CAAD 738/2015-T: Deduction of Financial Charges in SGPS and Fair Value of Financial Assets under IRC

ARBITRAL DECISION

The arbitrators, Counsellor Judge José Baeta de Queiroz as Arbitrator-President, Prof. Doctor António Martins and Dr. Luís M. S. Oliveira as Arbitrator-Members, appointed by the Ethics Council of the Centre for Administrative Arbitration to form the Arbitral Tribunal, agree on the following:

A... – SGPS, S.A., with the sole registration number and collective person number ..., with registered office at ..., … (Claimant), submitted a request for arbitral ruling with a view to declaring the illegality of the Corporate Income Tax (IRC) assessment act no. 2015 ..., relating to the 2011 tax year, in which it was determined to have a corrected tax loss of EUR 1,178,132.40, with all other legal consequences. It further petitions for the condemnation of the Tax Authority (AT) to pay the costs of litigation.

The Tax and Customs Authority (AT) submitted a Response, arguing that the request for arbitral ruling should be ruled unfounded.

By order of the Arbitrator-President: (a) the meeting provided for in paragraph 1 of article 18 of the Legal Regime for Tax Arbitration (RJAT) was dispensed with, (b) witness testimony was dispensed with, as the testimony was considered unnecessary, given that the parties' arguments reveal that their disagreement is based on the application of law, with no controversy over the facts; (c) the Parties were notified to submit written arguments if they so wished.

The arbitral tribunal was regularly constituted and is materially competent, in accordance with the provisions of subparagraph a) of paragraph 1 of article 2 and paragraph 1 of article 30 of the RJAT.

The parties have legal standing and capacity, are legitimately interested and are properly represented [article 4 and paragraph 2 of article 10 of the RJAT, article 1 of Ordinance no. 112-A/2011, of 22 March, and paragraph 1 of article 6 of the Code of Tax Procedure and Process (CPPT), applicable ex vi subparagraph c) of paragraph 1 of article 29 of the RJAT].

The proceedings do not suffer from any defects in form.

A – STATEMENT OF FACTS

Based on the documentary evidence contained in the proceedings and in the absence of controversy between the parties, the following facts are considered proven:

a) Following Service Order OI2014..., the Claimant was subject to an external general tax audit in the Corporate Income Tax sphere for the 2011 tax year, having been notified on 14 January 2015 of the respective Tax Audit Report (RIT), which is hereby reproduced;

b) According to the RIT, the Tax Audit Services made corrections to the tax loss of EUR 9,821,291.30 declared by the Claimant in the substitute income declaration Form 22 of the Corporate Income Tax for the 2011 tax year;

c) The corrections made by the Services amount to the total sum of EUR 8,643,158.90 and arise from the fact that the services understood that:

(i) the Claimant should have added back the financial charges related to the acquisition of equity interests, which are non-deductible pursuant to paragraph 2 of article 32 of the Tax Benefits Statute (EBF) (2011 version), in the amount of EUR 4,462,610.50;

(ii) the fair value losses recorded as expenses for the period, in the total amount of EUR 6,922,268.40, should contribute to the formation of taxable profit only in half of their value and not in their entirety (as done by the Claimant), so an increase of EUR 3,461,134.20 should be made; and

(iii) the fair value losses deducted from the amount of the positive capital variation arising from the transition adjustment, resulting from the change in the measurement of financial instruments held for trading – previously measured at acquisition cost in accordance with the POC accounting standard and which came to be measured at fair value through results, as a consequence of the approval of the SNC accounting standard – should contribute to the determination of transition adjustments only in half of their value, implying a correction in the amount of EUR 719,414.20.

d) The Claimant was notified of the Corporate Income Tax assessment no. 2015 ..., dated 28 January 2015, relating to the 2011 tax year, through a demonstration of assessment, a copy of which was submitted as exhibit 1, hereby reproduced, in which the tax loss determined by it in Form 22 was corrected from EUR 9,821,291.30 to EUR 1,178,132.40.

e) In summary (EUR):

Declared tax loss: - 9,821,291.30
Financial charges not accepted: 4,462,610.50
Fair Value – losses not accepted: 3,461,134.20
Positive capital variations: 719,414.20
Total corrections: 8,643,158.90
Corrected tax result: - 1,178,132.40

f) The Claimant did not accept the corrections and submitted an appeal for administrative review, which was processed at the Finance Department of ... under number ...2015..., and was dismissed by order dated 03.09.2015, which is hereby reproduced.

g) The Claimant was, in the 2011 tax year, a holder of equity interests (shares) in certain companies. In the present case, the shareholdings that generated the fair value adjustments at issue in the proceedings were less than 5%. These shares were listed on the Stock Exchange, and their price was formed in a regulated market.

h) Until 31 December 2009, the aforementioned shares were recorded at historical cost, in accordance with the accounting standard in force at that same date: the POC. After the approval and entry into force of the SNC, the shares held and listed on the Stock Exchange came to be recorded for accounting purposes at fair value.

i) Upon the transition to the SNC, for purposes of preparing the opening balance sheet, the Claimant determined a negative capital variation in the total amount of EUR 7,242,226.78 and a positive capital variation in the total amount of EUR 9,824,403.25.

j) Such variations were reflected in equity accounts of the company, namely in account 53, and resulted from the difference between the acquisition value of the shares listed on the Stock Exchange that the Claimant held and their official quotation (market price).

k) From the difference between the positive capital variation and the negative capital variation resulted a net positive capital variation in the total amount of EUR 2,582,176.47.

l) The Claimant indicated in table 07 of the Corporate Income Tax Form 22 income declaration for the 2011 tax year the amount EUR 516,435.29, that is, 1/5 of that amount, as shown in the following table:

m) The AT understood that the negative capital variation would be deductible for tax purposes only in half of its amount, so the positive capital variation indicated above should be increased by EUR 719,414.20.

n) Additionally, in view of the price variations that occurred in the shares held by the Claimant on 31 December 2011, it, in the 2011 tax year, recorded as an expense for the period fair value variations in the total amount of EUR 6,922,268.40. With respect to this expense, the AT understood that 50% of its amount should not contribute to the formation of taxable profit.

o) As the basis for these corrections, the AT applied paragraph 3 of article 45 of the Corporate Income Tax Code (in the version in force at that date), insofar as it provided that "losses or negative capital variations relating to equity interests or other components of equity, namely supplementary contributions, contribute to the formation of taxable profit only in half of their value".

No other facts of interest for the decision were proven.

B – STATEMENT OF LAW

B-1 – Regarding the Correction relating to financial charges incurred with the acquisition of equity interests

I – CLAIMANT'S POSITION

1. The Claimant does not accept the correction relating to financial charges incurred with the acquisition of equity interests, in the amount of EUR 4,462,610.50, and invokes, in summary as presented herein, seeking to systematize a statement that is quite repetitive and redundant, extended throughout 492 articles of its initial pleading, the following:

1.1. Illegality and unconstitutionality of the 'tax incidence rule created by Circular no. 7/2004'. Illegality of the correction, as it is based on the application of the Circular.

The legislator did not provide for the regulation of the regime provided for in paragraph 2 of article 32 of the Tax Benefits Statute (EBF), so as to establish in the law a method for determining the amount of financial charges that are not deductible for tax purposes, when it is impossible to specifically identify the financing obtained and the corresponding financial charges with the acquisition of equity interests. In the absence of such a method being properly regulated in the law, paragraph 2 of article 32 of the EBF cannot be applied, under penalty of violation of the principle of tax legality [articles 55 of the General Tax Law (LGT), subparagraph i) of paragraph 1 of article 165 and paragraph 2 of article 266 of the Constitution of the Portuguese Republic (CRP)].

Circular no. 7/2004, in which the AT sought to clarify a method of allocation of financial charges to the acquisition of equity interests, based on a formula by which the remunerated liabilities of SGPSs must be imputed firstly to remunerated loans granted by these to the companies in which they hold interests and to other investments generating interest, allocating the remainder to other assets, namely shareholdings, proportionally to their respective acquisition cost, does not have a legally binding character for taxpayers, as it is not law.

Besides being illegal due to lack of authorization to fill legislative gaps in matters of tax incidence (paragraph 2 of article 103 of the CRP), Circular no. 7/2004 is unconstitutional and illegal due to the abusive distortion of the principles underlying taxation by actual income and respect for taxpaying capacity (paragraph 2 of article 104 of the CRP and paragraph 1 of article 4 of the LGT), insofar as it advocates a fictional or indirect determination of financial charges that are not deductible, at the expense of a specified determination of those same charges – thus departing from the provisions of paragraph 2 of article 32 of the EBF.

1.2. Defect of lack of reasoning

The AT does not specify which concrete financing operations obtained are assigned to the acquisition of the shareholdings transmitted; it does not specify which concrete shareholdings were acquired, or which concrete equity acquisition operations were carried out with those financing operations; it omits any reference to the periods of holding of the shareholdings; it omits whether or not there were special relationships; it omits whether or not the sellers were based in territory subject to a more favorable tax regime; it omits whether or not the sellers of the shareholdings were subject to a special taxation regime.

1.3. Defect of lack of proof by the AT of the factual requirements for the corrections and disregard of the inquisitorial principle and discovery of material truth

It was the AT's responsibility to prove that the Claimant, in the 2011 tax year, incurred the alleged financial charges with financing obtained intended for the acquisition of shareholdings, as well as to ascertain whether these remained in its ownership for a period of no less than one year.

The correct application of paragraph 2 of article 32 of the EBF requires that it be read together with paragraph 3 and that it be ascertained whether equity interests were, or were not, acquired from companies with which there were special relationships, or whether they were acquired from residents in Portuguese territory subject to a special taxation regime and whether they remained, in any case, in the seller's ownership for less than 3 years.

The AT did not respect the inquisitorial principle and discovery of material truth, since it made corrections based on mathematical formulas invented by itself, based on mere proportions and allocation.

1.4. Illegality of application of an indirect method of determining taxable matter

Circular no. 7/2004 establishes the application of an indirect method of determining taxable matter, which is only permitted subsidiarily and exceptionally under the circumstances legally provided for in articles 87 and 88 of the LGT, which are the only circumstances that authorize the AT to resort to indirect methods of determining taxable matter.

1.5. Defect of lack of notification for the right to prior hearing with respect to the application of an indirect method

Given that the determination of taxable matter by indirect methods is at issue, the Claimant should have been notified, pursuant to subparagraph d) of paragraph 1 of article 60 of the LGT, to exercise the right to prior hearing regarding the application of this form of assessment.

1.6. Violation of the principles of taxpaying capacity, actual income taxation and substantive justice

The AT should have computed the correction only if and to the extent that the financial charges recorded were effectively related to the acquisition of shareholdings (held for more than one year) sold in 2011 and generating gains or losses realized in that same year and not subject to taxation in 2011.

Taxation should be done in accordance with the effective taxpaying capacity revealed by the accounting records, and the Claimant's accounting records do not reveal any financial charges related to the acquisition of equity interests.

1.7. Violation of the principle of specialization of tax years

There is no legal basis for the correction of financial charges to be made at a time when the requirements provided for in paragraphs 2 and 3 of article 32 of the EBF have not yet been fulfilled, as it is only at the moment when the shareholdings are sold that one knows whether or not the shares were held for a period of no less than one year, which represents a violation of the principle of specialization of tax years.

1.8. Material unconstitutionality of paragraph 2 of article 32 of the EBF, due to violation of the principle of proportionality and equality

Paragraph 2 of article 32 of the EBF constitutes an exceptional norm, with content that is onerous and unfavorable to the taxpayer, in negative discrimination of SGPSs compared to the generality of economic agents, in violation of the principle of equality. The stable holding of shareholdings representative of a significant part of the capital stock of the companies in which they hold interests constitutes the fundamental activity of SGPSs; therefore, the acquisition costs of the shareholdings must be relevant for the income statement, since the possible counterparts will be not only the gains or interest received from financing granted to companies in which they hold interests, but also dividends, these being income that adjust and are appropriate for a long-term participation relationship.

Paragraph 2 of article 32 of the EBF penalizes SGPSs doubly, both by the tax disregard of financial charges and by the tax disregard of losses realized with the sale of shareholdings, which violates the general principle of tax neutrality.

Paragraph 2 of article 32 of the EBF, by providing for the non-deductibility of financial charges, alongside the tax non-deductibility of losses, suffers from material unconstitutionality, due to violation of the principle of proportionality and equality, given the unjustified restriction of rights and unfounded discrimination against SGPSs.

II – RESPONDENT'S POSITION

2.1. Illegality and unconstitutionality of the 'tax incidence rule created by Circular no. 7/2014'. Illegality of the correction, as it is based on the application of the Circular.

As paragraph 2 of article 32 of the EBF does not determine the method for the allocation of financial charges, and with a view to interpreting and complying with the law – whose scope is to penalize interest related to the acquisition of equity interests and to ensure a regime of neutrality of expenses and income – it is necessary to conclude that any method, whether direct or indirect, that allows achieving the purpose and objective of the rule must be accepted as valid.

There is no illegality in the application of paragraph 2 of article 32 of the EBF in the formula contained in Circular no. 7/2004, even if it is not possible for the AT and the taxpayer to proceed with a specific or direct allocation, given that any method (direct or indirect) is good, provided the ratio legis of the rule is respected. Otherwise, there would be a risk of giving tax relevance to financial charges while at the same time exempting the gains that resulted from the sale of the shareholdings, which would violate the principle of tax neutrality and would lead to a solution contra legem (this would not be the case only if the law established a solution – which does not exist – that stipulated that, if taxpayers cannot demonstrate direct allocation, they could not benefit from the exemption of gains from equity interests that they come to sell).

It is not Circular no. 7/2004 that creates rules of incidence, but it is the law itself that excludes the deductibility of financial charges incurred with financing linked to the acquisition of the shareholdings sold and which generate, even if potentially, gains excluded from taxation, for purposes of determining the taxable profit for the year in which they are incurred.

The alleged violation of the principle of legality contained in paragraphs 2 and 3 of article 103 of the CRP is unfounded, insofar as the Circular did not alter or distort the legal provision of paragraph 2 of article 32 of the EBF.

The Constitutional Court, in Decision no. 42/2014, of 9/01/14, did not consider the question of the possible unconstitutionality of Circular no. 7/2004 because it is not a legal norm, but merely an administrative interpretation, whose constitutionality is therefore not subject to review by that Court: "we do not find grounds to affirm the parametric relevance of the normative sense adopted by the Tax Authority and expressed in the aforementioned circular, in terms of supporting the formation of binding effects on individuals ( …) and, above all, which constitute a criterion or normative standard for the jurisdictional actions of the Courts, when called upon to assess disputes in their respective field of action (see Jorge Miranda, Manual of Constitutional Law, Volume V, 4th edition, 2009, p.226)".

2.2. On the defect of lack of reasoning

It was the Claimant who did not want or could not proceed with a direct allocation between loans obtained and equity interests that it acquired. Such impossibility of direct allocation legitimizes indirect allocation based on the principle of tax neutrality, intrinsic to the tax benefit contained in paragraph 2 of article 32 of the EBF. The AT not only could but should apply this method of indirect allocation, proceeding with the application of the allocation method, in accordance with the provisions of Circular no. 7/2004.

The reasoning contained in the Tax Audit Report, which supports the corrections, is sufficient, clear and congruent, given that, taking into account the values recorded in the account of assets, liabilities and expenses and, invoking paragraph 2 of article 32 of the EBF, it refers to the formula contained in the Circular, which is properly reasoned therein and even exemplified, presenting thereafter the mathematical calculations made in the specific case.

The objectives sought with the reasoning were fully achieved, since the Claimant demonstrates complete knowledge of the reasoning of the act, having been fully capable of opposing it, both as regards the legal reasoning and as regards the facts that it chose not to contest (as indeed already occurred at the audit stage and in the appeal for administrative review).

2.3. Defect of lack of proof by the AT of the factual requirements for the corrections and disregard of the inquisitorial principle and discovery of material truth

As the application of a tax benefit is at issue, it is the Claimant who bears the burden of proving the facts necessary to enjoy the benefit (articles 14 and 74 of the LGT).

The regime of neutrality underlying the application of the benefit implies that gains cannot be disregarded if the costs associated with their obtaining are not likewise disregarded (paragraph 2 of article 32 of the EBF). The Claimant did not add to the net result for the year the financial charges attributable to equity interests, as it was required to do by article 32 of the EBF, in the version applicable at the date of the facts, and in the absence of any other information provided by the Claimant on this matter a correction was proposed through a calculation, which is contained in Annex 1 to the draft Report, and which took into account, in particular, the values recorded by the claimant in the account of assets, liabilities and expenses for the 2011 tax year, having determined the value of EUR 4,462,610.50, relating to financial charges attributable to the equity interests identified in the same Annex 1.

The Claimant did not exercise the right to hearing when notified of the draft Report and did not provide any additional clarifications, nor contested the merit or validity of the calculations made, nor provided the AT with any data on the specific or direct allocation of financial charges to the shareholdings, even admitting that it was unable to do so.

Even if, hypothetically, it were understood that there was no burden of proof on the Claimant, it would be meaningless for the AT to have to prove elements that must come from documents of the Claimant and which, if they exist, it does not mention or does not enable the AT's knowledge thereof, which would make proof impossible or impractical. As Lebre de Freitas teaches, the behavior of the non-cooperative party can determine, in accordance with paragraph 2 of article 344 of the Civil Code, the reversal of the burden of proof, when its attitude makes it impossible to prove the fact, at the charge of the other party, "because it is not possible to achieve it with other means of proof, either because the law prevents it (…), or because concretely other means produced are not sufficient for that purpose (…)". Impossible proof is proof that violates the principle of prohibition of defenselessness and attributing such proof to the AT would be unconstitutional, in particular due to violation of article 20 of the CRP.

2.4. On the illegality of application of an indirect method of determining taxable matter

As one is in the scope of application/control of a tax benefit, it does not make sense to speak of the application of an indirect method, as it is established in articles 85 and 87 of the LGT, since the application of an indirect method aims at the determination of the taxable matter of any tax, and, in the case of financial charges, the total determination of taxable matter is not at issue but only the calculation of a specific cost that is intended to be excluded from the determination of taxable matter taking into account the purpose of neutrality between income and costs sought by the tax benefit.

2.5. On the defect of lack of notification for the right to prior hearing with respect to the application of an indirect method:

The defense is implicit in the AT's rejection that one is faced with the application of an indirect method, as well as in the allegation that the Claimant did not exercise the right to hearing when notified of the draft Report, from which the application of the negative condition contained in the final part of subparagraph d) of paragraph 1 of article 60 of the LGT follows: "when there is no tax audit report".

2.6. On the violation of the principles of taxpaying capacity, actual income taxation and substantive justice:

Again relying on Decision no. 42/2014 of the Constitutional Court on the matter of non-deductibility of financial charges sub iudicio: "the Constitution does not make it essential that the taxation of company income always accompany, at the moment and according to accounting, the positive and negative financial flows, the gains, costs and losses realized or incurred in each tax period. As actual income is a normatively modeled concept, it does not violate the principle contained in paragraph 2 of article 104 of the Constitution the tax regime that, in favor of tax neutrality – as the gain is not taxed, the cost associated with it should not be either – establishes the non-deductibility of a cost based on the likelihood of the realization of gains exempt from taxation, whose future realization is considered probable or foreseeable."

With support in the Decision of the 2nd Section of the Administrative Court of Appeal (STA), of 13/07/15, handed down in Case no. 0144/14: it does not make sense, in the face of the rule of article 32 of the EBF, granting a tax benefit, to invoke violation of the principles of taxpaying capacity, actual income taxation and substantive justice, in order to assert the idea that costs with financial charges should be considered, notwithstanding the non-consideration of income associated with realized gains; according to the AT, tax neutrality is only guaranteed if the financial charges incurred with this acquisition of equity interests are not considered as costs, based on the likelihood of the realization of gains exempt from taxation, whose future realization is considered probable or foreseeable.

SGPSs (as was written in Arbitral Decision no. 21/2012) are not in equal circumstances with other corporate entities, given that the disregard of financial charges is counterbalanced by the applicability of the exclusion from taxation provided for in paragraph 2 of article 32 of the EBF, so one cannot expect that the principle of taxpaying capacity and taxation according to actual income be applicable to them as it is for other legal entities that do not enjoy the same exemption. The reason underlying the use of the method of imputation of financial charges to equity interests in the case at hand is that of taxation closer to actual profit as possible, respecting the provision of paragraph 2 of article 32 of the EBF, particularly in the context of absolute omission of quantification by the Claimant of the financial charges attributable to the equity interests it held, as well as in the subsequent absence of provision of clarifications or information, in any form, in the course of the inspection procedure.

The AT was left with no alternative other than the calculation of the taxable profit of the Claimant by way of the method described in the inspection Report, legally anchored in the special regime of article 32 of the EBF and constitutionally justified in the provision of paragraph 2 of article 104 of the CRP.

2.7. On the violation of the principle of specialization of tax years

The rule of paragraph 1 of article 18 of the CIRC suffers exceptions or adjustments, such as the case of paragraph 2 of the provision with respect to positive and negative components of taxable profit that at the time they were obtained or borne were "unforeseeable or manifestly unknown", a circumstance that the legislator understands justifies their consideration in a later tax period.

The solution adopted by Circular no. 7/2004, in the part concerning the year in which the tax corrections of the financial charges under discussion should be made, reflects the legislator's concern with not influencing the taxable profit of the year in which financial charges are borne with the acquisition of shareholdings capable of benefiting from paragraph 2 of article 32 of the EBF without first knowing whether those same charges can or cannot contribute to the formation of the taxable profit of the company, determining that, if it is concluded "at the moment of sale of the shareholdings, that not all the requirements for application of that regime are met, proceed, in that year, with the consideration as a tax cost of financial charges that were not considered as a cost" in the fiscal year in which they were borne; thus, charges that result in being able to contribute to the formation of taxable profit will, at most, be recognized in the period immediately following that in which they were borne, and those that cannot be recognized in that immediately subsequent period do not meet the requirements to be able to contribute to the formation of taxable profit.

2.8. On the material unconstitutionality, due to violation of the principle of proportionality and equality, of paragraph 2 of article 32 of the EBF.

Drawing support from Decision no. 42/2014 of the Constitutional Court, one cannot find in the normative framework under analysis discriminatory treatment of SGPSs compared to other IRC taxpayers holding equity interests. The comparison term with other companies cannot ignore that these are not in an equivalent starting position, insofar as gains resulting from realized gains with the sale of shareholdings are not susceptible of exemption from IRC taxation, so one cannot consider that a regime of taxation particularly unfavorable globally for SGPSs has been created, with reference to financial charges genetically linked to the acquisition of shareholdings.

The argument of the uncertainty of the realization of a gain, and consequently of the exemption of its contribution to the formation of taxable profit, does not, in this evaluative field, carry the result that the Claimant attributes to it; such susceptibility – in itself a carrier of value and based on a perspective of implicit continuity of the activity of the SGPS – persists in terms of neutralizing the financial charges it incurred, falling within its margin of economic determination, within the regular scope of the activity of managing shareholdings, the choice as to the convenience and opportunity of the sale of equity interests and the realization of gains. There are special reasons of practicability and feasibility and among the various normative solutions for the problem of delay between financial charges and the realization of a gain – criterion of intention to deduct, adoption of a principle of deductibility, adoption of a principle of non-deductibility – the Constitutional Court accompanies the position of Tiago Caiado Guerreiro, which rejects the first two, due to the invitation to tax fraud and the impossibility of proceeding with adjustment afterwards, particularly with the presentation of substitute income declarations relating to previous tax periods, and concludes that the third option seems the most viable and consists of taxpayers adopting as a general rule regime in generic terms and, at the moment of realization, if some of the situations provided for in paragraph 3 of article 32 that imply the departure from the general rule are verified, then make the appropriate corrections, allowing to consider for the formation of taxable profit the financial charges borne".

For the same reasons, it is necessary to reject, based on the mere temporal dissociation between the (immediate) non-deduction of financial charges and (future) exemption from taxation of realized gains, the violation of the principle of proportionality, which follows, from the outset, from the distinct nature and typology of formation of the tax facts in consideration, being delayed successively and over an extended time period, covering financial charges spanning various tax years and periods, while the realization of gains occurs in a single moment and tax period, so it is not considered excessive and intolerable the regime that weighs and makes the non-deductibility of financial charges act ex ante, in each tax period in which they are incurred, by reference to the measure that balances it, taking into account the preservation of the possibility of (effective and future) realization of gains, in line with the interpretive orientation endorsed by the AT in point 6 of Circular no. 7/2004, inscribing in the normative criterion applied the consideration that "the disregard of financial charges must operate immediately, not depending on the sale of the shareholdings and the realization of gains, which implies not considering, ab initio, the financial costs incurred with the acquisition of shareholdings that may come to benefit from the exclusion of taxation provided for in paragraph 2 of article 32 of the EBF, correcting this initial disregard if it is ascertained, a posteriori, that the temporal requirement provided for in that provision is not verified". The rule in this matter is that of non-deductibility of financial charges: SGPSs should not, ab initio, consider the financial costs incurred with acquisitions of shareholdings, given the possibility that these may come to benefit from the exclusion of taxation provided for in paragraph 2 of article 32 of the EBF, and if, when selling the equity interests in question, they do not meet the requirements for application of the special regime of exemption of gains, then proceed to the correction of costs not deducted in a previous tax period, as provided for in paragraph 6 of Circular 7/2004.

III - APPRAISAL

Pursuant to the provision of article 124 of the CPPT, subsidiarily applicable by virtue of the provision in subparagraph c) of paragraph 1 of article 29 of the RJAT, as no defects leading to a declaration of nonexistence or nullity are imputed to the disputed assessment, nor is a relationship of subsidiarity indicated, the order of appraisal of the defects should be that which determines, according to the prudent discretion of the judge, more stable or effective protection of the interests offended.

The Claimant does not impute defects that may lead to a declaration of nonexistence or nullity, so the effects that the judgment of the defects as well-founded can have at the level of stability and effectiveness of the protection of its interests are similar. Thus, the order indicated by the Claimant is followed, as provided for in the initial part of subparagraph b) of article 124.

Illegality and unconstitutionality of the 'tax incidence rule created by Circular no. 7/2014'. Illegality of the correction, as it is based on the application of the Circular.

For good settlement of the legal issues to be resolved, the appraisal of the question of possible unconstitutionality of Circular no. 7/2004 is excluded, accompanying the Constitutional Court in Decision no. 42/2014, cited and transcribed above in the relevant part: the Circular is not a legal norm, but merely an administrative interpretation, whose constitutionality is not subject to review. There is no "parametric relevance of the normative sense adopted by the Tax Authority and expressed in the aforementioned circular, in terms of supporting the formation of binding effects on individuals ( …) and, above all, constituting a criterion or normative standard for the jurisdictional actions of the Courts, when called upon to assess disputes in their respective field of action".

What the Arbitral Tribunal must decide is the legality or illegality of the act performed by the AT in making the corrections under appraisal.

Let us recall that paragraph 2 of article 32 of the EBF established, in the version in force for the 2011 tax year, the following:

"2 - The gains and losses realized by SGPSs, by SCRs and by ICRs on equity interests of which they are holders, provided they are held for a period of no less than one year, and likewise the financial charges borne with their acquisition, do not contribute to the formation of the taxable profit of these companies."

It is worth beginning this analysis seeking correct interpretation of this provision by affirming that it is understood as natural, if not even axiomatic, the tax disregard of financial charges borne by SGPSs with the acquisition of equity interests whose gains are exempt when the shareholdings are sold. From this it follows, be it said in passing, that it is absolutely inconsequent to question a purported offense to constitutional principles such as the one in force for the taxation of the income of legal entities, of taxation (tendentially) based on actual income.

Having established this ratio, clear, proportional and reasonable, the complex question which the wording of the provision immediately raises has long been identified and extensively analyzed in case law and also in legal doctrine: when there is objective impossibility for SGPSs to identify with precision, from among the mass of financial resources – internal and external – that they obtain and channel for purposes as diverse as granting credit to companies in which they hold interests, acquiring shareholdings, and others, so as to be able to make an actual allocation of each financing obtained and of each amount of financial charges borne directly to the acquisition of concrete shareholdings, how is the provision applied?

Basic precautions, inherent to quality substantive legislative drafting, should have led the legislator to have evaluated and anticipated this difficulty so evident and to have established in the law itself a method of quantification, eventually resorting to allocation by typologies of allocation – always on a subsidiary basis to the method of actual allocation, which better ensures the capture of effective taxpaying capacity –, which would permit an effective and secure application of the law in situations of objective and proven impossibility of taxpayers making a specific and direct allocation.

That such prior evaluation and adequate specification of the provision would not have been excessively complex and demanding tasks is demonstrated by the publication of Circular no. 7/2004 of 30.03 of the DSIRC, where, recognizing "(…) the extreme difficulty of use (…) of a method of direct or specific allocation (…)", the AT came to define a criterion, which it understood as valid and the closest to business reality, establishing that, in order to determine which financial charges borne are to be imputed to each acquisition of social equity interests, one should use a formula of this kind: "(…) the remunerated liabilities of SGPSs (…) should be imputed, in the first place, to remunerated loans granted by these to companies in which they hold interests and to other investments generating interest, allocating the remainder to other assets, namely shareholdings, proportionally to their respective acquisition cost."

The legislator's lack of provision opened, both the legal insecurity evident in all the conflict emerging from the corrections made by the AT based on Circular no. 7/2004, and, it must be acknowledged, a true highway of easy obstruction to the application of the law, through mere resort to calculated opacity in the flows of financing and their respective allocations. In the absence of financing contracts bound by the purpose of acquisition of a certain financial interest, the identification of a legally sustained nexus between financial charges borne and a concrete acquisition of social equity interests becomes a task made unfeasible with excessive ease, even if it were not unfeasible from the outset.

As the AT alleges and the Claimant accepts, in the present case the latter did not prepare any allocation map, despite having been notified of the draft RIT, with the above-specified corrections, to exercise the right to make representations. In cases like this, it becomes impossible – but also irrelevant in the context of a contentious purely for annulment, so the Tribunal makes no judgment on this matter – to determine whether the impossibility of actual allocation is authentic or merely tactical.

What matters for the decision is that the AT determined the financial charges which it understood to have been borne by the Claimant for acquiring the shareholdings by resorting to the method provided for in point 7 of Circular no. 7/2014.

Regarding the illegality of these corrections, the Tribunal accompanies several Arbitration decisions, which do not identify legal support for the interpretation conveyed in the Circular and made, in the present case, by the AT. Accompanying, in particular, the argumentation and doctrinal references contained in Case no. 326/2015-T, it will be said that "the norms relating to the assessment of taxes, specifically those that define incidence and tax benefits, are subordinated to the principle of legality, consequently ruling out the possibility of, through administrative action, creating norms that result in an effective burden on taxpayers (…) Point 7 of Circular no. 7/2014 embodies a norm of an innovative nature concerning the determination of the taxable matter of IRC and, ultimately, the scope of a tax benefit, so it is invalid due to violation of the principle of legality." And, further on, "it was this direct method that should have been used, since the Tax and Customs Authority cannot make use of an indirect method to determine the taxable matter of the Claimant without the legal requirements being met on which the law makes its use depend, provided for in articles 85 and 87 of the LGT, and cannot use for the quantification of taxable matter criteria not provided for in the law (article 90 of the LGT)."

In other words, it is not seen how the thesis – defended by the AT – that "there is no illegality in the application of paragraph 2 of article 32 of the EBF in the formula contained in Circular no. 7/2004, even if it is not possible for the AT and the taxpayer to proceed with a specific or direct allocation, given that any method (direct or indirect) is good, provided the ratio legis of the rule is respected" comes to be legally sustained, in terms of being the best interpretation of the law.

And it is not legally sustainable in terms of being the best interpretation of the law because the provision must be complied with in its precise terms, according to which the law applier must disregard the financial charges borne with the acquisition of the shareholdings whose gains, when realized, are exempt, which can only be done licitly if it is able to identify the relationship between the financing used and the acquisition of the shareholdings (whose gains, when realized, are exempt), segregating them from those used for other allocations, such as providing financing to companies in which they hold interests.

The AT also argues that "otherwise, there would be a risk of giving tax relevance to financial charges while at the same time exempting the gains that resulted from the sale of the shareholdings, which would violate the principle of tax neutrality and would lead to a solution contra legem (this would not be the case only if the law established a solution – which does not exist – that stipulated that, if taxpayers cannot demonstrate direct allocation, they could not benefit from the exemption of gains from equity interests that they come to sell)." The assertion is pertinent, but that risk, quite evident, should – and could only – have been prevented by the legislator. It is not a risk that a Circular praeter legem can come to repair.

The AT further states that "the alleged violation of the principle of legality contained in article 103, paragraphs 2 and 3, of the CRP is unfounded, insofar as the Circular did not alter or distort the legal provision of paragraph 2 of article 32 of the EBF." In this the AT is correct, for the Circular in question is not, in the Tribunal's understanding, contra legem. However, it suffices that it be, as abundant case law has decided, praeter legem, for it to lack the unavoidable support of an enabling law.

It is clear that what is being reviewed – be it emphasized – is not the legality of Circular no. 7/2004 in the abstract, but the concrete legality of the corrections made by the AT, in the part in which it disregarded the financial charges borne by the Claimant with the acquisition of shareholdings. However, as these corrections are based precisely on the Circular, of which they make express application, the illegality of the latter, for being praeter legem, determines that of the former, which were not supported in another interpretation and application of the law other than precisely the compliance – binding on the Services of the AT – of the Circular. Thus, the Tribunal considers verified the defect of violation of law in the corrections for tax disregard of financial charges borne by the Claimant with the acquisition of equity interests.

As mentioned above, pursuant to the provision of article 124 of the CPPT, as no defects leading to a declaration of nonexistence or nullity are imputed to the disputed assessment, nor is a relationship of subsidiarity indicated, the order of appraisal of the defects should be that which determines, according to the prudent discretion of the judge, more stable or effective protection of the interests offended, and the corollary of the norm is that, if a defect is judged to be well-founded which ensures effective protection of the Claimant's interests, it will not be necessary – and will be unnecessary pronouncement – to consider the remaining defects.

Thus it is with all the other defects invoked – and with the inherent legal issues – with the exception of one, on which the Tribunal must pronounce, because the decision on the same may lead to a different final decision.

In truth, even if there is a defect of violation of law in the corrections made by the AT, if it were the Claimant who bore the burden of proof of the non-connection of the financial charges borne and taken entirely as deductible expenses in the 2011 tax year with the acquisition of shareholdings, the disregard of the entirety of the aforementioned financial charges could, in mere preliminary thesis, be considered. The question at hand, therefore, is whether, as the AT argues, as the application of a tax benefit is at issue, it is the Claimant who bears the burden of proving the facts necessary to enjoy it (articles 14 and 74 of the LGT).

Now, the AT itself gives contradictory evidence of this thesis: – it is true that it affirms that the Claimant did not add to the net result for the year the financial charges attributable to equity interests, as it was required to do by article 32 of the EBF, nor did it exercise the right to hearing when notified of the draft Report, and did not provide any additional clarifications, nor contested the merit or validity of the calculations made, nor provided the AT with any data on the specific or direct allocation of financial charges to the shareholdings, even admitting that it was unable to do so.

However, it also affirms, at another point, that "if the thesis advocated by the Claimant were followed there would be a risk of giving tax relevance to financial charges while at the same time exempting the gains that resulted from the sale of the shareholdings, which would violate the principle of tax neutrality and would lead to a solution contra legem (…) And this would only not be the case if the law established a solution, which does not exist, stipulating that if taxpayers cannot demonstrate direct allocation, they could not subsequently benefit from the exemption of gains from equity interests that they come to sell."

And it must be acknowledged that this could be the consequence derived by the legislator, which would convert proof at the charge of taxpayers into a mere legal burden, instead of an obligation. But this is not in the law. By extension, one could not derive from a sustainable interpretation of the law, potentially still more onerous, which would extract from it a rule according to which if an SGPS taxpayer did not make proof of which specific allocation of financing of whose financial charges were at issue, the entire volume of financial charges would be disregarded. Such an interpretation would lead to correction acts that are apodictically illegal.

Furthermore – and we now accompany and praise ourselves in Case no. 326/2015-T – that, "although in the matter of tax benefits there are special norms from which it is inferred that the burden of proof of facts necessary to enjoy them falls on whoever invokes them (articles 14, paragraph 2, and 74, paragraph 1, of the LGT), in the specific situation at hand one is not faced with the invocation of requirements of tax benefits, because the part of article 32, paragraph 2, of the EBF that provides for the non-deductibility of financial charges borne with the acquisition of equity interests does not establish a tax benefit, but rather a limitation on the deductibility of financial charges, negative for the taxpayer, established with the purpose of attenuating the tax favorable regime enjoyed by SGPSs in relation to companies in general. For this reason, in determining the non-deductibility of financial charges, the Tax and Customs Authority is carrying out an activity of a nature unfavorable to the taxpayer, so it bears the burden of proof of the facts it invokes to ground its action, namely, when choosing to use an indirect method of determining taxable matter, of proving that some or various of the legal requirements for its application, indicated in article 87 of the LGT, were verified, as follows from paragraph 3 of article 74 of the LGT. If concrete 'facts implying recourse to indirect methods' were not proven, indirect methods cannot be used to determine taxable matter, as these can only be used when it is demonstrated that it is not viable to use direct methods, as follows from article 85, paragraph 1, of the LGT."

It is thus concluded that – in the part in which it disregards the financial charges indirectly determined as having been borne by the Claimant with the acquisition of equity interests whose gains will be exempt when the shareholdings are sold – the disputed act suffers from the defect of violation of law, due to incorrect application of the regime of paragraph 2 of article 32 of the EBF.

B.2 – Regarding the corrections arising from the application of fair value

I - CLAIMANT'S POSITION

The Claimant alleges that the legislator, as a general rule, prevented adjustments arising from the application of fair value from contributing to the formation of taxable profit. However, it exceptionally allowed these adjustments to contribute to the formation of taxable profit provided that: (i) they were instruments of equity; (ii) they were recognized at fair value through results; (iii) they had the price formed in regulated markets; and (iv) the taxpayer holding those instruments did not hold, directly or indirectly, a shareholding in the capital exceeding 5%.

In the Claimant's view, the legislator came to allow those adjustments to contribute to the taxpayer's taxable profit provided that the reliability of the fair value determination was ensured and, likewise, provided that the taxpayer did not hold a significant shareholding capable of influencing the decisions of the company in which it held the interest.

Contrary to what the AT argues, the provision of paragraph 3 of article 45 of the Corporate Income Tax Code (CIRC) should not be applied to losses deducted from the net result for the period, nor to negative capital variations suffered by the Claimant – both deductions resulting from the measurement at fair value of the shareholdings held by the Claimant at that date.

Citing the Arbitral Decision of 25/11/2013, handed down in Case no. 108/2013-T, it is stated that before the republication of the CIRC, which came to align the taxation of the income of legal entities with the SNC, "(…) variations relating to financial instruments were irrelevant from the point of view of the formation of taxable profit for each period, due to the effect of the norm of article 21/1/b) of the CIRC. Only at the moment of realization of the gain or loss did the capital variation verified assume tax relevance."

In this way, this tax context was embodied: (i) in a single taxation, which occurred only once over the entire period of holding of financial instruments; and (ii) in a voluntary action of the taxpayer, in that the transaction of financial instruments only occurred as a result of the taxpayer's will; (iii) and the measure of the capital variation was fixed based on the concrete transaction/transfer, which triggered its treatment and tax relevance.

This tax context, which depended intrinsically on the taxpayer's will, could permit deviant behaviors of taxpayers, because it would allow them to choose the moment most favorable for their taxation. With the republication of the CIRC, the legislator used legislative alterations that allowed it to condition the taxpayer's action, establishing legal provisions that would come to be similar to true anti-abuse rules. This is exactly what happens with the norm of article 18, paragraph 9, of the CIRC, more specifically with the exceptions included therein, where the legislator established the limitation on adjustments arising from the application of fair value.

The Claimant maintains that, from a careful reading of the three provisions – articles 23, paragraph 1, 24, paragraph 1 and 45, paragraph 3, all of the CIRC – it is clear and indubitable that the concepts of expenses and losses and negative capital variations are distinct and autonomous concepts, which must necessarily have a distinct tax treatment, and not an indistinct and uniform treatment. The AT would be overlaying article 45, paragraph 3 of the CIRC, which establishes a general rule, onto the special rule contained in subparagraph a) of paragraph 9 of article 18 of the same statute, which determines the exception: "Relating to financial instruments recognized at fair value through results, provided that, if these are equity instruments, they have a price formed in a regulated market and the taxpayer does not hold a shareholding in the capital exceeding 5% of the respective capital stock".

According to the Preamble to Decree-Law no. 159/2009, of 13 July, "Also in the area of the approximation between accounting and tax, the application of the fair value model to financial instruments, whose counterpart is recognized through results, is accepted, but only in cases where the reliability of the fair value determination is in principle assured. Thus, equity instruments that do not have a price formed in a regulated market are excluded".

Thus, by virtue of the historical element of interpretation of the law (see article 9 of the Civil Code (CC), by referral of article 11, paragraph 1 of the LGT), the Claimant would easily conclude that article 45, paragraph 3, of the CIRC could not have intended to cover expenses arising from the application of the accounting fair value model introduced by the SNC whose counterpart was recognized through results, as occurred in the concrete case.

The legislative changes of 2009, which entered into force on 01.01.2010, cannot obviously fall within the legal hypothesis or factual basis of a rule of 2006 (article 45, paragraph 3 of the CIRC) – which for obvious reasons could not have taken them into account, as at the date of its entry into force they were still nonexistent.

Once the objective conditions contained in subparagraph a) of paragraph 9 of article 18 of the CIRC have been verified, as the Claimant understands to be the case, it does not make sense to apply an "anti-abuse" rule such as that enshrined in article 45, paragraph 3, of the CIRC.

Relying on Arbitral Decision no. 108-2013-T, it is stated that "Such analysis must duly take into account the necessary systematic perspective of its integration, likewise weighing the historical context of its genesis. In fact, each of the norms considered relevant for the appraisal of the question to be decided must be understood in the corresponding concrete framework, from which its significant content is derived. (….) Already paragraph 9 of article 18 of the CIRC applicable obtains directly its justification in the preamble to Decree-Law 159/2009, of 13 July, which introduced it into the said Code, where it can be read:

The system established was suited to the adoption of mechanisms for conditioning that will, in the sense of conforming it to economically more desirable behaviors, which, in this case, pass through the preference for the realization of gains, to the detriment of the realization of losses. It is in this context that the emergence of the norm of the previous article 42/3 of the CIRC, which precedes the current article 45/3 of the same, is explained.

Such norm, both in its original wording, resulting from Law 32-B/2002, of 30 December, and in that given to it by Law 60-A/2005 of 30 December, is explained both objectively and subjectively (that is, in the face of the motivation expressed by the legislator) by needs linked to the fight against tax fraud and evasion and the broadening of the tax base, aimed at the desired consolidation of public accounts. The acceptance of the application of the fair value model to financial instruments, carried out by Decree-Law 159/2009, of 13 July, came to introduce, in the part covered, a radically different model, both of valuation and of tax relevance of capital variations relating to the holding of those instruments.

Thus, where previously we had a single tax relevance (one-off), at the moment of transaction of those instruments, we now have a continuous tax relevance. That is, in the face of the new norms comprising the regime of tax relevance of the accounting for fair value of financial instruments, the income or expenses resulting from the application of fair value to these now come to be directly relevant for the formation of taxable profit (articles 20/1/f) and 23/1/i) of the CIRC) of the very year in which they occur, provided that certain conditions are met (article 18/9 of the CIRC), which include the formation of the price in a regulated market, with gains or losses not being taxed as capital variations (article 46/1/b) of the CIRC). In this framework, there clearly cease to be any needs relating to the fight against tax fraud and evasion, not only because the tax relevance of capital variations ceases to be conditioned by an act of will of the taxpayer, but also because the valuation is objectively fixed.

The Claimant further invokes the Arbitral Decision of the CAAD, of 18.06.2015, handed down in Case no. 776/2014-T, according to which "The arbitrators analyzed all the rhetoric presented by the parties (in their written submissions and arguments), as well as the argumentation and weighing of the arbitral decision handed down in a case with similar contours (Decision 108/2013-T), but always bearing in mind the small changes in the case ("each case is a case"). After mature deliberation, they decide in the sense of the Judgment in Case 108/2013-T, henceforth following, with all due respect, the essential arguments of that decision."

II – RESPONDENT'S POSITION

The temporal imputation regime associated with the adoption of fair value as a measurement criterion did not emerge, in the context of IRC, with the creation of article 18, paragraph 9, subparagraph a), so in no way can this rule be considered as an innovation. Furthermore, the characterization of the provision of article 18, paragraph 9, subparagraph a) as an exceptional norm would be inappropriate, because for that type of assets with listing in a regulated market, the CIRC does not contemplate a general rule and a special rule of temporal imputation for income and expenses.

For the AT, it also completely lacks meaning the attempt to defend that article 18, paragraph 9, subparagraph a) and article 45, paragraph 3, of the CIRC mutually exclude each other, on the grounds that expenses are not included within the scope of article 45, even if relating to equity interests or other components of equity.

The deduction in half of the negative difference between realized gains and realized losses and of other losses and negative capital variations relating to equity interests covered by article 45, paragraph 3, has always been applied both to cases in which those losses, as well as other losses and negative capital variations, resulted from operations carried out in regulated markets (stock exchanges) and outside those markets.

That is, for the AT, it is true that this provision, like other provisions scattered throughout the CIRC, has underlying it the purpose of attenuating the effects of tax base erosion practices, which also fall within the objectives of current tax policy. But the legislator, by giving it a broad and generic wording, chose not to include in its provision any consideration of particular circumstances of the concrete operations that give rise to the losses, as well as other losses and negative capital variations.

Article 45, paragraph 3, of the CIRC provides, without more, that "The negative difference between realized gains and realized losses and the onerous transmission of equity interests, including their waiver and amortization with reduction of capital, as well as other losses or negative capital variations relating to equity interests or other components of equity, namely supplementary contributions, contribute to the formation of taxable profit only in half of their value".

Not permitting such a rule that the interpreter arrogate themselves the right to subtract from its scope any losses or other losses or negative capital variations, based on the manner and place of realization of the concrete operations that gave rise to them.

It follows from the case law produced by the CT, such as Decision no. 85/2010, of 03 March, when it ruled on article 23, paragraph 7 and article 45, paragraph 3, of the CIRC, that the faculty of creation of tax provisions – like that of article 45, paragraph 3 and other provisions of the CIRC that wholly or partially disregard the deduction of certain expenses or losses – with a view to protecting the tax base from erosion risks, is not prohibited to the legislator either by the Constitution, as they do not collide with the principle of taxation by actual profit enshrined in article 104, paragraph 2, "nor by the principles of European Law, specifically those of proportionality and necessity".

It is undeniable that there were underlying to the wording given to article 45, paragraph 3, of the CIRC considerations and concerns related to the prevention of evasive practices, the scope of which has been evolving in the direction of its broadening, so as not to exclude operations and situations that, likewise involving equity interests or other components of equity, could produce the same effects as those initially contemplated.

The importance given by the Claimant to questions of semantics around "costs", "losses", "expenses", results in a decontextualized reading of the provision of article 45, paragraph 3, which inevitably leads to a reductive interpretation of the scope of the norm. In the first place, it is not correct to think that the rule emerged only in the context of the exclusive application, on the tax plane, of the realization rule.

It suffices, for that, to note the transitional provisions created for Banking and Insurance Companies, as well as provisions establishing general rules applicable to derivative financial instruments already opened the possibility of the periodization of income or gains and expenses or losses in operations carried out on stock exchanges attending to market value. Secondly, the interpretation of the scope of application of a rule does not remain crystallized by the legal framework in force at the date of its creation. The successive evolution of the wording of article 45, paragraph 3 reveals, according to the AT, on the one hand, the legislator's concern with its improvement based on experience acquired, proceeding with its broadening in an express manner, by the inclusion of new realities, and, on the other, as was the case, the extension was also the reflection of changes made in other provisions, both in the accounting area and in tax legislation, which determined changes to the concepts or to the forms of determination of the elements that make up the normative provision.

Thirdly, the AT states that, considering the system of taxation in IRC, despite the potential or latent gains and losses being, in fact, excluded from taxation, even if when expressed in accounting, it is certain that adjustments arising from the application of fair value are tax-relevant when they respect the requirements prescribed in article 18, paragraph 9, subparagraph a), by virtue of the provision of articles 20, paragraph 1, subparagraph f), 23, paragraph 1, i) and 45, paragraph 3, all of the CIRC.

The concept of "losses" inherent in article 45, paragraph 3 of the CIRC is formulated in an open manner, within the scope of which all types of losses relating to equity interests are included, including potential losses. Thus, for the AT, the legislator, by enshrining the broad concept of losses, did not intend to exclude any losses relating to equity interests that are reflected in accounting, not having expressly rejected potential losses, resulting from the application of fair value to financial instruments, whether recorded in accounts of expenses and losses or in equity accounts. The idea runs through the body of the Request for Arbitral Ruling that in article 18, paragraph 9, of the CIRC is defined the tax treatment of positive or negative adjustments arising from the application of fair value to equity instruments with a price formed in a regulated market.

For the AT, this constitutes an error of analysis, because the purpose of this article is contained only in the definition of the criteria for temporal imputation of the positive and negative components of taxable profit, giving effect to the principle of specialization of tax years, being left to articles 20 and following the determination of the rules applicable in determining taxable profit. Also the AT considers as totally irrelevant the semantic question – e.g. articles 80 and following of the Request for Arbitral Ruling, of the arbitral decision handed down in Case no. 108/2013-T – constructed around the dichotomy between the term "losses" used in article 45, paragraph 3, and the term "expenses" used in article 23 and in article 18, paragraph 9, subparagraph a), of the CIRC. Although each of those terms has its own meaning, that dichotomy between "expenses" and "losses" can only be characterized as an imprecision of legislative terminology without consequences at the level of interpretation of those provisions. Furthermore, nor could it be otherwise, taking into account article 17, paragraph 1 of the CIRC, since, in the Chart of Accounts of the System of Normalization of Accounting (SNC), account 661, where negative adjustments arising from the use of fair value are recorded, was always named Losses from reductions in fair value of financial instruments, that imprecision having been corrected by Law no. 2/2014, of 16 January, with the substitution, in those provisions, of "expenses" by "losses".

The AT further mentions some doctrinal positions, such as that of André A. Vasconcelos when noting that: "From the reading of this provision [paragraph 3 of article 42, current article 45], and given the extensive scope thereof, we are led to conclude that all losses relating to equity interests, which include the financial assets now under analysis [those referred to in subparagraph a) of paragraph 9 of article 18 of the CIRC], will only be relevant for tax purposes in half of their value.

And it further emphasizes that the AT's interpretation of the controversial question was considered perfectly legal within the framework of the decision recently handed down, on 24 September 2015, in the case that proceeded in the CAAD under number 25/2015-T, and which dealt with a situation coinciding with that found in the present proceedings.

III – APPRAISAL (ENACTING PART)

1 - Legal norms to be applied

For the decision to be taken, the following norms of the CIRC are relevant, hereinafter cited in the version in force at the date of the facts (2011):

Article 18, paragraph 9:

"Adjustments arising from the application of fair value do not contribute to the formation of taxable profit, being imputed as income or expenses in the tax period in which the elements or rights that gave rise to them are sold, exercised, extinguished or liquidated, except when:

a) They relate to financial instruments recognized at fair value through results, provided that, when these are equity instruments, they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a shareholding in the capital equal to or greater than 5% of the respective capital stock

…."

Article 23

Expenses

"1 — Expenses are those that are demonstrably necessary for the realization of income subject to tax or for the maintenance of the source of production, namely:

a) Those relating to the production or acquisition of any goods or services, such as materials used, labor, energy and other costs of general production, conservation and repairs;

b) Those relating to distribution and sale, covering those of transport, advertising and placement of goods and products;

c) Of a financial nature, such as interest on foreign capital applied in operations, discounts, premiums, transfers, exchange rate differences, expenses with credit operations, collection of debts and issuance of bonds and other securities, reimbursement premiums and those resulting from the application of the effective interest rate method to financial instruments valued at amortized cost;

d) Of an administrative nature, such as remuneration, including that attributed as a share in profits, allowances, current consumption materials, transport and communications, rents, litigation, insurance, including life insurance and operations in the "Life" class, contributions to pension savings funds, contributions to pension funds and to any supplementary social security schemes, as well as expenses with employment termination benefits and other post-employment or long-term employee benefits;

e) Those relating to analyses, streamlining, research and consultation;

f) Of a fiscal and parafiscal nature;

g) Depreciation and amortization;

h) Adjustments in inventories, impairment losses and provisions;

i) Expenses resulting from the application of fair value in financial instruments;

j) Expenses resulting from the application of fair value in consumable biological assets that are not multi-year forestry operations;

l) Realized losses;

m) Indemnifications resulting from events whose risk is not insurable.

…"

Article 45, paragraph 3:

"The negative difference between realized gains and realized losses through the onerous transmission of equity interests, including their waiver and amortization with reduction of capital, as well as other losses or negative capital variations relating to equity interests or other components of equity, namely supplementary contributions, contribute to the formation of taxable profit only in half of their value."

Article 46

"1-Realized gains or losses are gains obtained or losses suffered through onerous transmission, in whatever manner it is operated, and likewise those arising from losses or those resulting from permanent allocation to ends unrelated to the activity carried on, relating to:

a) Tangible fixed assets, intangible assets, non-consumable biological assets and investment properties, even if any of these assets has been reclassified as a non-current asset held for sale;

b) Financial instruments, with the exception of those recognized at fair value in accordance with subparagraphs a) and b) of paragraph 9 of article 18.

…"

1. Arbitral decisions with differing views on the matter at hand

The question of whether decreases in fair value of financial instruments that are recognized in the period's results should or should not be subject to the limitation contained in article 45, paragraph 3, has already been the subject of arbitral decisions with differing views. The essence of the arguments presented is set forth below, in relatively extensive form, given the importance attributed to them for the theses in confrontation.

2.1. Cases 108/2013-T and 776/2014-T

In the Decisions relating to Cases 108/2013-T and 776/2014-T (available at www.caad.org.pt), a decision is observed that is favorable to the non-application of the limitation of article 45, paragraph 3, of the CIRC (that is, admitting the 100% deductibility of the fair value losses in question) with the arguments summarized below:

A) "Prior to the adoption of fair value, variations relating to financial instruments were irrelevant from the point of view of the formation of taxable profit for each period, due to the effect of the norm of article 21/1/b) of the CIRC. Only at the moment of realization of the gain or loss did the capital variation verified assume tax relevance. This tax framework had (as it has in the part in which it remains) three well-marked characteristics, namely:

• It was a single taxation, that is, which occurred only once over the entire period of holding of financial instruments;

• It was dependent on a voluntary action of the taxpayer, in that the transaction of financial instruments generating the capital variation, a condition of its tax relevance, would only occur if and when the taxpayer so wished;

• The valuation of the capital variation was fixed based on the concrete transaction that triggered its tax relevance.

The combination of these three characteristics that have been pointed out provided, from the outset, fertile ground for accounting and tax manipulation, since the taxpayer could choose to trigger the tax relevance of the capital variation at the moment and on terms most fiscally advantageous to it.

On the other hand, and considering the importance of the taxpayer's will in the mechanism of tax relevance of the capital variation, the system established was suited to the adoption of mechanisms for conditioning that will, in the sense of conforming it to economically more desirable behaviors, which, in this case, pass through the preference for the realization of gains, to the detriment of the realization of losses.

It is in this context that the emergence of the norm of the previous article 42/3 of the CIRC, which precedes the current article 45/3 of the same, is explained.

Such norm, both in its original wording, resulting from Law 32-B/2002, of 30 December, and in that given to it by Law 60-A/2005 of 30 December, is explained both objectively and subjectively (that is, in the face of the motivation expressed by the legislator) by needs linked to the fight against tax fraud and evasion and the broadening of the tax base, aimed at the desired consolidation of public accounts.

The acceptance of the application of the fair value model to financial instruments, carried out by Decree-Law 159/2009, of 13 July, came to introduce, in the part covered, a radically different model, both of valuation and of tax relevance of capital variations relating to the holding of those instruments.

In fact, the legislator's intention when adopting the fair value model, duly evidenced, was assumed and expressly the maintenance of "the application of the realization principle with respect to financial instruments measured at fair value whose counterpart is recognized in equity, as well as equity interests corresponding to more than 5% of the capital stock, even if recognized at fair value through results".

Already with respect to "financial instruments" that correspond to less "than 5% of the capital stock", "whose counterpart is recognized through results, (...) in cases where the reliability of the fair value determination is in principle assured", the legislative intention was to accept "the application of the fair value model", excluding the realization principle.

In consonance, article 18/9 of the applicable CIRC came to provide that, as a rule, "Adjustments arising from the application of fair value do not contribute to the formation of taxable profit, being imputed as income or expenses in the tax period in which the elements or rights that gave rise to them are sold, exercised, extinguished or liquidated." This is here an evident and deliberate manifestation of the assumed realization principle.

However, the same provision, in its subparagraph a), establishes the exception to this regime, in the following terms: "except when: a) They relate to financial instruments recognized at fair value through results, provided that, when these are equity instruments, they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a shareholding in the capital exceeding 5% of the respective capital stock;".

That is, and equally as assumed by the legislative entity, when "income or expenses (...) Relate to financial instruments recognized at fair value", "contribute to the formation of taxable profit" "provided that":

a. They are recognized "through results";

b. They are "equity instruments";

c. "they have a price formed in a regulated market"; and

d. "the taxpayer does not hold, directly or indirectly, a shareholding in the capital exceeding 5% of the respective capital stock.".

Once these conditions are met:

a. income resulting from the application of fair value in financial instruments are considered (article 20/1/f) of the CIRC); and

b. expenses resulting from the application of fair value in financial instruments are considered (article 23/1/i) of the CIRC).

Thus, where previously we had a single tax relevance (one-off), at the moment of transaction of those instruments, we now have a continuous tax relevance. That is, in the face of the new norms comprising the regime of tax relevance of accounting for fair value of financial instruments, income or expenses resulting from the application of fair value to these now come to be directly relevant for the formation of taxable profit (articles 20/1/f) and 23/1/i) of the CIRC) of the very year in which they occur, provided that certain conditions are met (article 18/9 of the CIRC), which include the formation of the price in a regulated market, with gains or losses not being taxed as capital variations (article 46/1/b) of the CIRC).

In this framework, there clearly cease to be any needs relating to the fight against tax fraud and evasion, not only because the tax relevance of capital variations ceases to be conditioned by an act of will of the taxpayer, but also because the valuation is objectively fixed.

B) On the other hand, and for the same reasons, there equally lacks any meaning any measure of conditioning the taxpayer's will, in the sense of favoring economically more "desirable" behaviors and, as such, conform to the interests of broadening the tax base and consolidating public accounts. The analysis of the normative text reveals with clarity that the legislator elected, for inclusion therein, three types of situations that should be had, in function of the presumption of good legislative technique, as distinct, namely:

a. "The negative difference between realized gains and realized losses through the onerous transmission of equity interests";

b. "other losses (...) relating to equity interests or other components of equity";

c. "other (...) negative capital variations relating to equity interests or other components of equity".

Let us see, then, whether the situation of the proceedings falls within any of the listed situations. The situation alluded to under subparagraph a) above will be manifestly inapplicable, not only because there was no realization by means of onerous transmission, but because article 46/1/b) excludes the situations described in article 18/9/a) from the concept of realized gains. Thus, any difficulty that exists in the case can only fall within one of the situations listed in subparagraphs b) and c) above.

In this way, it is concluded that article 45/3 of the applicable CIRC will refer to:

a. negative differences between gains and

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