IRC Cost Deductibility Under Article 23 CIRC: CAAD Arbitration on Business Expense Necessity (79/2017-T)

ARBITRAL DECISION

The Arbitrators José Baeta de Queiroz (Presiding Arbitrator), Nuno Cunha Rodrigues and José do Vale Marçal, appointed by the Deontological Council of the Administrative Arbitration Center to form the Arbitral Tribunal, hereby decide:

I – REPORT

a) A A… S.A., with registered office at Travessa …, nº…, …-… Lisbon, with the single registration and tax identification number…, hereinafter referred to as "Claimant", having been notified of the additional assessment of Corporate Income Tax (IRC), relating to the fiscal year 2012 and not conforming thereto, comes, pursuant to paragraph a) of n.º 1 of article 2, paragraph a) of n.º 3 of article 5, paragraph a) of n.º 2 of article 6 and n.º 2 of article 10, all of the Legal Regime for Arbitration in Tax Matters ("RJAT"), to request the constitution of a collective arbitral tribunal in tax matters.

b) The Claimant intends for the Arbitral Tribunal to pronounce that an additional IRC tax assessment relating to fiscal year 2012 and respective compensatory interest is illegal and therefore should be annulled, in which the amount of € 369,177.53 (three hundred sixty-nine thousand, one hundred seventy-seven euros and fifty-three cents) was determined.

c) The request for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority (AT) on 31 January 2017.

d) The Claimant did not proceed with the appointment of an arbitrator, wherefore, pursuant to paragraph a) of n.º 2 of article 6 and paragraph a) of n.º 1 of article 11 of the RJAT, the President of the Deontological Council of CAAD appointed the undersigned as arbitrators of the collective arbitral tribunal, who communicated their acceptance of the appointment within the applicable period.

e) On 15-03-2017, the parties were notified of such appointments and did not manifest any intention to refuse any of them.

f) In accordance with the provision of paragraph c) of n.º 1 of article 11 of the RJAT, the collective Arbitral Tribunal was constituted on 11-04-2017.

g) The Tax and Customs Authority responded on 17 May 2017, arguing that the Claimant's request should be judged without merit.

h) On 30 May 2017, the first meeting of the Collective Arbitral Tribunal took place, pursuant to the terms and effects of article 18 of the RJAT, for the examination of the two witnesses summoned by the Claimant, with minutes thereof being drawn up, which are attached to the case file.

i) In that meeting the Tribunal:

1. Notified the Claimant and the Respondent to present written submissions within a period of 10 days, in that order and in succession, with the period for the Respondent beginning to run upon notification of the filing of the Claimant's submissions.

2. Requested from the parties the submission of case files in Word format.

3. In compliance with the provision of article 18 n.º 2 of the RJAT, fixed 29-09-2017 as the date for the delivery of the arbitral decision.

j) The Claimant and the Respondent submitted their written submissions on 9 and 27 June 2017, respectively.

1. Preliminary Ruling

The arbitral tribunal was regularly constituted and is materially competent, in light of the provisions of articles 2, n.º 1, paragraph a), and 30, n.º 1, of DL n.º 10/2011, of 20 January.

The parties have legal personality and legal capacity, are legitimate and are duly represented (articles 4 and 10, n.º 2, of the same diploma and article 1 of Order n.º 112-A/2011, of 22 March.

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

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

2.1. Factual Matter

2.1.1. Established Facts

The following facts are considered established and of interest for a proper decision of the case:

a) The Claimant is a joint-stock commercial corporation, established in 1990, whose corporate purpose consists of making investments in real and personal property, in particular in equity stakes in other corporations or non-profit institutions.

b) In addition to financial investments, the Claimant also has "own activity", in particular in the development of IT systems and communication networks between pharmacies and the pharmacy loyalty program.

c) A A…, SA is 100% owned by B…, SA NIF…, a company that has presented consolidated accounts since fiscal year 2010, with C… NIF: … being the final controlling parent company of the taxpayer with a stake of 90.26% as at 31 December 2012 (p. 14 RIT)

d) As at 31/12/2017 the financial investments (measured at MEP - Equity Method) represented 52% of the assets of A….

e) The claimant held, at the date of the facts, the following equity stakes (cfr. document 6, p. 13 attached with the arbitration request):

f) The A… S.A. resorted to borrowed capital, bearing the respective financing costs, in order to provide the investees with permanent capital, or "capital contribution", without charging them any interest.

g) The item with the greatest weight in the liabilities of A… refers to obtained financing (€ 124,999,468.67), representing 96% of its total liabilities.

h) Following from financing operations, mostly with financial institutions, the Claimant bore, during fiscal year 2012, expenses with interest and similar expenses in the amount of € 7,236,753.76, (representing 43.3% of the total expenses borne by A… in the said period) having subsequently deducted all of such charges pursuant to article 23 of the Corporate Income Tax Code (CIRC).

i) The final balances, as at 31/12/2012, of the loans granted to the investees, in their majority, in the form of supplementary contributions and ancillary payments, showed the value of € 55,858,260.21.

j) In fiscal year 2012, the Claimant presented a positive net result of € 1,646,654.22. However, after additions and deductions reflected in table 07 of the periodic income statement (model 22), A… determined a tax loss of 89,821.96 € (p. 13 RIT).

k) Pursuant to the agreement concluded with M… (annex XIII to the Tax Inspection Report, herein reproduced), the Claimant acquired from it, subsequently reselling to it, for the same value, 3,130,000 shares of the Bank….

l) To finance this operation the Claimant obtained a financing line from that Bank, bearing the respective costs, of which, in the year 2012, it charged nothing to M….

m) However, following a partial external inspection action carried out on fiscal year 2012, the claimant was notified of the Draft Tax Inspection Report, in which a correction to taxable profit in the amount of € 3,549,393 was proposed, as follows:

n) Essentially, the Tax and Customs Authority (AT) challenged the deductibility of financing expenses incurred by the Claimant, arguing that it obtained loans from financial institutions and bore the corresponding interest, while the financed amounts were, however, also destined, by way of loan, to the free financing of some of its investees.

The AT understands that financial charges associated with borrowed capital, applied in the free financing of corporations invested in by the Claimant, are not tax-deductible pursuant to article 23 of the CIRC, in the wording in force at the date of the facts.

o) In the methodology for calculating the financial charges not accepted for tax purposes, the AT took into account the weight of the ratio "loans granted/loans obtained", which was applied to the monthly balance of financial charges, the sum of which, as at 31/12/2012 is € 3,549,393.62 (Annex XV of the RIT).

p) The aforementioned corrections gave rise to the additional IRC tax assessment and respective compensatory interest, in which the amount of € 369,177.53 was determined, being € 326,903.93 the base value of the IRC increased by € 42,273.60 of compensatory interest (documents 1 to 3 attached with the arbitration request).

The facts found to be proven result from the tribunal's conviction, based on critical analysis of the documents attached to the proceedings, complemented by the testimony of the witnesses examined, who proved to be knowledgeable of the facts and testified with evident impartiality.

Nothing further was proven that is relevant to the application of law.

B. ON THE LAW:

i) On the interpretation of article 23 of the CIRC and the issue of "necessity" of expenses in tax case law:

At the time to which the disputed facts refer, article 23 of the CIRC provided, in the part relevant to consider here:

"Article 23

Expenses

1 — Expenses are those which are demonstrably necessary for the realization of income subject to taxation or for the maintenance of the source of income, in particular:

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

b) Those relating to distribution and sale, including expenses for transport, advertising and placement of goods and products;

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

d) Of an administrative nature, such as remuneration, including those attributed as profit-sharing, allowances, current consumption materials, transport and communications, rents, litigation, insurance, including life insurance and life branch operations, contributions to retirement 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, rationalization, research and consultation;

f) Of a fiscal and parafiscal nature;

g) Depreciations and amortizations;

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) Indemnities resulting from events whose risk is not insurable."

A core requirement emerges in this provision for the admissibility of expenses for tax purposes: their necessity.

What should be understood by "necessity"?

In fact, obtaining borrowed financing to use within the scope of business activity and considering the financial charges incurred with such obtaining as expenses does not, as a rule, raise any tax issue.

However, placing financial resources, whether one's own or borrowed, at the disposal of other entities without charging interest generates no taxable income, meaning that the balancing rule that should exist, from a tax perspective, between expenses and income is broken.

In the understanding of the Southern Central Administrative Court "...the legal notion of necessity is therefore defined from an economic-business perspective, by direct or indirect fulfillment of the ultimate motivation contributing to obtaining profit" (Decision of the TCA-South, of 27 March 2012, Case n.º 05312/12).

The aforementioned decision further adds that "...the deductibility of the cost depends, solely, on a causal and justified relationship with the company's activity. And outside the concept of necessity will remain only acts that do not conform to the corporate purpose, those that do not fall within the society's interest, especially because they do not aim at profit".

In this sense, once it is proven that the orientation of expenses is towards the pursuit of the company's activity and, consequently, towards obtaining profit, the criterion of necessity is understood to be met, with it being outside the scope of the Tax Authority to make value judgments about the soundness of the business management pursued by the Claimant.

This understanding is, furthermore, what has been followed by CAAD arbitral tribunals.

In fact, according to the decision issued in case 444/2015T, "from a general point of view, the essential features of the path established by national doctrine and case law on the necessity of expenses can be summarized as follows":

• the judgment about the necessity of expenses incurred implies that their contribution to obtaining income or gains subject to taxation or to the maintenance of the source of income be verified, whereby "The legal notion of necessity is therefore defined from an economic-business perspective, by direct or indirect fulfillment of the ultimate motivation contributing to obtaining profit" and "the tax deductibility of the cost depends, solely, on a causal and justified relationship with the company's activity." (Decision of the STA, rendered on 30-11-2011, in case n.º 0107/11);

• the costs (...) cannot fail to respect, from the outset, the taxpayer company itself. That is, for a given amount to be considered a cost of such company, it is necessary that the respective activity be developed by it itself, not by other companies." (Decision of the STA, rendered on 30-05-2012, in case n.º 0171/11);

• "a concept of necessity that, moving definitively away from the idea of causality between expenses and income, places emphasis on the relationship of expenses with the activity pursued by the taxpayer, that is, considering that the said concept of necessity is met whenever expenses are incurred in the interest of the company, in the pursuit of its respective activities." (Decision of the STA, rendered on 04-09-2013, in case n.º 0164/12);

• the concept of necessity has factual determination and the nexus of economic causality cannot be disconnected from the factuality of the specific case, whereby "the Tax Authority cannot evaluate the necessity of costs in light of criteria focused on the opportunity and merit of the expense. A cost is necessary when it relates to the company's activity, being that costs foreign to the company's activity will be only those in which it is not possible to discern any causal nexus with the income or gains (or with the income, in the current expression of the code - cfr. art. 23, n.º 1, of C.I.R.C.), explained in terms of normality, necessity, congruence and economic rationality." (Decision of the TCA-South, rendered on 16-10-2014, case n.º 06754/13);

• "The necessity of a cost must result simply from its connection to business activity. If the cost is not foreign to the company's activity, that is, if it relates to the normal activity of the company (regardless of whether the degree of intensity or proximity is greater or lesser), and if its existence is accepted (it is not an apparent or simulated cost), the cost is necessary." (Decision of the TCA-North, rendered on 20-12-2011, case n.º 01747/06.3BEVIS);

• "from the legal notion of cost provided by article 23 of the CIRC does not result that the AT can challenge the principle of freedom of management, scrutinizing the soundness and opportunity of the company's management economic decisions and considering that only those costs from which profits directly accrue to the company or which prove to be convenient for the company can be fiscally assumed. The necessity to which article 23 of the CIRC refers as a condition for a cost to be deductible does not refer to necessity (the expense as a sine qua non condition of income), nor even to convenience (the expense as convenient for business organization), under pain of intolerable interference by the AT in the autonomy and freedom of management of the taxpayer, but requires, solely, a relationship of economic causality, in the sense that it is sufficient that the cost is incurred in the interest of the company, in order, direct or indirectly, to obtain profits.

• The legal notion of necessity is therefore defined from an economic-business perspective, by direct or indirect fulfillment of the ultimate motivation contributing to obtaining profit. Essential costs are equivalent to expenses incurred in the interest of the company or, in other words, in all acts abstractly subsumed under a profit-making profile. This objective intentionally brings the economic and fiscal categories closer together, through a primarily logical and economic interpretation of legal causality. The indispensable expense is equivalent to every cost incurred in order to obtain income and which represents an economic decline for the company. As a rule, therefore, the tax deductibility of the cost depends, solely, on a causal and justified relationship with the company's activity. And outside the concept of necessity will remain only acts that do not conform to the corporate purpose, those that do not fall within the society's interest, especially because they do not aim at profit." (Ac. STA, rendered on 30-11-2011, case n.º 0107/11);

• "The rule is that correctly recorded expenses are tax costs; the criterion of necessity was created by the legislator, not to allow the Administration to interfere in the company's management, dictating how it should apply its resources, but to prevent the tax recognition of expenses which, even if recorded as costs, do not fall within the scope of the company's activity, were incurred not for its pursuit but for other foreign interests. Strictly speaking, these are not genuine costs of the company, but expenses which, given their object, were abusively recorded as such. Without the Administration being able to evaluate the necessity of costs in light of criteria focused on their opportunity and merit.

The concept of necessity cannot only not be equated to a strict judgment of imperative necessity, as already stated, but also cannot rest on a judgment about the convenience of the expense, made necessarily, after the fact. For example, expenses made on an advertising campaign that proved unfruitful cannot, solely based on that result, be stated to be unnecessary.

The judgment about the opportunity and convenience of expenses is exclusive to the businessman. If he decides to make expenses in order to pursue the company's purpose but is unsuccessful and those expenses prove, in the end, fruitless, they still do not cease to be tax costs. But every expense he records as a cost and which proves to be foreign to the company's purpose is not a tax cost, because not necessary.

We understand (...) that, under pain of violation of the principle of ability to pay, the Administration can only exclude expenses not directly set aside by law under strong motivation that convinces that they were incurred beyond the corporate purpose, that is, in the pursuit of another interest than the business one or, at least, with clear excess, deviating, in relation to the objective needs and capacities of the company." (Decision of the STA, rendered on 29-03-2006, case n.º 01236/05).

Having reached this point, it is necessary to subsume the proven facts to the provision of article 23 of the CIRC.

ii) The deductibility of costs in the case at issue:

As results from the facts found to be proven, it was demonstrated that A… contracted various loans with financial institutions in order, in part, to provide its investees with funds in the form of supplementary contributions and ancillary payments.

Thus, the requirement of proof of the cost is met, as explicitly follows from the content of the Tax Inspection Report, when it states that "the taxpayer documented the operations referenced in the previous points through the submission of concluded contracts and accounting elements that allow assessment of the accounting for financing operations, thus gathering the first criterion stipulated in article 23 of the CIRC.

With respect to the other requirements set forth in article 23 of the CIRC, (necessity of the expense and link to income subject to taxation) the AT disregarded the financial nature expenses (interest) incurred by the Claimant in fiscal year 2012, as the taxpayer used borrowed capital to finance free of charge the related companies.

The AT collected monthly, for fiscal year 2012, the value of loans granted and loans obtained (weight of loans granted/obtained) and the amount of charges borne with the level of indebtedness, having subsequently determined that, of the total interest and similar expenses borne (€ 7,236,753.76), € 3,549,393.62 corresponds to the amount of financial charges aimed at financing activities developed by related entities, and as such, not accepted for tax purposes pursuant to article 23 of the CIRC and, therefore, subject to correction to 2012 taxable profit (p. 27 and Annex XV of the Tax Inspection Report).

In the specific case the different invested companies, financed by A…, are autonomous entities, with autonomous purpose of determining taxable matter, having distinct legal personality and capacity, not being affected by any relationship of control between them whereby the costs of each one are only determined individually.

It is therefore important to determine whether the requirement of necessity of the expense, which results from article 23 of the CIRC, is met, which implies a justified relationship with the company's activity, that is, that the obtained financing be applied in the company's activity and not in financing the activity of third parties.

Let us see.

Pursuant to article 23 of the CIRC, the tax deductibility of the interest borne, like any other expense, depends on a judgment as to its necessity for the realization of income or gains subject to taxation or for the maintenance of the source of income (body of n.º 1), with paragraph c) of n.º 1 of this provision even clarifying that interest on borrowed capital is "applied in operations".

This requirement of necessity of costs/expenses for the realization of income/gains subject to taxation or for the maintenance of the source of income, established by article 23 of the CIRC, has been duly addressed in the case law in order to resolve the specific cases that must be faced, whereby the solution to be given to the case at issue is supported by previous judicial decisions, as moreover results from the principle contained in n.º 3 of article 8 of the Civil Code.

The Supreme Administrative Court has declared on several occasions, as to the meaning and functioning of the requirement of necessity of costs for tax purposes, that "the requirement of necessity of a cost must be interpreted as an indeterminate concept of necessary factual determination, as a result of an analysis from an economic business perspective, in the perception of a relationship of economic causality between the assumption of a cost and its realization in the interest of the company, attentive to the corporate purpose of the business entity in question" (cfr., for example, the decisions of the STA of 15.6.2011, case n.º 049/11, n.º III and 29.3.2006, case n.º 01236/05, n.º 3.4 and the decision of the TCA South of 16.10.2014).

It is therefore a matter of knowing whether the interest subject to correction (resulting from loans contracted to (a) carry out ancillary payments, by the Claimant, to K…, S.A.; (b) carry out supplementary payments, by the Claimant, to E…, Lda. and (c) an operation carried out with M… which substantively is considered as a financing, all of them, have the potential to positively influence the obtaining of income by the Claimant.

At this point it should be emphasized that, in the specific case of the operation carried out with M… (M…), it was considered that the transaction embodied, from a material or substantive point of view, a financing to M… since the latter obtained liquidity through the purchase of its shares by A…, with the re(purchase) of those same Bank … shares (for the same amount) having been established according to a successively altered schedule.

To apply to the case at hand the requirement of necessity of costs, it is crucial to ascertain, on the basis of all relevant facts and circumstances, the actual and concrete allocation of the financing, of which the interest borne is the remuneration, or, put another way, it is important to verify the destination or use of the funds obtained in relation to which the taxpayer intends to fiscally deduct, for the purpose of determining its taxable profit, the interest and other associated charges it bore.

Thus, it is strictly in relation to the entity whose costs are under consideration for the purpose of determining its taxable profit that it is important to assess, taking into account the business activity it develops, the tax deductibility of financial charges, and it is therefore necessary to ascertain the necessity, adequacy, normality or the connection to a lucrative transaction of the costs under review, i.e., the expense recorded by the Claimant resulting from the three operations described above, i.e. (a) carrying out ancillary payments, by the Claimant, to K…, S.A.; (b) carrying out supplementary payments, by the Claimant, to E…, Lda. and (c) the operation carried out with M… which substantively is considered as a financing.

With effect, in the relationship of economic causality of the cost with the interest of the company, the business interest assessed is that of the company itself that fiscally deducts the cost.

Thus, the Supreme Administrative Court stated, in the decision of 10.7.2002, case n.º 0246/02, that "the costs provided for in article 23 must respect the taxpayer company itself, to itself", whereby "for a given amount to be considered a cost of such company, it is necessary that the respective activity be developed by it itself, not by other companies even if in a relationship of control", reiterating, in the subsequent decisions of 7.2.2007, case n.º 01046/05, n.º III, 20.5.2009, case 01077/08, 30.11.2011, case n.º 0107/11 and 30.05.2012, case n.º 0171/11, that "the costs must respect from the outset the taxpayer company itself, that is, for a given amount to be considered a cost of such company, it is necessary that the respective activity be developed by it itself, not by other companies", since, "[o]therwise, how could the exercise of the activity of one company be imputed to another with which it had some relationship".

In another aspect, it is equally made explicit by the case law that it is a required assumption of the application of article 23 of the CIRC "the individualized consideration of each company or institution whereby no reasoning can interfere here in which appeal is made to criteria of management of the "group" or even of financing – even if free of charge – of its shareholders or even the will of these which in this matter is irrelevant, given that it is a legal criterion, with only relevance being the legal entity whose costs are under consideration" (vd. the decisions of the Southern Central Administrative Court of 16.10.2007, case n.º 01276/06 and 18.12.2008, case n.º 02515/08).

Hence, in compliance with the provision of n.º 1 of article 23 of the CIRC, it is perfectly appropriate to verify whether the requirements for tax deductibility of costs with interest were satisfied in light of the Claimant's activity and the tax period in question.

As results from the factuality found to be proven and set out above, in the case at hand, the economic and financial motivations that influenced the decision were not confined to the interest of the Claimant.

Now, for the requirement of necessity to be met, the expense must respect the taxpayer entity itself, considered in itself, in which the source of income is that of the dominant society or that which controls, and not that of the investees.

In truth, the Claimant is not a financial holding company, remaining as an IRC taxpayer autonomously in relation to the companies associated with it.

The loans in question were not applied in the company itself but rather in the co-invested companies, independent commercial corporations, which are dedicated to their own and autonomous activities and which have distinct legal personality and tax capacities, with their accounting organized independently in relation to the others, which implies, on the one hand, that each one has its own income and costs and, as such, must record them and, on the other hand, that those costs and income cannot be part of the accounting of the others.

Now, in this regard, the STA understood in the decision of the STA, of 19.04.2017, case n.º 0925/16, the following:

"I - Not being the appellant a financial holding company nor being covered by the group taxation regime the financial charges borne by it resulting from supplementary contributions and supplementary payments made to associated companies free of charge cannot be considered as tax-deductible costs as they are not necessary for the realization of income of the appellant subject to taxation or for its maintenance as a source of income thereof pursuant to article 23 of the CIRC in the wording in force at the date of the facts.

II - Remaining the appellant autonomously as an IRC taxpayer and the companies associated with it equally autonomous and equally IRC taxpayers the financial charges borne by it resulting from supplementary contributions and supplementary payments made in favor of the companies associated with it cannot be considered as essential costs for the purpose of deductibility in the IRC sphere under article 23 of the CIRC as they are foreign to the exercise of its activity."

In like manner, the STA decided, in the decision of 12 July 2006 in case nº 186/06, that "the loans in question were not applied in the company itself but rather in (...) co-invested companies (...), and that even in the case, in which the entity that resorted to credit to lend to its investees held all of the equity of the investees, it would still be a different entity from each of them, with different activities, with individualized accounting (...), that is, "are independent commercial corporations, which are dedicated to their own and autonomous activities and which have distinct legal personality and tax capacity (...) has its accounting organized independently in relation to the others, which implies, on the one hand, that each one has its own income and costs and, as such, must record them and, on the other hand, that those costs and income cannot be part of the accounting of the others".

The STA thus concluded that the loans "were not necessary to obtain their gains or income or to maintain their source of income, whereby the interest resulting therefrom could not be recorded as costs".

Also in the Arbitral Decision of 2017-01-26, rendered in case nº 273/2016-T of CAAD, rendered regarding article 23 of the CIRC the following was decided:

"Furthermore, the placing at the disposal of other entities of such financial resources was carried out as previously stated, without there being any charging of interest or any other remuneration, a situation which generated the establishment of emphasis in the legal certification of accounts.

With effect, it is unequivocal that it is foreign to the corporate purpose of the company the placing at the disposal of other entities of financial resources, if we take into account, in particular, what is provided for in article 6 of the Commercial Companies Code.

It is not, in truth, in the interest of the Claimant, to place financial resources at the disposal of other entities, without charging interest, at the same time that there is a need, albeit partial, to request obtaining financing, and for that, to bear the financial charges resulting therefrom.

The mutually loaned amounts, without any remuneration, could always avoid that part of the financial charges had to be borne.

In this context, it is considered that the position of the AT in not considering as business expenses the financial charges borne and directly related to the financial resources that the Claimant placed at the disposal of other entities in the group and which could have been used within the scope of the activity, avoiding that part of the charges had to be borne, merits no censure.

(…)

What is being said is that the granting of free loans to third parties, using the resources of the Claimant – which, naturally, result from the financing obtained and the income from its activity – does not meet the said criterion of necessity.

Furthermore, the AT, to arrive at the result it reached, used an appropriate criterion, described in item K) of the factual matter, and it is certain that the Claimant does not criticize it, nor proposes another, saying, only, that there is no direct allocation between the financing obtained and the loans granted – which is true and, it is reiterated, the AT did not affirm.

What there is is an economic reality that translates as follows: if the Claimant had not granted the said free loans, it would not have needed to resort to credit to the extent that it did.

Therefore, the charges with such recourse to credit are not, in their entirety, necessary expenses".

It cannot, in this regard, invoke the corporate purpose of the Claimant – which, in the specific case, encompasses equity stakes in other corporations or non-profit institutions - to justify the necessity of the cost.

In this context, it is understood that the carrying out of ancillary payments or supplementary payments, by the Claimant, or even the execution of a contract for the purchase and subsequent resale of shares, concluded with M…, which materially constitutes a financing, cannot be considered as operations potentially generating income in the sphere of the Claimant.

Consequently, the requirement of necessity of the cost for the company specifically in question is not met.

That is, in light of the purpose of these proceedings, it is important to emphasize the necessity, for the judgment of necessity of costs, of the perception of a relationship of economic causality between the assumption of a cost and its realization in the interest of the company to be concretized in relation to the business entity in question.

This means that the financial charges borne in fiscal year 2012 in question in the present proceedings and attributable to (a) carrying out ancillary payments, by the Claimant, to K…, S.A.; (b) carrying out supplementary payments, by the Claimant, to E…, Lda. and (c) the operation carried out with M… - do not find a nexus of economic causality with the interest and activity of the Claimant itself, and have no potential for generating profits within its legal sphere.

With effect, the tax deductibility of costs, by virtue of the principle of necessity provided for in article 23 of the CIRC, presupposes a nexus of economic causality between the costs in question and their realization in the interest of the company.

See, in this regard, the decision of the Northern Central Administrative Court of 14.3.2013, case n.º 01393/06.1BEBRG in which it was considered that "only the costs of the fiscal year which were demonstrably necessary for the realization of income or gains or for the maintenance of the source of income but of the company itself and not of a third party should be considered. That is, the costs must be related to the activity developed by the company in question and not by another company".

In these terms, the scrutiny that the AT carried out of the destination of the financing and the allocation of the corresponding interest is congruent and sufficient for it to be concluded that such financial costs are not potentially generating income for the Claimant or relevant to the maintenance of the source of income.

Hence it must be concluded that, in the situation of the present case, there is no "positive judgment of subsumption in the corporate activity" by which "essential costs would be equivalent to costs incurred in the interest of the company" (cfr. decision of the STA of 30.11.2011, case n.º 0107/11).

Thus, regardless of whether the assumption of the loan in question by the Claimant resulted from carrying out ancillary payments; supplementary payments or financing operations, it must be declared that the costs recorded by the Claimant in the fiscal year in question with financial charges relating to such loans do not satisfy the requirement of necessity of costs/expenses imposed for tax purposes by article 23 of the CIRC, given the lack of necessary allocation of costs to the business interest and the productive activity of the Claimant itself.

The correction carried out by the AT is therefore legitimate, which is the subject of the present proceedings, since, as recognized by the Supreme Administrative Court in the decision rendered on 29-03-2006, case n.º 01236/05, "the Administration can only exclude expenses not directly set aside by law under strong motivation that convinces that they were incurred beyond the corporate purpose, that is, in the pursuit of another interest than the business one or, at least, with clear excess, deviating, in relation to the objective needs and capacities of the company."

In like manner, RUI DUARTE MORAIS[1] considers that, "if the charge was determined by other motivations (personal interest of shareholders, administrators, creditors, other group companies, business partners, etc.), then such cost should not be deemed necessary." (our emphasis)

And let it not be said, to the contrary, that, within the framework of assessing the necessity of costs, account should be taken of the objective of increasing income and thus giving rise to taxable income which, in the case of supplementary or ancillary payments, would be embodied in dividends and potential capital gains.

That is, within the framework of the transparent entity regime, profits distributed by transparent entities to their shareholders are not fiscally treated as capital income (cfr. paragraph h) of n.º 2 of article 5 of the IRC Code) and in the calculation of future capital gains resulting from the transfer, to avoid the occurrence of double taxation, the profits attributed to shareholders and not yet distributed must be expunged, as moreover currently provided for in n.º 5 of article 20 of the IRS Code and n.º 5 of article 81 of the IRC Code.

Observe, finally, that the recognition, or not, of the legal relevance, for the purpose of applying the Commercial Companies Code, of carrying out ancillary or supplementary payments does not interfere with the judgment relating to the deductibility of expenses deriving from such operations, the formulation of which follows a different reasoning since they are based on fulfilling the requirements set forth in n.º 1 of article 23 of the IRC Code.

In these terms, the financial charges borne in the year 2012, relating to the interest borne by the Claimant with loans contracted for the (a) carrying out of ancillary payments, by the Claimant, to K…, S.A.; (b) carrying out of supplementary payments, by the Claimant, to E…, Lda. and (c) operation carried out with M…, cannot be considered tax-deductible, as they are not necessary to obtain its income or to maintain the source of income, given that they do not have a nexus of economic causality with the activity of the Claimant or with assets capable of generating income for the Claimant, with the requirements of article 23 of the CIRC not being met, whereby the disregard of its deductibility does not suffer from any legal defect.

In consequence, in light of the provision of article 23 of the CIRC, there does not occur the legal defect of violation imputed to the additional IRC tax assessment of the Claimant relating to the year 2012 and respective compensatory interest, in which the amount of EUR 369,177.53 (three hundred sixty-nine thousand, one hundred seventy-seven euros and fifty-three cents) was determined.

Reason why the principal request must fail and all the consequential requests formulated by the Claimant relating to the principal request equally fail.

C. DECISION

In these terms, this Arbitral Tribunal decides to judge the arbitration request filed totally without merit and, in consequence, to condemn the Claimant in the costs of the proceedings, hereinafter fixed.

D. VALUE OF THE PROCEEDINGS

The value of the proceedings is fixed at € 369,177.53 (three hundred sixty-nine thousand, one hundred seventy-seven euros and fifty-three cents), pursuant to article 97-A, n.º 1, a), of the Code of Procedure and Tax Procedure, applicable by virtue of paragraphs a) and b) of n.º 1 of article 29 of the RJAT and n.º 2 of article 3 of the Regulation of Costs in Tax Arbitration Proceedings.

E. COSTS

The arbitration fee is fixed at € 6,120.00 (six thousand, one hundred twenty euros), pursuant to Table I of the Regulation of Costs of Tax Arbitration Proceedings, to be paid by the Claimant, since the request was totally without merit, pursuant to articles 12, n.º 2, and 22, n.º 4, both of the RJAT, and article 4, n.º 4, of the said Regulation.

Let notification be made.

Lisbon, 20 July 2017

The Arbitrators

(José Baeta de Queiroz - president)

(Nuno Cunha Rodrigues - member)

(José do Vale Marçal - member)

[1] In Notes to the IRC, Coimbra, 2007, p. 87.