragraph i), both of the Constitution. This notwithstanding the mere illegality that would always result from the comparison between that Circular and article 8.º of the General Tax Law".

In the same sense, the Decision of the Central Administrative Court of the North, of 15 January 2015, Proc. 00946/09.0BEPRT, pronounced itself:

"The fact that in its methodology it used the criteria recommended in circular no. 7/2004, of 30 March, in particular its points no. 7 and 8 does not save the legality of the operation, as the criteria and assumptions for allocation of remunerated liabilities of SGPS go far beyond the content of art. 31º/2 of the Tax Benefits Statute creating presumptions and proportional calculations that the legislator clearly did not assume or consent to.

As Júlio Tormenta emphasizes[10]: «A question that arises regarding the provision in art. 32.º of the Tax Benefits Statute in its no. 2 and 3 is how to determine or which are the financial charges directly related to the acquisition of equity interests (most of them consisting of current interest on debt service relating to a loan or other form of credit used by the SGPS to acquire equity interests) from those that are used by the SGPS in the pursuit of its purpose that has nothing to do with the acquisition of equity interests.

The tax administration has been arguing that this allocation should be made in respect of the "principle of financial balance" (cf. the Official Notice of 1 September 2003 of the Director-General of Corporate Income Tax Services), which advises that an asset be financed with capital of maturity compatible with the economic life of that asset and capacity to generate monetary means.

For the tax administration financial charges should be allocated on the basis of a formula that takes into account the following: remunerated liabilities of SGPS should be allocated, first, to remunerated loans granted by these to the subsidiary companies and to other interest-bearing investments, with the remainder being allocated, directly and automatically, to other assets, namely equity interests, proportionally to their respective acquisition cost.

In Portugal the principle of legality prevails having as a corollary according to classical doctrine the principle of closed typicality being the matter of tax incidence of relative legislative reserve of the National Assembly. In the present case the law does not establish criteria for allocation of financial resources to the acquisition of equity interests and the tax administration cannot, through administrative means, create norms of incidence (through the so-called "circulatory law"), under penalty of being faced with a material unconstitutionality, since such norms must emanate from law (of the National Assembly) or Decree-Law (of the Government) duly authorized.

Taxpayers are not obliged to follow the procedures set out in Circular 7/2004 of 30.3.2004 (hereinafter designated by circular 7/2004) since only the tax officials under their supervision are bound by them and nothing more.

We cannot agree with what is stated in Circular 7/2004 in its point 7 where it states "given the extreme difficulty of using, in this matter, a method of direct or specific allocation and the possibility of manipulation that the same would allow": due to the development and sophistication of management information systems available on the market, the direct allocation method should be favored and only in the impossibility of using the same; it is that one would advance as an alternative method the one recommended in Circular 7/2004»

If the legislator did not institute any criterion that makes it possible to distinguish in the total financial costs of SGPS which are due to the purchase of equity interests and which were used for other purposes, the ATA could only move within the scope of a method that respected direct or specific allocation, because only this would be compatible with the principle of legality and impartiality to which it is subject (art. 55º General Tax Law) and which results from the wording of art. 31º/2 Tax Benefits Statute in excluding from the formation of taxable profit the financial charges borne with the acquisition of the equity interests alienated. By referring to charges borne the law clearly circumscribes – in our view – that only these (determined specifically and directly) are excluded from taxation (this is also the interpretation adopted in the learned opinion of the Honorable Attorney General at the Supreme Administrative Court handed down on fls. 849 and following: «…Now, it follows from the letter and spirit of the said normative that only charges borne with its acquisition do not contribute to the formation of taxable profit. The criterion to be taken into account for the determination of the financial charges seems to be only the criterion of direct or actual allocation/assignment and not the indirect criterion sanctioned by Circular 7/2004. A supposed practical impossibility in distinguishing the financial charges actually borne with the acquisition of capital shares, from the remaining charges, unless we are mistaken, cannot serve as a basis for the use of a criterion that seems to have no legal support…»

However, admitting that it is not possible from the company's records to know the purpose for which the financing was obtained, this could call into question legal control by the ATA. But even if this is the case, the ATA cannot complete the norm through a circular that institutes a system of proportional, indirect, or presumptive calculation, creating conditions more burdensome for the taxpayer than those provided in the law, disrespecting the normative framework in force. With this interpretation, circular 7/2004 proposes to complete the norm of art. 31º/2 Tax Benefits Statute creating a calculation mode different from that of direct and specific allocation of remunerated liabilities of SGPS that the legislator did not contemplate and which drastically exceeds mere interpretation of the norm."

It is now important to assess, in concreto, the legality of the act of additional assessment subject to this challenge.

In the inspection report, the Respondent substantiates and justifies the fiscal correction by stating that "In fiscal year 2009 the company did not add to the N.R.E. of the fiscal year the charges allocable to capital shares." In the response and allegations presented before this tribunal, it further states that the correction "originates from the absolute omission of quantification on the part of the Claimant of financial charges allocable to equity interests held by it in the income declaration for the period in question" (article 57.º of the Response), as well as from the "subsequent absence of provision of clarifications or information." (article 58.º of the Response).

Thus, facing the alleged lack of information from the taxpayer, the Respondent proceeds to apply the method provided in Circular no. 7/2004, of 30 March, using, for this purpose, the information contained in the analytical trial balance and the Financial Information System.

Now, from the analysis of the administrative process and the inspection report it results that, faced with the non-existence of any fiscal correction in model 22 declaration of charges allocable to equity interests that do not concur to taxable profit, the TA presumed its omission and proceeded to the determination of the respective charges through the method provided in Circular no. 7/2004.

Without prejudice to the judgment of the legality assessment of the method used, it should be made clear that it was incumbent on the TA to prove the prerequisites of the fiscal correction carried out, namely the existence of financial charges not taxed with the acquisition of capital shares.

First, the non-existence of fiscal corrections in model 22 declaration does not mean, per se, that there was an omission or error of the taxpayer, but only that there are no financial charges not accepted for tax purposes, given the presumption of truthfulness and good faith of the taxpayer's declarations (article 75.º of the General Tax Law). In fact, upon consultation of the administrative process, it appears that a representative of the taxpayer, in response to a request for information from the TA prior to the undertaking of the inspection procedure, states that "Nevertheless, according to the information available to me, A... SGPS will not have borne financial charges with financing specifically intended for the acquisition of capital shares…" (p. 146).

Existing indications that this declaration did not correspond to the truth, it was incumbent on the TA to demonstrate and prove the existence of non-deductible financial charges, pursuant to no. 1 of article 74.º of the General Tax Law, which did not occur.

On the contrary, instead of proof, and despite the Claimant having made financial investments (acquisition of capital shares or establishment of new companies) during 2009, the TA merely proceeded to correct a certain amount of financial charges, without taking care to prove the existence of the factual prerequisites of its action.

Next, as we concluded above, by applying the method provided in paragraph 7 of Circular no. 7/2004, of 30 March, the TA violated the provision of no. 2 of article 32.º of the Tax Benefits Statute, which provides for the non-deductibility of financial charges of charges actually borne with the acquisition of capital shares.

C. DECISION

For these reasons, this Arbitral Tribunal decides:

a) To declare the petition for declaration of illegality of the additional assessment of Corporate Income Tax no. 2013 …, of 5 December 2013, which resulted in the reduction of the tax loss determined in 2009 to the value of € 555.998,06, to be well-founded;

b) To condemn the Respondent to pay the costs of the proceedings, in the amount of € 11.016.00, taking into account what has already been paid.

D. Value of the Proceedings

The value of the proceedings is set at € 768.976,42, pursuant to article 97.º-A, no. 1, a), of the Tax Procedure Code, applicable by virtue of paragraphs a) and b) of no. 1 of article 29.º of the RJAT and no. 2 of article 3.º of the Regulation of Costs in Tax Arbitration Proceedings.

E. Costs

The arbitration fee is set at €11.016,00, pursuant to Table I of the Regulation of Costs of Tax Arbitration Proceedings, to be paid by the Respondent, since the petition was fully well-founded, pursuant to articles 12.º, no. 2, and 22.º, no. 4, both of the RJAT, and article 4.º, no. 4, of the said Regulation.

Notify the parties.

Lisbon

21 May 2015

The President Arbitrator

(Jorge Lopes de Sousa)

Arbitrator Member

(Amândio Silva)

Arbitrator Member

(Ana Maria Rodrigues)

[1] Júlio Tormenta, Companies Managing Equity Interests as a Fiscal Planning Instrument and Its Limits, 2011, pp. 73 to 95.

[2] Decree-Law no. 495/1988, of 30 December.

[3] This provision corresponds to current no. 2 of article 32.º of the Tax Benefits Statute, by virtue of the re-publication carried out by Decree-Law no. 108/2008, of 26/06.

[4] Now, in SNC, designated as "financial investments".

[5] LUÍS GRAÇA MOURA, The "new" Taxation of the Income of SGPS: Reflections on Capital Gains Taxation within the Framework of the Principle of Legal Security, in Legal Journal of the Portucalense University Infante D. Henrique, no. 10, March 2003, p. 122.

[6] Soares Martinez, Tax Law, Coimbra, 1993, p. 111.

[7] Alberto Xavier, Manual of Tax Law, Lisbon, 1974.

[8] See, by way of example, the Decisions:

• Supreme Administrative Court of 14 June 1995, process no. 18.297;

• Supreme Administrative Court of 15 November 1995, process no. 19.451.

[9] As suggested by the Opinion of the Tax Studies Center, Opinion no. 42/2003, of 17 June, cited by the Claimant.

[10] Júlio Tormenta, Op. Cit., 2011, p. 145.