CAAD 87/2014-T: Deductibility of Financial Charges Under Article 23 CIRC – IRC Ruling

ARBITRAL DECISION

CAAD: Tax Arbitration

Case No. 87/2014 – T

Subject: CIT – Financial Charges; Non-deductibility; Art. 23 of CIRC

The arbitrators José Poças Falcão, arbitrator president of the Collective Court, Paulo Lourenço and João Menezes Leitão, arbitrator members, designated by the Ethics Council of the Administrative Arbitration Centre for the constitution of this Arbitral Tribunal, hereby agree:

I. REPORT

1. "A", SA, legal entity no. …, with registered office at Street …, …, … floor, room …, …-…, Porto (hereinafter "Claimant" or "A"), filed on 04.02.2014, pursuant to Article 10(1)(a) of Decree-Law no. 10/2011, of 20 January, as subsequently amended (Legal Framework for Tax Arbitration, hereinafter LFTA), a request for arbitral pronouncement, in which the Tax and Customs Authority (hereinafter, "Respondent" or "AT") is requested, regarding the additional CIT assessment no. 2013 …, relating to the tax year 2009.

2. In accordance with Articles 5(3)(a), 6(2)(a) and 11(1)(a) of the LFTA, the Ethics Council of this Administrative Arbitration Centre (CAAD) designated as arbitrators of the Collective Arbitral Tribunal Mr. Judge José Poças Falcão, with the functions of Arbitrator President, and Messrs. Drs. Paulo Lourenço and João Menezes Leitão, as arbitrator members, who accepted the appointment.

3. Pursuant to Article 11(1)(c) and Article 11(8) of the LFTA, as communicated by the President of the Ethics Council of CAAD, the Arbitral Tribunal was constituted on 07.04.2014.

4. In the request for arbitral pronouncement (hereinafter initial petition or IP), the Claimant formulated the following claims:

"i) That the assessment act be annulled due to violation of law, by not allowing fiscal deductibility of financial charges in crisis, or, alternatively,

ii) That the assessment act be annulled by disregarding the entirety of the tax losses determined in the tax year 2008 and properly carried forward to the tax year 2009 and

iii) In any case, that the Claimant be reimbursed the amount of €359,190.00 unduly paid, plus corresponding compensatory interest and default interest until full reimbursement".

1. The AT submitted a response, in which it petitioned that the request for arbitral pronouncement be judged unfounded as unproven and, consequently, the AT be absolved of all claims formulated, as well as, with regard to the alternative claim, the exceptions invoked of impropriety of the procedural means and material incompetence of the Tribunal be judged well-founded, accordingly absolving the Respondent from the instance.

2. By order of 30.05.2014, the meeting of the Tribunal with the parties was waived (Article 18 of the LFTA), without opposition from them, given that: "a) it is, in this case, a proceeding not subject to the definition of specific procedural steps, different from those commonly followed by CAAD in the generality of arbitral proceedings; b) there are no exceptions to be examined and decided before ruling on the claim nor apparent necessity for correction of procedural documents and c) the evidence presented is of a documentary basis and is already incorporated in the case". The parties subsequently submitted successive written submissions. By order of 05.09.2014, the Tribunal designated 07.10.2014 for the pronouncement and notification of the award, having subsequently extended, pursuant to Article 21(2) of the LFTA, the deadline and date provided for in Articles 18-2 and 21-1 of the LFTA.

II. GROUNDS

1. Object of the proceeding and issues to be decided

2. Given the request for arbitral pronouncement filed, the present proceeding has as its object the intended declaration of illegality and the consequent annulment of the CIT assessment no. 2013 …, insofar as it resulted from corrections to the taxable matter of the Claimant in the tax year 2009 which were based on the disregard of the fiscal deduction of interest relating to financing incurred by the company "B", SA, incorporated by merger into the Claimant, for the acquisition of equity interests in the company "C", SGPS, SA, a company that was holder, until the year 2009, of an equity interest, initially of 85% and subsequently of 100%, in the capital of the Claimant.

In these terms and more specifically, the essential issue to be resolved, in light of the fiscal regulation subject of the Corporate Income Tax Code (CIRC) applicable ratione temporis[1], is the following:

• the financial charges in the amount of €1,615,252.30 fiscally deducted by the Claimant in the year 2009 relating to financing incurred for the acquisition of the aforementioned equity interests, should be considered as comprovedly indispensable according to Article 23 of the CIRC?

1. Furthermore, the Claimant intends, as a subsidiary claim, that the impugned tax act be annulled by disregarding the entirety of the tax losses determined in the tax year 2008 carried forward to the tax year 2009.

Given that a subsidiary claim is presented to the tribunal to be taken into consideration only in the event that a prior claim does not succeed (Article 554 of CPC 2013), its examination can only take place following the ruling on the principal claim, if it has not been prejudiced by the decision thereof.

1. The arbitral tribunal was regularly constituted, is competent to examine the issues raised in the principal claim, the parties enjoy legal capacity and personality and are legitimate (Articles 4 and 10(2) of the same statute and Article 1 of Ordinance no. 112-A/2011, of 22 March). The proceeding does not suffer from nullities.

2. Essential facts

3. On the factual basis, having examined the uncontested documentary evidence produced, and the administrative tax proceeding attached relating to the gracious complaint filed (hereinafter AP), the following facts are considered proven with relevance for the decision:

I. The Claimant is a commercial joint-stock company whose activity is the provision of services in the field of clinical pathology (clinical analyses), being registered for the exercise of the activity of "A" (…) and classified, for purposes of CIT, in the tax year 2009 in question, under the general system for determining taxable profit (see Tax Inspection Report, hereinafter abbreviated TIR, attached as doc. no. 3 to the IP and set out at pp. 35 et seq. of the AP, respective p. 6).

II. The Claimant was subject to tax inspection regarding the tax years 2009, 2010 and 2011, which was authorized by Service Order OI2012….

III. On 30.12.2005, the Dutch company "B", BV, subsidiary of the Swiss company "D", SA (belonging to the "D" business group), acquired the entirety of the capital of "C" SGPS SA (hereinafter, "C"), a company which held 85% of the capital of the Claimant, whose remaining 15% belonged to "Family E", as well as acquired 85% of the equity interests of the company "F" - Medical Management and IT Company, SA (hereinafter "F") – see TIR, p. 7 and Articles 16 and 18 of the IP.

IV. In 2007 the company "B", SA was incorporated, whose share capital was held in its entirety by the Dutch company "B" BV - see TIR, p. 7 and Article 20 of the IP.

V. Also in 2007 "B" BV sold to "B", SA, for the price of 87,000,000.00 Swiss francs (at the date €52,409,640.00), the financial interests held in the following companies (see TIR, p. 7 and Article 22 of the IP):

• 100% of "C" (holder of 85% of the share capital of both the Claimant and "F");

• 100% of "G" SA;

• 100% of company "H" SA;

• 100% of "I" Ltd.;

• 100% of company "J" SA;

• 100% of company "K" SA;

• 85% of "L" SA.

VI. In the contract for the acquisition of the equity interests it was provided that the amount to be paid by the purchasing entity ("B", SA) was the subject of a loan by the selling entity "B" BV (see TIR, p. 7 and Article 23 of the IP).

VII. In July 2008, as part of financing obtained from the Royal Bank of Scotland, "B" SA obtained the amount necessary for the settlement of almost all of the amount owed to "B" BV for the acquisition of the financial interests (CHF 24,943.05 remained owed, at the date €15,294.04), as well as an additional loan in the amount of €5,600,000.00 (see TIR, p. 8).

VIII. This amount of €5,600,000.00 was channeled by "B", SA, as ancillary contributions, to the subsidiary "C", which used it for the acquisition, for the same amount, of the equity interests representing 15% of the capital of the Claimant and "F" which were still held by the former shareholders, the family "E" (see TIR, p. 8 and Articles 25 and 26 of the IP).

IX. As a result, from that date, "C" became the holder of the entirety of the capital of the Claimant and "F" (see TIR, p. 8 and Article 26 of the IP).

X. In September 2008, a refinancing was carried out with a banking consortium led by Nordea Bank, which included the amounts that "B", SA benefited from as referred to above in VII (see TIR, p. 8 and Article 27 of the IP).

XI. At the end of 2008, the "D" group decided to proceed with the reorganization of the structure of its holdings in Portugal, with the objective of concentrating in the Claimant (a company which, within the group in Portugal, assumed the most consolidated financial position and which held the brand with greater visibility and recognition) the various equity interests, as well as external debt (see TIR, p. 8 and Articles 28 and 29 of the IP).

XII. The aforementioned reorganization process proceeded as follows (see TIR, p. 8 and Articles 31-33 of the IP, as well as merger project attached as doc. no. 6 to the IP):

i) First, alienation, by contract signed on 5 December 2008, by "C" (held 100% by "B" SA) to "B" BV of the equity interest held in the Claimant (100% of the capital), for the amount of €29,862,000.00;

ii) Second, acquisition of "B" SA by the Claimant itself, through the contribution in kind of the entirety of the capital of "B" SA for purposes of an increase in the capital of the Claimant, in the amount of €200,000.00, by its sole shareholder "B" BV;

iii) Third, acquisition by the Claimant of other equity interests held by the "D" Group in Portugal, but which were outside the sphere of "B" SA;

iv) Finally, incorporation by merger of "B" SA into the Claimant, which was completed on 29 December 2008, with effects as of 1 January 2008.

XIII. With the merger, at the end of the year 2008, between the Claimant and "B" SA, with effects as of 1 January 2008, through the incorporation of the latter into the former and the corresponding global transfer of assets, the Claimant became the holder of the entirety of the equity interests then held by "B" SA (excluding the indirect interest relating to 100% of the share capital of the Claimant, as referred to in XII, i)), and integrated the entirety of the liabilities arising from the financing used for the acquisition of the equity interests by "B" SA, with its results being affected by the charges relating to debt service (see TIR, pp. 8-9 and Article 34 of the IP).

XIV. The financing and respective charges are related to the following (see TIR, p. 9):

i) The acquisition, on 20 December 2007, by "B" SA from "B" BV, holder of the entirety of its capital, of the financial interests which are thereafter detailed, for the total amount of €52,409,640.00, which, given the accounting treatment adopted and the information provided regarding the criteria followed by the Claimant, is apportioned as follows (taking into account a correction arising from the Claimant not having taken into account that "C", at that date, did not possess the entirety, but only 85% of the capital of the Claimant and "F"):

ii) The acquisition, on 21 July 2008, by "C", subsidiary of "B" SA, of the equity interest of 15% of the capital of the Claimant and "F" which were still held by the former shareholders (Family "E"), for the amounts of €5,546,000.00 and €54,000.00, respectively, totaling the amount of €5,600,000.00.

XV. As a result of the merger that occurred in 2008 between the Claimant and "B", SA, the expenses accounted for by the Claimant with the interest relating to the aforementioned loans amounted, in the tax year 2009, to €2,842,202.56 (see TIR, pp. 9-10).

XVI. On 27.11.2012, the Claimant was notified to itemize the expenses accounted for, in the tax years 2009 and 2010, with the loans contracted for the acquisition of the equity interests, relating, namely, to interest, in the total amounts of €2,842,202.56 and €2,222,033.05 respectively, the notification indicating that the itemization of costs should be carried out by equity interest, namely, those relating to the acquisition of the entirety of the capital of the Claimant and those relating to the acquisition of the remaining equity interests, and contain reasoned indication of the criteria used (see TIR, p. 16).

XVII. In response to what was requested, the Claimant sent an e-mail, on 20 December 2012, in which it sent the itemization of expenses by equity interest, and in which the following was indicated for 2009:

In the aforementioned e-mail, the taxpayer also stated that:

"(...) the criteria used were:

· Allocation of the interest of the loan made in July 2008 to the interest in "C"-SGPS;

· Allocation of the remaining charges referred to in proportion to the acquisition cost of each of the interests;

· The acquisition cost considered for the aforementioned allocation was not the accounting one since as a result of the conversations held in the ongoing inspection proceedings we identified a lapse in the allocation initially made" (see TIR, p. 16).

XVIII. In the Tax Inspection Report concerning the aforementioned tax years 2009, 2010 and 2011, notified to the Claimant by Office no. …/…, dated 12.09.2013, attached as doc. no. 3 to the IP and set out at pp. 35 et seq. of the AP, the following was considered, with relevance for the present case regarding the tax year 2009:

• "REASON [for the inspection action]":

"Need to control financial charges of a high amount and with very significant weight relative to the income recorded, which would have their origin in loans contracted for the acquisition of equity interests in a related entity" [p. 6];

• "FISCAL TREATMENT OF FINANCIAL CHARGES RELATING TO THE ACQUISITION OF EQUITY INTERESTS"

• "From the facts reported (...) it is concluded that:

• "A" SA contracted a loan to buy "C" and the remaining equity interests (...).

• With regard to "C", this company, as a company managing equity interests, was valued by the interests it held in "A" and in "F". The same was considered by "A" SA, since it accounted for the value of "C" as the sum of the values attributed to its interests in the capital of those companies.

• The purpose of the purchase of "C" for "A" SA was the acquisition of "A", since "F" possessed a reduced intrinsic value from the investor's perspective. (...)

• "C" sold the equity interest it held in "A" to "B" BV, emptying "C" of content and placing "A" under the control of the company that held "B" SA, which came to create the conditions for the option of the merger of these two companies ("A" and "B" SA)" – [pp. 13-14].

• "The determination of the indispensability of the financial charges relating to the financing contracted, an essential condition for assessing their fiscal deductibility, must necessarily be based on the analysis of the purpose and destination of the financing.

This purpose cannot be understood in a narrow sense, evaluating exclusively the direct and immediate application of the financing, but should instead adopt a broader and more comprehensive perspective for determining the ultimate purpose, even if indirect and mediate, thereof.

In this sense, the analysis should relativize the direct application of the financing and the complex of operations that followed, related, essentially, to the merger operation between "A" and "B" SA, in light of the final result arising from these operations.

Thus, to assess the indispensability of the expenses, the actual and concrete allocation of the financing for which interest is borne should be determined, that is, it is important to assess the destination or use of the funds obtained in relation to which the taxpayer intends to fiscally deduct the interest it bore.

All of this justifies the need to proceed with an analysis subordinated to the demonstrative process, internationally used, of tracing approach for determination and tracking of the use and destination of the financing.

Applying the aforementioned tracing approach to the case in question, it must necessarily be concluded that the financing contracted and which, through merger, become the responsibility of "A", in substantial terms, were directed:

• To the acquisition of other equity interests;

• To the acquisition of "C" for the value corresponding to "F";

• To the acquisition of "A" itself effected through "C"" [p. 14].

• "(...) Article 23 of the CIT Code establishes the requirement of a causal nexus between the expense and the income obtained and the maintenance of the income-producing source. With regard to financial charges, this nexus will exist when the corresponding means are applied to the acquisition of assets capable of generating income, even if future income.

On the other hand, for an expense to be considered fiscally deductible it is required that it be indispensable, so it becomes necessary to assess what the concept of indispensability is. (...) indispensable expenses will correspond to those incurred in the interest of the company, above all, because they aim at profit" [pp. 14-15].

• "Leaving no doubt whatsoever that the expenses accounted for in the tax years 2009, 2010 and 2011, in the amounts of 2,842,202.56, €2,222,033.05 and €2,543,972.76, respectively, consist of charges on the loans initially contracted by "B" SA and the responsibility of the taxpayer through its merger with that company, the issue to be decided concerns exclusively the indispensability of "A" bearing the part of these expenses that relates to the acquisition of its own capital so that it fulfills the objective of obtaining income or maintaining the income-producing source.

(...) It is certain that the determination of the profit corresponding to the activity of "A" was affected, as a result of the incorporation by merger of "B" SA, namely, by the charges arising from the financing contracted by this for the purpose of effecting the acquisition of "A" itself.

The corporate purpose of "A" corresponds basically to the exercise of the laboratory activity of clinical analyses, as well as the import, export or lease of related materials and equipment.

Thus, restricting the activity of "A" to the provision of clinical analysis services, the following is not identified:

a) Any type of income that might accrue to it directly through these expenses;

b) Or any other form of benefit for the activity carried out by "A" in the form of improvement in the company's performance in the pursuit of this activity, whether through an increase in the value of the services provided, a decrease in expenses incurred or any other, as a result of the acquisition effected;

which leads to the classification of such expenses as not essential" [p. 15].

• "In the assessment of the non-essentiality of the expenses, no argument directed at demonstrating that the financial charges are fiscally acceptable should be accepted, due to the fact that, due to the merger effected, they have become an inevitability to be borne by "A".

In fact, the fiscal treatment of this matter must be found in accordance with the framework defined for the companies in question and not in light of any other circumstances that might have been created" [p. 16].

• "(…) verifying that part of the expenses accounted for with interest consist of charges on loans relating to the acquisition of its own capital (initially contracted by "B" SA and the responsibility of "A" through its merger with that company), it is understood that, in light of the analysis of the nature of the income obtained by "A" (provision of services in the field of clinical analyses) and the means enabling the development of this activity, such expenses cannot be considered fiscally for purposes of determining the result" [p. 16].

• "DETERMINATION OF THE VALUE OF FINANCIAL CHARGES RELATING TO THE ACQUISITION OF "A"":

(...) The taxpayer did not itemize the expenses relating to the acquisition of the capital of "A" (...), doing so only with regard to the equity interests held directly, which includes "C". It is therefore necessary to proceed with this itemization.

"C", as a company managing equity interests, was valued by the interests it held in "A" and in "F". The same was considered by "B" SA, by accounting for the value of "C" as the sum of the value attributed to its interests in the capital of those companies (...).

Thus, the expenses attributable to each of these interests (in "A" and in "F") will result from the division of the expenses attributable to the acquisition of "C" by each of the interests in proportion to their relative value, that is, according to the relative weight of the value of each of the two interests in the total value of "C"" [p. 17].

• "The financial charges attributable to the acquisition of 85% of the capital of "A" result from the division of the total value of the financial charges relating to the acquisition of "C" by the interests held in "A" and "F", according to the relative weight of the value of these interests in the total value of "C", as determined in Table VII.

Table VII

• "(...) The allocation of the financial charges relating to the acquisition of the remainder of the capital of "A" and "F" will be effected in accordance with the actual purchase values of the capital portions, which, recall, were €5,546,000.00 and €54,000.00, respectively.

The expense attributable to the acquisition of the remaining 15% of the capital of "A" is thus that determined in Table VIII.

Table VIII

[pp. 16 to 18].

• "CONCLUSION

"(…) The financial charges attributable to the acquisition of the capital of "A" determined from the values indicated by the taxpayer for "C", of the criteria defined by the same for the valuation of this company and of the actual purchase values of the 15% of the capital of "A" and "F", amounted, in the tax years 2009, 2010 and 2011, to €1,615,252.30, to €1,260,956.15 and to €1,444,938.68, respectively.

The expenses relating to the acquisition of "A", even if effected through "C", cannot be considered fiscally deductible, because they are manifestly not essential to the obtaining of its income or for the maintenance of the income-producing source.

Thus, the amounts of €1,615,252.30, €1,260,956.15 and €1,444,938.68, relating to the financial charges attributable to the acquisition of the capital of "A", will not be accepted fiscally according to Article 23 of the CIT Code, and should therefore be added for the purpose of determining the Taxable Profit of the tax years 2009, 2010 and 2011, respectively(…)" [p. 19].

XIX. As a result of this Tax Inspection Report, merely arithmetic corrections to the taxable matter in the tax year 2009 were made in the amount of €1,615,252.30, according to the note fixing the taxable matter for the tax year 2009 also contained in the Office indicated above (see doc. no. 3 attached to the IP and p. 36 of the AP).

XX. The Claimant was notified on 22 September 2013 of the additional CIT assessment no. 2013 … relating to the tax year 2009, which sets forth the amount to be paid of €407,426.48, as well as the statement of account adjustment with amount to be paid of €406,406.97, in accordance with doc. no. 1 attached to the IP which is hereby reproduced.

XXI. The Claimant filed a gracious complaint against the aforementioned CIT assessment, in accordance with doc. no. 4 attached to the IP and the attached administrative proceeding, which was not subject to decision by the AT.

XXII. The Claimant, pursuant to the Exceptional Framework for Regularization of Tax and Social Security Debts, approved by Decree-Law no. 151-A/2013, of 31 October, proceeded to payment of the amount of €359,190.00, with extinction of compensatory and default interest, in accordance with doc. no. 5 attached to the IP.

1. There is no relevant factuality for the decision of the case given as unproven.

2. Grounds for the factual matter

3. The Tribunal's conviction regarding the facts given as proven resulted from the uncontested documents attached to the IP, from the recognition of facts assumed in the same IP, and from the reports and documents included in the administrative instruction proceeding attached to these proceedings, all as specified in the points of the factual matter outlined above.

4. The Law

a) Principal claim

1. The AT decided, as a result of tax inspection carried out on the Claimant, that the financial charges attributable to the acquisition of the capital of "A", determined from the values indicated by the taxpayer for "C", of the criteria defined by the same for the valuation of this company and of the actual purchase values of 15% of the capital of "A" and "F" which amounted, in the tax years 2009, 2010 and 2011, to €1,615,252.30, to €1,260,956.15 and to €1,444,938.68, respectively, are not fiscally deductible because they "manifestly" are not essential to the obtaining of its income or for the maintenance of the income-producing source, according to Article 23 of the CIT Code.

As such, insofar as it matters for the object of the present proceedings, which relates to the tax year 2009, the amount of €1,615,252.30, relating to the financial charges attributable to the acquisition of the capital of "A", was added for the purpose of determining the Taxable Profit of the tax year 2009 (see TIR, p. 19), giving rise to the official assessment of CIT no. 2013 … relating to the tax year 2009.

It should be noted, given what the Claimant invokes in nos. 2 and 3 of its written submissions and in Articles 47 and 48 of its IP, that the justifying discourse of this correction to the taxable matter, which is the basis of the official assessment impugned, is based on the following three essential reasons (as observed in the passages of the TIR cited above in no. XVIII of the factual section):

1. first, that "to assess the indispensability of the expenses, the actual and concrete allocation of the financing for which interest is borne should be determined, that is, it is important to assess the destination or use of the funds obtained in relation to which the taxpayer intends to fiscally deduct the interest it bore", operating the "demonstrative process, internationally used, of tracing approach for determination and tracking of the use and destination of the financing" [p. 14 of the TIR], such that "Article 23 of the CIT Code establishes the requirement of a causal nexus between the expense and the income obtained and the maintenance of the income-producing source" and "With regard to financial charges, this nexus will exist when the corresponding means are applied to the acquisition of assets capable of generating income, even if future income" [pp. 14-15 of the TIR];

2. then, that "Applying the aforementioned tracing approach to the case in question, it must necessarily be concluded that the financing contracted and which, through merger, become the responsibility of "A", in substantial terms, were directed: - To the acquisition of other equity interests; - To the acquisition of "C" for the value corresponding to "F"; - To the acquisition of "A" itself effected through "C"" [p. 14 of the TIR];

3. finally, that "the issue to be decided concerns exclusively the indispensability of "A" bearing the part of these expenses that relates to the acquisition of its own capital so that it fulfills the objective of obtaining income or maintaining the income-producing source", concluding the AT that "restricting the activity of "A" to the provision of clinical analysis services, the following is not identified: a) Any type of income that might accrue to it directly through these expenses; b) Or any other form of benefit for the activity carried out by "A" in the form of improvement in the company's performance in the pursuit of this activity, whether through an increase in the value of the services provided, a decrease in expenses incurred or any other, as a result of the acquisition effected; which leads to the classification of such expenses as not essential" [p. 15 of the TIR].

It is thus necessary, given this justification, to examine the legality of the administrative judgment of non-deductibility of the interest relating to the financing in question and of the consequent correction to the taxable matter, which constitutes the crucial issue that is the object of the present proceedings (see above no. 7).

1. First, regarding the applicable legal framework, it should be noted that the interest borne by CIT taxpayers as remuneration of loans contracted and other financial charges associated are deductible as costs in the determination of taxable profit in accordance with Article 23(1)(c) of the CIRC, according to which, in the wording in force in 2009, "costs or losses are considered those that are comprovedly indispensable for the realization of the income or gains subject to tax or for the maintenance of the income-producing source", namely "financial charges, such as interest on borrowed capital applied in the operation".

Thus, according to this legal provision, the fiscal deductibility of the interest borne, like any other expense, depends on a judgment regarding its indispensability for the realization of the income or gains subject to tax or for the maintenance of the income-producing source (body of no. 1), with Article (c) of no. 1 of this provision even explaining that this interest on borrowed capital is "applied in the operation".

This requirement of the indispensability of costs/expenses for the realization of income/gains subject to tax or for the maintenance of the income-producing source, established by Article 23 of the CIRC, has been properly addressed by case law in order to resolve the specific cases it must face, so the solution to be given to the case sub judice is directly grounded in the application of the jurisprudential guidelines developed in this field, as, moreover, is required by the elementary principle contained in Article 8(3) of the Civil Code.

It should be noted, then, that, in a synthesis often reiterated, the Supreme Administrative Court declared regarding the meaning and functioning of the requirement of indispensability of costs for fiscal purposes that: "the requirement of indispensability of a cost must be interpreted as an indeterminate concept requiring case-by-case completion, as a result of an analysis from an economic business perspective, in the perception of an economic causal relationship between the assumption of a cost and its realization in the interest of the company, given the corporate purpose of the commercial entity in question" (see, for example, the judgments of the SAC of 15.6.2011, case no. 049/11, no. III and of 29.3.2006, case no. 01236/05, no. 3.4; see also recently the judgment of the ACT South of 16.10.2014).

Well, in light of the object of these proceedings, it is important to emphasize the necessity, for the judgment of indispensability of costs, that the "perception of an economic causal relationship between the assumption of a cost and its realization in the interest of the company" must be concretized in relation to the "commercial entity in question". Indeed, in the economic causal relationship of the cost with the interest of the company, the business interest that is assessed is that of the company itself that fiscally deducts the cost. Thus, the Supreme Administrative Court declared in its judgment of 10.7.2002, case no. 0246/02, that "the costs provided for in that Article 23 must relate to the taxpayer company itself", so that "for a certain item to be considered a cost of that company it is necessary that the respective activity be developed by it itself, not by other companies even if in a relationship of control", reiterating in its subsequent judgments of 7.2.2007, case no. 01046/05, no. III, of 20.5.2009, case 01077/08, of 30.11.2011, case no. 0107/11 and of 30.05.2012, case no. 0171/11, that: "the costs must relate from the outset to the taxpayer company itself, that is, for a certain item to be considered a cost of that company it is necessary that the respective activity be developed by it itself, not by other companies", because, "[o]therwise, how could the exercise of the activity of another company with which it had some relationship be attributed to a company". On another aspect, it is equally explicit from case law that it is an exigible prerequisite of the application of Article 23 of the CIRC "the individual consideration of each company or institution so that reasoning in which appeal is made to criteria of management of the "group" or even of financing – even if free of charge – of its shareholders or even their will in this matter is irrelevant, since it is a legal criterion, with only the legal person whose costs are under examination being relevant" (see the judgments of the Central Administrative Court South of 16.10.2007, case no. 01276/06 and of 18.12.2008, case no. 02515/08).

In this way, it is strictly in relation to the entity whose costs are under consideration for purposes of determining its respective taxable profit that it is important to examine, taking into account the business activity it develops, the fiscal deductibility of the financial charges.

1. It follows from what has just been stated that the fact that the financing with its charges and corresponding liabilities were the subject of transmission in the context of merger by incorporation (see the fact set out in no. XIII) does not imply that its fiscal treatment in the incorporating company must necessarily be, without more, the exact mirror of what occurred in the incorporated company.

It should be noted from the outset that to reach any conclusion about the deductibility of the financial charges in the incorporating company no element is obtained from the conception adopted, in general terms, regarding the legal nature of the merger, whether it is considered to be a phenomenon of universal succession of the incorporated company to the incorporating company or whether it is considered to be the modification of the companies involved through transformation. This is because the merger constitutes a reality that Tax Law treats with its own autonomy in relation to Common Law, through specific solutions, given the fact that such operation constitutes an act of realization analogous to any exchange of assets, and may even, possibly, involve payments in cash (see, at the date of the facts, the references in Articles (a) and (b) of no. 1 of Article 67 of the CIRC to the attribution of "cash sums"). Moreover, otherwise the establishment in tax law, beyond the general regulation (Article 43(1) and (3)(d) of the CIRC), of a "special regime applicable to mergers, splits, contributions of assets and exchanges of shares" (Articles 67 et seq. of the CIRC) would not be understood.

But also no conclusion is drawn from the regime of tax neutrality itself (to which the merger in question in the present case was subject – see nos. XII, iv) and XIII of the factual section and the merger project attached as doc. no. 6 to the IP) since this regime did not contemplate, at any point, the transmissibility to the incorporating company of the fiscal treatment afforded to costs in the incorporated company, focusing instead on the prescription, on the one hand, that, in the determination of the taxable profit of the merged company, no result derived from the transfer of the assets in consequence of the merger is considered, there being therefore no place for the determination of gains or losses realized by reason of the merger, nor for the consideration as income or gains, according to no. 2 of Article 34, of the provisions constituted in the merged company relating to debts, inventories and obligations or charges subject to transfer (no. 1 of Article 68 of the CIRC); on the other hand, that, in the determination of the taxable profit of the beneficiary company, the determination of results relating to the transferred assets is made as if the merger had not taken place, the write-offs or depreciation on the transferred fixed assets are made in accordance with the regime that was being followed in the merged company, and the provisions that were transferred have, for fiscal purposes, the regime that was applicable to them in the merged company (no. 4 of Article 68 of the CIRC); providing furthermore, in certain terms, for the possibility of deduction of the tax losses of the merged company in the taxable profits of the new company or of the incorporating company (Article 69 of the CIRC). The Respondent is therefore correct when it notes in Articles 132 and 133 of its response that: "The regime of tax neutrality in the context of mergers does not cover the issue of costs/expenses that are indispensable for the realization of income, according to the provisions of Article 23 of the CIRC", not containing "any rule that, by virtue of any merger, eliminates the need to assess the character of indispensability of costs in the sphere of the beneficiary company".

In the same way, there is not in the current Directive 2009/133/CE of the Council of 19 October 2009 on the common system of taxation applicable to mergers, splits, partial splits, contributions of assets and exchanges of shares between companies of different Member States and to the transfer of the registered office of an SE or SCE from one Member State and in the previous Directive 90/434/CEE of the Council, of 23 July 1990, on the common system of taxation applicable to mergers, splits, contributions of assets and exchanges of shares, any rule regarding the deductibility of financial charges in the incorporating company whose interpretation could be useful for the resolution of the case sub judice (see Articles 4, 5 and 6 of Directive 2009/133/CE).

In summary, the fiscal deduction of the financial charges incurred in the year 2009 must be assessed in the context of the business activity proper to the Claimant, in light of the normative criteria resulting from no. 1 of Article 23 of the CIRC, which is, in fact, the decisive legal framework in light of which the matter of these proceedings must be resolved.

Hence, in compliance with no. 1 of Article 23 of the CIRC, it is entirely appropriate to verify, as the AT did in the tax inspection of the 2009 tax year which it carried out and which is here under examination, whether the prerequisites for fiscal deductibility of the costs with interest were satisfied in light of the activity of the Claimant and the taxation period in question (see Article 18 of the CIRC), regardless of what occurred in the incorporated company.

In fact, as the Constitutional Court understood recently in its judgment no. 42/2014, no. 16: "the interest that remunerate borrowed capital, particularly from credit operations, integrate the concept of financial charges, according to the exemplification contained in Article 23(1)(c) of the CIRC"; "But, in the same way, such charges do not depart from the general principles that govern the allocation of deductible costs, particularly the principle of exercise specialization (Article 18 of the CIRC) and the principle of homogeneity between deductible costs and the income or income subject to tax to which they are linked, so that a treatment is not attributed to the cause (cost) and another to the effect (income or income), particularly in the context of the temporal scope of application of the relevant regime".

It is thus concluded that the fact that certain financial charges were previously fiscally deductible within the scope of determining the taxable matter of a certain company does not mean, in itself, that they necessarily are in the same terms within the scope of the company that, by merger, incorporated that company.

In fact, so much so is this the case that the Claimant itself acknowledges that the maintenance of the deductibility of the interest of a certain financing initially contracted depends on the prerequisite that "the financing remains allocated to the same purpose" (see Articles 43 and 100 of the IP).

Now, precisely, it is this basic question about the allocation of the financing that gave rise to the correction to the taxable matter determined by the AT (see above no. 13): by observing that "the financing contracted and which, through merger, become the responsibility of "A" were directed" "to the acquisition of "A" itself, effected through "C"", but that the interests in "A" itself do not naturally form part of its assets, the AT considered that there fails the indispensability of ""A" bearing the part of these expenses that relates to the acquisition of its own capital so that it fulfills the objective of obtaining income or maintaining the income-producing source", since "restricting the activity of "A" to the provision of clinical analysis services, the following is not identified: a) Any type of income that might accrue to it directly through these expenses; b) Or any other form of benefit for the activity carried out by "A"".

For this reason, the matter that actually matters to decide for the resolution of the case sub judice concerns the verification in the year 2009, in light of the situation of the Claimant, of the economic causal nexus between the assumption of the financial costs in question and its realization in the interest of the company.

1. In light of this guideline, to proceed with the application to the case in question of the requirement of indispensability of costs, it is decisive to ascertain, on the basis of all relevant facts and circumstances, the actual and concrete allocation of the financing of which the interest borne is the remuneration or, in other words, it is important to verify the destination or use of the funds obtained in relation to which the taxpayer intends to fiscally deduct, for purposes of determining its taxable profit, the interest and other associated charges that it bore.

There is support, in this regard and in essence, for the understanding of the AT, set out in the TIR (see above no. XVIII of the factual section) that: "The determination of the indispensability of the financial charges relating to the financing contracted, an essential condition for assessing their fiscal deductibility, must necessarily be based on the analysis of the purpose and destination of the financing", such that: "This purpose cannot be understood in a narrow sense, evaluating exclusively the direct and immediate application of the financing, but should instead adopt a broader and more comprehensive perspective for determining the ultimate purpose, even if indirect and mediate, thereof", through "an analysis subordinated to the demonstrative process, internationally used, of tracing approach for determination and tracking of the use and destination of the financing.

Well, as appears from the facts proven above, the entirety of the financing assumed by "B", SA (see nos. VII and X of the factual section) for the acquisition of the interests in "C", holder of 85% of the share capital of the Claimant (see nos. V, VII and XIV, i) of the factual section), and later for the performance of ancillary contributions for the acquisition by "C" of the interests representing 15% of the capital of the Claimant (see nos. VIII and XIV, i) of the factual section), were transferred, by force of the merger, in their entirety, to the Claimant, which thus integrated "the entirety of the liabilities arising from the financing used for the acquisition of the equity interests by "B" SA, with its results being affected by the charges relating to debt service" (see no. XIII of the factual section), but the entirety of the equity interests held, directly and indirectly, by "B", SA was not subject to the same transfer, inasmuch as the interest relating to 100% of the share capital of the Claimant from the ownership of "C" was excluded (see nos. XII, i) and XIII of the factual section).

It follows therefore from here that the financing, transferred through the merger, to the Claimant, which had been incurred by "B", SA for the acquisition of the equity interests in "C", then holder of 85% of the share capital of the Claimant, and also for the subsequent acquisition by "C" of the equity interests corresponding to the entirety of the share capital of the Claimant (see fact proven under XIV), equity interests in the capital of the Claimant which formed part of the assets of "C", no longer continue to be allocated in the sphere of the Claimant exactly in the same terms to the same direct and indirect equity interests, to whose acquisition such financing was directed when it was contracted (see again the fact proven under XIV).

As such, the Claimant bore in the year 2009 financial charges relating to the entirety of the financing in question (see no. XV of the factual section), but the equity interests relating to the capital of the Claimant itself, to which this financing was also directed (see no. XIV of the factual section), do not belong naturally to the Claimant, but are instead held by "B" BV, which does not bear the corresponding costs of this financing (see nos. XII, i), XIII and XV of the factual section).

1. This means that the financial charges borne in the tax year 2009 attributable to the acquisition of the capital of "A" do not find economic causal nexus with the interest and activity of the Claimant itself, not having potential for generation of profits in the legal sphere thereof.

These equity interests, in fact, can only generate taxable income (dividends in light of the distribution of profits by the company in which an interest is held, gains in light of the alienation of the interests) in the legal sphere of the company holding the interests ("B" BV), not in the legal sphere of the debtor of the financial charges (the here Claimant). As such, the financial charges in question do not have as their destination the financing of the business activity of the Claimant itself, namely the investment in equity interests held by it, but instead concern equity interests held by others.

Now, as noted above (no. 14), the fiscal deductibility of costs, by force of the principle of indispensability provided for by Article 23 of the CIRC, presupposes an economic causal nexus between the costs in question and its realization in the interest of the company.

It is therefore necessary, for fiscal purposes, that the expenses incurred with financial charges possess a causal connection with the business activity developed, especially if they serve the development of the activity of the company that owes them, in order to obtain profits. Consequently, as observed by MARIA DOS PRAZERES LOUSA, ["The problem of interest deductibility for purposes of determining taxable profit," in Studies in honor of Dr. Maria de Lourdes Correia e Vale, Lisbon, 1995, p. 349], cannot be accepted as deductible the interest borne by a company with respect to loans in which it is manifestly proven that the funds obtained are "diverted from the operation and applied to purposes foreign to it".

In this sequence, also convoke what is stated in the judgment of the Central Administrative Court North of 14.3.2013, case no. 01393/06.1BEBRG: "only those costs that are comprovedly indispensable for the realization of the income or gains or for the maintenance of the income-producing source should be considered costs of the exercise of the company itself and not of a third party. That is, the costs must be reported to the activity developed by the company in question and not by another company".

Therefore, it is correct the understanding of the AT, expressed in the TIR (see above no. 13), that: "restricting the activity of "A" to the provision of clinical analysis services, the following is not identified: - Any type of income that might accrue to it directly through these expenses; - Or any other form of benefit for the activity carried out by "A" in the form of improvement in the company's performance in the pursuit of this activity, whether through an increase in the value of the services provided, a decrease in expenses incurred or any other, as a result of the acquisition effected".

It should be made clear that this conclusion is not based on any disregard of the legal autonomy of the different companies of the "D" Group, contrary to what the Claimant alleges in its IP, namely in Articles 54 et seq. What is at issue is, as stated above in no. 16, the determination, through the application of a tracing approach method, of the substantial use and destination of the financing in relation to which financial charges are borne.

In this regard, given that the Claimant did not itemize the expenses with interest of the financing relating to the acquisition of the capital of "A", doing so only with respect to the equity interests held directly, which includes "C" (see the facts object of nos. XVI and XVII of the factual section), the analysis of the AT, set out in the TIR (see no. XVIII of the factual section), is supported, according to which:

"(…)"C", as a company managing equity interests, was valued by the interests it held in "A" and in "F". The same was considered by "B" SA, by accounting for the value of "C" as the sum of the value attributed to its interests in the capital of those companies (...).

Thus, the expenses attributable to each of these interests (in "A" and in "F") will result from the division of the expenses attributable to the acquisition of "C" by each of the interests in proportion to their relative value, that is, according to the relative weight of the value of each of the two interests in the total value of "C".

The financial charges attributable to the acquisition of 85% of the capital of "A" result from the division of the total value of the financial charges relating to the acquisition of "C", by the interests held in "A" and "F", according to the relative weight of the value of these interests in the total value of "C" (...).".

"(...) The allocation of the financial charges relating to the acquisition of the remainder of the capital of "A" and "F" will be effected in accordance with the actual purchase values of the capital portions, which, were €5,546,000.00 and €54,000.00, respectively".

"The financial charges attributable to the acquisition of the capital of "A" determined from the values indicated by the taxpayer for "C", of the criteria defined by the same for the valuation of this company and of the actual purchase values of the 15% of the capital of "A" and "F", amounted, in the tax years 2009, 2010 and 2011, to €1,615,252.30, to €1,260,956.15 and to €1,444,938.68, respectively".

In effect, in light of the "tracing approach" methodology [on this method and its application see ARNOLD, General Report, in Cahiers de Droit Fiscal International, vol. 79A (1994), Deductibility of interest and other financing charges in computing income, pp. 498 to 500], it appears clearly from the factual matter given as proven that the financial charges indicated have as purpose, destination and use the acquisition of the equity interests in the Claimant itself by the company "C", SGPS, whereby, in that part, the allocation of the loan is not connected with the activity or with assets held by the company that is the debtor of these charges, the here Claimant, but rather concerns assets that came to be held by "B" BV, as the sole shareholder of the Claimant.

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

Hence it must be concluded that, in the situation of the present case, there is no place for "the positive judgment of subsumption in the corporate activity" by which "indispensable costs will be equivalent to costs incurred in the interest of the company" (to cite the judgment of the SAC of 30.11.2011, case no. 0107/11).

In this way, regardless of the assumption of the loan in question by the Claimant having resulted from a merger operation, it is necessary to declare that the costs accounted for by the Claimant in the tax year in question with the financial charges relating to such loan, insofar as they refer to the aforementioned equity interests in the Claimant itself, do not satisfy the requirement of indispensability of costs/expenses imposed for fiscal purposes by Article 23 of the CIRC, given the lack of the necessary allocation of costs to the business interest and to the productive activity proper to the Claimant (see the decided in the Arbitral Award – CAAD – Case 14/2011-T, in https://caad.org.pt/tributario/decisoes, which is accepted here).

1. In these terms, the financial charges borne in the year 2009 by the Claimant, in the amount of €1,615,252.30, attributable to the acquisition of the capital of "A", cannot be considered fiscally deductible, because they are not necessary to the obtaining of its income or to the maintenance of the income-producing source, given that they do not possess economic causal nexus with the activity of the Claimant or with assets capable of generating income for the Claimant.

Consequently, in light of Article 23 of the CIRC, the defect of violation of law attributed to the CIT assessment of 2009 of the Claimant does not occur with regard to the correction to the taxable profit relating to the financial charges in the amount of €1,615,252.30 fiscally disregarded by the AT.

For which reason the principal claim must fail.

b) Subsidiary claim

1. As a subsidiary claim, the Claimant petitions the annulment of the aforementioned assessment "for not considering the tax losses declared by the Claimant, in the tax year 2008, and duly carried forward to the tax year 2009".

More specifically, the Claimant invokes, in Articles 151 and 152 of its IP – and to that the justification of this claim is limited – that "as a subsidiary claim, according to Articles 101 and 124(2)(b) of the CPPT, applicable ex vi Article 29(1)(a) of the LFTA, that, following the success of the aforementioned request for arbitral pronouncement, relating to the tax year 2008, in the context of Arbitral Case no. 101/2013-T, the entirety of the tax losses determined in the tax year 2008, as declared and carried forward by the Claimant for the following tax years (in the amount of €3,205,014.99) should be considered", whereby "the present assessment, relating to the tax year of CIT of 2009, is also, for this reason, tainted with invalidity, by considering only one tax loss (officially fixed), relating to the tax year 2008, in the amount of €287,949.91".

In this regard, the Respondent maintains (Articles 147 et seq. of the response) that what the Claimant actually seeks is the execution of the arbitral decision handed down in the context of case no. 101/2013, whereby, beyond the impropriety of the means, the arbitral tribunal lacks competence to examine such a claim, as such competence does not result either from Ordinance no. 112-A/2011 of 22 March or from Article 2 of the LFTA.

It is necessary to examine this.

1. Although the Claimant frames the matter in question as a defect of the assessment impugned relating to the year 2009, it is manifest that the decision on the claim thus formulated implies that this Tribunal pronounce itself, even if following the decision handed down in arbitral case no. 101/2013-T, on the tax losses incurred in the year 2008 and on the consequent right to its carryforward for the year 2009.

Thus, what is at issue in this examination is the verification of the official execution of the judgment resulting from that case, in accordance with the provisions of Articles 24(1)(b) and (c) of the LFTA, which determines that the arbitral decision on the merits of the claim of which no recourse or challenge may be available binds the tax administration from the end of the period provided for recourse or challenge, this body having to, in the exact terms of the success of the arbitral decision in favor of the taxpayer and until the end of the period provided for spontaneous execution of the sentences of the judicial tax tribunals, "restore the situation that would exist if the tax act subject of the arbitral decision had not been made, adopting the acts and operations necessary for that effect" and "review the tax acts that are in a relationship of prejudiciality or dependence with the tax acts subject of the arbitral decision, namely because they fall within the scope of the same legal relationship of tax, even if corresponding to distinct periodic obligations, altering or replacing them, wholly or partially".

As such, this examination of execution of the judgment relating to the assessment for the year 2008, in addition to not directly bearing on the assessment of 2009 that is the object of this proceeding, but depending on the declaration of the right to deduction of the tax losses incurred in 2008 possibly resulting from the official execution of the judgment relating to the assessment of that year, does not directly concern the examination of the legality of acts of tax assessment, self-assessment, withholding at the source, payment by account or fixation of taxable matter, which constitute, insofar as it matters here, the claims whose competence falls to the arbitral tribunals according to Article 2(1) of the LFTA.

Consequently, the material incompetence of this Arbitral Tribunal to examine the deduction of the tax losses declared by the Claimant in the tax year 2008 for the tax year 2009 is declared, with the Respondent being absolved from the instance relating to the subsidiary claim.

III. DECISION

In accordance with the foregoing, the arbitrators of this Tribunal hereby agree to:

a) judge the principal claim to be wholly unfounded and absolve the Respondent, the Tax and Customs Authority, thereof;

b) judge the Arbitral Tribunal to be materially incompetent to examine the subsidiary claim, with the Tax and Customs Authority being absolved from the instance.

Value of the case

In accordance with Article 315(2) of the CPC and Article 97-A(1)(a) of the CPPT and Article 3(2) of the Regulation of Costs in Tax Arbitration Proceedings, the value of the case is fixed at €360,209.51.

Costs

Pursuant to Article 22(4) of the LFTA, the amount of costs is fixed at €6,120.00, according to Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, charged to the Claimant, "A", SA.

Notification ordered.

Lisbon, 9-12-2014

The Arbitrators

José Poças Falcão

(President)

João Menezes Leitão

(Member)

Paulo Lourenço

(Member)

Text produced by computer, according to Article 131(5) of the CPC, applicable by reference to Article 29(1)(e) of Decree-Law no. 10/2011, of 20/01.

The wording of this decision follows the old orthography.

[1] Note that Decree-Law no. 159/2009, of 13 July, which renumbered the CIRC (Article 7(1)), applies only to taxation periods beginning on or after 1 January 2010 (Article 9).