Summary
Full Decision
ARBITRAL DECISION
I. REPORT
On 20 January 2017, the company A…, SA, with the NIPC … and with registered office at Rua …, no. …–…, in … (hereinafter referred to as Claimant), came, pursuant to articles 97, no. 1, paragraph a), 99, paragraphs a), c) and d), all of the Code of Tax Procedure and Process (CPPT) and articles 2, no. 1, paragraph a) and 10, no. 1, paragraph a), of Decree-Law no. 10/2011, of 20 January, which approved the Legal Framework for Tax Arbitration (RJAT), to request the constitution of a Single Arbitral Tribunal, in which the Tax and Customs Authority (hereinafter AT or Respondent) is the Respondent, with a view to the declaration of illegality and consequent annulment of the assessment of Corporate Income Tax (IRC) no. 2016 …, of 12 October 2016 and of the assessments of compensatory interest nos. 2016 … and 2016 …, relating to the tax year 2012, in the total amount of € 29,742.20, also requesting the condemnation of the Respondent to the payment of indemnificatory interest on the amount paid, from the date of payment until the date of its full reimbursement.
Summary of the Parties' Positions
a. Of the Claimant:
The contested assessment is based on corrections made in the context of a tax inspection procedure, of whose draft Report the Claimant was notified in June 2016, in order to exercise the right to prior hearing.
Only with such notification did the Claimant become formally aware that an external inspection procedure had been opened in its name and with reference to the 2012 tax year, carried out based on elements from its accounting, which it had sent to the AT pursuant to the duty of cooperation invoked by the latter in office no. …, of 24/06/2015, relating to OI2015… .
As a preliminary question, the Claimant questions the classification of "internal inspection action" given by the AT to the aforementioned procedure, because it did not comply with the procedure provided for in the Supplementary Regime of Tax and Customs Inspection Procedure (RCPITA), which constitutes a defect giving rise to voidability of the assessment that was based on it.
As for the grounds of the corrections made by the AT, what is at issue is the question of whether the costs with bank financing incurred by the Claimant, which the AT relates to the extension of payment of debts and the granting of unremunerated loans to its associated entities, with which the AT claims, without substantiation, the existence of special relationships, which would lead, at minimum, to the application of transfer pricing rules, should be recognised as tax-deductible expense, to the extent that they are related to its business activity.
The Claimant asserts that the charges resulting from such financing are indispensable to its activity, because they are related to it, all the more so as they were incurred on dates much earlier than the loans granted to one of its associated entities or the extension of the payment of debts, in conditions similar to the extension of payment of debts of other customers in which it does not hold any interest.
On the other hand, the AT is prohibited from making an assessment of the opportuneness and merit of the expense, which would constitute an intolerable interference with the freedom of management of companies, with it only being incumbent upon it to ascertain whether the expenses are or are not related to the object of the taxpayer's business and whether they meet the formal documentation requirements, regardless of whether or not they are immediately and directly profit-generating.
In the case at hand, the AT not only requires that the Claimant produce taxable profit, but that it have a profit greater than that which it had, which has no legal basis whatsoever.
Furthermore, the AT considers that the expenses relating to the interest on bank financing obtained by the Claimant are not essential, a thesis which it does not sustain on any concrete fact, when it was incumbent upon it to prove their dispensability, contradicted by the dates of the contraction of bank loans against the non-payment of invoices or the date of the capital contributions made.
For the reasons set out, the Claimant concludes by the illegality of the contested IRC assessment, due to a defect of violation of law, requesting its annulment and the condemnation of the Respondent to restitution of the unduly paid amount, plus indemnificatory interest, as provided by law.
b. Of the Respondent:
Notified pursuant to and for the purposes provided for in article 17 of RJAT, the AT submitted its Response and attached the administrative file (PA), defending the legality and maintenance of the assessment that is the subject of the present request for arbitral ruling.
With regard to the preliminary question of the classification of the inspection procedure, the Respondent argues that, in light of the current wording of paragraph a) of article 13 of RCPITA, as given by Decree-Law no. 36/2016, of 1 July, with immediate application, as it is a procedural rule, the procedure under examination is classified as internal, comprising "the formal analysis and consistency of documents held by the Tax and Customs Authority or obtained in the course of the aforementioned procedure".
As for the corrections to the result declared by the Claimant for the 2012 tax year, the Respondent understands that the financial charges resulting from financing obtained in that year, recorded in the various sub-accounts of account SNC 25 (Financing Obtained), cannot be accepted as tax-deductible expense, in light of the provisions of article 23 of CIRC, given that, while it incurred financial charges, namely interest on bank financing, resulting from loans contracted, it granted loans to other companies, its associated entities (the shareholders and/or members of the corporate bodies of the company now in question are also shareholders and/or members of the corporate bodies of the debtor companies, its clients), and the Claimant was not remunerated for the value of the loans granted.
That, in order for these expenses to be accepted fiscally, their indispensability would be necessary with a view to the realisation of income subject to taxation or to the maintenance of the source of production, that is, that it be proven that they are used in its activity, as an autonomous entity, since the assessment of the tax deductibility of the cost depends on a causal and justified relationship with the productive activity carried out by the company itself and not by other companies, even if related to it.
That the criterion of indispensability created by the legislator prevents the fiscal consideration of expenses which, although recorded as costs, have been incurred for the pursuit of interests alien to the company, such as the case of interest borne by a company, resulting from loans whose funds are diverted from its own operation to that of another entity with which it is related.
That, as the AT does not question the operations carried out between the Claimant and the entities related to it, the transfer pricing regime is not applicable to them, which aims to safeguard full market competition, ensuring that operations on goods, services and rights, carried out between related entities, are conducted under substantially identical conditions to those that normally would be contracted, accepted and practiced between independent entities in comparable operations.
Invoking case law of the Superior Courts, the AT concludes that, in the case sub judice, "there is no doubt that the correction made by the SIT (contested in this proceeding) is valid and legitimate, embodying in itself a correct subsumption of the facts to the applicable law, thereby falling away (all) the grounds invoked by the now Claimant", and that the request for arbitral ruling should be judged unfounded and the contested assessment maintained.
Procedural Progress:
The meeting referred to in article 18 of RJAT took place on 13 July 2017, with the examination of the witnesses called by the Claimant and the definition of the subsequent procedural course, determining that the process proceed with successive written submissions, within the period of 10 days, beginning with the Claimant.
The date of 29 September 2017 was set for the issuance of the arbitral decision, warning the Claimant that, by that date, it should proceed with payment of the subsequent arbitral fee.
The Parties presented written submissions, pronouncing themselves on the evidence produced and reiterating and developing their respective legal positions.
Together with the Submissions, the Claimant presented five documents relating to the bank financing mentioned in articles 181 to 185 of the Initial Petition (PI), facts on which witness evidence had been produced.
The Respondent presented Submissions and a Motion, in which it requested the removal of the documents presented by the Claimant, as being out of time and on the grounds that their admission would result in the allegation of new facts, which would constitute a violation of the principle of equality of the parties.
By arbitral order of 1 September 2017, the Parties were notified of the admission of the documents attached by the Claimant, given their presentation on a date prior to the closing of the discussion of the case, because they had been referred to in the meeting provided for in article 18 of RJAT, and because the AT had the opportunity to pronounce itself on them in the course of written submissions.
II. SANITATION
1. The request for arbitral ruling was filed at CAAD on 20 January 2017 and automatically notified to the AT on 31 January 2017.
2. The Arbitral Tribunal is competent and was regularly constituted on 31 March 2017, pursuant to articles 2, no. 1, paragraph a), 5 and 6, all of RJAT.
3. The parties have legal capacity and standing, are legitimate and are legally represented, pursuant to articles 4 and 10 of RJAT and article 1 of Ordinance no. 112-A/2011, of 22 March.
4. The process does not suffer from defects that would invalidate it and no exceptions were invoked that need to be considered, nothing standing in the way of the decision on the merits of the case.
III. GROUNDS
III.1. FACTUAL MATTER
The factual matter relevant for the understanding and decision of the case, after critical examination of the documentary evidence attached to the initial petition (PI), of the administrative file (PA) and of the witness evidence produced and not contested by the AT, is set out as follows:
A – Proven Facts
1. The Claimant carries out, as its main activity, wholesale trade in chemical products (CAE 46750) and, as secondary activity, wholesale trade in cereals, seeds, legumes, oilseeds and other agricultural raw materials (CAE 46214), classified under the general IRC regime, whose taxation period runs between 1 October and 30 September (as set out in the model 22 IRC declarations and annexes to the Tax Inspection Report (RIT));
2. The seeds commercialised by the Claimant are acquired, for the most part, from international suppliers who require payment at 30 or 45 days, while its retail customers, who in turn sell to farmers, see their payments dependent on agricultural campaigns and state financial support, paid in two periods of the year (witness evidence);
3. The market conditions in which the activity is carried out lead the Claimant to frequently resort to financing from various banking institutions (witness evidence);
4. Although invoices are issued to customers for payment at 60 days and efforts are made to ensure their timely payment, that period is rarely met, with several customers paying only at 10 or 11 months, as is the case with companies B…, C…, D…, E… and F… (witness evidence);
5. In 2012, the Claimant granted a loan to its subsidiary G…, Ltd., in which it was accompanied by the other shareholders of that company (witness evidence);
6. In the loan agreement with G…, in the total amount of € 120,000.00, to be made available in two phases (€ 90,000.00 up to 11 September 2012 and € 30,000.00 up to 5 August 2013) and which has already been repaid, an interest rate of 4% per annum was agreed, payable in a single instalment at the moment of reimbursement of the borrowed capital (witness evidence and copy of the "Capital Contribution Agreement", dated 17 July 2012, attached to the PI);
7. The medium and long-term bank financing obtained by the Claimant, in force in the 2012 tax year, resulted from the extension of contracts previously concluded:
a. With Bank H… (formerly I…), in 2001 (article 181 of PI, witness evidence and Doc. 1 attached to the Claimant's Submissions);
b. With Bank J…, SA, in 2002 (article 182 of PI, witness evidence and Doc. 2 attached to the Claimant's Submissions);
c. With Bank K…, in 2003 (article 183 of PI, witness evidence and Doc. 3 attached to the Claimant's Submissions);
d. With Bank L…, SA, in 2004 (article 184 of PI, witness evidence and Doc. 4 attached to the Claimant's Submissions);
e. With M…, SA, in 2006 (article 185 of PI, witness evidence and Doc. 5 attached to the Claimant's Submissions);
8. In July 2015, the Claimant was notified, through office no. … of the Tax Inspection of the Finance Directorate of Lisbon, of 24 June 2015, in the course of the inspection procedure titled by Service Order no. OI2015…, of 19 June 2015, to, within the period of 15 days and pursuant to the principle of cooperation provided for in article 9 of RCPITA, send to those Services various elements of its accounting, relating to the 2012 tax year, namely, "Analytical Trial Balances relating to 31/12/2012, before and after the determination of results, list of Capital Holders in the said tax year and at the date of financing, list of Capital Parties in the tax year under analysis, presentation of all credit obtained and granted appearing in the balance sheet, among others" (Doc. 3 attached to PI and page 5 of RIT);
9. From the analysis carried out on the elements sent for monitoring of the situation relating to "Financial Charges" of the 2012 tax year, in the course of the aforementioned procedure, of limited scope (IRC), corrections to the tax result declared by the Claimant ensued, in accordance with the respective draft RIT, notified to the taxpayer by office no. … of the Tax Inspection of the Finance Directorate of Lisbon, of 2 June 2016, sent under cover of the registry of CTT no. RC … PT;
10. According to section III.1.1 – Corrections in the context of IRC, of the RIT, the accounting-tax analysis focused especially on the areas of loans obtained/granted and financing expenses/income, with corrections being proposed as follows justified:
a. The taxpayer resorted to bank financing, recorded in the various sub-accounts of account SNC 25 (Financing Obtained), whose final balances appear in the table below:
[Table with financing amounts]
b. With reference to the bank financing obtained, the Claimant incurred the following financial charges:
[Table with financial charges]
c. The statement of results also indicates that the activity of the Claimant, in the 2012 tax year, recorded a negative variation of 8.11% compared to the previous tax year, having decreased by 5.24% the cost of goods sold and raw materials consumed (CMVMC) and increased by 4.70% customer credit, with the Customer balance in the amount of € 3,744,101.98 and financing obtained of € 3,897,460.32;
d. As for the debtor balances of the customer account, those of G…, Ltd., stand out, in which the Claimant holds 60% of the share capital and which with it has common shareholders, with "a weight of approximately 4.79% of the total customer balance" (€ 179,362.57); B…, SA, whose share capital is held by the Claimant at 24% and with which it has common shareholders, with "a weight of approximately 20.10% of the total customer balance" (€ 753,217.40) and N…, SA, whose corporate bodies are simultaneously shareholders of the Claimant, which represents "a weight of approximately 6.53% of the total customer balance" (€ 244,698.25), with the debtor balances of the customer accounts of these companies totalling € 1,177,278.22;
e. The Claimant granted unremunerated financing to company G…, Ltd., in the amount of € 120,000.00;
f. The financial expenses incurred by the Claimant in the 2012 tax year were subject to the following classification: "Given the fact that the taxpayer is incurring financial charges, namely interest, resulting from loans that it contracted and, at the same time, is financing associated companies free of charge, in the form of sales, through non-payment by the same and the granting of unremunerated loans, it is important to assess whether these charges are or are not accepted fiscally, in light of the provisions of article 23 of CIRC. (…)
For costs to be considered tax-deductible it is necessary to verify whether the cost was actually borne by the taxpayer, whether it was indispensable for the realisation of its activity, taking into account also the requirement of connection to "gains subject to or the maintenance of the source of production". (…) if its customers B…, SA, N… SA and G… LDA, entities with which it maintains a situation of special relationships, had made payment of their debts and had not granted unremunerated loans to company G… LDA, the taxpayer would not need to maintain such a high bank financing and support the respective charges." (…);
11. As a result of the above analysis, the following corrections to the result declared in the context of IRC for the 2012 tax year were proposed:
[Table with corrections]
12. In the exercise of the right to hearing (Doc. 5, attached to PI), the Claimant argued, in particular, that the financing obtained is indispensable for the exercise of its activity (acquisition of premises, payments to suppliers and the State, salaries and current expenses), and that the medium and long-term financing was contracted much earlier than the issuance of invoices pending from its associated entities or the loan granted; that, as regards customers, as the transfer pricing rules were not applied, pursuant to article 63 of the IRC Code, the proposed corrections are illegal, all the more so as the policy of payment extension is practiced in the same way for all company customers and not just for those identified in the draft RIT; that the capital contributions granted are remunerated;
13. Appreciating the arguments invoked and the evidence elements presented by the Claimant, although denying the applicability of transfer pricing rules, the AT reformulated the calculations relating to the debts of N… and B…, excluding the entirety of the former and, as for the latter, those relating to invoices with less than two months, the general payment period of two of the customers whose accounts were subject to comparative analysis with those of the participated companies, reducing the proposed corrections from € 134,159.00 to € 101,745.01;
14. Annex 1 to the RIT demonstrates the calculations made by the AT for determination, month by month, of non-deductible financial charges: the percentage of the sum of the monthly balances of the debts of accounts 21141001 (B…, SA) and 2111300357 (G…, Ltd.) and 26601 (loans granted to this latter company) in the value of the monthly balances of financing obtained was applied to the monthly value of financial charges borne by the Claimant, thus obtaining the value of charges not accepted fiscally, of € 101,745.01;
15. Annex 3 to the RIT contains part of the General and Cumulative Trial Balance, relating to account 21 (Customers), which comprises more than one hundred customers, some with high debtor balances, as is the case with company D…, Ltd. (account 2111100149), which does not appear in the list of "Customers with doubtful collection";
16. Annex 5 to the RIT comprises the extracts of accounts 211100003 (T…) and 2111100034 (O…), customers whose payments are made at 60 days and whose operations served as a basis for comparison with those of the Claimant's associated entities;
17. The RIT, in its final version, was notified to the Claimant and its Representatives by offices nos. … and …, of the Tax Inspection of the Finance Directorate of Lisbon, both of 3 October 2016 (registries of CTT nos. RC … PT and RC … PT, respectively);
18. On 12 October 2016, assessment no. 2016… was issued, with a compensation date of 14 October 2016, the statement of the assessment of compensatory interest no. 2016 … and the statement of account settlement no. 2016…, in the amount of € 29,724.26, with a voluntary payment deadline of 12 December 2016;
19. The Claimant proceeded to payment of the assessed tax, in the amount of € 26,962.43, on 16 November 2016, with waiver of payment of compensatory interest, under the Peres Plan, approved by Decree-Law no. 67/2016, of 3 November.
B – Unproven Facts
It was not proven that there is a direct and immediate relationship between the financial charges borne by the Claimant in the 2012 tax year and the loan granted to G…, Ltd.
It was not proven that the period for payment of the debts of that company and B…, SA was different from the period granted for payment of debts to other company customers of the Claimant, in which it does not hold any shareholding interest.
III.2. LAW
The questions to be decided
1. Preliminary question – classification of the tax inspection procedure
Pursuant to no. 1 of article 124 of CPPT, applicable subsidiarily to the tax arbitration process, pursuant to article 29, no. 1, paragraph a) of RJAT, in the absence of defects leading to a declaration of non-existence or nullity of the challenged act, the tribunal should consider the defects alleged that determine its voidability.
In the situation under analysis, the Claimant invokes defects of the tax inspection procedure which, in its view, determine its nullity.
The Claimant argues that, although the Tax Inspection Services of the Finance Directorate of Lisbon classified the inspection procedure as an internal procedure, it did not comprise acts of inspection exclusively carried out in the services through formal analysis and consistency of documents, but rather the corrections were based on the analysis of accounting elements made available by it, external to the AT, and should therefore be classified as external.
In that measure, the AT evaded the requirements imposed by articles 49 (prior notification to the taxpayer), 46 (issuance of service order), 51 (notification of the service order to the taxpayer), all of the Supplementary Regime of Tax and Customs Inspection Procedure (RCPITA).
Considering that there were two inspection procedures, one for information gathering and another for analysis of the gathered elements, the Claimant alleges violation of the provisions of article 63, no. 4 of the General Tax Law (LGT), as well as the six-month period provided for in no. 2 of article 36 of RCPITA.
The Claimant further invokes the inapplicability of paragraph a) of article 13 of RCPITA, in the wording given to it by Decree-Law no. 36/2016, of 1 July, to a procedure initiated before the date of its entry into force, in light of the provisions of no. 3 of article 12 of LGT, as they concern guarantees, rights and legitimate interests previously constituted of taxpayers.
As for the purposes, the tax inspection procedure is classified as (a) a procedure of verification and confirmation, aimed at confirming compliance with the obligations of the taxpayer and other tax-bound parties, and (b) an information procedure, aimed at compliance with the legal duties of information or opinion that the tax inspection is legally entrusted with (article 12, no. 1 of RCPITA).
As for the place where the inspection is carried out, the inspection procedure may be classified as internal or external, depending on whether the acts that comprise it are carried out exclusively in the facilities and services of the AT or in facilities or dependencies of taxpayers and other tax-bound parties, of third parties with whom these maintain economic relationships or in any other location to which the AT has access (cf. article 13, paragraphs a) and b) of RCPITA, respectively).
Within the scope of the previous wording of paragraph a) of article 13 of RCPIT, Joaquim Freitas da Rocha and João Damião Caldeira[1] understood that "The internal procedure is a kind of cadastral inspection, carried out within the inspection services themselves, using elements declared by taxpayers, and encompasses activities of mere verification in which the Administration merely verifies compliance by taxpayers of their declarative duties (…) particularly limits itself to cross-checking through the crossing of information available in its databases, whether the taxpayer complied or not with its duties and whether the elements declared match the elements provided by declarations filed by other tax-bound parties with whom the taxpayer maintains or maintained relationships (…) it is an activity of formal verification to verify the accuracy of formally declared by the taxpayer."; on the other hand, "The procedure will be external when the inspection acts are carried out, wholly or in part, in the facilities or dependencies of taxpayers or other tax-bound parties, of third parties with whom they maintain economic relationships or in any other place to which the administration has access. In this activity, of a more investigatory nature, the aim is to verify the accuracy of the values declared based on the elements in its accounting and documents, whether or not any omission of values occurs and whether the values declared are in accordance with the tax incidence standards applicable to its activity. Whenever the inspection procedure aims at the analysis or verification of accounting, account books or other documents related to the activity of the inspected taxpayer, the inspection procedure should always be classified as being external in nature and is normally carried out in the facilities or dependencies where such elements are or should be located" (emphasis ours).
Although the current wording of paragraph a) of article 13 of RCPITA is broader than the previous wording, clarifying that "the internal inspection procedure comprises the formal analysis and consistency of documents held by the Tax and Customs Authority or obtained in the course of the aforementioned procedure", the fact is that, at the date of issuance of office no. … of the Tax Inspection of the Finance Directorate of Lisbon, of 24 June 2015, through which the Claimant was notified to send the elements of its accounting, the new wording of the rule was not yet in force.
Furthermore, in the situation under examination, the inspection procedure opened in the name of the Claimant, through service order no. OI2015…, issued by the Finance Directorate of Lisbon on 19 June 2015, was not aimed solely at verifying compliance with the Claimant's declarative operations, but also served, as follows from the RIT, to, through analysis of the accounting elements obtained, justify corrections to the taxable matter of the 2012 tax year.
Thus, there is no doubt that the tax inspection procedure from which resulted the additional IRC assessment for the 2012 tax year now contested, having been based on information collected from the Claimant's accounting, capable of justifying corrections to the taxable matter, should be classified as an external procedure, notwithstanding the Respondent having classified it as an internal procedure, as it took place in the AT's services.
However, this does not necessarily result in the nullity of the procedure; indeed, as has been decided by case law, "being certain that no. 1 of art. 49 of RCPIT applies in the tax context the principle of communication provided for in art. 55 of CPA, one must not overlook that, in light of this norm, the lack of notification of the beginning of an ex officio proceeding does not generate invalidity if, notwithstanding the same, it is demonstrated that the interested party had knowledge of the proceeding (and its respective object) in time to be able to intervene in it (…) «if, notwithstanding the occurrence of lack of notification of the proceeding «… it is demonstrated that the interested party in question had knowledge of the proceeding in time to be able to intervene in it – and if there is to be a hearing, the interest in question may already be satisfied, despite the lack of notification» " – cf. the Order of the Supreme Administrative Court, of 5/11/2014, Case no. 0914/13, available at http://www.dgsi.pt.
Having been notified by the Claimant of the draft RIT, through office no. … of the Tax Inspection of the Finance Directorate of Lisbon, of 2 June 2016, following which it exercised the right to hearing, by request filed on 16 June 2016, it is concluded, in accordance with the Order of the STA, cited above, that "(…) considering that the final act of the inspection procedure is reduced to its respective final report, the alleged lack of notification referred to in no. 1 of the cited art. 49 of RCPIT will always be degraded, necessarily, to a mere irregularity, without invalidating effects, provided that the interested party is given the legal possibility of exercising its right to hearing, either during the procedure, or at the end of the procedure when preparing the draft final report. That is, the alleged violation of law would always be degraded, necessarily, to a mere irregularity, without invalidating effects of the assessment act".
The invoked nullity of the inspection procedure is thus unfounded, for the reasons indicated.
2. The corrections to the taxable matter – Financial charges not accepted fiscally
The question that falls to the Tribunal to decide consists in whether financial charges, resulting from bank loans obtained and borne by a company, can be deducted from the respective taxable matter of a given tax year, when that same company grants unremunerated financing to other companies in which it holds shares, of whose share capital it is not the sole holder.
It shall be for the Tribunal to decide, specifically, whether, in light of no. 1 of article 23 of the IRC Code, as in force at the date of the facts, the financial charges in the amount of € 101,745.01, borne by the Claimant during the 2012 tax year with the contracting of bank financing, whose final balance amounted to € 3,897,460.32, are considered or not as fiscally deductible expenses, given that, in the same tax year, it granted credit to a company in which it holds a shareholding of 60% of the share capital and that the debtor balances of the current accounts of its customer associated entities relate to invoices issued more than two months before, and without having received any kind of remuneration with reference to the financing granted.
Such expenses being documentally proven and recorded in the accounting of the Respondent, constituting accounting expenses, it is therefore not a question of verification, but rather of the qualification of such expenses as deductible or non-deductible, that is, their subsumption into the indeterminate concept of "indispensability".
In order to respond to such question, it will be necessary to proceed, preliminarily, with the normative interpretation of that no. 1 of article 23 of the IRC Code, with a view to its application to the concrete case, without losing sight of the fact that to the interpretation of tax norms are applicable, in accordance with no. 1 of article 11 of the General Tax Law (LGT), the general rules and principles of interpretation of laws, in particular article 9 of the Civil Code (CC), with special emphasis, when there persists "doubt about the meaning of the incidence norms to be applied", on the "economic substance of the tax facts" (cf. no. 3 of article 11 of LGT).
But there will also be a need to question whether, in the absence of total control by the Claimant in its subsidiaries, the expenses incurred in their financing, although such expenses may be qualified as indispensable for the activity of the Claimant, are deductible in their entirety, for purposes of determining the taxable matter of the tax year under analysis. We would then be faced with a problem of quantification, in the sphere of verification and burden of proof.
i. On the interpretation of no. 1 of article 23 of the IRC Code – the concepts of indispensability and source of production:
The wording of no. 1 of article 23 of the IRC Code, in force for the year 2012, was as follows:
"Article 23 – Expenses
1 — Expenses are those that are provably indispensable for the realisation of income subject to taxation or for the maintenance of the source of production, namely:
(…)
a) Of a financial nature, such as interest on third-party capital applied in the operation, discounts, premiums, transfers, exchange differences, expenses with credit operations, debt collection 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 amortised cost;
(…)".
As has already been advanced, the concept of indispensability enshrines the criterion of distribution between non-accepted and fiscally accepted expenses as negative elements in the determination of taxable profit, "constituted by the algebraic sum of the net result for the year and the positive and negative patrimonial variations verified in the same period and not reflected in that result, determined on the basis of accounting and possibly corrected in accordance with this Code", as provided for in no. 1 of article 17 of the IRC Code.
It should be noted that this concept of indispensability has been used, in its concrete application, according to a restricted perspective, requiring direct correlation between an expense incurred and income obtained (principle of necessity) and in a broader sense, which admits the deductibility of any expense incurred within the scope of operations relating to the corporate purpose (economic-business perspective).
The most relevant doctrine on the matter has argued that "(…) Indispensability subsumes all and any act carried out in the interest of the company (…) The legal notion of indispensability thus repels acts inconsistent with the corporate purpose, not insertable in the corporate interest (…)"[2], that "Only may costs be subject to direct correction, pursuant to article 23 of CIRC, when they are facts which, by nature and uniqueness, are evidenced as foreign to the object and the overall economic and management purpose of the company"[3], that " (…) The solution accepted among us (at least in the doctrine), in the wake of the understandings advocated by Italian doctrine, has been to interpret indispensability in function of the corporate purpose (…)"[4] and that "The invocation of the rule of indispensability of costs can never be made to replace the judgment of convenience and opportuneness of the charges assumed, as they resulted from the decision of the corporate bodies, by another judgment, also of a business nature, made by the tax administration or the courts. A cost does not cease to be one (should not cease to be considered as such for tax purposes) because, in a posteriori evaluation, it proves to be useless or ineffective (e.g. because it does not prove to be profit-generating) or, simply, excessive in the eyes of treasury interests."[5]
Indispensability of expenses refers to "the realisation of income subject to taxation or to the maintenance of the source of production".
In this manner, with the legislator placing, as an alternative, the indispensability of expenses, as a condition for their fiscal acceptance, in relation to the realisation of income subject to taxation or to the maintenance of the source of production, "the verification, a posteriori, of the absence of profits directly related to the expense is not a relevant factor to conclude by the non-deductibility of the cost. If it were so, charges borne with investment projects that proved not to be profitable would never be fiscally deductible costs. Such a position is certainly not defensible."[6]
It is concluded, thus, that the realisation of income is not a sine qua non condition of the fiscal deductibility of expenses incurred by the company. It remains, therefore, to analyse what consists of "the maintenance of the source of production".
The source of production of a company, as a set of technical, human and financial means, organised with a view to the realisation of a certain economic purpose, includes the assets (tangible, intangible biological, financial and other) that allow it to pursue its activity, with the definition of an asset from § 49 of the Conceptual Framework (CF) of the Accounting Standardisation System (SNC) being "a resource controlled by the entity as a result of past events and from which it is expected that economic benefits will flow to it", with the concept of future economic benefits specified in §§ 52 to 58 of the same CF, in particular in §§ 52 and 54 to 56:
"52 – The economic benefits future incorporated in an asset are the potential to contribute, directly or indirectly, to the flow of cash and cash equivalents to the entity. The potential may be a productive potential that is part of the operational activities of the entity. It may also take the form of convertibility into cash or cash equivalents or the ability to reduce cash outflows, such as when an alternative manufacturing process lowers production costs.
54 – The future economic benefits incorporated in an asset may flow to the entity in different ways. For example, an asset may be:
(a) Used alone or in combination with other assets in the production of goods or services to be sold by the entity;
(b) Exchanged for other assets;
(c) Used to settle a liability; or
(d) Distributed to the owners of the entity.
55 – Many assets, for example, tangible fixed assets, have a physical form. However, physical form is not essential to the existence of an asset; hence patents and copyrights, for example, are assets if it is expected that economic benefits will flow to the entity from them and if they are controlled by the entity.
56 – Many assets, for example, receivables and properties, are associated with legal rights, including the right of ownership.".
In turn, the Chart of Accounts of the SNC individualises, in account 4, the species of assets (investments), among which are financial investments, which include shareholdings:
"4 – INVESTMENTS
41 Financial investments
42 Investment properties
43 Tangible fixed assets
44 Intangible assets
45 Investments in progress
46 Non-current assets held for sale".
As follows from the cited norms, the potential for production of future economic benefits of an asset for the entity that controls it can both "be a productive potential that is part of the operational activities of the entity", as well as be a potential "associated with legal rights, including the right of ownership" (§ 56 of the Conceptual Framework).
Hence the understanding that the activity of a company is not exhausted in its productive or operational activity, but rather, as was established in the Order issued in case no. 695/2015-T, of 18 May 2016, which, with due respect is transcribed:
"In this sense, the activity of a company will consist of the operations resulting from the use of its assets, in particular of its assets and the management of its liabilities. That is, in the manner in which its management will use the business assets in the scope of the various operations (productive, commercial, investment and disinvestment, general financing, acquisition of financial interests and others) which, taken together, allow the entity in question to comply with its economic purpose: the search (immediate or in the long term) for an economic surplus (profit).
(…) the "activity" of a company is not exhausted, as sometimes seems to emerge from some interpretations, in the set of productive or operational operations. "Activity" is also the set of operations which have the purpose of the realisation of investments or the sale of assets, the acquisition of financial interests and their subsequent sale, the application of liquidity in short-term investments or securities and their management, the receipts and payments resulting from operating or non-operating income and expenses, and many others not expressly referred to here.".
As Rui Duarte Morais states, "The expression maintenance of the source of production cannot be understood in a static sense (of conservation of the company as it exists), but rather in a dynamic sense. Companies aim for their development, their growth".[7], being free in their management choices, within the scope of their capacity for exercise. For this reason, the Author continues[8], "(…) the question of whether a cost should or should not be deemed indispensable should be resolved from the objective purpose of the transaction (that is, using the business purpose test, current in Anglo-Saxon doctrine and case law)" or the "French theory of abnormal management acts. An abnormal management act will be one which, although legitimate, was not pursued by corporate interest".
For the reasons that precede, we follow the reasoning of the Arbitral Decision issued in case no. 12/2013-T of CAAD, in which Tomás Tavares was the sole Arbitrator, pursuant to which "A company may obtain funds (and pay interest) and subsequently deliver those funds to a subsidiary without any causal and direct remuneration – and still adequately exercise its activity, within its capacity and lucrative scope: it may effect an increase in capital (art. 25 of CSC), supplementary or accessory contributions without interest (art. 210 and 287 of CSC) or capital contributions without interest (art. 243 of CSC) – and in any of those cases acts entirely within its capacity for exercise and with a lucrative intent and in the exercise of its activity".
Concluding, therefore, that, provided they are directed towards the interest of the entity and inserted in its lucrative scope, the financial charges borne by a company, which grants unremunerated financing to other companies in which it holds shares, constitute deductible charges, for purposes of determining its taxable matter, pursuant to article 23, no. 1, paragraph c) of the IRC Code.
ii. The quantification of non-deductible financial charges. The condition of proportionality.
The doctrine and case law cited emphasise the relationship between the deductibility of expenses and the pursuit of corporate interest, albeit indirectly, through unremunerated financing to subsidiary companies, equating, for this purpose, unremunerated financing to a true investment.
Because, as noted by Fernando Carreira de Araújo and António Fernandes de Oliveira[9], "The expression "unremunerated capital contribution" is, especially when used in the fiscal context, highly misleading (…) this investment via capital contribution without interest of unremunerated has nothing (…)".
And, the Authors continue[10], "What is a financing with remuneration? From a strictly legal perspective, in the civilistic sense of the term, we would say, would it be one in which on the occasion of the financing it is agreed, as consideration for the same in a certain remuneration guaranteed (…). A financing via subscription of share capital does not fulfill, in our legal system, this requirement of this narrow, formal, legal concept of onerousness financing (…). And yet, it is known that this investment via share capital aims at obtaining remuneration, and in potential terms may generate much higher remuneration than financing with advance-fixed consideration: the remuneration will be a function of the business success of the company, and will be received in the form of dividends, capital gains (appreciation of the shareholding) or liquidation quota.
For tax law in the context of income taxation (…), both financing (with and without agreed interest) fit into the very same category: that of capital applications, or investments, with business causation, i.e., with lucrative purposes.".
Ending by establishing an equivalence between investments via share capital, via supplementary contributions and via unremunerated capital contributions, as "If the investment in subsidiaries is made via share capital, it will generate capital shares (…) and if it is made via supplementary contributions or so-called "unremunerated" capital contributions it will generate credits or reimbursement expectations for the shareholder (…) they strengthen the financial capacity of the subsidiary and, with it, enhance its investments and activities, so they have indirectly the very same economic effect for the shareholder investor as an additional capital contribution: strengthening of the subsidiary's capacity to generate additional returns, i.e., strengthening of the shareholder investor's lucrative potential in the subsidiary".
However, in order for the financing charges to be fully deductible in the sphere of the holding company, it is necessary that it be either the sole shareholder or, if not, that all other shareholders of the subsidiary accompany the investment made, in proportion to their respective shareholdings (condition of proportionality), so that the "potential return from it benefits the shareholder who makes it"[11].
Should this not happen and the company that does not hold all of the share capital of the subsidiary to which it lends money without interest, be the only one to contribute to the financing of the subsidiary, it cannot be said that the return on its investment will benefit it exclusively, but rather having the character of liberality, to the extent that it benefits the other shareholders of the subsidiary.
It cannot then be said that, in this situation, where the financing benefits third parties, the expenses incurred should be fully deductible, for purposes of determining the taxable matter of the company that provided it to its subsidiary; however, neither will the logic of "all or nothing" apply, of the non-fiscal acceptance of the part of expenses incurred in proportion to the shareholding in the financed company.
And, should the other shareholders of the subsidiary to which a company provided unremunerated financing and it be linked by "special relationships", would it not be appropriate here to invoke the transfer pricing regime in order to effect the due corrections to the taxable matter? We are of the belief that it would. The question is that they be correctly determined, quantified, the financial charges borne by the holding company, the percentage of participation in the share capital of the subsidiary and the existence of special relationships between the financing company and the other shareholders of the financed company.
However, transfer pricing rules cannot be applied to relationships between a company and another company in which it holds shares, as the AT rightly points out, "The transfer pricing regime aims to safeguard full market competition, ensuring that operations on goods, services and rights, carried out between related entities, are conducted under substantially identical conditions to those normally would be contracted, accepted and practiced between independent entities in comparable operations." and the relationship between the shareholder, in that capacity, and the company, "finds no comparables except in the very same universe of relationships between shareholder and company."[12].
There are, however, borderline cases, such as those where the relationships between the company and its associated entity are not equated with relationships between the shareholder and the company, as they have, for example, a commercial nature. Which happens, in particular, in cases where the associated company is simultaneously a customer of the holding company and the latter grants it extended payment periods than those granted to other customers with which it is not related.
iii. The contested assessment.
Reverting to the situation of the case, it is verified that, in accordance with section III.1.1 of the RIT, the purely arithmetical corrections to the result declared by the Claimant, for the 2012 tax year, are based on the following facts:
a. The taxpayer resorted to bank financing, recorded in the various sub-accounts of account SNC 25 (Financing Obtained), whose final balances (…) totalled € 3,898,460.32
b. With reference to the bank financing obtained, the Claimant incurred financial charges corresponding to interest in the amount of € 234,323.43, banking services in the amount of € 67,297.94 and stamp duty of € 33,523.48, all in a total of € 335,144.85;
c. The balance of customers was € 3,744,101.98;
d. The debtor balances of the customer accounts of the Claimant's associated entities were € 179,362.57 (G…, Ltd.) and € 753,217.40 (B…, SA);
e. The Claimant granted an unremunerated loan to G…, Ltd., in which it holds a shareholding of 60%.
And, in conclusion, "should its customers (…), entities with which it maintains a situation of special relationships, have made payment of their debts and had not granted unremunerated loans to company G… LDA, the taxpayer would not need to maintain such high bank financing and support the respective charges".
Reasoning that seems to contain "another judgment, also of a business nature, made by the tax administration (…)", which the doctrine rejects, as not consonant with the principle of freedom of management of companies.
Based on such judgment, the AT did not accept financial charges in the amount of € 101,745.01, without taking into account that the "situation of special relationships", at least in commercial relationships between the Claimant and its associated entities, if they were not considered "financings" and, as such, fully deductible, as they are made in the interest of the Claimant, would give rise to the application of transfer pricing regime.
How did the AT arrive at the calculation of non-deductible fiscal expenses? Not based on concrete facts, but by calculating the percentage of the sum of the monthly balances of the debts of accounts 21141001 (B…, SA) and 2111300357 (G…, Ltd.) and 26601 (loans granted to this latter company) in the value of the monthly balances of financing obtained and applying that same percentage to the monthly value of financial charges borne by the Claimant.
Now, with respect to capital contributions, article 243 of the Commercial Companies Code does not prevent their free nature, certainly because the legislator considered that they represent investments in the company, made in the interest of the shareholders.
It would thus be incumbent upon the AT to prove that the Claimant was not accompanied by the other shareholders of G…, Ltd., in order to meet a condition of proportionality, as a key for distribution between deductible and non-deductible financial charges in the sphere of the Claimant, with respect to the capital contribution, making use, as the case may be, of the rules relating to transfer pricing, to effect the corrections that would be necessary in light of those rules, if it concluded that, among the other shareholders and the Claimant there exist the special relationships it invokes.
However, from the uncontested witness evidence by the Respondent, it results that all other shareholders of G…, Ltd. accompanied the Claimant in the granting of financing to that company, for which reason it must be concluded by the full deductibility of any financial charges borne with the financing granted, for purposes of determining the taxable matter of the Claimant, because, evidencing these a lucrative purpose, they cannot fail to be deemed indispensable for the maintenance of its source of production.
As for the extension of payment of the debts of the Claimant's associated entities, while denying the application of transfer pricing regime, the AT does not fail to establish the comparison between the conditions of the operations underlying them with the conditions of payments of two other customers, whose payments are made at sixty days, from among more than one hundred customers of the Claimant.
Now, not making use of the transfer pricing regime and the corrections made not being based on concrete facts, it results that the AT starts from known facts (the values of the final balances of the various sub-accounts of account SNC 25 – Financing obtained; of account 691 – Interest borne; of account 622 – Specialised services; 68123 – Stamp duty and 21 – Customers), to establish unknown facts, that is, that the financial charges borne by the Claimant are directly related to the non-payment by its associated entities, because if these "had made payment of their debts (…) the taxpayer would not need to maintain such high bank financing and support the respective charges".
In proceeding in this manner, the AT seems, in fact, to establish a presumption of dispensability of the financial charges borne by the Claimant, which translates into an indirect method of determining the taxable matter, outside the cases expressly provided for in articles 87 and following of the General Tax Law (LGT).
In the concrete case of the instant proceedings, none of the circumstances provided for in articles 87 or 88 of LGT are present, but rather the corrections were made based on the accounting of the taxpayer.
For the reasons that precede, it is already clear that, as the AT is not authorised to introduce corrections to the values declared by the Claimant based on presumptions, such corrections are illegal, and the assessment based on them cannot stand.
3. The request for indemnificatory interest
Pursuant to no. 1 of article 43 of the General Tax Law (LGT), applicable subsidiarily to the tax arbitration process, pursuant to article 29, no. 1, paragraph a) of RJAT, "Indemnificatory interest is due when it is determined, in gracious reclamation or judicial impugnation, that there was an error attributable to the services that resulted in payment of the tax debt in an amount higher than legally due.".
The cumulative requirements for the right to indemnificatory interest are thus: "– that there is an error in a tax assessment act; – that it be attributable to the services; – that the existence of such error is determined in a process of gracious reclamation or judicial impugnation; – that such error resulted in payment of a tax debt in an amount higher than legally due."[13].
On the other hand, the tax arbitration process was conceived as an alternative means to the judicial impugnation process (cf. the legislative authorisation given to the Government by article 124, no. 2 (first part) of Law no. 3-B/2010, of 28 April – State Budget Law for 2010), and it should be understood that within the competence of the arbitral tribunals functioning under the aegis of CAAD are the same powers that, in judicial impugnation proceedings, are attributed to tax tribunals, such as the power to assess the error attributable to the services.
In the present case, it is evident that, with the declaration of illegality and consequent annulment of the assessment that is the subject of the request for arbitral ruling, the right of the Claimant to indemnificatory interest on the amount unduly paid must be recognised, from the date of the respective payment, as provided for in no. 5 of article 61 of CPPT, since such illegality is exclusively attributable to the Tax Administration, which committed that tax act without the necessary legal support.
IV. DECISION
Based on the grounds of fact and law set out above and, pursuant to article 2 of RJAT, it is decided, judging the present request for arbitral ruling to be entirely well-founded:
a. To declare the illegality of the IRC assessment for the 2012 tax year and of the interest assessment associated with it, determining its annulment;
b. To condemn the AT to restitution of the amount unduly paid by the Claimant, plus indemnificatory interest, from the date of the unduly payment until the date of issuance of the respective credit notes.
c. To condemn the AT to payment of the arbitral fee.
VALUE OF THE CASE: In accordance with the provisions of article 306, nos. 1 and 2 of CPC, 97-A, no. 1, paragraph a) of CPPT and 3, no. 2 of the Regulations on Costs in Tax Arbitration Proceedings, the value of the case is set at € 26,962.43 (twenty-six thousand, nine hundred and sixty-two euros and forty-three cents).
COSTS: Calculated in accordance with article 4 of the Regulations on Costs in Tax Arbitration Proceedings and Table I attached thereto, in the amount of € 1,530.00 (one thousand five hundred and thirty euros), at the charge of the AT.
Lisbon, 18 September 2017.
The Arbitrator,
Mariana Vargas
Text prepared by computer, pursuant to no. 5 of article 131 of CPC, applicable by referral of paragraph e) of no. 1 of Decree-Law 10/2011, of 20 January.
The wording of this decision is governed by the 1990 Orthographic Agreement.
[1] Cf. the Authors cited, in "Supplementary Regime of Tax Inspection (RCPIT) – Annotated and Commented", Coimbra Editora, 1st Edition, May 2013, pages 81 et seq.
[2] Cf. TOMÁS TAVARES, "On the relationship of partial dependence between accounting and tax law in the determination of taxable income of legal entities: some reflections at the level of costs", in Science and Technical Tax, no. 396, 1999, page 137.
[3] VÍTOR FAVEIRO, "The Status of the Taxpayer: the person of the taxpayer in the social state of law", Coimbra, 2002, pages 847 and 848.
[4] ANTÓNIO M. PORTUGAL, "The deductibility of costs in Portuguese tax case law", Coimbra Editora, 2004, page 112.
[5] RUI DUARTE MORAIS, "Notes on the IRC", Almedina, Coimbra, 2009, page 86.
[6] ANTÓNIO MARTINS, "A note on the concept of source of production contained in article 23 of CIRC: its relationship with capital shares and supplementary contributions", in Journal of Public Finances and Tax Law, Year 1, no. 2, Almedina, Coimbra, 2008, page 37.
[7] Op. Cit., page 83.
[8] Op. Cit., page 87 and note 191.
[9] Cf. the Authors cited, "The Limited Applicability of Transfer Pricing Regime to Shareholder Financing to the Company", in Transfer Pricing Notebooks 2013, Coord. João Taborda da Gama, Almedina (reprint), pages 75 to 110 – page 85, note 14.
[10] Idem, pages 88 to 90.
[11] Fernando Carreira de Araújo and António Fernandes de Oliveira, Op. Cit., page 86.
[12] Fernando Carreira de Araújo and António Fernandes de Oliveira, Op. Cit., page 83.
[13] Cf. SOUSA, Jorge Lopes de, Code of Tax Procedure and Process – annotated and commented, Volume I, Áreas Editora, 2006, page 472.
Frequently Asked Questions
Automatically Created