IRC Deductibility of Financial Charges and Loans to Subsidiaries - CAAD 80/2017-T

ARBITRAL DECISION

The Arbitrator Raquel Franco, designated by the Deontological Council of the Center for Administrative Arbitration (CAAD) to form the sole arbitral tribunal constituted on 30 March 2017, decides as follows:

REPORT

On 20-01-2017, the company "A…, S.A.", Tax ID…, filed a request for constitution of a sole 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 JAT), against the Tax Authority and Customs Authority.

The request for constitution of the arbitral tribunal was accepted by the Esteemed President of CAAD and was automatically notified to the Tax Authority and Customs Authority on 31-01-2017.

Pursuant to the provisions of subparagraph a) of paragraph 2 of Article 6 and subparagraph b) of paragraph 1 of Article 11 of Decree-Law No. 10/2011, of 20 January, as amended by Article 228 of Law No. 66-B/2012, of 31 December, the Deontological Council appointed as arbitrator of the sole arbitral tribunal the undersigned, who communicated acceptance of the appointment within the applicable timeframe, and notified the parties of this appointment on 15-03-2017.

Thus, in accordance with the provisions of subparagraph c) of paragraph 1 of Article 11 of Decree-Law No. 10/2011, of 20 January, as amended by Article 228 of Law No. 66-B/2012, of 31 December, the sole arbitral tribunal was constituted on 30-03-2017, following the pertinent legal proceedings.

The Applicant requests the declaration of illegality of the Corporate Income Tax (IRC) assessment No. 2016…, in the amount of €13,638.44, of the compensatory interest assessment No. 2016…, and of the statement of account reconciliation No. 2016…, dated 31.08.2016, relating to the fiscal year 2012.

The disputed IRC assessment resulted from an internal inspection conducted for the fiscal year in question, which resulted in a correction to the IRC calculated by the Applicant in the total amount of €1,144,274.97.

The AT (Tax Authority) alleged, as justification for the aforementioned corrections, that "Given that the taxpayer is bearing financial expenses, namely loan interest and expenses with bank guarantees and simultaneously is financing subsidiary/associated companies, either through loans granted or through accessory contributions, without any remuneration, it is necessary to assess whether these expenses are or are not fiscally accepted, in light of the provisions of Article 23 of the CIRC."

It further adds that:

• "the taxpayer incurred financial expenses that it recorded as a cost and did not receive financial benefits with respect to the accessory contributions granted. It follows that the financial expenses borne by the company are not directly related to the activity of the taxpayer, whose corporate purpose, as already previously mentioned, consists of the development of concession projects, namely of road, railway, port, sports, hospital and prison structures, involving operation and possibly design, financing and construction and provision of services and consultancy in the context of projects of the same nature."

• "The source producing the subsidiary and the participant are distinct, and in order for a certain sum to be considered a cost it is necessary that the respective activity be developed by it itself, not by another company, even if in a relationship of control. (...) even if A… SA may have or have an interest in the economic development of the activity of the subsidiary, both cannot but pursue autonomous activities, with distinct legal personality and tax capacity which are not affected;"

• " (...) it should be noted that the financial expenses, whose deduction is controversial, concern foreign capital that was not applied in the operation of A… SA, were applied in their entirety in other companies, with A… SA not receiving any remuneration for the capital ceded." (p. 18 of doc. no. 1);

• "Since they are not related to the activity of the taxpayer, the requirement of indispensability of all the expenses recorded by the taxpayer is not met, as established in Article 23 of the CIRC. Therefore, the entirety of the expenses with bank loans borne by the taxpayer cannot be accepted fiscally, nor can the entirety of the expenses borne with the guarantees." (pp. 18-19 of doc. no. 1);

The Applicant alleges that the costs incurred have an implicit return associated with them, which is realized upon receipt of dividends from the associates of A…. Thus, the expenses borne are directly allocated to safeguard the operationalization and profitability of the investments made by the Applicant, which form the core of its activity.

In the year 2012, the Applicant held shareholdings in the following companies:

On 31.05.2011, the Applicant entered into a loan agreement with another group company, B…, S.A., for the amount of €3,240,000.00, at a rate of EURIBOR for 6 months + 4% spread.

And on 20.05.2012, the Applicant entered into a loan agreement with another group company, C…, S.A., for the amount of €3,300,685.59, at a rate of EURIBOR for 6 months + 4% spread.

The loans obtained were intended to support the cash flow of A…, so as to allow it to advance the completion of accessory contributions to company D… (D…), due under the terms of the capital subscription and realization agreement concluded on 30.05.2008 (from the Capital Subscription and Realization Agreement attached as Annex 3 to doc. no. 1 it appears that the Applicant is part of a group of shareholder companies that "formed a consortium intended to submit its bid for the Public Tender for the Concession of … (…)" and for that purpose established company D…").

Following the adjudication of the concession to D…, it entered into the respective concession contract with the Portuguese State and, simultaneously, the shareholders undertook to "subscribe and realize own funds beyond the share capital, in the form of free monetary accessory contributions (…) and subordinated loans to the credits of the financing Banks (…). The Shareholders may also make available to the Company financial resources in the form of advances (…)." (pp. 3-4 of the Capital Subscription and Realization Agreement which constitutes Annex 3 to doc. no. 1).

It is stated in the aforementioned agreement that " (…) to guarantee the fulfillment of the payment obligations of the aforementioned amounts (…) and, if applicable, of default interest (…), each of the shareholders delivers to the Company [D…], on the date of execution of this Agreement, autonomous bank guarantees on first demand (…)." (p. 9 of Annex 3 to doc. no. 1).

The obligations assumed by the Applicant were the subject of deliberation at the General Assembly on 30.07.2012 (Annex 7 to doc. no. 1).

The loans granted by B…, S.A. and by C…, SGPS, S.A. to the Applicant were wholly and directly applied in the investment of the Applicant consisting of company D….

Company D…, S.A. has a corporate purpose and activity coinciding with that of the Applicant, being held in majority by the Applicant.

The segregation of the concessionary activity by multiple corporate structures results from the legal requirement of the Public Contracts Code that the concessionaire must have as its exclusive corporate purpose throughout the entire period of duration of the concession contract the activities that are integrated in the concession.

By virtue of the conclusion of the aforementioned loan agreements, the Applicant bore interest expenses and recorded the total amount of €6,540,685.59 in account #25800001 – Financing Obtained – Other Financiers (Annex 1 to doc. no. 1); the accessory contributions to D… were recorded in account #4113 – Financial Investments – Investments in Subsidiaries – Loans Granted (Annex 4 to doc. no. 1).

With respect to company E…, the Applicant, together with other shareholders "(…) formed a consortium intended to submit its bid for the Negotiated Tender for the conclusion of the concession contract for the management of the Building of … (…)", and for that purpose established company E… (p. 4 of the Capital Subscription and Realization Agreement which constitutes Annex 11 to doc. no. 1).

Following the adjudication of the concession to E…, it entered into the respective concession contract with the Portuguese State and, simultaneously, the shareholders undertook to " (…) subscribe and realize own funds beyond the share capital, in the form of free monetary accessory contributions (…) and subordinated loans to the credits of the financing Banks (…)." (p. 3 of Annex 11 to doc. no. 1).

It is further stated in the aforementioned agreement that "(…) to guarantee the fulfillment of the payment obligations of the aforementioned amounts (…) and, if applicable, of default interest (…), each of the shareholders delivers to the Company (…), autonomous bank guarantees on first demand (…)." (p. 7 of Annex 11 to doc. no. 1).

Company E… has a corporate purpose and activity coinciding with that of the Applicant.

The accessory contributions to company E… were recorded in account #4113 – Financial Investments – Investments in Subsidiaries – Loans Granted (Annex 4 to doc. no. 1).

With respect to company F…, the Applicant, together with other shareholders, integrates " (…) the Consortium competing in the public tender for the conclusion of the Management Contract concerning the …;" having been "(…) awarded to the Consortium the provision of health-promoting, preventive or therapeutic services within the scope of the National Health Service, through the Hospital … and the management of the New Hospital Building, comprising the activities of design, planning, construction, financing, maintenance and upkeep of the same (…)." (Annex 11 to doc. no. 1).

Company F… has a corporate purpose and activity coinciding with that of the Applicant, being held in majority by the Applicant.

In the scope of the aforementioned capital realization and subscription agreement, it is also provided that the shareholders contribute to the Own Funds of the Building Management Entity (clause 5 of the aforementioned capital realization and subscription agreement, which constitutes Annex 11 to doc. no. 1) and establish bank guarantees to guarantee their subscription obligations (clause 8 of the aforementioned agreement which constitutes Annex 11 to doc. no. 1).

The accessory contributions to company F… were recorded in account #4113 – Financial Investments – Investments in Subsidiaries – Loans Granted (Annex 4 to doc. no. 1).

The Applicant believes that, from the doctrine and case law collected regarding the question of the deductibility of the costs in question, it follows that the correct interpretation of the concept of indispensability set forth in Article 23 of the Corporate Income Tax Code is that which equates deductible costs to costs incurred in the interest of the company and borne in the context of activities resulting from its corporate purpose or profit profile and that there need not be a necessary connection between costs and revenues, or an obligatory nexus of causality between them, it being sufficient that there exists a causal and justified relationship of the costs with the company's activity.

Specifically with respect to financial expenses, the Applicant believes that financial expenses allocated to the realization of accessory contributions, supplementary contributions, subscription of share capital or any contributions of own capital in participating companies can be perfectly framed within the exercise of business activity.

The analysis of the specificities of this type of costs should first pass, as will be seen, through the materialization of the concept of "activity" of a given company, as well as through the characterization of its assets, since the activity of the company encompasses the entire set of operations resulting from the use of its assets, which includes the management of its assets and liabilities.

The activity of a given company includes productive and commercial operations, as well as investment operations, disinvestment, financing in general, acquisition of shareholdings, etc., so the business activity that generates deductible costs will be any activity that results in the execution of operations with an intention to obtain income, or with the purpose of maintaining the potential of a source producing income, whether they are operational or non-operational activities (it mentions, by way of example, the arbitral decisions issued on 18 May 2016, in case no. 695/2015-T, and on 23 May 2016, in case no. 614/2015-T).

In the case at hand, there are non-remunerated accessory contributions, to which the treatment of supplementary contributions is given, therefore, recorded in the sphere of the beneficiary company in capital accounts and in the sphere of the shareholder in financial investment accounts. Now, financial investments in participating and/or associated entities constitute assets of a company, among others (Class 4 of the chart of accounts approved by the SNC and previously by the POC). Like any other business asset, financial investments comply with the general definition of an asset, to be recognized as such from an accounting perspective, which is to be "a resource controlled by an entity as a result of past events, and from which it is expected that future economic benefits will flow to the entity." (§ 49 of the Conceptual Framework of the SNC).

The distinguishing characteristic compared to another type of assets will be, in particular, the circumstance that the income derived from these financial assets or their remuneration is not pre-determined or pre-fixed, which does not deprive them of the nature of an asset generating future economic benefits, and the management thereof contributes, in any case, to the corporate purpose of obtaining profit. The operational activity of the now-Applicant consists of the management of the shareholdings it holds in the concessionaires, with its operational revenues being, at 100%, derived from that activity.

It further adds that there is no replacement of the participating companies in the exercise of their respective activity – what there is is the structuring of the group in a multi-corporate manner, corresponding to each concession an autonomous company, which also results from the rules on public procurement. The participating entity uses funds that are contributed to it, but such contribution of funds is made in the interest of the participant, that is, in the context of normal management acts that are encompassed in its profit-seeking purpose. The financial participation is an asset whose management constitutes activity of the participant, from which it expects to result income, which, in this case, occurs based on the expected evolution of the business of the participated company. All management decisions made by the participant regarding the financial participation held in a participated company are made with a view to the profitability of that investment, with the intention of obtaining an immediate or future income, so they are naturally made in its interest and never foreign to the activity of the participant.

The contribution of funds to a participated company through subscription of its capital or through the realization of accessory or supplementary contributions is made in the interest of the participant, in order to, by guaranteeing the financial sustainability of the acquired asset, increase its potential as a source generating income (it indicates, in this sense, the arbitral decisions issued in cases nos. 39/2013-T, of 14.10.2013, 113/2013, of 03.02.2014 and 376/2014-T, of 16.01.2015).

It understands from the facts alleged that the loan agreements concluded between the Applicant and C… SGPS, S.A. and between the Applicant and B…, S.A., were concluded by virtue of the necessity and obligation of the Applicant to make "monetary accessory contributions, due under the terms of the capital subscription and realization agreement concluded on 30 May 2008 (…)", in its capacity as "shareholder of D…, S.A.; in turn, it results from the Capital Subscription and Realization Agreement that the Applicant is part of a group of shareholder companies that "formed a consortium intended to submit its bid for the Public Tender for the Concession of … (…)" and for that purpose established company D…; following the adjudication of the concession to D…, it entered into the respective concession contract with the Portuguese State and, simultaneously, the shareholders undertook to " (…) subscribe and realize own funds beyond the share capital, in the form of free monetary accessory contributions (…) and subordinated loans to the credits of the financing Banks (…). The Shareholders may also make available to the Company financial resources in the form of advances (…)." (pp. 3-4 of Annex 3 to doc. no. 1).

Similarly with respect to company E… – the Applicant is part of a group of shareholder companies (2) that " (…) formed a consortium intended to submit its bid for the management of the Building of … (…)" and for that purpose established company E…. Following the adjudication of the concession to E…, it entered into the respective concession contract with the Portuguese State and, simultaneously, the shareholders undertook to " (…) subscribe and realize own funds beyond the share capital, in the form of free monetary accessory contributions (…) and subordinated loans to the credits of the financing Banks (…)." (cf. p. 3 of Annex 11 to doc. no. 1).

It further results from the aforementioned agreement that " (…) The Accessory Contributions and Subordinated Loans shall be required by the Company from the Shareholders in the proportion of their respective shareholdings in the share capital [in the case of the Applicant, 40%, cf. p. 3 of Annex 11 to doc. no. 1] and following deliberations of the Board of Directors, as established in the following number, up to the following maximum global amounts: Accessory Contributions up to 30-08-2012 €15,154,410.23 (…). The Shareholders undertake, jointly and limitedly, in the proportions of their respective shareholdings in the share capital of the Company, to make available to the Company Contingent Own Funds, intended to meet additional fund needs not foreseen in the Base Case, up to the maximum amount, global, of €500,000.00 (…)." (Annex 11 to doc. no. 1).

The Applicant further alleges, alternatively, should it be understood that the aforementioned legal provision prevents the fiscal deductibility of such expenses because they are not indispensable, in that the contributions granted are not directly remunerated through the charging of interest, then the aforementioned provision, with this interpretation, suffers from unconstitutionality, for violation of the principle of private initiative, as well as for violation of the principle of contributory capacity, established, respectively, in Article 61 and Article 104, paragraph 2, of the Constitution.

Finally, the Applicant petitions for the payment of compensatory interest in accordance with the provisions of Articles 43 of the LGT and 61 of the CPPT.

In Response, the AT came to say the following:

Article c) of No. 1 of Article 23 (current rules) of the Corporate Income Tax Code states that "1 - Expenses are considered those which are demonstrably indispensable for the realization of income subject to taxation or for the maintenance of the source producing it, namely: (…) c) Of a financial nature, such as interest on foreign capital applied in the operation (…) "

The requirements imposed by the rule are cumulative, so the fulfillment of one does not exclude the fulfillment of the other, but, on the contrary, it will be sufficient that one of them is not met for the expenses to no longer be eligible for purposes of determining fiscal results.

With the specific objective of financing its associates G…, E… and H…, so that they could proceed with the operation of their activity, the Applicant contracted loans, resulting in substantial financial expenses; these financial costs, as the company does not pass them on to its associates, negatively influenced the taxable profit of the Applicant.

In the petition the Applicant defends the thesis that the benefits will be imputed at a later moment, when it receives dividends from the concessionaires, being the financial investments assets that it expects to generate future economic benefits, whose profitability is implicit, but forgets that for a sum to be considered a cost of a company it is necessary that the respective activity be developed by it itself, not by other companies, as results, moreover, from the case law and the doctrine referenced both in the RIT and in this response.

The sums in question are not directly related to any activity of the Applicant - this is not about interest on foreign capital applied in the operation itself, those being the ones provided for as costs in subparagraph c) of paragraph 1 of Article 23 of the CIRC (wording at the time).

It indicates case law contrary to that which was indicated by the Applicant, namely that contained in the judgment of 19.04.2017, case no. 0925/16, of the Supreme Administrative Court, which is reproduced here:

« I - Since the plaintiff is not a SGPS nor covered by the group of companies taxation regime, the financial expenses borne by it resulting from advances and supplementary contributions made to associated companies free of charge cannot be considered as fiscally deductible costs as they are not indispensable for the realization of profits of the plaintiff subject to taxation or for its maintenance as a source producing the same pursuant to Article 23 of the CIRC in the wording in force at the time of the facts. II - Maintaining itself the plaintiff autonomously as a taxpayer of IRC and the companies associated to it equally autonomous and equally IRC taxpayers, the financial expenses borne by it resulting from advances and supplementary contributions made in favor of the companies associated to it cannot be considered as an indispensable cost for purposes of deductibility in IRC under the provisions of Article 23 of the CIRC as they are foreign to the exercise of its activity.»

It further indicates the decision issued in case no. 273/2016-T CAAD, in which the following was understood: «Moreover, the placing at the disposal of other entities of such financial resources was done, as previously mentioned, without there being any charging of interest or any other remuneration, a situation which generated the establishment of an emphasis in the legal certification of accounts. Indeed, it is unequivocal that it is foreign to the corporate purpose of the company the placement at the disposal of other entities of financial resources, if we bear in mind, in particular, what is provided for in Article 6 of the Commercial Companies Code. It is not, in truth, in the interest of the Applicant to place financial resources at the disposal of other entities, without charging interest, at the same time that there is a need, even if partial, to request the obtaining of financing, having for that to bear the financial expenses resulting therefrom. The sums loaned, without any remuneration, could always prevent that part of the financial expenses had to be borne. In this context, it is believed that the position of the AT in not considering as activity expenses the financial expenses borne and directly related to the financial resources that the Applicant placed at the disposal of other entities of the group and which could have been used in the context of the activity, avoiding that part of the expenses had to be borne, deserves no censure. (…) What is said is that the granting of free loans to third parties, using the resources of the Applicant – which, naturally, result from the financing obtained and the income from its activity – does not meet the aforementioned criterion of indispensability. Furthermore, the AT, to arrive at the result it did, used an appropriate criterion, described in item K) of the statement of facts, and it is certain that the Applicant does not criticize it, nor proposes another, saying only that there is not a direct allocation between the financing obtained and the loans granted – which is true and, it is repeated, the AT did not assert. What there is is an economic reality that translates as follows: if the Applicant had not granted the aforementioned free loans, it would not have needed to resort to credit to the extent that it did. Therefore, the expenses with this recourse to credit are not, in their entirety, indispensable.»

Regarding the issue of unconstitutionality raised by the Applicant, it understands that it is not, in this case, an intrusion of the Tax Administration in the management of the Applicant, nor of the oversight of its acts, which only it is entitled to decide and implement; the Applicant just cannot classify as a fiscal cost the costs it incurred which do not meet the requirements set forth in Article 23 of the CIRC, namely when they are costs, as happens in this case, which are not demonstrably indispensable for the realization of income (profits or gains) subject to taxation or for the maintenance of the productive force.

As results from the contracts, the financing was carried out only in the direct interest of the associates and not of the Applicant, making it irrelevant the argument concerning the perspective of future gains.

It concludes by saying that, because the costs have no relation whatsoever with the operation activity, in accordance with the corporate purpose of "ENGINEERING AND RELATED TECHNICAL ACTIVITIES", they do not meet the requirement of indispensability provided for in No. 1 of Article 23 of the Corporate Income Tax Code, so the Services of Tax Inspection of the Finance Directorate of Lisbon proceeded correctly in disregarding, for tax purposes, the respective recognized amount, with the correction to be maintained since the indispensable requirements for the fiscal deductibility of these expenses are not met, as established in Article 23 of the CIRC.

SANITATION

1. The Tribunal is competent and is regularly constituted, pursuant to Articles 2, No. 1, subparagraph a), 5 and 6, all of the JAT.

2. The parties have legal personality and capacity, are legitimate and are legally represented, pursuant to Articles 4 and 10 of the JAT and Article 1 of Ordinance No. 112-A/2011, of 22 March.

3. The case does not suffer from defects that would invalidate it.

STATEMENT OF FACTS

Before entering into the appreciation of questions of law, it is necessary to present the factual matter relevant to their understanding and decision, which, having examined the documentary evidence and the administrative file (PA) attached to the proceedings and having also taken into account the facts alleged, is fixed as follows:

III.1. Proven Facts

• The corporate purpose of the Applicant is the development of concession projects, namely of road, railway, port, sports, hospital and prison structures, involving operation and possibly design, financing and construction and provision of services and consultancy in the context of projects of the same nature.

• In the context of IRC, in the period of 2012, the Applicant was a taxpayer pursuant to subparagraph a) of No. 1 of Article 2 of the Corporate Income Tax Code with profits obtained being subject to IRC pursuant to subparagraph a) of No. 1 of Article 3 and No. 1 of Article 17, both of the same Code.

• In the year 2012, the accounts of the Applicant disclosed the recording of the sum of €6,540,685.59 in account #25 – Financing Obtained.

• The loan agreements concluded between the Applicant and B…, S.A. and C… SGPS, S.A., were recorded as follows:

• The loan to B…, S.A., in the amount of €3,240,000.00 contemplated an interest rate of EURIBOR for 6 months + 4% spread;

• The loan to C… SGPS, S.A., in the amount of €3,300,685.59 contemplated an interest rate of EURIBOR for 6 months + 4% spread;

• The loans were intended to support the cash flow of the Applicant, so as to allow it to advance the completion of accessory contributions to D… (D…), due under the terms of the capital subscription and realization agreement concluded on 30 May 2008, cfr. Annex 3 to the RIT.

• Both contracts contain the obligation of the Applicant to make "monetary accessory contributions, due under the terms of the capital subscription and realization agreement concluded on 30 May 2008", "in its capacity as shareholder of D…, S.A. (hereinafter D…), company concessionaire of the concession of…".

• At the end of the year 2012, the accounts of the Applicant reveal the recording, in account #41 – Financial Investments, sub-account #411300001 – Loans Granted to Subsidiaries of the balance of €15,915,000.00.

• In accordance with the information provided by the Applicant, these are free accessory contributions granted to company G… in the amount of €9,792,000.00, and to company E… in the amount of €6,123,000.00.

• With respect to company E…, the Applicant, together with other shareholders, formed a consortium intended to submit its bid for the Negotiated Tender for the conclusion of the concession contract for the management of the Building of …, and for that purpose established company E….

• Following the adjudication, the concession contract was concluded between the Portuguese State and company E…, and, at that moment, the respective shareholders undertook to subscribe and realize own funds beyond the share capital, in the form of free monetary accessory contributions and subordinated loans to the credits of the financing Banks.

• With respect to company F…, the Applicant, together with other shareholders, formed part of the Consortium competing in the public tender for the conclusion of the Management Contract concerning the New Hospital of …, to which was awarded the provision of health-promoting, preventive or therapeutic services within the scope of the National Health Service, through the Hospital of … and the management of the New Hospital Building, comprising the activities of design, planning, construction, financing, maintenance and upkeep of the same.

• In the context of the capital realization and subscription agreement of company F… it is provided that the shareholders contribute to the Own Funds of the Building Management Entity and establish bank guarantees to guarantee their subscription obligations.

• In account #412300001 – Loans Granted to Associates, there is recorded the amount of €14,655,669.94, which according to the information provided by the Applicant refers, respectively, to accessory contributions in the amount of €10,000,000.00, and to financing in the amount of €4,655,670.00 granted to company H….

• In account #69 – Financing Expenses and Losses, in the course of the year 2012, the Applicant recorded financing expenses with the credits obtained, in the total amount of €1,117,994.57, as itemized below:

• From the inspection action performed by the SIT resulted a correction to the IRC calculated by the Applicant in the total amount of €1,144,274.97.

• The aforementioned amount is composed of the following items:

• The Applicant made payment of the disputed additional IRC assessment.

III.2. Unproven Facts

There are no facts relevant to the decision that have been deemed unproven.

LEGAL REASONING

The fundamental question to be decided in this case is concerning the fiscal deductibility of expenses incurred with financial charges (loan interest and bank guarantee expenses) borne by the Applicant with financing to subsidiary/associated companies, either through loans granted or through accessory contributions, in both cases without remuneration. Both parties presented arguments in defense of their theses, in both cases with broad doctrinal and case law support.

Thus, it is now for this tribunal to decide in the present case.

The Applicant bases the request for declaration of illegality and consequent annulment of the 2012 IRC assessment and of the other disputed tax acts, on the violation of Art. 23, No. 1, subparagraph c), of the Corporate Income Tax Code, further arguing the unconstitutionality of this same legal provision, for violation of the principle of private initiative, contained in Art. 61 of the Constitution of the Portuguese Republic.

Art. 124 of the CPPT, applicable by virtue of Art. 29, No. 1, subparagraph a), of the JAT, establishes that the tribunal must assess primarily the defects that lead to the declaration of non-existence or nullity of the challenged act and, subsequently, the defects that lead to its annulment (No. 1). Concerning the defects that constitute non-existence or nullity, the judge must primarily consider the defects whose substantiation determine, in his prudent judgment, more stable or effective protection of the offended interests. Regarding the defects that constitute annulability, the same criterion is established, which will only not be applicable if the challenger has established a relationship of subsidiarity among the defects attributed to the act – which is permitted by Art. 101 of the CPPT –, because in that case priority is given to its will (provided that the Public Prosecutor has not raised other defects) (No. 2).

In accordance with what has been set forth, it is therefore necessary, in the present case, to begin with the assessment of the defect of violation of Art. 23, No. 1, subparagraph c), of the Corporate Income Tax Code, because, if verified, it will definitively preclude the possibility of imposing on the Applicant a new tax assessment act, thus achieving more stable and effective protection of its interests. Furthermore, it will only be necessary to proceed to the assessment of the question of the unconstitutionality of that same legal provision, as alleged, if and to the extent that it is concluded that the interpretation and implementation of the regulatory solution resulting therefrom precludes the subsuming of the situation sub judice to its respective legal provision.

Let us then examine Article 23 of the CIRC and its application in the present case.

Article 23 - Expenses

"1 — Expenses are considered those which are demonstrably indispensable for the realization of income subject to taxation or for the maintenance of the source producing it, namely:

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

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

c) Of a financial nature, such as interest on foreign capital applied in the operation, discounts, premiums, transfers, exchange differences, expenses with 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 valued at amortized cost;

d) Of an administrative nature, such as remunerations, including those awarded as profit participation, per diem allowances, current material of consumption, transport and communications, rents, litigation, insurance, including life insurance and operations of the "Life" branch, contributions to savings-pension funds, contributions to pension funds and to any supplementary social security schemes, as well as expenses with employee severance benefits and other post-employment benefits or long-term benefits;

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

f) Of a fiscal and parafiscal nature;

g) Depreciation and amortization;

h) Adjustments in inventories, losses by impairment 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 not being multi-annual forestry operations;

l) Losses realized;

m) Indemnifications resulting from events the risk of which is not insurable.

2 — Unlawful expenses are not accepted as expenses, namely those that result from conduct which reasonably indicates the violation of Portuguese criminal legislation, even if occurred outside the scope of its application.

3 — Expenses borne with the expensive transfer of capital shares, whatever the basis for the transaction, are not accepted as expenses for the taxation period when held by the transferor for less than three years and provided that:

a) The capital shares have been acquired from entities with which there are special relationships, pursuant to No. 4 of Article 63;

b) The capital shares have been acquired from entities resident in Portuguese territory subject to a special taxation regime.

4 — Nor are expenses borne with the expensive transfer of capital shares, whatever the basis for the transaction, accepted as expenses for the taxation period, whenever the transferor entity has resulted from a transformation, including modification of the corporate purpose, of a company to which a different fiscal regime was applicable with respect to these expenses and less than three years have elapsed between the date of the occurrence of that fact and the date of the transfer.

5 — Neither are expenses borne with the expensive transfer of capital shares, whatever the basis for the transaction, to entities with which there are special relationships, pursuant to No. 4 of Article 63, or to entities resident in Portuguese territory subject to a special taxation regime, accepted as expenses for the taxation period, as well as losses resulting from changes in the valuation model relevant for tax purposes, pursuant to No. 9 of Article 18, which result, in particular, from reclassification in accounting or from changes in the assumptions referred to in subparagraph a) of No. 9 of this article."

The concept that constitutes the axis around which the matter of deductibility of costs for tax purposes revolves is that of "indispensability", and it is therefore fundamental to the decision of the present case to know what is implied by the same.

The fundamental works in this matter were invoked in the proceedings by the parties, so we will here note them very briefly.

For Tomás Tavares[1], the correct interpretation of the concept of indispensability is that which equates indispensable expenses to costs incurred in the interest of the company, in the pursuit of activities resulting from its corporate purpose: "The legal notion of indispensability is therefore outlined, from an economic-business perspective, by fulfillment, direct or indirect, of the ultimate motivation for obtaining profit. Indispensable costs are equivalent to expenses incurred in the interest of the company or, in other words, in all acts abstractly subsumed in a profit profile. This desideratum deliberately brings closer the economic and fiscal categories, through an interpretation primarily logical and economic of legal causality. The essential expense is equivalent to every cost incurred in order to obtain income and which represents an economic loss for the company. As a rule, therefore, the fiscal deductibility of the cost depends only on a causal and justified relationship with the company's productive activity".

The same author, in the arbitral decision issued in case 12/2013-T, recalls that "The Tax Authority cannot review the soundness and timeliness of the company's management decisions. It cannot intrude on the freedom and autonomy of the company's management. A cost will be accepted fiscally if it is appropriate to the company's productive structure and to the obtaining of profits, even if it turns out to be an unfruitful or economically ruinous transaction.

The essential expense is equivalent to every expense incurred in order to obtain benefits and which represents an economic loss for the company. Art. 23 of the CIRC requires not only an adequate causal connection between the cost and the benefit (in the aforementioned economic terms), but it also connects alternatively (as indicated by the word "or") with the maintenance of the source producing – in the sense of an economic connection between the expense and the vigor and maintenance of the company and its activity.

A company can obtain funds (and pay interest) and then deliver those funds to a subsidiary without any causal and direct remuneration – and still properly exercise its activity, within its capacity and profit-seeking purpose: it can effect a capital increase (art. 25 of the CSC), supplementary or accessory contributions without interest (art. 210 and 287 of the CSC) or advances without interest (art. 243 of the CSC) – and in any of these cases acts totally within its capacity for exercise and with a profit-making intent and in the exercise of its activity".

For António Moura Portugal[2], "The solution adopted among us (at least in the doctrine), following the understandings advocated by Italian doctrine, has been to interpret indispensability in function of the corporate object. This position is present from the outset in the writings of Vítor Faveiro, who traces the indispensability of the expense to its assessment as a management act in function of the concrete corporate object, refusing that this indispensability can be assessed freely from any subjective judgment of the law applicator".

The Supreme Administrative Court, in judgment of 29/3/2006 – case no. 1236/05 - sustains that "the criterion of indispensability was created by the legislator, not to allow the Administration to intrude into the management of the company, dictating how it should apply its resources, but to prevent the fiscal consideration of expenses which, although 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 true costs of the company, but expenses which, having regard to its object, were abusively recorded as such. Without the Administration being able to assess the indispensability of costs in light of criteria affecting their opportunity and merit". It further states, the SAC that "that, under penalty of violation of the principle of contributory capacity, the Administration can only exclude expenses not directly precluded by law under strong motivation that convinces that they were incurred beyond the social objective, or, at least, with clear excess, deviant, against the objective needs and capacities of the company".

Having arrived here, we conclude, in line with the doctrinal and case law stream set forth in the citations above transcribed, that the concept of indispensability dispenses with a necessary connection to benefits; an obligatory nexus of causality between benefits obtained and costs incurred for these to be considered deductible for tax purposes.

The second concept that needs to be clarified is that of activity: what is the corporate activity relevant for purposes of calculating deductible expenses? Commercial companies have a corporate purpose defined in the respective contract which will be the scope within which they develop their activity with a view to obtaining profit. Activity will therefore be the set of management acts developed with a view to achieving this profit-making purpose within the scope defined in the company contract, be it a productive activity (i.e., the set of operations of transformation or production of goods and services), a pre-productive activity (the formation of the company itself or of companies through which its object is also realized; studies, research and development, procurement, etc.) or a post-productive activity (marketing and advertising, after-sales assistance, market evaluation, etc.). On the other hand, within the set of management acts that constitute the activity of the company, there are those that have an administrative or financial nature and others considered accessory or auxiliary to the activities mainly developed. The activity with which costs must be related is thus the activity related to a source producing income for the entity bearing the expenses. In that sense, "the activity of a company will consist in the operations resulting from the use of its assets, in particular its assets and the management of its liabilities. That is, in the way its management will use the business assets within the scope of the various operations (productive, commercial, investment and disinvestment, general financing, acquisition of financial participations and others) which, taken together, allow the entity in question to fulfill its economic object: the pursuit (immediately or at a later date) of an economic surplus (profit)"; "the "activity" of a company is not exhausted, as often seems to emerge from some interpretations, in the set of productive or operational operations. "Activity" is also the set of operations aimed at making investments or disposing of assets, acquiring financial participations and their subsequent disposal, applying liquidity in short-term investments or securities and their management, receipts and payments resulting from operational or non-operational income and expenses, and many others not expressly referred to here.[3]

That is, this tribunal understands that the activity to be considered relevant for purposes of Article 23 of the CIRC is the activity aimed at profit, directly or indirectly, through the pursuit of an excess realized through the various types of assets held by a company and which integrate the concept of "company", that is, the assets with functional aptitude, capability to achieve the aforementioned profit-making purpose. This set of operations encompasses, in the understanding of this Tribunal, the management acts of the assets and liabilities that constitute the means at the disposal of business entities, provided that such acts conform to the purpose, aim or objective of the company. In short, following the case law contained in the judgment issued in case 695/2015-T, we say that "the business activity that generates deductible costs must be that which results in operations that have a purpose, an intent (and never an obligatory nexus of direct causality) of obtaining income or the purpose of maintaining the potential of a source producing income."

And what is the relationship with the company's assets? The breadth of assets recorded in the balance sheet is very significant. There are physical assets (e.g., goods, tangible fixed assets), intangible assets (intangibles), money and equivalents (e.g., cash and deposits), long-term financial assets (e.g., financial investments); contractual rights (e.g., customers, loans granted, other receivables). In essence, if an entity possesses a resource controlled by it (tangible, intangible, biological, financial or of another type) from which future economic benefits are expected, such element will constitute an asset to be recorded in the balance sheet. A patrimonal element, of a financial nature, embodied in an equity instrument of another entity, in a contractual right to receive money or another financial asset from another entity, or to exchange financial assets or financial liabilities under conditions that are potentially favorable, constitutes an asset, given its characteristic of (expected) generation of future economic benefits. Descending to the present case, we say that a financial asset that translates into a capital participation in a certain entity will have revenues subject to the variability of the performance of the entities in which it invested, and not the nature of a pre-fixed or deterministic remuneration. On the other hand, from the perspective of the risk management of one who invested in an asset expecting to obtain a certain economic benefit therefrom, certain investments, even with the potential for more diluted benefits in time, may make sense and generate costs that are apt for the maintenance of the source producing. Thus, we understand that the AT is not right when it states that "the mere possibility of being able to have future gains resulting from the application of those capitals in its associates does not determine by itself that such investments can be framed in the concept of fiscal costs, for that it was necessary that such expenses were indispensable for the realization of profits or gains subject to taxation or for the maintenance of the source producing".

It further states the AT, in the present case, that "in order for a sum to be considered a cost of a company it is necessary that the respective activity be developed by it itself, not by other companies (...)". From this the AT derives the non-deductibility of the financial expenses borne by the Applicant with the financing contracted and used by its associated companies at zero cost and with the financing contracted for the realization of non-remunerated accessory contributions to its participated companies. It is important to note here that we are not analyzing the amount of interest charged or not charged to the participated company by the Applicant (on this particular aspect other rules of the CIRC provide that are not Article 23, which is at issue here), but rather whether the financial expenses borne upstream – that is, by the Applicant, which then makes the funds available to its participated companies – should or should not be considered indispensable for "the realization of income subject to taxation or for the maintenance of the source producing".

Now, the income subject to taxation is, in this case, the dividends that the requesting company may derive from its shareholdings and the source producing such income will be each of the participated companies, insofar as the income of the shareholding (the dividend) will be all the greater as the greater the income of the participated company.

And will the fact that the cost is borne in a legal sphere (that of the Applicant) for the borrowed capital to be used in another legal sphere (that of each of the participated companies that received the financing) disqualify the cost as a deductible expense for tax purposes? No, by virtue of the fact that, in this case, the cost is borne with a view to making capital available for the maintenance of the source producing the income (the participated company). That is, the financial investment does not cease to be an asset managed in the interest of the entity that acquired and holds it; it simply, instead of using it in its own house, directs it to where it considers, according to its management criteria, that it will generate greater income – in this case, enabling its participated companies to develop activity which, otherwise, they would not develop. The fact that the management decision has positive repercussions on the patrimonial position of third parties does not mean that it is made only in the interest of third parties and that it is foreign to the activity of the participant. Indeed, it is the interest of the applicant in maintaining and developing the activity of its participated companies that leads it to make the capital contributions made. The participated companies are thus an investment of the applicant in which this, with a view to its maintenance and development, injects capital necessary for its operation.

Will the fact that, in the corporate purpose of the Applicant, there appears "the development of concession projects, namely of road, railway, port, sports, hospital and prison structures, involving operation and possibly design, financing and construction and provision of services and consultancy in the context of projects of the same nature" detract from all this? We do not believe so. In reality, if that is its purpose, it does not mean that it cannot develop it through its participated entities if such a form of management is more convenient for pursuing the ultimate purpose of obtaining profit. In the present case, given the rules applicable to concessions, the Applicant could not directly develop all the activities it develops through its participated companies, so we do not see how this aspect can be considered an obstacle to considering the costs in analysis as deductible expenses in the sphere of the Applicant.

Given the foregoing, this tribunal concludes that the disputed IRC assessment, relating to the fiscal year 2012, the corresponding compensatory interest assessment and the corresponding statement of account reconciliation suffer from an error concerning the factual and legal bases, due to misinterpretation and misapplication of the provisions of Article 23, No. 1, subparagraph c) of the CIRC, which constitutes a defect of violation of law. Thus, the same acts should be declared illegal and, consequently, annulled.

Given the substantiation of the request for declaration of illegality and consequent annulment of the impugned tax acts, due to a defect that prevents their renewal, it becomes unnecessary, as moot, the consideration of the invoked unconstitutionality of Article 23, No. 1, subparagraph c) of the CIRC, for violation of the principle of private initiative, contained in Article 61 of the Constitution.

The Applicant further filed a request for payment of compensatory interest, pursuant to the provisions of Article 43 of the LGT, which must now be appreciated since it was previously determined that the assessment is illegal and its consequent annulment and the indebtedness of the undue tax has been paid.

Now, in these cases, Article 43 of the LGT establishes that the right to compensatory interest will exist whenever the error that is the origin of the assessment comes from the AT.

Article 65, No. 1, of the CPPT further establishes that, when due to error attributable to the fiscal administration services, the taxpayer indebtedly pays a tribute and the assessment act was challenged through a complaint or judicial challenge [or request for arbitral pronouncement] within the respective legal timeframe (Article 43, Nos. 1 and 2 of the LGT), the compensatory interest is counted from the date of the indebtedly payment until the respective credit note is issued (Article 61, No. 5 of the CPPT).

Given the case law of the SAC, "in general, it can be stated that the error attributable to the services that made the assessment, understood these in a global sense, is demonstrated when they proceed to a complaint or challenge of that same assessment" (cf. the judgment of 31 October 2001, Case no. 26167). It is doubtful that this understanding applies to cases where the substantiation of the complaint or challenge results from a judgment of unconstitutionality formulated with respect to the provision(s) on which the assessment act was based, but that is not the case here.

Thus, with the requirements met from which the payment of compensatory interest by the Respondent results, we determine its payment, with the same being calculated from the date of the actual payment of the undue amount until its actual payment.

DECISION

In accordance with what is set forth above, it is decided:

1. To rule in favor of the request for arbitral pronouncement due to an error concerning the factual and legal bases, due to misinterpretation and misapplication of the provisions of Article 23, No. 1, subparagraph c) of the CIRC, which constitutes a defect of violation of law and, consequently, to declare illegal the act of assessment of Corporate Income Tax No. 2016…, in the amount of €13,638.44, the assessment of compensatory interest No. 2016…, and the statement of account reconciliation No. 2016..., dated 31.08.2016, relating to the fiscal year 2012.

2. To condemn the Tax Authority and Customs Authority to pay compensatory interest, pursuant to the provisions of Article 43 of the LGT and 61 of the CPPT.

3. To condemn the Tax Authority and Customs Authority to pay the costs of the proceedings.

Amount: in accordance with the provisions of No. 2 of Art. 315 of the CPC, combined with subparagraph a) of No. 1 of Art. 97-A of the CPPT and with No. 2 of Art. 3 of the Regulation of Costs in Tax Arbitration Proceedings, the amount of €13,638.44 is fixed for the proceedings.

Costs: pursuant to the provisions of Article 22, No. 4, of the JAT and pursuant to Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, the amount of the costs is fixed at €918.00, to be borne by the Respondent pursuant to Articles 12, No. 2, and 22, No. 4, both of the JAT, and Article 4, No. 4, of the aforementioned Regulation.

Be recorded and notified.

Lisbon, 26 September 2017

The Arbitrator,

Raquel Franco

[1] "On the relationship of partial dependence between accounting and tax law in determining the taxable income of legal entities: some reflections at the level of costs", in Science and Tax Technique, no. 396, 1999, p.7-180.

[2] "The deductibility of costs in Portuguese tax case law", Coimbra Publisher, 2004.

[3] In this sense, cf. the judgment issued by the collective arbitral tribunal constituted with the CAAD in the context of case 695/2015-T.