Fair Value Adjustments in Corporate Tax (IRC): CAAD Arbitration on Taxable Profit Contributions – Process 77/2016-T

ARBITRATION DECISION

The arbitrators José Pedro Carvalho (arbitrator-president), Diogo Feio and Pedro Galego (arbitrator-members), appointed by the Ethics Council of the Centre for Administrative Arbitration to form the Arbitral Tribunal hereby agree as follows:

1. Report

A…, S.A., with unique registration and tax identification number…, with registered office at…, no.…, in Lisbon, presented a request for constitution of a collective arbitral tribunal, pursuant to the combined provisions of articles 2° and 10° of Decree-Law no. 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter referred to only as RJAT), in which the Tax and Customs Authority is the Respondent, with a view to declaring the illegality of the assessment act for Corporate Income Tax (IRC) with no. 2015…, relating to the fiscal year 2011.

The request for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority on 12-02-2016.

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

On 12-04-2016, the parties were duly notified of this appointment, and expressed no wish to refuse the designation of the arbitrators, pursuant to the combined provisions of article 11°, section 1, paragraphs a) and b) of RJAT and articles 6° and 7° of the Ethics Code.

Thus, in accordance with the provision in paragraph c) of section 1 of article 11° of RJAT, in the wording introduced by article 228° of Law no. 66-B/2012, of 31 December, the collective arbitral tribunal was constituted on 02-05-2016.

The Tax and Customs Authority responded, arguing that the request should be dismissed.

Given that the general procedural principles of procedural economy and prohibition of futile acts apply in the arbitral proceedings, pursuant to the provisions of paragraphs c) and e) of article 16° of RJAT, the holding of the meeting referred to in article 18° of RJAT was dispensed with.

The parties were afforded the possibility of, if they so wished, submitting written pleadings, which they did.

The arbitral tribunal was regularly constituted and is materially competent, in light of the provisions of articles 2°, section 1, paragraph a), and 30°, section 1, of Decree-Law no. 10/2011, of 20 January.

The parties have legal personality and capacity, are legitimate and are represented (articles 4° and 10°, section 2, of the same decree and article 1° of Ordinance no. 112-A/2011, of 22 March).

The proceedings are not affected by any nullities and no exceptions were raised.

Thus, there is no obstacle to examination of the merits of the case.

2. Factual Matters

2.1. Proven Facts

Based on the elements contained in the proceedings and in the administrative file attached to the case record, the following facts are considered proven:

• The Claimant is a commercial company engaged in the construction and development of real estate and tourism projects in the Algarve, its activities including, among others, the promotion and real estate and tourism development of tourism enterprises and related and similar establishments, including a tourist village, a hotel establishment, tourist apartments and food and beverage establishments.

• The Claimant is registered with the Tax and Customs Authority under the General Regime for Determination of Taxable Profit, for IRC purposes, with main business activity code (CAE) no.… (Hotels with restaurant) and with secondary CAE no.… (Purchase and sale of real estate property), being classified, for VAT purposes, under the Normal Regime with monthly periodicity.

• Following an internal inspection action with partial scope, aimed at analyzing the determination of IRC by the Claimant, with reference to the fiscal years 2011, 2012 and 2013, in compliance with Service Orders OI2015…/…/…, the Claimant was notified on 22 July 2015, through Official Notice no.…, of 20.07.2015, of the respective Draft Report.

• The said Draft Report proposed the following correction for IRC purposes relating to the fiscal years 2011, 2012 and 2013:

• Following notification of the said inspection draft report, the Claimant voluntarily regularized the incorrections identified in Points III.1.2. and III.1.3. by submitting a replacement IRC Form 22 income declaration for the fiscal years 2011, 2012 and 2013, from which resulted taxable profit of €1,362,475.36 for fiscal year 2011 (consumed in full with tax losses) and losses for tax purposes in the amounts of €6,915,527.32 for 2012 and €1,636,422.61 for 2013.

• Not conforming to the correction advocated in Point III.1.1. of the inspection draft report, the Claimant submitted, on 6 August 2015, its request for participation in the procedure (prior hearing).

• Notwithstanding the arguments presented by the Claimant, the Tax Inspection Services maintained the proposed corrections for the said fiscal years, invoking, in summary, that:

i. "Case law is the set of decisions (judgments and rulings) delivered by courts when interpreting and applying the law to concrete cases assigned to them", and "court decisions only bind the concrete case on which the court decision is delivered, even though the situation in question is identical to that discussed therein and even though the Arbitral Award relating to proceedings no. 108/2013-T has become final and definitive in the legal order";

ii. "(…) the Tax Inspection Services of the Finance Directorate of Lisbon do not have competence to proceed with the revision of the said generic guidance", since "[t]hese services, as we referred to in the Corrections Project, pursuant to section 1 of the said article 68°-A of the LGT and article 55° of CPPT, are bound by the understanding set forth in the said Doctrinal Note relating to Case no. 39/2011, of dispatch dated 24/02/2011 of the Director-General of Taxes";

iii. "The Doctrinal Note relating to Case no. 39/2011, with dispatch dated 24/02/2011 of the Director-General of Taxes, concerning a company holding shares in companies listed on the Stock Exchange, representing less than 5% of the respective capital, whose evolution of the corresponding quotation was negative, in its points 5 and 6 states the following:

1. In the event that a loss due to fair value reduction is determined, article 45°, section 3 of CIRC establishes that "…other losses… relating to equity shares, …, concur in the formation of taxable profit in only half of their value."

2. Being the reductions of fair value of these equity shares qualified as losses, they should be considered, pursuant to the said article 45°, section 3, of CIRC, at 50% of their value."

iv. "(…) we will not pronounce on the considerations presented by the taxpayer, thus maintaining the corrections initially proposed of non-acceptance for tax purposes of 50% of the losses from fair value reductions of financial investments, in the amount of €281,352.30 in 2011, €328,099.59 in 2012 and €1,029,416.67 in 2013, pursuant to the combined provisions of paragraph a) of section 9 of article 18° with section 3 of article 45° of the IRC Code, for purposes of determining the taxable profit of fiscal years 2011, 2012 and 2013."

• The corrections made are based on the fact that the Claimant did not add to Table 07 of the periodic income declaration Form 22 of IRC, submitted for the fiscal years 2011, 2012 and 2013, the losses and fair value reduction suffered in the said year with reference to shares - 4,602,750 shares in 2011 and 4,584,750 shares in 2012 and 2013 - which it holds in the listed company B… with registered office in Kuwait, representing approximately 1% of the share capital or voting rights of the company.

• According to the understanding of the Tax Inspection Services of the Finance Directorate of Lisbon - underlying the corrections made - the Claimant could only have deducted 50% of the losses from fair value reduction of B… shares in light of the provisions of article 45°, section 3 of the IRC Code.

• Considering this interpretation, the Tax Inspection Services corrected the loss declared by the Claimant for tax purposes in fiscal years 2011, 2012 and 2013, by disregarding 50% of the losses from fair value reduction recorded in those years at cost by the Claimant with reference to the shares held by the company in the share capital of the listed company B… with registered office in Kuwait, as follows:

• Following the conclusions contained in the Inspection Report, the Claimant was notified on 21 September 2015 of the IRC Assessment Demonstration, the Interest Assessment Demonstration and the Settlement Demonstration, relating to fiscal year 2011, in which the amount of €4,760.90 was determined to be paid, with the voluntary payment period ending on 13 November 2015.

• The said amount of €4,760.90 corresponds to the surcharge and compensatory interest, following the disregard of the losses from fair value reductions of financial investments, in the amount of €281,352.30, which was paid by the Claimant under the principle of "solve et repete" on 26 December 2015.

• On that same day, the Claimant was notified of the IRC Assessment Demonstration and the Settlement Demonstration, relating to fiscal years 2012 and 2013, which, not conforming, it contested through the submission of an administrative review request.

2.2. Unproven Facts

There are no facts relevant to the examination of the merits of the case that have not been proven.

2.3. Reasoning for Determination of Factual Matters

Regarding the factual matters, the Tribunal does not need to pronounce on everything that was alleged by the parties, but rather has the duty to select the facts that matter for the decision and to distinguish proven from unproven matters (cf. article 123°, section 2, of CPPT and article 607°, section 3 of CPC, applicable by virtue of article 29°, section 1, paragraphs a) and e), of RJAT).

In this manner, the facts relevant to the judgment of the case are chosen and selected in function of their legal relevance, which is established considering the various plausible solutions of the legal question(s) (cf. former article 511°, section 1, of CPC, corresponding to current article 596°, applicable by virtue of article 29°, section 1, paragraph e), of RJAT).

Thus, having considered the positions assumed by the parties, in light of article 110°/7 of CPPT, the documentary evidence and the administrative file attached to the case record, the facts listed above were considered proven as relevant to the decision.

3. Legal Matters

As is peacefully accepted by Claimant and Respondent, "The issue at hand is, then, to decide whether the negative change in equity, or loss, relating to the equity interest held in the listed company B…, resulting from the recognition at fair value, occurring in the period of 2011, should be considered at only 50% for tax purposes."[1]

Specifically, in the present case, it is verified that the Claimant, in fiscal year 2011, held a financial equity interest of approximately 1%, corresponding to 4,602,750 shares in the listed company B… with registered office in Kuwait, which, by application of the accounting criterion of fair value, suffered two depreciations corresponding to the difference between the acquisition value of the said shares and their official quotation on 1 January, on the one hand, and the variation occurring in fiscal year 2011, on the other. It is necessary, then, to determine to what extent and in what terms such depreciation should concur in the determination of the Claimant's taxable profit.

Equally accepted by both procedural parties is that the financial equity interest in question should be accounted for in accordance with the fair value criterion, and that it was recognized through results.

In this manner, the issue to be resolved in the proceedings is properly delimited, which is, then, to know whether the accounting loss verified in fiscal year 2011, resulting from the depreciation of the quotation of B… shares, properly accounted for in accordance with the applicable fair value criterion, and recognized in results, should be considered in full, or only at 50%.

Normatively, the center of the dispute embodied in the proceedings is located in the provision of article 45°/3 of the applicable CIRC, whose text states that:

"The negative difference between gains and losses realized through the sale of equity shares, including their redemption and amortization with capital reduction, as well as other losses or negative changes in equity relating to equity shares or other components of equity, namely supplementary contributions, concur in the formation of taxable profit in only half of their value."

In the proceedings, it will thus be necessary to determine whether this provision applies or not to the case at hand, as the TA argues in its response, or whether, on the contrary, the situation sub iudice does not come within such provision.

Let us see, then.

The ATA argues that the aforementioned provision, when specifically referring to "other losses or negative changes in equity relating to equity shares or other components of equity (…), concur in the formation of taxable profit in only half of their value", will be encompassing situations such as those in the proceedings, imposing that the negative change in equity in question concurs in the formation of taxable profit in only half of its value.

The TA relies on the opinion of André A. Vasconcelos[3], A. C. Pires Caiado, Luís C. Viana, Luís P. Ramos[4], Luísa Anacoreta Correia[5], and Helena Martins[6], which are justified by the extensive scope of the (apparent) literality of the provision.

The TA also notes, observing the maintenance of the wording of the provision in question in light of the CIRC alterations motivated by the beginning of the SNC's entry into force, that the absence of alterations verified in the provision in question reveals that it was not intended that the regime in question suffer any alteration, in function of the changes introduced in the accounting system.

Finally, it also invokes the ATA the Constitutional Court Ruling 85/2010[7], which found the provision in question constitutional.

The specific question at hand in the proceedings is rooted in the generic question of determination of taxable profit of IRC taxpayers.

In this regard, article 17°/1 of the applicable CIRC provides that:

"The taxable profit of legal entities and other entities mentioned in paragraph a) of section 1 of article 3° is constituted by the algebraic sum of the net income of the fiscal year and positive and negative changes in equity verified in the same period and not reflected in that income, determined on the basis of accounting and possibly corrected pursuant to this Code."

Section 9 of article 18° of the same Code provides that:

"The adjustments resulting from the application of fair value do not concur in 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, terminated or settled, except when:

a) They relate to financial instruments recognized at fair value through results, provided that, in the case of equity instruments, they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a stake in capital exceeding 5% of the respective share capital; or

b) This is expressly provided for in this Code."

Article 20°/1 of the CIRC provides that:

"Income shall be considered as those resulting from operations of any nature, as a consequence of a normal or occasional action, basic or merely accessory, namely:
(...)
f) Income resulting from the application of fair value in financial instruments; (...)
h) Realized gains;"

Similarly, article 23°/1 of the same provides that:

"Expenses shall be considered as those that are duly proven to be necessary for the realization of income subject to tax or for the maintenance of the income-producing source, namely:
(...)
i) Expenses resulting from the application of fair value in financial instruments; (...)
l) Realized losses;"

Regarding positive changes in equity, article 21°/1 of the CIRC provides that:

"Positive changes in equity not reflected in the net income of the tax period also concur in the formation of taxable profit, except:
(...)
b) Potential or latent gains, even if expressed in accounting, including revaluation reserves under tax legislation;"

As for negative changes in equity, article 24°/1, also of the same statute, provides that:

"Under the same conditions as those referred to for expenses, negative changes in equity not reflected in the net income of the tax period also concur in the formation of taxable profit, except:
(...)
b) Potential or latent losses, even if expressed in accounting;"

With respect to gains and losses, article 46°/1 of the same Code provides that:

"Realized gains or losses shall be considered as those obtained or suffered through the sale, regardless of the title by which it is operated, as well as those resulting from casualties or those resulting from the permanent dedication to purposes other than the activity exercised, relating to:
(...)
b) Financial instruments, with the exception of those recognized at fair value pursuant to paragraphs a) and b) of section 9 of article 18°"

The relevant regulatory framework for examination of the question sub iudice closes with the provision of article 45°/3, also of the applicable CIRC, already transcribed.

With the relevant regulatory framework delimited, it is necessary to proceed to the analysis and combination of the various provisions that compose it.

Such analysis must take into proper account the necessary systematic perspective of its integration, weighing equally both the historical context of its genesis and the teleology that is inherent to it.

Effectively, each of the provisions considered relevant for examination of the question to be decided should be understood in its corresponding concrete context, from which should be drawn its meaningful content, in function of its (or greatest possible) adherence to the fundamental values of the legal and constitutional legal framework, which inexorably condense the legislative intent.

Thus, and first and foremost, it must be borne in mind that the current article 45°/3 of the CIRC results from the renumbering of the former article 42°/3, effected by Decree-Law 159/2009.

That section of article 42° in question, in turn, was introduced by Law 32-B/2002, of 30 December, with the following wording:

"The negative difference between gains and losses realized through the sale of equity shares, including their redemption and amortization with capital reduction, concurs in the formation of taxable profit in only half of its value."

According to the Report of the Ministry of Finances for the State Budget of 2003 (p. 33), the legislative intervention in the area in question (IRC) was guided by "two priorities, namely, the fight against tax fraud and evasion and the broadening of the tax base," with the alteration of interest here fitting within the scope of "Broadening of the tax base and measures of moralization and neutrality" (p. 51).

The current wording of the provision under analysis resulted from the alteration implemented by Law 60-A/2005 of 30 December, and pursuant to the corresponding Report of the Ministry of Finances (p.31), the measure in question fit within the scope of "COMBATING TAX EVASION AND FRAUD AND OTHER MEASURES DIRECTED AT BUDGETARY CONSOLIDATION".

Already section 9 of article 18° of the applicable CIRC obtains its justification directly from the preamble of Decree-Law 159/2009, of 13 July, which introduced it in the said Code, where it can be read:

"Still in the field of approximation between accounting and taxation, the application of the fair value model in financial instruments is accepted, the counterparty of which is recognized through results, but only in cases where the reliability of the determination of fair value is in principle assured. Thus, equity instruments that do not have a price formed in a regulated market are excluded. Furthermore, the application of the realization principle was maintained with respect to financial instruments measured at fair value whose counterparty is recognized in equity, as well as equity shares corresponding to more than 5% of the share capital, even though recognized at fair value through results.(...)

In the same vein, assets covered by the regime of realized gains and losses are identified as tangible fixed assets, intangible assets, investment properties, financial instruments, with the exception of those in which the adjustments resulting from the application of fair value concur in the formation of taxable profit in the tax period."

These expressed intentions have correspondence in that provision of section 9 of article 18°, as well as in the introduction, by the same legal provision, of paragraphs f) and i) of section 1 of articles 20° and 24° of the CIRC, as well as of paragraph b) of section 1 of article 46°.

Within the set of alterations introduced by the said Decree-Law 159/2009, of 13 July, it is still necessary to note that where previously one spoke of revenues and gains (article 20°), one now speaks of income, and where one previously spoke of costs or losses (article 23°), one now speaks of expenses.

The adoption of the application of fair value as an accounting valuation criterion with tax relevance corresponds to a Copernican shift in the regime of taxation of income or expenses resulting from the acquisition of financial instruments.

Effectively, prior to the adoption of fair value, changes in equity relating to financial instruments were irrelevant from the point of view of the formation of the taxable profit of each period, due to the effect of the provision of article 21°/1/b) of the CIRC. Only at the moment of realization of the gain or loss did the change in equity assume tax relevance.

This tax framework had (as it has in the part that is maintained) three well-marked characteristics, namely:

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

• It was dependent on a voluntary action by the taxpayer, in that the transaction of the instruments generating the change in equity, condition of the tax relevance thereof, would only occur if and when the taxpayer so wished;

• The valuation of the change in equity was determined based on the concrete transaction that triggered its tax relevance.

The combination of these three characteristics just pointed out provided fertile ground for accounting and tax manipulations, since the taxpayer could choose to trigger the tax relevance of the change in equity at the moment and on the terms that would be most fiscally beneficial.

On the other hand, attentive to the relevance of the taxpayer's will in the mechanism of tax relevance of the change in equity, 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 by the preference for the realization of gains, to the detriment of the realization of losses.

It is in this framework that the emergence of the provision of the former article 42°/3 of the CIRC, which precedes the current article 45°/3 of the same, in the applicable wording, is explained.

Such provision, 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 objectively and subjectively (that is, faced with the motivation expressed by the legislator) by needs linked to the fight against tax fraud and evasion and to the broadening of the tax base, directed at the desired budgetary consolidation of public accounts.

The acceptance of the application of the fair value model in financial instruments, operated by Decree-Law 159/2009, of 13 July, introduced, in the part covered, a model radically different, both in valuation and in tax relevance of changes in equity relating to the holding of such instruments.

Effectively, the legislative intent when welcoming the fair value model, duly evident, was, assumed and expressly, to maintain "the application of the realization principle with respect to financial instruments measured at fair value whose counterparty is recognized in equity, as well as equity shares corresponding to more than 5% of the share capital, even though recognized at fair value through results".

As for "financial instruments" that correspond to less "than 5% of the share capital", "whose counterparty is recognized through results, (…) in cases where the reliability of the determination of fair value is in principle assured", the legislative intent 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, "The adjustments resulting from the application of fair value do not concur in 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, terminated or settled." This is a clear and deliberate manifestation of the assumed realization principle.

However, the same provision, in its paragraph 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, in the case of equity instruments, they have a price formed in a regulated market and the taxpayer does not hold, directly or indirectly, a stake in capital exceeding 5% of the respective share capital;".

That is, and equally as assumed by the legislative entity, when the "income or expenses (…) relate to financial instruments recognized at fair value," they "concur in 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 stake in capital exceeding 5% of the respective share capital."

When 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).

In this manner, where previously we had a single tax relevance (one-off), when the transaction of such instruments occurred, we now have a continued tax relevance. That is, faced with the new provisions composing the regime of tax relevance of the accounting at fair value of financial instruments, income or expenses resulting from the application of fair value to these now directly affect 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 positive and negative changes in equity not being taxed as gains and losses (article 46°/1/b) of the CIRC).

In this framework, any needs whatsoever relating to the fight against tax fraud and evasion clearly cease to exist, both because the tax relevance of changes in equity ceases to be conditioned by a voluntary act of the taxpayer and because the valuation is objectively fixed.

On the other hand, and for the same reasons, any measure of conditioning the taxpayer's will also lacks sense, in the sense of favoring economically more "desirable" behaviors and, as such, conforming to the interests of broadening the tax base and budgetary consolidation.

Notwithstanding all the alterations introduced by Decree-Law 159/2009, of 13 July, the former article 42°/3 of the CIRC, renumbered to article 45°/3, maintained its respective vigence, with its unaltered wording.

Hence the question, as occurs in the proceedings, of whether such provision will apply or not to the depreciations relating to financial instruments that concur in the formation of taxable profit, pursuant to article 18°/9/a) of the CIRC.

Prima facie, the answer to such question would be affirmative, as the TA argues, attentive to the scope of the provision in question, pointed out by the Authors cited by it in its response.

A careful and coordinated reading of the regulatory provisions relevant for examination of the case, which have already been indicated, will, however, allow a different conclusion.

Let us see.

Article 45°/3 of the CIRC, already transcribed, states that:

"The negative difference between gains and losses realized through the sale of equity shares, including their redemption and amortization with capital reduction, as well as other losses or negative changes in equity relating to equity shares or other components of equity, namely supplementary contributions, concur in the formation of taxable profit in only half of their value."

Analysis of the regulatory text reveals with clarity that the legislator chose, for inclusion therein, three types of situations that should be considered, in function of the presumption of good legislative technique, as distinct, namely:

a) "The negative difference between gains and losses realized through the sale of equity shares";

b) "Other losses (…) relating to equity shares or other components of equity";

c) "Other (…) negative changes in equity relating to equity shares or other components of equity".

Let us see, then, whether the situation in the proceedings comes within any of the enumerated situations.

The situation referred to under paragraph a) above will be manifestly inapplicable, not only because there was no realization through the sale, but also because article 46°/1/b) excludes the situations described in article 18°/9/a) from the concept of realized gains. In this manner, any difficulty that may exist in the case can only come within some of the situations enumerated in paragraphs b) and c) above.

The apparent indiscriminate scope of the provisions in question can, however, be reasonably mitigated if one notes that "losses" and "other negative changes in equity" will be concepts, not redundant, but endowed with their own and distinct sense.

To understand this fact, it will be necessary to recur to articles 23° and 24° of the same Code, attenting to the terminological evolution operated by article 159/2009, of 13 December.

Indeed, before the entry into force of this latter statute, the said articles of the CIRC referred, respectively, that:

• "Costs or losses shall be considered as those duly proven to be necessary for the realization of income or gains subject to tax or for the maintenance of the income-producing source, namely the following: (…)";

• "Under the same conditions as those referred to for costs or losses, negative changes in equity not reflected in the net income of the fiscal year also concur in the formation of taxable profit, except: (…)".

It is verified, in this manner, that when the current wording of article 45°/3 of the CIRC was established, this Code expressly distinguished, for what here is relevant, three types of situations, namely:

a) Costs;

b) Losses;

c) Negative changes in equity not reflected in the net income of the fiscal year.

The provision of article 42°/3 (predecessor of the current 45°/3), should be considered, thus, as referring to these concepts, defined in articles 23° and 24°. In this manner, and for obvious reasons, costs relating to "equity shares or other components of equity" should be excluded from the provision of that provision, including therein only losses (as defined in article 23°) and negative changes in equity (as defined in article 24°), relating to those shares.

And that this is so, that is, that the expression "other losses or negative changes in equity" used in the current article 45°/3 of the CIRC does not have an indiscriminately comprehensive sense, but rather a precise sense, defined in articles 23° and 24°, follows from the very fact that the legislator employed the same distinction, which, contrary to what is suggested by the TA in its response, in no case "can be qualified as a terminological imprecision of the legislator without consequences at the level of interpretation of those provisions", which is evident, from the start, from the fact that the reading now made, contrary to that sustained by the TA, does not lead to any arbitrary, unjust or, in any other manner, non-conforming result to the legal-constitutional principles that guide the legislator and, in the first place, condense the content of the legislative purpose.

Further reinforcing that this is so, it suffices to note that the inclusion within the scope of the provision in question, not only of losses (as defined in article 23°) and negative changes in equity (as defined in article 24°), but also of costs (as defined in article 23°), would lead to the fact that, for example, the cost of acquisition of equity shares would only concur at half of the respective value in the determination of taxable profit, which would be, obviously, inconceivable in a minimally reasonable legislator.

The normative alteration implemented by Decree-Law 159/2009, of 13 July, will not have altered anything of relevance in the matter in question. Effectively, notwithstanding that the body of article 23° has come to refer only to expenses, the fact is that the CIRC continues to use the expression "losses", including in the article 23° itself (see section 1, paragraph h)). This occurs in coherence, moreover, with the SNC, which pursuant to point 2.1.3.e) of the annex to Decree-Law 158/2009 of 12 July, maintains the distinction between "expenses" and "losses".

In this manner, it is concluded that article 45°/3 of the applicable CIRC will relate to:

a) Negative differences between gains and losses realized through the sale of equity shares;

b) Other losses relating to equity shares or other components of equity; and

c) Other negative changes in equity relating to equity shares or other components of equity.

being that by "losses" should be understood the facts qualifiable as such in light of the CIRC, and by "negative changes in equity" should be understood negative changes in equity not reflected in the net income of the fiscal year, as defined in article 24° of the same Code.

Not included in the scope of the provision in question will be the facts qualifiable as "expenses", in light of the CIRC, even though relating to equity shares or other components of equity.

The TA itself seems to recognize this very fact, since in the "Manual for Completion of Table 07, Form 22"[8], with respect to field 737, refers that "In this field are entered, at 50%, the amounts relating to other losses (which are not losses realized, since these are subject to the 'mechanism' of gains and losses realized) relating to equity shares or other components of equity capital. For example, the amounts corresponding to 50% of the losses from fair value reductions are entered in this field 737, when these fit within the scope of article 23°, section 1, paragraph i), by force of the provisions of article 18°, section 9, paragraph a)." It happens that article 23°/1/i) of the CIRC does not refer to the amounts in question as "losses", but as "expenses", so its entry in the field in question will be incorrect.

Moreover, and if there were any doubts, if the legislator, when the Decree-Law 159/2009 of 13 December entered into force, intended to encompass the situations enumerated in article 18°/9/a) of the CIRC within the scope of article 45°/3 of the same, would have:

• Included "Expenses resulting from the application of fair value in financial instruments", not in article 23°, but in article 24° of the CIRC[9]; or

• Referred to such situations as "losses resulting from the application of fair value in financial instruments" and not as "expenses".

Furthermore, the alteration applied to the CIRC by Law 2/2014, brought to bear by the Respondent in its response, points, contrary to what it argues, in the direction of the interpretation of the legal framework carried out here.

Effectively, the Draft IRC Reform, cited by the TA itself in its Response, refers that "in a logic of neutrality, the same treatment should be conferred on gains and losses in equity instruments, regardless of the measurement criterion that is used".

Now, this intention only makes sense if – before the entry into force of the alterations introduced by Law 2/2014, there was a distinction in the "treatment of gains and losses in equity instruments" depending on "the measurement criterion that is used".

Now, in the interpretation advocated by the TA, there was no distinction in the treatment of losses, since regardless of the measurement criterion used, the expenses resulting from the application of fair value would always have the same treatment as the remaining losses realized and negative changes in equity, occurred within the framework of the use of other measurement criteria.

In the framework that has just been exposed, it should then be considered that Decree-Law 159/2009, of 13 July introduced, with respect to the part covered by the acceptance of the application of the fair value model in financial instruments, a special regime of relevance for the computation of taxable profit, justified both by its own objectivity and by the confessed intention of approximation of accounting to taxation.

This circumstance is, faced with the subsequent wording of the CIRC, not susceptible to generating any type of doubts, as is verified, in particular, by the wording of articles 20°/1/f) and h), 23°/1/i) and l), and especially 46°/1/b), faced with which the intention of the legislator is clearly evidenced to move away the adjustments resulting from the application of the fair value criterion in financial instruments, pursuant to the CIRC, from the regime of gains and losses realized.

Already the regime resulting from the combination of articles 45°/3 and 46° of the CIRC only makes sense from the perspective of the acceptability of the changes in equity in question under the prism of the said realization principle.

That is, being at stake, faced with such principle, the ascertainment of the change in equity in function of a transaction, there will always be a voluntary factor in relation to that.

That is, in the regime for which the provision of article 45°/3 was thought and instituted, the realization of losses, and other situations enumerated, was dependent on a voluntary action corresponding to the realization thereof. Now, in this framework, it will be understandable that the legislator institutes mechanisms of disincentive to action susceptible to being considered as undesirable, in this case the realization of losses or other negative changes in equity. In providing that such situations will only be relevant at 50% of the accounted amount, the tax legislator is, objectively, conditioning the actions covered by the legal provision, imposing a negative incentive to the same.

On the other hand, and being at stake financial instruments of value not objectively quantifiable, the disregard of 50% of the negative changes in equity verified would also have a function of "compensating" the natural tendency of economic operators to, at the tax level, inflate losses.

However, those aspects will not be verified already in the situations covered by article 18°/9/a). Here, being faced with adjustments resulting from the accounting of fair value, determined by objective criteria (with "a price formed in a regulated market"), there is no doubt whatsoever or intervention of the taxpayer's will in the verification of the negative or positive change in equity. That is, these will occur or not, independently of the action and will of the taxpayer.

Now, to penalize, in these cases, the taxpayer with a disregard of 50% of the expense incurred, would be wholly unjustified, both from an economic point of view and from a legal point of view.

That is, recall, this situation of contingent (aleatory, even) unjustified penalization would only occur by force of the exception to the regime of the realization principle of the situations covered by article 18°/9/a) of the applicable CIRC. That is, if with respect to those situations the general regime of the body of article 18°/9 applied, according to which the same would not concur "in 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, terminated or settled", the pointed incoherence would not be verified, since the fact that would trigger the concurrence in the formation of taxable profit would only occur by will of the taxpayer, so it would fall to the latter to choose to realize the negative change in equity, with the consequent tax penalization, or to defer this to a moment when it was less voluminous or, even positive, diminishing or eliminating the penalization resulting from the operation for itself and for the Treasury. It is the exception of paragraph a), by removing the situations provided for therein from the scope of the realization principle, that justifies the new regime of relevance for taxable profit, instituted.

Evident of all that has been said is presented in the table elaborated below, which demonstrates the unreasonableness of the application of the provision of article 45°/3 to the situations covered by article 18°/9/a):

*with application of article 45°/3 of CIRC

The non-application of the provision of article 45°/3 of the CIRC to expenses, and specifically to "Expenses resulting from the application of fair value in financial instruments", with the full consideration of the changes in equity verified, whether positive or negative, leads to a coherence of taxation whatever the time at which the sale of the financial instrument occurs. That is, at whatever time it is chosen to proceed with the sale of the financial instrument, the positive and negative changes in equity offset each other, so that, in the end, the taxpayer only has increased or decreased his taxable profit by the difference between the acquisition value and the sale value.

If the provision of article 45°/3 of the CIRC were to be applied, as the ATA argues, from the moment a negative change in equity occurs, there will be a discrepancy between the tax relevance of negative and positive changes in equity, without any justification, as has been said, since those changes occur in an objective manner and independent of the action or will of the taxpayer. Thus, if at the end of the second year the taxpayer in the above example proceeded with the realization of the financial instrument in question, notwithstanding having realized a gain of only 20 (which would be taxed as such under the realization principle), would, in the end, have paid tax on 30 (40-10). In the same way, if the taxpayer proceeded with that realization at the end of the third year, would have paid tax on 20, notwithstanding not having had any increase in equity with the operation. And if the taxpayer proceeded with the same realization at the end of the sixth year, would have paid tax as if having had an increase in equity of 30 (80-50), notwithstanding having had an actual change in equity of -20, which, under the realization principle enshrined in the CIRC, would be acceptable, albeit at only 50% of the respective value (-10)!

It seems clear that such results, merely random and without any substantive justification sustaining them, cannot have been intended by a reasonable legislator, a circumstance that – by not having been addressed therein – from the start moves away any possibility of convergence with what was decided in the arbitral proceedings 25/2015T.

It is true that the alternative solution, which excludes the application of article 45°/3, leads to the fact that, in the event that, in the end, there is a loss, this ends up having been considered at 100%, and not at 50%, as would occur under the realization principle. Would be the case of, in the example of the table above, the realization occurring in years 4 or 6. However, this positive discrimination (or rather, non-negative discrimination) by the option for the fair value criterion can be justified, from the start, in that in the regime of article 18°/9/a), there ceases to make sense any disincentive to the realization of losses, since the same will be relevant for tax purposes independently of their actual realization. One should not overlook equally that, on one hand, the accounting at fair value is considered more conforming to the approximation between accounting and taxation, a purpose confessedly pursued by the legislator of Decree-Law no. 159/2009, of 13 July, and, on the other, the circumstance that we are faced with objectively evaluated realities, without there being significant margins for tax-convenient manipulations. That is, as had been advanced already, the reasons for fighting tax fraud and evasion do not exist, nor do the reasons for budgetary consolidation, that demonstrably were in the genesis of the provision of article 45°/3 of the CIRC.

Does not hold, note, the objection raised by the Respondent in its Response, questioning "with what legitimacy can an interpretation of article 45°, section 3 be constructed that would exclude from its scope losses, as well as other losses and negative changes in equity determined in operations with equity instruments realized in regulated markets?"[10], objection that passes, precisely, beside the crux of the matter, which is that expenses and income resulting from fair value adjustments do not result from the realization of any operations with equity instruments, but simply from the action of their value faced with criteria (taken by the legislator) as objective.

As does not hold, incurring in a petitio principii, the argument that "if the legislator, neither before nor after 2010, introduced any provision establishing a symmetric solution for income/gains and expenses/losses resulting from the application of fair value, pursuant to the terms and conditions to which article 18°, section 9, paragraph a) refers, neither can the interpreter, whether the TA or the taxpayer, replace the legislator in that task."[11], since what is being discussed is, precisely, whether the legislator introduced or not such provision, in particular in the wording given to article 18°/9/a), in the context of a code containing the provision of article 45°/3.

In this manner, and in sum, in obedience to the hermeneutic impositions of article 9° of the Civil Code, according to which "Interpretation should not be confined to the letter of the law, but should reconstruct from the texts the legislative thought, taking especially into account the unity of the legal system, the circumstances in which the law was elaborated and the specific conditions of the time in which it is applied" (section 1), and "In the fixing of the sense and scope of the law, the interpreter will presume that the legislator established the most correct solutions and knew how to express his thought in adequate terms." (section 3), it is understood that article 45°/3 of the CIRC should be interpreted in the sense that its provision does not include expenses resulting from the application of fair value in financial instruments, that are relevant for the formation of taxable profit pursuant to paragraph a) of section 9 of article 18°.

In these terms, considering that article 18°/9/a) of the applicable CIRC imposes the concurrence "in the formation of taxable profit", without reservations or limitations, of "income or expenses" that "(…) relate to financial instruments recognized at fair value", "provided that" they are recognized "through results"; they are "equity instruments"; they "have a price formed in a regulated market"; and "the taxpayer does not hold, directly or indirectly, a stake in capital exceeding 5% of the respective share capital", not applying, in these cases, article 45°/3 of the said Code, in that they are not covered by the normative provision thereof, it is understood that the claim merits approval.

The Claimant combines, with the request for annulment of the tax act object of the present proceedings, a request for condemnation of the TA to the payment of compensatory interest.

Faced with the merits of the annulment request, the prestations that, relating to the tax acts annulled, are shown to be paid by the Claimant should be restituted, if necessary in execution of sentence. In the case at hand, it is manifest that the illegality of the assessment acts, whose amount the Claimant paid, is imputable to the Respondent, which, by its own initiative, committed them without legal support.

Consequently, the Claimant is entitled to compensatory interest, pursuant to the provisions of articles 43°, section 1, of the LGT and 61° of the CPPT. Compensatory interest is due, from the date of payments shown to be made, and calculated on the basis of the respective value, until its full restitution to the Claimant, at the legal rate, pursuant to the provisions of articles 43°, sections 1 and 4, and 35°, section 10, of the LGT, 61° of the CPPT and 559° of the Civil Code and Ordinance no. 291/2003, of 8 April (without prejudice to any subsequent alterations of the legal rate).

Further, in accordance with the provision of paragraph b) of article 24° of the RJAT, the arbitral decision on the merits of the claim that does not permit appeal or impugnation binds the tax administration from the end of the period provided for appeal or impugnation, and this one must, in the exact terms of the merits of the arbitral decision in favor of the taxpayer and until the end of the period provided for the spontaneous execution of decisions of the judicial tax courts, "reestablish the situation that would exist if the tax act object of the arbitral decision had not been committed, adopting the acts and operations necessary for such effect", which is in harmony with the provision of article 100° of the LGT [applicable by force of the provision of paragraph a) of section 1 of article 29° of the RJAT] which establishes that "the tax administration is obliged, in case of total or partial merits of an administrative review request, judicial impugnation or appeal in favor of the taxpayer, to immediate and full reestablishment of the legality of the act or situation object of the dispute, including the payment of compensatory interest, if applicable, from the end of the period of execution of the decision."

Although article 2°, section 1, paragraphs a) and b), of the RJAT uses the expression "declaration of illegality" to define the competence of the arbitral tribunals functioning in the CAAD, not making reference to condemnatory decisions, it should be understood that the powers that in judicial impugnation proceedings are attributed to tax courts are comprised within its competences, being that the interpretation that harmonizes with the sense of the legislative authorization on which the Government based itself to approve the RJAT and in which is proclaimed, as a first directive, that "the tax arbitral process should constitute an alternative procedural means to the judicial impugnation process and to the action for the recognition of a right or legitimate interest in tax matters".

The judicial impugnation process, despite being essentially a process of annulment of tax acts, admits condemnation of the tax administration to the payment of compensatory interest, as is inferred from article 43°, section 1, of the LGT, in which it is established that "compensatory interest is due when it is determined, in administrative review or judicial impugnation, that there was error imputable to the services from which results payment of the tax debt in amount greater than legally due" and article 61°, section 4 of the CPPT (in the wording given by Law no. 55-A/2010, of 31 December, to which corresponds section 2 in the original wording), that "if the decision recognizing the right to compensatory interest is judicial, the payment period runs from the beginning of the period of its spontaneous execution".

Thus, section 5 of article 24° of the RJAT when stating that "payment of interest, regardless of its nature, is due, pursuant to the terms provided for in the general tax law and in the Code of Tax Procedure and Process" should be understood as permitting the recognition of the right to compensatory interest in the arbitral process. In the case at hand, it is manifest that, following the declaration of illegality and consequent annulment of the assessment acts impugned, there is place for reimbursement of the tax, by force of the said articles 24°, section 1, paragraph b), of the RJAT and 100° of the LGT, since this is essential to "reestablish the situation that would exist if the tax act object of the arbitral decision had not been committed", in the part corresponding to the correction that was found to be illegal.

By the foregoing, the Respondent should give execution to the present award, pursuant to article 24°, section 1, of the RJAT, determining the amount to be restituted to the Claimant and calculating the respective compensatory interest, at the supplementary legal rate for civil debts, pursuant to the provisions of articles 35°, section 10, and 43°, sections 1 and 5, of the LGT, 61° of the CPPT, 559° of the Civil Code and Ordinance no. 291/2003, of 8 April (or statute or statutes that succeed it).

Compensatory interest is due from the dates of payments made until that of the processing of the credit note, in which they are included (article 61°, section 5, of the CPPT).

4. Decision

In accordance with the foregoing, this Arbitral Tribunal hereby agrees to judge the present tax arbitral action with merit, and, in consequence:

a) Annul the correction to the taxable amount of IRC of 2011, in the amount of €281,352.30;

b) Annul the IRC assessment no. 2015… and the respective settlement demonstration, in which the amount of tax and respective compensatory interest of €4,760.90 is determined, relating to the fiscal year 2011;

c) Condemn the Respondent to the reimbursement of the amounts indebtedly paid by the Claimant, plus compensatory interest accrued and accruing;

d) Condemn the Respondent for the costs of the proceedings, fixed below.

5. Value of the Case

In its defense, the Respondent raised the question of alteration of the value of the case, to which the Claimant did not object, arguing that, in article 97°-A of the CPPT, applicable by virtue of article 29° of the RJAT, it is provided as follows:

"1 - The values that may be taken into account, for purposes of costs or others provided for in the law, for actions that proceed in tax courts, are the following:

a) When the assessment is impugned, the amount whose annulment is sought;".

However, paragraph b) of the same provision provides that:

"b) When the act of determination of the taxable amount is impugned, the amount disputed;".

Now, in the case, the Claimant also requested annulment of the correction to the taxable amount of IRC of 2011, in the amount of €281,352.30, a request which, from the point of view of its admissibility, suffered no objection whatsoever from the part of the TA, ending up, even, by proceeding entirely thereto.

Hence, pursuant to the said paragraph b) of section 1 of article 97°-A of the CPPT, there is ground to add the value of this request to the value of the case.

Thus, in accordance with the provision of article 315°, section 2, of the CPC and 97°-A, section 1, paragraphs a) and b), of the CPPT and 3°, section 2, of the Regulation of Costs in Tax Arbitration Proceedings, the case is assigned the value of €286,113.20.

6. Costs

Pursuant to article 22°, section 4, of the RJAT, the amount of costs is fixed at €5,202.00, pursuant to Table I annexed to the Regulation of Costs in Tax Arbitration Proceedings, to be borne by the Tax and Customs Authority.

Lisbon, 28 October 2016

The Arbitrators

(José Pedro Carvalho – President/Reporter)

(Diogo Feio - Member)

(Pedro Galego - Member)