Reverse Merger Financing Costs Under Article 23 CIRC – CAAD Arbitral Decision 88/2016-T

ARBITRAL DECISION

The arbitrators Judge Counselor José Baeta de Queiroz (president-arbitrator), Professor Doctor Tomás Cantista Tavares and Professor Doctor Américo Brás Carlos (member-arbitrators), designated respectively by the CAAD (in the absence of agreement by the arbitrators appointed by the parties), by the Claimant and by the Respondent to form the Arbitral Tribunal, constituted on 29/4/2016, agree as follows:

1. Report

A…, SA, NIPC…, with registered office at Rua … …, …, … (hereinafter A… or Claimant), filed a petition for the constitution of a collective arbitral tribunal, pursuant to the combined provisions of Articles 2, No. 1, para. a), and 6, No. 2, para. b) of Decree-Law No. 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter RJAT), in which the Tax and Customs Authority (hereinafter TA) is respondent, with a view to declaring the illegality of the assessment of Corporate Income Tax and compensatory interest for 2009, in the amount of €255,655.46 (No. 2013…, compensation 2013…), plus indemnificatory interest in accordance with law.

The petition for constitution of the arbitral tribunal was accepted by the President of the CAAD and followed its normal procedural course, namely with notification to the TA. All arbitrators communicated their acceptance within the applicable deadline. The parties did not manifest any intention to refuse the designation of the arbitrators.

The collective arbitral tribunal was constituted on 29/4/2016.

The TA responded, by way of exception and challenge, arguing that the petition should be judged unfounded.

On 27/4/2015, the meeting provided for in Article 18 of the RJAT took place, at which the exception raised by the TA was decided in the sense of its lack of merit – and a decision was made in favor of the timeliness of the present petition for arbitral pronouncement; and subsequently, the parties made their oral arguments.

The arbitral tribunal was duly constituted and is materially competent, as provided in Articles 2, No. 1, para. a) and 4, both of the RJAT.

The parties possess legal personality and capacity, are legitimate and are duly represented (Articles 4 and 10, No. 2, of the same act and Articles 1 to 3 of Order No. 112-A/2011, of 22 March).

The case is not affected by any defects and there is no obstacle to consideration of the merits of the case.

2. Matter of Fact

2.1. Proven Facts

The following facts relevant to the decision are considered proven:

a) In 1978, the Claimant was established, with the principal activity of manufacturing boilers and radiators for central heating;

b) In May 2008, the Claimant transformed itself into a joint-stock company, with share capital of €2.4 Million;

c) On 28/7/2008, the shareholders of the claimant promised to sell all of the share capital of A… to B…– ....

d) C… (and its subsidiaries) is a venture capital entity, engaging in the acquisition of shareholdings and control, with a view to capital appreciation through improved management quality, and consequent remuneration of investors.

e) On 1/10/2008, the sale of the shares of A… took place – which were acquired for €15,250,000.00 by D…, SA, taxpayer … (entity of Group E…), constituted on 25/September/2008 and with the purpose of manufacturing household units and equipment for the use of renewable energies, in the metallurgical sector, as well as any and all related or connected activities.

f) B… held 88.73% of the share capital of F… SGPS, SA (entity constituted on 22/9/2008); F… held 100% of the share capital of D…, which in turn acquired all of the share capital of A….

g) D…, for the consummation of the purchase of A…, financed itself through: i) Shareholder advances from F… of €6,880,000.00; ii) Bank loans (from G…) of €8 Million.

h) Between June and September 2009 (with accounting effects as of 1/1/2009), D… (incorporated company) merged into A… (incorporating company), by global transfer of the assets of the incorporated company to the incorporating company – in an operation commonly designated as reverse or inverted merger.

i) Following the merger, the Claimant (incorporating company) assumed (i) all of the liabilities of D… and (ii) the charges (interest) incurred by D… with the banks and shareholders – which in 2009 amounted to €836,274.67.

j) In the venture capital activity (as conducted by Group E…) it is customary for the purchase of shares of the company to be acquired by a special-purpose vehicle company (D…) and subsequently to promote merger with the operational entity (A…) – normal or inverted – in order to (i) reduce administrative costs (as stated in the merger procedure) and (ii) by banking requirement (to place the debt in the same legal entity that owns the assets).

k) The TA does not accept the tax deduction of these charges (interest), pursuant to Article 23 of the Corporate Income Tax Code (CIRC), on the ground that they are allegedly not indispensable for obtaining income or for maintaining the source of income, and consequently promotes the assessment that is the subject of the present arbitral process.

l) The Claimant paid the contested assessment in this process: €180,031.36, on 18 December 2013, under the RERD (with waiver of interest); €51,916.98 (principal outstanding and interest), on 23 April 2014, by way of compensation.

2.2. Unproven Facts

There are no facts of relevance to consideration of the merits of the case that have not been proven.

2.3. Reasoning for the Determination of the Facts

The proven facts are based on documents presented by the parties (which are essentially documents issued by the tax authorities and relating to the merger), on the agreement of the parties (also as regards documents and values and payment dates) and on official information joined to the case.

3. Matter of Law

3.1. Question to be Decided

As is accepted by the parties, the question raised in the present case relates solely to the tax treatment to be given to the interest and other charges borne in 2009 by A… relating to loans (from shareholders and from third parties) for the purchase of the capital of A… itself, and which the claimant bears by virtue of and as a consequence of the merger with its shareholder D…, which originally contracted those liabilities.

In the opinion of the TA, such interest and charges would not be tax-deductible, pursuant to Article 23 of the CIRC (in the wording and numbering at the time of the facts) because they are not indispensable for obtaining income or for maintaining the source of income. For the Claimant, conversely, such interest and charges would be tax-deductible, by fulfilling the requirements inherent in Article 23 of the CIRC.

3.2. The Applicable Laws

According to Article 23 of the CIRC (in the wording and numbering at the time of the facts), the following are considered costs or expenses:

"1. […] those which are demonstrably indispensable for the achievement of income subject to tax or for the maintenance of the source of income, in particular:

(…)

c) Of a financial nature, such as interest on borrowed capital applied in the conduct of business […], expenses related to credit operations […]";

Moreover, with the merger of companies "the incorporated companies are extinguished […], transmitting their rights and obligations to the incorporating company" (Article 112, para. a), of the Companies Code).

3.3. The Arguments of the Parties

The reasoning for the assessment (and response of the Respondent and other pronouncements of the TA throughout the process) invokes, in summary, that the interest borne by A… after the consummation of the merger (and as a consequence of this operation) relating to the financing originally contracted by D… directly for the acquisition of the capital of A… does not merit the character of being indispensable for the income or maintenance of the source of income: after the merger, they no longer finance the acquisition of shareholdings; there would need to be, in each year in which interest is recorded, a balancing between the financial charges borne and the income and existence of the asset; such interest would not be linked to the claimant's normal activity and the associated asset does not exist and would not contribute in the future to taxable income.

The Claimant argues, conversely, that the interest borne in 2009 by A… is indispensable for the income or maintenance of the source of income, and is therefore classified as a tax cost under Article 23 of the CIRC. The interest is borne by A… in the conduct of its activity; the interest, when initially incurred (by D…), was indispensable for the income and maintenance of the source of income – and if it was at the initial moment, it must be forever, whatever subsequent modifications (even with the merger); the merger, among its normal effects, leads to the economic and fiscal result of the case; the merger is an operation permitted by commercial and tax law and the TA, in the reasoning of the act, does not invoke the alleged abuse of the merger operation followed by the acquisition, pursuant to Article 38, No. 2, of the LGT.

3.4. Decision

The arbitrators analyzed all the rhetoric presented by the parties (in their written pleadings, documents and arguments), as well as the argumentation and consideration of previous arbitral decisions on the subject – moreover abundantly explained by the parties – but always bearing in mind the minor variations of the case ("each case is a case").

Indeed, various arbitral awards (for example, in proceedings 14/2011-T and 87/2014-T) refused the tax deduction of interest borne by the incorporating company post-merger, relating to financing contracted by the incorporated company pre-merger with a view to the acquisition of the share capital of the future incorporating company. Conversely, the arbitral awards 101/2013-T, 42/2015-T (here in a non-reversed merger, but the considerations are the same), 92/2015-T and 93/2015-T pronounce themselves in the opposite sense, accepting the deduction of such financial charges, by considering them manifestly indispensable for obtaining income or for maintaining the source of income.

The arbitrators weighed all the arguments of the parties, and the content of the decision of all the above-mentioned awards – summarized in the decision of proceedings 93/2015-T – and decided, by majority, in the sense of annulling the contested assessment and considering that such interest and charges borne by the Claimant are indispensable for the income and maintenance of the source of income of A…, based on the reasoning and decision of the arbitral award in proceedings 93/2015-T, to which we adhere and hereinafter reproduce the operative part, also adopted in this proceeding.

(Beginning of the citation of the Award in Arbitral Proceedings 93/2015-T)

" […] exclusively at issue are interest on borrowed capital, it is then considered that the starting point of the decision-making process of the dispute that must now be resolved is situated within the framework of Article 23, No. 1, para. c) of the CIRC.

Such provision establishes, moreover and insofar as what is now relevant, that "Expenses are considered (…) in particular: c) interest on borrowed capital applied in the conduct of business.".

Thus, and before proceeding to ascertain whether the aforementioned provision results, or not, in a limitation of the deductibility of interest on borrowed capital, to its application in the conduct of business, or whether, as was concluded in Award 42/2015T, interest on borrowed capital applied for other purposes will be deductible within its scope, it is necessary to assess whether, in the present case, that is, or is not, the situation that is verified.

In such assessment, and without prejudice to a better opinion, account must be taken, as decisive references, besides what has already been duly addressed, of four aspects that are considered fundamental, namely:

• The first […] is the circumstance that the shareholdings of the incorporating company, which formed part of the assets of the incorporated company, do not exist in the assets of the company resulting from the merger process;

• The second, it is believed to be as unavoidable as the preceding one, is that the "borrowed capital" to which the borne interest refers and whose deductibility is questioned are found, in a moment prior to the merger, already fully applied;

• The third, much less evident, but equally unavoidable and relevant, is that the company resulting from the merger process is not materially identified (from the perspective of economic reality) with the beneficiary company of the merger, as it was configured prior thereto;

• The fourth, it is believed will not be, likewise, contestable, is that the shares attributed, in the merger process, to the shareholders of the incorporated company, will be consideration, not for the capital obtained by that company through the financing whose interest deductibility is in question, but, as has already been seen, for the shares of that same incorporated company and which, by force of the merger process, are extinguished.

In light of these references, it is considered that the conclusion is sound that, indeed, in the case the requirements of the aforementioned para. c) of No. 1 of Article 23 of the CIRC are fulfilled, because the interest charges in question correspond to borrowed capital that was applied in the conduct of the entity that bears them.

This statement, which at first sight may appear counterintuitive, will be assimilable if the third of the fundamental decision-making criteria listed above is duly borne in mind.

Indeed, and as was written in the Award of the STA of 13-04-2005, handed down in proceedings 01265/04[1]:

"The merger by incorporation, even though it implies that only the company into which the others are incorporated survives with its own legal personality, does not have as a consequence, in the field of economic and business realities, the disappearance of the merged companies. Some commercial law doctrine – see PINTO FURTADO, PINTO COELHO and PUPO CORREIA in the places cited in the appealed sentence – points out that the merged company, losing its legal personality, nonetheless persists, modified, forming a whole with others, in conditions different from those that existed before the merger. But the same economic reality continues to exist, the same set (now integrated in another broader one) of means assigned to a productive activity, which the shareholders, moreover, wished to enhance with the merger.

That is, with merger by incorporation there occurs a transformation of the company, but not an extinction, not resulting from the integration its disappearance, but its alteration, even though it implies the loss of legal personality."

Also in the Award of the TCA-South of 17-04-2012, handed down in proceedings 04172/10[2], it was written that "the merger of companies is the act by which two or more companies combine their economic forces to form, with the shareholders of all of them, a single collective entity, a new economic and legal subject.

Hence it can be stated, as it appears to have been done by A., that the merger is, as a general rule, and the situation under analysis is not an exception, recommended by interests common to the companies participating in it, and not merely to one of them."

And further: "It is true that it could be argued that the merged company, losing its legal personality, nonetheless persists, modified, forming a whole with others, in conditions different from those that existed before the merger; however, it is also true that the same economic reality continues to exist, the same set (now integrated in another broader one) of means assigned to a productive activity, which the shareholders, moreover, wished to enhance with the merger.

In another formulation, it can be stated that with merger by incorporation there occurs a transformation of the company, but not an extinction, not resulting from the integration its disappearance, but its alteration, even though it implies the loss of legal personality.".

Understood in this way, it will be understandable, then, the statement that the interest charges in question correspond to borrowed capital that was applied in the conduct of the entity that bears them. Indeed, properly understood the post-merger reality (not fraudulent), it should be accepted that the entity resulting therefrom, although contained in the legal "shell" of the incorporating company, no longer corresponds to this, as it was configured before the said process of corporate reorganization, being rather a synthesis between the incorporated company and the incorporating company.

Citing the jurisprudence that precedes, it continues "the same economic reality" to exist, the "same set (now integrated in another broader one) of means assigned to a productive activity", in the conduct of which the borrowed capital whose interest expenses see their deductibility questioned was applied, since the integration did not result in its disappearance, but in its alteration, even though with the loss of legal personality.

Thus, in light of this understanding of the effects of merger by incorporation – including the inverted or reverse merger – it cannot be concluded in any other way than by the fulfillment of the requirements of the aforementioned para. c) of No. 1 of Article 23 of the CIRC.

It becomes, therefore, understandable the passage of Award 42/2015T cited above, according to which "the merger maintains in the Claimant the financing for which it paid interest, and had as a patrimonial consequence the joining, in the same balance sheet, of the assets that such debt financed and continued to finance. Not already financial assets, but their real translation into assets and liabilities of an operational character". Indeed, the perspective of the aforementioned award, which will be unquestionable in cases of "ordinary" merger by incorporation (not inverted or upstream), where it is evident that the incorporating company exchanges the shareholdings it holds for the economic reality into which the investee company translates, should be considered equally valid in cases of reverse merger, since the post-merger material reality (the "economic reality", the "set (…) of means assigned to a productive activity"), will be, at least as far as aspects relevant to the problem under discussion constitute, precisely the same[3].

It does not invalidate, it should be said, this conclusion that, as is affirmed in Arbitral Award 87/2014T, "the tax deduction of the financial charges incurred (…) must be assessed in the context of the business enterprise of the Claimant, in view of the normative criteria resulting from No. 1 of Article 23 of the CIRC", and that "in order to apply to the present case the requirement of the indispensability of costs, it is decisive to ascertain (…) the effective and concrete affectation of the financing of which the borne interest 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 seeks to tax-deduct, for the purposes of determining taxable profit, the interest and other related charges that it has borne".

Rather on the contrary. Understood that the Claimant, as it presents itself post-merger, is not already the same center of interests that existed before that process, but another different one that synthesized itself with the incorporated company and that, therefore, the business context of the Claimant incorporates, also, the economic reality before corporately embodied autonomously by the company incorporated into it, then – truly – the "normative criteria resulting from No. 1 of Article 23 of the CIRC" will be assessed "in the business context proper to the Claimant".

On the other hand, and as has already been referred, it is also not verified that there has been any alteration in the "(…) effective and concrete affectation of the financing of which the borne interest is the remuneration", or deviation in the "destination or use of the funds obtained in relation to which the taxpayer seeks to tax-deduct, for the purposes of determining taxable profit, the interest and other related charges that it has borne", because, on the one hand and as has been seen, the financing was fully applied in a moment prior to the merger, and, on the other and as has equally been seen already, it was not even the product of that application diverted to a third party, in particular to the shareholder (before the incorporation and, after, of the incorporating company), inasmuch as the shares of the incorporating company of which that shareholder became the holder derive, not from the financing whose interest is in question, but from the shares of the incorporated company that it held, and which were extinguished by the merger process.

The position adopted is equally compatible with the assertion that can be read in the same award that has just been referred to, according to which "the fact that certain financial charges were previously tax-deductible within the scope of determining the taxable income of a certain company does not mean, by itself, that they are necessarily so in the same terms within the scope of the company that, by merger, incorporated that one".

Indeed, and as was already stated by Professor Teixeira Ribeiro, in light of the Industrial Contribution Code (CCI)[4], the paragraphs of No. 1 of Article 23 of the CIRC cannot be understood in any other way than that when costs or losses are specifically listed in Article 23, their essentiality is presumed, and consequently the taxpayer is relieved of the corresponding proof, being precisely that the purpose of the enumeration (derived, moreover, from the use of the expression "in particular").

The fulfillment, in the case, of para. c) of No. 1 of Article 23 of the CIRC does not mean that the TA cannot question the general requirement of deductibility of expenses, contained in the body of the article, by demonstrating that, despite fulfilling one of its paragraphs (in the case para. c)), the merger was carried out for interests not business in nature of the companies party to it[5].

Similarly, the TA could demonstrate that, despite fulfilling one of the paragraphs of No. 1 of Article 23, and that the merger was determined by interests of the companies party to it, the same was carried out in a fraudulent context, in terms of not producing tax effects, as prescribed by Article 38, No. 2 of the General Tax Law (LGT)[6].

But in the case, neither one nor the other of these routes was pursued by the TA, so it will not be incumbent upon the Tribunal to assess their validity.

It is not considered, finally, that the circumstance, also identified above, that, at the moment the interest is borne, the assets in which the borrowed capital was applied, to which such interest refers, no longer form part of the legal sphere of the company resulting from the merger, assumes relevance.

Indeed, if the borrowed capital is applied in the conduct of business (a situation different from the "diversion" of part of the capital for applications foreign to business interest, which, as has already been seen, does not occur in the case), it is considered that it would still be possible to refuse the tax deductibility of the corresponding financial charges, by demonstrating (and thus eliminating the presumption of deductibility arising from para. c) of No. 1 of Article 23 of the CIRC, detected in the wake of Professor Teixeira Ribeiro), that the product of that application – and not the borrowed capital itself – would have been diverted for extra-business purposes.

What has just been stated will be easily understandable with recourse to the example of a company that, using borrowed capital, acquires a vehicle, which it assigns, from the outset, to the conduct of business within its activity, but which, from a given moment onward, ceases to permit use of the same exclusively in the interest of third parties (e.g.: shareholders; other companies).

In this situation, it is believed, the presumption of indispensability of the financial charges borne with the acquisition of the vehicle, arising from the application of borrowed capital in the conduct of the company in question, will be displaced[7], so that the deductibility of those charges must be refused. It is not, however, once more, the situation of the case.

Rather, what occurs in the situation before us is that, by way of the merger operation carried out, there was a disappearance of the object of the application of the borrowed capital. That is: such object, which existed, ceased to exist (which is different and, it is repeated once more, is not what happens in the situation sub iudice, of continuing to exist in the sphere of third parties).

Returning to the example of the vehicle, the situation would be the same as would occur in the case where, by way of a business decision, that vehicle became unusable before the period of payment of the financial charges related to its acquisition ended (e.g.: its use in an advertising campaign that destroyed it). Still, it is believed, those charges would remain deductible, notwithstanding the disappearance – by way of a business decision – of the object in which the borrowed capital that remunerate them were applied. This would only not happen, in the sequence of what has just been stated, if it were demonstrated that the decision that caused the disappearance of such object was motivated by interests foreign to the enterprise or, then, that it was abusive. What – once more – is not what is at issue in the present proceeding.

It should be said, finally, that it is considered that the regime relating to the prohibition of financial assistance for the acquisition of own shareholdings essentially regulated in Articles 322, No. 1 of the CSC, and Article 23 of the Second Directive 77/91/CEE of the Council, of 13 December 1976, will not invalidate either the decision-making references from which we departed, nor the conclusions that have been drawn.

Notwithstanding this question was neither a ground of the tax act that is the subject of the present arbitral action[8], nor raised by the parties themselves[9], it will always be said, in support of the integrity of the decision, that it is not discernible that any act has been practiced that, concretely, can be pointed out as having occurred in violation of the said prohibition.

Indeed, Article 23, No. 1 itself of the Second Directive 77/91/CEE of the Council, of 13 December 1976, in force at the date of the tax fact[10], and in light of which the provision of Article 322, No. 1 of the Companies Code (CSC)[11] must, in the case, be read, considers financial assistance the advance of funds, the granting of loans or the provision of guarantees, and it is certain that, in the case, it is not established that any of these situations has occurred.

Indeed, the funds used for the acquisition of the shareholdings of the Claimant were provided by banking entities, and not advanced or granted on credit by the Claimant, and this, insofar as it is established, did not provide any guarantee in favor of the creditors of the financing used for the acquisition of the said shareholdings, so that, except in the case of fraud, it cannot be considered that, in the case, the Claimant has provided financial assistance, prohibited by the rules referred to.

That is, and in summary: there is no doubt that funds were not advanced, credits granted or guarantees provided by the Claimant, with a view to the acquisition of own shares. If – and in the case, it is believed, this is a discussion that will not be appropriate to pursue, so it will not be relevant whether this is questionable or unquestionable – the same results were obtained by other non-prohibited means, we would then be in the presence of fraudulent conduct, to be treated as such.

For any violation of the prohibition of financial assistance to be considered verified, the same would always have to be derived from the combination of all of the legal acts practiced by the Claimant, and of the intention – in that case, fraudulent – to, by that means, obtain a result that the law prohibits.

Indeed, a conclusion of violation of the prohibition of financial assistance by the Claimant will – it is believed – always have to rest on the combination of the complex of acts practiced, from the initial institution of the group corporate organization, to the carrying out of the reverse merger by incorporation, passing through the financing operation performed, it being certain that all of these acts, in themselves considered, will present themselves as lawful and proper to the various business entities involved in them, and only a fraudulent purpose and result actually demonstrated will be capable of stripping the mantle of lawfulness that covers them.

Now, except for a better opinion, being then each of the various legal acts practiced by the different participants in the complex action at issue in the present proceeding, lawful and business-related, the proper means of effecting the said demonstration, and drawing from it the proper effects in the tax sphere, will be by way of the anti-abuse clause[12].

This conclusion will not, it is believed, be capable of being affected, by way of the consideration – moreover not made by the TA itself – of the prohibition of financial assistance in the densification of the general criterion of indispensability of Article 23, No. 1 of the CIRC, not least because it is understood that not only would it be necessary, previously, that an effective (and not merely generic or potential) violation of the said prohibition be demonstrated, but that, being at issue – in the present case, as has been said – a global act of tax avoidance, the use of the general clause of indispensability would constitute – without prejudice to the respect due and, if the expression be allowed – itself a "tax avoidance", in that it would be an expeditious means of removing the guarantees that the law intended to confer on the taxpayer, in cases where the TA understands that the legal forms used by the latter do not have correspondence in the economic reality pursued.

In any event, it should be noted that there is no doubt that in the case there was carried out a so-called "leveraged merger" ("merger leveraged buy-out", mLBO), no less certain is that such a figure is known, from a date that can be considered already long, by the legislator, who – to this date – has understood not to withdraw from that knowledge either its general illegalization (there is no record, moreover, that this has occurred in any community legal system), nor any other effects on the tax plane.

Moreover, in systems, such as the Italian one, where mLBO operations have already been regulated, the regulation instituted insists especially on obligations of disclosure and audit, thus making evident, that the operation in itself is not intrinsically unlawful and/or fraudulent, but that, uniquely, it encloses in itself a potential for unlawfulness/fraud, superior to the normal. Therefore, it is considered that the mere occurrence of a leveraged merger operation will not, by itself, be capable of being considered fraudulent and, still less, contrary to business interest.

Finally, it will always be said that the application to the case, by way of the general criterion of indispensability of expenses, of the prohibition of financial assistance for the acquisition of own shares, under the argument that all the acts and contracts performed were characterized by the purpose that it be the assets of the Claimant that bear the cost of the acquisition of its own shareholdings, will equally run up against the finding that this same result would be obtained if the reverse merger by incorporation had been carried out in the opposite sense.

Concluding, and as was stated by Professor Saldanha Sanches[13], if "The operations of scission and merger are an area where attempts to obtain tax savings through abusive practices are very frequently verified, which motivates the legitimate concerns of the legislator.", one cannot however depart from an "irreconcilable distrust (…) in relation to the reverse merger, as if this operation could only be carried out to circumvent tax law or were, in itself, an abusive operation".

Thus, considering that, in the case, the requirements of Article 23, No. 1, para. c) are met, in particular, that the borrowed capital to which the financial charges whose deductibility is questioned by the TA refer, were effectively applied in the conduct of the Claimant, as it presented itself at the date on which it bore those charges (post-merger), in question in the present proceeding, and that it is not demonstrated (nor did this fact even constitute a ground of the tax acts that are the subject of the present arbitral proceeding) that the merger operation, which resulted in the disappearance of the shareholdings in which the said borrowed capital had been applied, was exclusively or mainly motivated by interests not business in nature, or fraudulent, the arbitral petitions for annulment that were formulated must proceed in their entirety.

(End of the citation of the Award in Arbitral Proceedings 93/2015-T)

It should be noted, for the sake of truth, that the matter of financial assistance is not properly a subject to be decided, since it was never wielded by the TA during the process (nor in subsidiary form). It is addressed only as a mere note suggested by the subject matter, as indeed occurred in proceedings 93/2015-T.

The Claimant also requested that, in addition to the annulment of the contested assessment, the TA be condemned to return the tax paid plus indemnificatory interest under law.

Article 43, No. 1, of the LGT provides that indemnificatory interest is owed to the taxpayer when it is determined in judicial impugnation (and the arbitral action is included in this legal provision, by coherence and unity of the legal system) that there was error attributable to the services from which results the payment of a tax liability superior to what was owed.

Now, this is what occurs in the case. The TA, in introducing an additional Corporate Income Tax assessment – now annulled – resulted in the payment of tax by the taxpayer, ultimately unjustified and required solely, by error attributable to the services of the TA (which demanded assessment of unlawful tax).

Whereby, fulfilling the requirements of Article 43 of the LGT, the TA must proceed to the payment of indemnificatory interest, at the legal rate, from the moment of payment by the taxpayer until full reimbursement to the taxpayer of the tax paid by it.

5. Decision

In accordance with the foregoing, the arbitrators agree in this Arbitral Tribunal to:

• Judge well-founded the petition for a declaration of the illegality of the contested assessment of Corporate Income Tax and compensatory interest for 2009, No. 2013…, compensation 2013…;

• Annul the acts of express dismissal of the gracious reclamation and hierarchical appeal practiced in this proceeding;

And in consequence:

• Order the reimbursement to the claimant of the 2009 Corporate Income Tax paid by it with respect to the subject matter of this proceeding, in the amount of €231,948.34;

• And condemn the TA to pay indemnificatory interest to the Claimant, on the amount defined in the preceding points, as follows itemized: on €180,031.36, from 18/12/2013 until full reimbursement; on €51,916.98, from 23/4/2014 until full reimbursement.

6. Value of the Case

In accordance with the provisions of Article 97-A, No. 1, para. a), of the Code of Procedure and Tax Process (CPPT) and Article 3, No. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the case value is set at €255,655.46.

According to Article 97-A, No. 1, para. a), of the CPPT, when the assessment is impugned (as in the present case), the value of the case is "the amount whose annulment is sought". Now, the taxpayer seeks to annul the assessment, the value of which, in the contested portion, amounts to €255,655.46. Something different is the subsequent existence of special laws for forgiveness or waiver of interest – which may reduce the amount required. The taxpayer fully complies if it pays the reduced amount (as occurred in the case) – and the reimbursement determined in the Award is limited to the amounts paid. But the assessment is maintained at the higher value – and that is the measure for determining the value of the legal action.

7. Costs

The amount of costs is set at €24,000.00, pursuant to Article 5, No. 2 of the Regulation of Costs in Tax Arbitration and Annex Table II.

Let Notice be Given

Lisbon, 21 October 2016

The Arbitrators

José Baeta de Queiroz (President Arbitrator)

Tomás Cantista Tavares (Member Arbitrator)

Américo Brás Carlos (Member Arbitrator)
(voted dissenting as per attached statement, which forms an integral part of this decision)

DECLARATION OF DISSENT

I voted against the decision contained in the award, essentially because:

1. Not deferring to the jurisprudence of the STA and the TCA – rather supporting its reasoning in decisions of the Arbitral Tribunal – disregards the conforming role of the jurisprudence of those superior courts and is subject to recourse in accordance with No. 2 of Article 25 of the RJAT.

2. The assessment of the "demonstrated indispensability of expenses for the achievement of income subject to tax or for the maintenance of the source of income" referred to in No. 1 of Article 23 of the CIRC can only be made with respect to the entity that accounts for and bears them, as moreover is admitted in page 12 of the Award and results from the Award of the STA of 30.05.2012, proceedings No. 171/11, which concluded: "costs cannot fail to relate to the taxpayer company itself". Taxpayer company which is, in the case sub judice, the Claimant, unquestionably the only person – the only center of imputation of rights and duties – who after the merger survived in the legal order[15], including the part thereof that relates to taxation.

3. In the case of the payment of charges relating to loans, I understand that it is the use of the assets acquired with the funds thus obtained that determines the characterization and regime that applies – indispensability and tax deductibility, or not – to the concomitant interest[16].

4. The assessment of the demonstrated indispensability of expenses, although it should not involve prior value judgments about the correctness or incorrectness of the company's management decisions, must rest on the idea of the demonstrated "necessity"[17] of the same, "having regard to the corporate object of the business entity in question"[18].

5. Moreover, the exercise of assessment of demonstrated indispensability or demonstrated necessity of expenses cannot likewise fail to rest on a judgment based on a vision of normality or verisimilitude (as is moreover common in any assessment for the purposes of legal judgment) in face of the expense in itself, but also in face of all the circumstances that determined that the same be incurred in the circumstances in which they were. As was decided in the Award of the TCA-South of 16.10.2014, proceedings No. 6754/13, an expense is indispensable when there is "a causal nexus with the income or gains explained in terms of normality, necessity, congruence and economic rationality".

6. Now in the case of the instant proceedings, the factual journey of the entire operation was:

• On 2/5/2008, the Claimant – A…– was transformed into a joint-stock company;

• On 28/7/2008, the shareholders of the Claimant executed a contract of promise to sell and purchase with the Venture Capital Investment Fund B…, undertaking to sell to this Fund all of its shares;

• On 22/9/2008, F… SGPS was constituted, being held by B… in 88.73% of its share capital;

• On 25/9/2008, D…, SA was constituted, with a similar purpose to that of the Claimant, with all of its share capital held by F… SGPS. It should be noted that D… is an entity of Group E… without operational activity and without assets to satisfy the guarantee requirements imposed by banking creditors (see page 4 of the award)[19].

• On 1/10/2008 D… purchased all of the shares of the Claimant, for which purpose it obtained on the same day financing from its sole shareholder – F… SGPS – and from a credit institution.

• On 31/8/2009 the total merger of D… (parent company) into the Claimant (incorporating company) was approved, with effects reported to 1/1/2009.

1. As, with meridian clarity can be perceived, the entire operative course from the promise contract between the shareholders of the Claimant and Fund H… is subordinated to the following objective: acquisition of all of the share capital of the Claimant by Group E… and placement of the debt resulting from the respective financing in the company itself acquired – the Claimant – the only entity with relevant operational activity and with income which, as has been said, permits the tax deduction of the charges borne as a result of debts contracted by a third party for the acquisition of its own shares.

2. All of the steps of the operation are inserted in the same "unity of intention and action" and are, from the beginning, exclusively directed to the objective referred to in the preceding number. An objective foreign to the business interest of the Claimant, the financing not being and the payment of the concomitant charges not being necessary to its activity, nor indispensable for the pursuit of its specific business interest embodied in the production of its income subject to tax or in the maintenance of its generating source. The obligation to payment of the charges under analysis was never, from the outset, contracted in the business interest of the Claimant, and it is clear to me that it could not, after the merger, come to be considered that such financing were indispensable to it for the purposes of No. 1 of Article 23 of the CIRC.

3. And the noted "unity of intention and action" in which the facts referred to above are inserted makes all the difference with respect to the situation of continuation of payment and deduction of interest beyond the existence of an asset whose acquisition generated charges, which the Award used to, by way of example, support its decision. In the example used in the Award, the subsequent vicissitude that determines the disappearance of the asset – a vehicle that is removed from the assets – is not inserted in the "line of intention and action" that had determined its acquisition with recourse to credit[20]. The unity of action that results from the factuality recorded in the case, noted above, equally places in crisis the touchstone of the Award which rests on the idea of making relevant the fact that the purchase of the shares of the Claimant occurred, in their entirety, before the merger.

4. In consequence, having regard to the foregoing, the charges relating to those loans, borne by the Claimant, do not fulfill the requirement of indispensability referred to in No. 1 of Article 23 of the CIRC, because, in summary:

a) They do not relate to the activity conducted by it (Award STA, proceedings 171/11);

b) The charges corresponding to interest borne by an incorporating company by virtue of the acquisition of borrowed capital by the incorporated company for the acquisition of 100% of the shares of the first, are not indispensable to this incorporating company, because they were not constituted in its business interest, and are not, thus, necessary for the pursuit of its corporate scope (Award STA, proceedings 164/12 and Awards TCA-South, proceedings No. 5327/12 and proceedings No. 8137/14);

c) There is no causal nexus between those charges and its income or gains, explained in terms of normality, necessity, congruence and economic rationality (Award TCA-South, proceedings No. 6754/13);

1. And these reasons would suffice for such charges not to be tax-deductible.

2. But the impossibility of tax deduction of such charges is further prescribed by para. c) of No. 1 of Article 23 of the CIRC.

3. Such consequence is not prevented by the exemplary enumeration formed by the set of paragraphs of the said number. As a whole, the paragraphs of No. 1 form an exemplary enumeration in that it is admitted that there exist other expenses in which a business may incur. However, this does not mean that within some of these paragraphs the law has not included taxative statutes, such as those resulting from part of its para. c) and para. j)[21].

4. Relevance must be given to the fact that in para. c) of No. 1 of Article 23 of the CIRC the legislator has imposed for financial charges a limitation (and it also did so for expenses relating to some financial instruments, including in the rule some instruments and excluding others, depending on its measurement method) which it did not wish to repeat with respect to other expenses mentioned there (discounts, premiums, transfers, exchange differences, etc.). The norm exists and the interpreter cannot act as if it did not exist, considering it useless (see No. 3 of Article 9 of the Civil Code).

5. In the provision of para. c) of No. 1 of Article 23 of the CIRC, the law, within the general scope of financial charges, establishes for interest the following rule: "interest on borrowed capital applied in the conduct of business is tax-deductible". And, from its combination with the requirement of demonstrated indispensability referred to in said No. 1, bearing in mind the criteria of normality, necessity, congruence and economic rationality, I adhere to the understandings of MARIA DOS PRAZERES LOUSA[22] and RUI MARQUES[23], to conclude that, in the case of borrowed capital, this must be applied in the conduct of business by the company that bears them, in order for the corresponding charges to be tax-deductible. Which is not the case in the instant proceedings.

6. The Award further brought to the discussion the problematic of "prohibition of financial assistance", to conclude that it does not apply in the present case, because the Claimant did not proceed to the "advance of funds, the granting of loans or the provision of guarantees". Without prejudice to considering this subject relevant because it touches on the principle of indispensability of costs, I also differ here, because, except for a better opinion, it is the Claimant that through its payments of the debt contracted by the incorporated company goes "supplying the funds" to a third party so that it holds the shares representing its capital. This directly conflicts with the provision of No. 1, of Article 322 of the Companies Code (CSC)[24].

7. And these prohibited acts of financial assistance are sanctioned by No. 3 of the same Article 322, with the strongest of the negative values reserved for unlawful acts – nullity.

8. Combining the provisions of Nos. 1 and 3 of Article 322 of the CSC, with No. 1 of Article 23 of the CIRC, an act that the legal order "sanctions" with nullity cannot be considered indispensable or necessary for tax purposes. It would be the negation of the principle of unity of the legal order.

For all of this, the tax act under analysis should be maintained; and for this reason I set forth this dissenting vote.

Lisbon, 18 October 2016

Américo Brás Carlos

(Text prepared by computer, in accordance with Article 131, No. 5 of the Code of Civil Procedure, applicable by referral of Article 29, No. 1, para. e) of the Legal Framework for Arbitration

[1] Available for consultation at www.dgsi.pt.

[2] Ibid.

[3] It should be noted that one is not here working a hypothetical scenario in which the merger operation would have to be carried out in other terms. What is being asserted is an identity of situations, from the perspective of the topics relevant to the approach of the question to be decided, between the situation verified and another, with respect to which there are no doubts about the response to be given to the same question.

[4] Comment to the award of the Supreme Court of 9 October 1985, RLJ No. 3743, p. 39-43.

[5] Notwithstanding the circumstance that it does not constitute a ground of the tax acts in crisis to motivate the non-business motivation of the merger, it will always be said that what is affirmed by the TA is not correct, in the arbitral proceedings, when it refers that "The reality of the facts, however, does not permit discerning the positive effects accruing to the merger for the conduct of its activity. Rather, on the contrary, it is certain that the funds were not used in the conduct of business." (see Article 33 of the response). Indeed, it results from the facts that, prior to the merger, the Claimant bore management expenses, in favor of the company that came to incorporate it, expenses that, with the merger, ceased to be borne. A different question, but which, in accordance with the jurisprudence already listed, will escape the scrutiny of the TA, will be to know whether the decision to proceed with the merger was good or bad.

[6] Where, except for a better opinion, would be situated the proper seat for considerations relating to a possible situation of, in tax avoidance, placing a company to finance its own acquisition, in violation of the provision of Article 322, No. 1 of the CSC, and the Second Directive 77/91/CEE of the Council, of 13 December 1976 (Article 23), in force at the date of the tax fact, as finally will be developed.

[7] It is thus considered that the question of the diversion of the product of the application of the borrowed capital shall be distinct from the question of such application. One thing will be, therefore, the application of borrowed capital in the conduct of the entity that contracted the financing, which, if verified, will determine the fulfillment of para. c) of No. 1 of Article 23 of the CIRC, which will produce its respective effects, namely as regards the presumption of indispensability of expenses "for the achievement of income subject to tax or for the maintenance of the source of income". Another thing will be the diversion of the product of the application of borrowed capital borrowed, for non-business purposes, which may be relevant, not already at the level of para. c) referred to, but – rather – at the level of the body of No. 1 of the same provision, as an infirmation of the presumption arising from that para. c).

What triggers the presumption of indispensability is the application of capital; but the judgment of deductibility relates to the interest borne. Thus, these will be presumed deductible if the borrowed capital to which they relate has been applied in the conduct of business. This application, however, does not equate to nor is identified with the indispensability thereof; it is rather a known fact from which an unknown fact is drawn (presumed): that the financial charges, at the moment they are, are borne in the interest of the enterprise. Hence, the demonstration that the product of the application of borrowed capital was "diverted", in its use, for extra-business purposes, does not mean that, after all, those (the borrowed capital) were applied outside of the conduct of business. That demonstration means, rather, that, notwithstanding the borrowed capital having been applied in the conduct of business, the charges borne, at the moment they are, are not borne in the interest of the enterprise, so that the (presumed) indispensability, in the case and in that period, then does not verify. Thus it is also demonstrated that, in the perspective adopted, the "test of indispensability of expenses", as the TA advocates, is carried out in "each period of taxation (…) not being this exercise carried out only at the moment the loan is contracted" (see Articles 69 et seq. of the Response). Indeed, the said test is carried out in all exercises, notwithstanding the fact known in which the presumption rests that responds, in the first instance, to such test, relates to the moment the loan was contracted.

[8] Indeed, as has been repeatedly affirmed by the STA, "It is exclusively in light of the reasoning set forth by the TA when practicing the additional Corporate Income Tax assessment that the legality of this tax act must be assessed." (Award of the STA of 23-09-2015, handed down in proceedings 01034/11), so that the Tribunal must, in assessing the legality of the act in question, confine itself to the grounds, whether of fact or of law, set forth therein.

[9] It does not appear in the Reasoning of the assessment.

[10] Corresponding to No. 1 of Article 25 of the current Directive 2012/30/EU of the Council, of 25 October 2012.

[11] Which, moreover, is contained in the heading "Loans and guarantees for the acquisition of own shares", and prohibits the granting of loans or the provision of guarantees.

[12] Being spoken of fraud, here, as in note 16, above, there will be, it is believed, any overlap between the provision, in the case, of Article 322 of the CSC and of Article 38, No. 2 of the LGT, in that by way of this will be sought to realize the prohibition enshrined in the first, which by a means of fraudulent conduct may have been formally evaded. Indeed, one thing will be the practice of an act of prohibited financial assistance, which will be null in accordance with Article 322, No. 3 of the CSC and, as such, will not summon the application of the general anti-abuse clause. Another thing will be situations in which, without any act being practiced in violation of that provision, fraudulently, the same economic results are obtained that the same seeks to prohibit. Evaded, thereby the prohibition of law, and the nullity thereof resulting, will be, it is believed, the CGA the proper means of achieving tax legality.

[13] "Reverse Merger and Tax Neutrality (Of the Administration)", Fiscality No. 34 – Magazine of Law and Tax Management.

[14] Without prejudice to subscribing to the correct option of not making relevant the crux of the claimant's position that there exists a purported general principle of tax neutrality underlying the tax regime of mergers that would determine the transposition of the entirety of the tax treatment to which the incorporated company would be subject to the tax regime applicable to the incorporating company. What exists are aspects of postponement and continuity expressly and imperatively circumscribed to the elements contained in Nos. 1 and 4 of Article 74 of the CIRC and no more. As results from those provisions, the said continuity of regime does not extend to the tax deductibility of the financial charges that are the subject of the instant case.

[15] Which, naturally, did not occur with the incorporated company, despite the reasoning of the Award, sustaining, also for tax purposes, the subsistence of a certain prolongation of its existence.

[16] BRIAN ARNOLD, "General Report", in Cahiers of Tax Law International, vol. 79A, 1994, Deductibility of Interest and other Financing Charges in Computing Income, p. 500.

[17] RUI DUARTE MORAIS, Notes to the Corporate Income Tax, Almedina, 2007, p. 83.

[18] Awards TCA-South of 19.02.2015, proceedings No. 8137/14 and of 22.01.2015, proceedings No. 5327/12.

[19] Unlike the Claimant, already with 30 years of active existence in the market, which as is referred in the merger project "has valuable goodwill which translates, in particular, into the maintenance of lasting business relations with suppliers, customers and financial institutions, in the confidence that the company enjoys in the market and, likewise, in the notoriety of the name and trademarks associated with its products".

[20] As is customary, enterprises do not acquire an asset of fixed assets (unlike what occurs with inventories or inventory) with the objective of immediately disposing of it.

[21] Relating to expenses resulting from the application of fair value in consumable biological assets that are not multi-year forest management operations.

[22] The problem of deductibility of interest, Center for Tax Studies, Notebook CTF No. 171, 1995, p. 353.

[23] Mergers and Shareholdings: on the deductibility of financial charges under Corporate Income Tax, Auditors and Reviewers, No. 73, 2016, p. 40.

[24] No. 1 of Article 322 of the CSC provides: "A company may not grant loans or in any form provide funds or provide guarantees for a third party to subscribe or otherwise acquire shares representing its capital."