Fair Value Application & Deductible Capital Losses in IRC Liquidation | CAAD 90/2016-T

ARBITRAL DECISION

I. Report

1. The company A…, SGPS, S.A. (hereinafter designated as "Claimant"), with tax identification number…, with registered office at Rua…, no.…, …, submitted, on 17 February 2016, pursuant to the combined provisions of Articles 2 and 10 of Decree-Law no. 10/2011, of 20 January, namely the Legal Regime for Arbitration in Tax Matters ("RJAT"), a request for the constitution of an Arbitral Tribunal, in order to declare illegal the express denial of a Gracious Complaint filed against the tax assessment no. 2014…, relating to the tax year 2010, concerning Corporate Income Tax ("IRC"), plus compensatory interest, in the total amount of €63,409.11 (already paid by the Claimant), with the Tax and Customs Authority ("Respondent" or "TA") being the defendant.

A) Constitution of the Collective Arbitral Tribunal

1. In accordance with paragraph (a) of article 6, paragraph 2, and paragraph (b) of article 11, paragraph 1, of the RJAT, the Ethics Council of the Administrative Arbitration Center ("CAAD") designated the undersigned as arbitrators of the Collective Arbitral Tribunal, who communicated acceptance of the appointment within the applicable timeframe, and notified the parties of such appointment on 13 April 2016.

2. Thus, in accordance with the provisions of paragraph (c) of article 11, paragraph 1, of the RJAT, and through communication from the President of the Ethics Council of CAAD, the Collective Arbitral Tribunal was constituted on 29 April 2016.

B) Procedural History

1. In the request for arbitral pronouncement, the Claimant petitioned for the declaration of illegality of the express denial of the Gracious Complaint mentioned above, and consequently, the illegality of the IRC tax assessment previously referred to, already paid, which provided for the following corrections to the Claimant's taxable profit, raised in the context of an inspection carried out by the TA, with respect to the tax period of 2010:

[Table of corrections included in original]

1. The TA submitted a response, petitioning for the dismissal of the request for arbitral pronouncement, as there was no violation of law, requesting that the tax assessment under analysis, as it did not violate any legal or constitutional provision, be maintained in the legal system.

2. By order of 8 June 2016, the Collective Arbitral Tribunal, pursuant to the provisions of paragraph (c) of article 16 of the RJAT, decided, without objection from the parties, that it was not necessary to hold the meeting referred to in article 18 of the RJAT, as it considered that it had at its disposal all the necessary elements to make a clear and impartial decision.

3. It likewise decided, in accordance with article 18, paragraph 2, of the RJAT, that oral arguments were not necessary, as the positions of the parties were clearly defined in their respective pleadings, without prejudice to the principles of adversarial procedure and equality of the parties.

4. The final deadline set for the issuance of the arbitral decision was 28 October 2016.

5. The parties were also summoned to submit final arguments, but neither exercised that right.

6. The Collective Arbitral Tribunal was properly constituted and is competent to determine the issues indicated (article 2, paragraph 1, paragraph (a) of the RJAT), the parties possess legal personality and capacity and have full standing (articles 4 and 10, paragraph 2 of the RJAT and article 1 of Order no. 112-A/2011, of 22 March). No nullities occur, and therefore nothing prevents judgment on the merits.

7. The present proceedings are thus in a position for a final decision to be rendered.

II. Question to be Decided

1. This Tribunal will examine and decide on the merits of the case, which consists, in particular, of examining the legality of the corrections made by the TA to the Claimant's taxable profit (listed above), in the context of the additional assessment previously mentioned.

2. That is, this Tribunal will assess whether, as the Claimant alleges, the corrections made to its taxable profit (previously detailed) are illegal or, conversely, as the Respondent argues, legal, according to the legal framework applicable at the time.

III. Decision on Factual Matters and Its Reasoning

1. Having examined the documentary evidence produced, this Tribunal considers the following facts proven, relevant to the decision of the case:

I. The Claimant is a holding company;

II. It adopted Accounting Standard and Financial Reporting ("NCRF") 27, following the transition from the Official Accounting Plan ("POC") to the System of Accounting Standardization ("SNC") in Portugal, altering its accounting policy for the recognition of financial instruments traded on a regulated market, namely equity instruments, from the cost model to the fair value model;

III. In 2010, the Claimant still recognized losses from fair value reductions in profit/loss, having considered them fully deductible for IRC purposes, as follows:

a) Losses from fair value reduction of shares: €5,793.10;

b) Losses from disposal of capital shares valued at fair value: €676.08;

c) Discretionary portfolio: losses borne from fair value reduction of shares valued at fair value and from disposal of capital shares valued at fair value: €262.57.

IV. In the same tax period, the Claimant also recorded a loss, which it accepted for tax purposes, in the amount of €200,000.10, relating to the liquidation of a subsidiary company (the dissolution of that company occurred in September 2010 and the liquidation on 27 December of the same year), B…, S.A., acquired in May 2008;

V. The present initial petition was preceded by a Gracious Complaint, expressly denied on 23 November 2015.

1. The Tribunal's conviction regarding the facts found proven resulted from the examination of the documents attached to the case file and contained in the petition and response of the parties, as specified in the points of factual matters set out above.

IV. Legal Analysis

A) Legal Framework

1. Given that the legal question to be decided in this proceeding requires interpretation of the relevant legal texts, it is important, first, to list the rules that make up the relevant legal framework, as of the date of the occurrence of the facts (2010).

2. First, it is necessary to cite Decree-Law no. 159/2009, of 13 July, which established a transitional regime, in the context of IRC, for the effects resulting from the adoption, for the first time, of International Accounting Standards, as follows:

"Article 5

(Transitional Regime)

1. The effects on equity resulting from the adoption, for the first time, of international accounting standards adopted pursuant to article 3 of Regulation no. 1606/2002 of the European Parliament and of the Council, of 19 July, which are considered fiscally relevant pursuant to the IRC Code and its complementary legislation, resulting from the recognition or non-recognition of assets or liabilities, or from changes in their measurement, shall contribute, in equal parts, to the formation of the taxable profit of the first tax period in which such standards apply and of the four following tax periods.

2. (…).

3. The adjustments referred to in the preceding paragraphs must be duly evidenced in the tax documentation process provided for in article 130 of the IRC Code, in accordance with the renumbering introduced.

4. (…).

5. The transitional regime established in the preceding paragraphs shall also apply to the adoption, for the first time, of the System of Accounting Standardization, approved by Decree-Law no. 158/2009, of 13 July, of the Adjusted Accounting Standards, approved by Notice of the Bank of Portugal no. 1/2005, or of the Chart of Accounts for Insurance Companies, approved by Regulatory Standard no. 4/2007-R, of 27 April, of the Institute of Insurance of Portugal, without prejudice to, with respect to entities already applying these new accounting frameworks, the period referred to in paragraph 1 being counted from the tax period in which they were first adopted.

6. With respect to entities that have opted, pursuant to Decree-Law no. 35/2005, of 17 February, to prepare their individual accounts in accordance with international accounting standards adopted pursuant to article 3 of Regulation (EC) no. 1606/2002 of the European Parliament and of the Council, of 19 July, the effects referred to in paragraph 1 of this article are determined by reference to the individual accounts, organized in accordance with national accounting standardization, provided for in article 14 of that decree-law".

7. Additionally, we also list the relevant rules, for the purposes of this decision, set out in the IRC Code, as of the date of the facts (2010).

"Article 18

(Period of Taxable Profit)

9 — Adjustments arising from the application of fair value shall not contribute to the formation of taxable profit, being allocated as income or expenses in the tax period in which the elements or rights that gave rise to them are disposed of, exercised, extinguished or liquidated, except when:

a) They relate to financial instruments recognized at fair value through profit or loss, provided that, in the case of equity instruments, they have a price formed on a regulated market and the taxpayer does not hold, directly or indirectly, a participation in capital exceeding 5% of the respective capital stock; or

b) This is expressly provided for in this Code.

Article 21

(Positive Patrimonial Variations)

1. Positive patrimonial variations not reflected in the net result of the tax period shall also contribute to the formation of taxable profit, except:

a) Capital contributions, including premiums on the issuance of shares, coverage of losses, in any form, made by the holders of capital, as well as other positive patrimonial variations resulting from transactions on capital instruments of the issuing entity, including those resulting from the attribution of financial derivative instruments that must be recognized as capital instruments;

b) Potential or latent capital gains, even if expressed in the accounts, including revaluation reserves under legislation of a fiscal nature;

c) Contributions, including participation in losses by the associate to the associating party, in the context of participation association and quota association;

d) Those relating to income taxes.

(…)

Article 45

(Non-Deductible Expenses for Tax Purposes)

(…)

1. The negative difference between capital gains and capital losses realized through the onerous transfer of capital shares, including their redemption and amortization with capital reduction, as well as other losses or negative patrimonial variations relating to capital shares or other components of equity, designedly supplementary contributions, shall contribute to the formation of taxable profit in only half of its value.

(…)

Article 46

(Concept of Capital Gains and Capital Losses)

1. Capital gains or capital losses realized are considered as gains obtained or losses suffered through onerous transfer, whatever the reason for its operation, and likewise, those resulting from casualties or those resulting from permanent allocation to purposes unrelated to the activity carried out, regarding:

(…)

b) Financial instruments, with the exception of those recognized at fair value pursuant to paragraphs (a) and (b) of paragraph 9 of article 18

(…)

Article 81

(Result of Liquidation Distribution)

1. For purposes of taxation of partners, in the tax period in which it is put at their disposal, the amount attributed to each of them as a result of liquidation distribution, net of the acquisition cost of the corresponding capital shares, shall be included.

2. In the inclusion, for purposes of taxation of the difference referred to in the preceding paragraph, the following must be observed:

a) This difference, when positive, is considered as income from capital application up to the limit of the difference between the amount attributed and that, in view of the liquidated company's accounts, corresponds to effectively made contributions for capital realization, with any excess being considered taxable capital gain;

b) This difference, when negative, is considered a capital loss, being deductible only when the capital shares have remained in the ownership of the taxpayer during the three years immediately preceding the date of dissolution, and for the amount exceeding the tax losses transferred in the context of the special regime for taxation of groups of companies and provided that the liquidated entity is not a resident of a country, territory or region with a clearly more favorable tax regime appearing on a list approved by order of the Minister of Finance.

(…)".

1. Finally, it is also necessary to transcribe part of article 32 of the Tax Benefits Statute ("EBF"), as of the date of the facts, namely:

"Article 32

(Holding Companies (SGPS), Venture Capital Companies (SCR) and Venture Capital Investors (ICR))

(…)

1. Capital gains and capital losses realized by SGPSs, SCRs and ICRs from capital shares they hold, provided they are held for a period of not less than one year, and likewise, the financial charges incurred with their acquisition, shall not contribute to the formation of the taxable profit of these companies.

(…)".

1. Thus, it is within this legal framework that it is important to determine whether the corrections made by the Respondent to the Claimant's taxable profit, by reference to the tax period of 2010, suffer from any illegality (as argued by the latter).

B) Arguments of the Parties

1. The Claimant began by arguing that the IRC assessment would be illegal, due to lack of reasoning, error in the legal premises, and also violation of the principles of legality, taxpaying ability, and taxation of actual income.

2. With respect to the required lack of reasoning, the Claimant considers that "the reasoning invoked by the TA fails to justify the legality of the arithmetic corrections and, consequently, of the IRC assessment for the year 2010.

(…)

As for the gains from fair value increase recognized in retained earnings (positive patrimonial variations) for the three years, it merely refers the reasoning to the content of the doctrinal note in process no. 39/2011, with Dispatch of 24/02/2011 from the Director-General of the Tax Authority.

(…)

As for the losses from fair value reductions and losses in financial instruments recognized at fair value, including those in the discretionary portfolio, recorded in the three years and evidenced in the accounts and in the Tax Inspection Report, the TA invariably invokes the following: 'article 18, paragraph 9 of the IRC Code establishes that adjustments resulting from fair value do not contribute to the formation of taxable profit (…) however, if a loss from fair value reduction is identified, article 45, paragraph 3 of the IRC Code, establishes that "…other losses…relating to capital shares…shall contribute to the formation of taxable profit in only half of its value". Being the fair value reductions of these capital shares qualified as losses, they should be considered, pursuant to the said article 45, paragraph 3 of the IRC Code, at 50% of their value".

Nothing more is added, resorting to the interpretation of the rules set out in the aforementioned doctrinal note which (…) is nothing more than an internal understanding thereof and, as is known, binds only the TA and never the taxpayers and the courts.

(…)

In sum, argued in the context of the Gracious Complaint, as it does here, that the assessment is completely lacking in factual and legal reasoning, which will not fail to undermine its formal and substantive validity".

1. Additionally, and as to errors in legal premises, the Claimant understands, by way of a preliminary matter, that the correction made, by the Respondent, with respect to the capital loss resulting from the dissolution and liquidation of company B…, S.A., "goes beyond the scope of the order of service, as this was subordinated to the inspection procedure for validation resulting from fair value adjustments".

2. Nonetheless, in the words of the Claimant, "it will still be said that it is not clear how the TA can subsume the loss recorded under the regime of article 32 of the EBF and, thereby, disregard the respective amount.

What is at issue is a loss recorded by dissolution and liquidation of the company, and not an accounting capital loss.

As a loss that it is, it should be accepted fiscally in full, given the definition of expense contained in articles 23 and following of the IRC Code.

It is worth highlighting in this regard the decision handed down by the Central Administrative Court of the South in process no. 5097/11 of 31.01.2012 (…) "as for article 23 of the IRC Code, indispensability as a condition for a cost to be deductible does not refer to necessity (the expense as a sine qua non condition of revenues), nor even to convenience (…) but requires only an economic causal relationship, in the sense that it is sufficient for the cost to be incurred in the interest of the enterprise (…).

In the case at hand, in which costs corresponding to capital losses resulting from the extinction of companies are in question, taking into account the price of acquisition of their capital shares by the Claimants and that such elements were part of the assets of the enterprises (…), the capital loss resulting from the dissolution and liquidation of the companies cannot be disregarded on the basis of the cited article 23 of the IRC Code"".

1. In parallel, and with respect to adjustments resulting from the transitional regime provided for in Decree-Law no. 159/2009, of 13 July, cited above, the Claimant "considers that there is no place for the application of the regime provided for in article 18, paragraph 9, paragraph (a) of the IRC Code, as the conditions provided for therein are not met.

To that extent, the taxation of the gain follows the rules of the general regime, which is based on the principles of realization and specialization of the tax periods".

1. Making reference, in that sense, to the decision of the Supreme Administrative Court relating to process no. 0269/12 of 9 May, as it considered that the same went to the heart of its claim.

2. Finally, in the context of the thesis of error in legal premises, the Claimant further supported its understanding, with respect to the consideration of losses from fair value reduction of capital shares and losses from disposal of capital shares valued at fair value in only 50% of their value, "in the legal solution given in the arbitral decision in process no. 108/2013-T of CAAD".

3. In that decision, the following was sanctioned:

"Article 45/3 of the IRC Code, already transcribed, states that 'the negative difference between capital gains and capital losses realized (…)'.

The analysis of the legal text reveals (…) that the legislator chose (…) three types of situations which should, in view of the presumption of good legislative technique, be considered distinct, namely: 'a) the negative difference between capital gains and capital losses realized through the onerous transfer of capital shares; b) other losses (…) relating to capital shares or other components of equity; other (…) negative patrimonial variations relating to capital shares or other components of equity'.

(…)

The apparent indiscriminate scope of the provisions in question may, however, be reasonably mitigated if one notes that 'losses' and 'other negative patrimonial variations', will be concepts, not redundant, but endowed with a proper and distinct sense.

(…)

Thus, it is concluded that article 45/3 of the applicable IRC Code will relate to: a) negative differences between capital gains and capital losses realized through the onerous transfer of capital shares; b) other losses relating to capital shares or other components of equity; and c) other negative patrimonial variations relating to capital shares or other components of equity. Whereas by 'losses' should be understood facts qualifiable as such in the light of the IRC Code, and by 'negative patrimonial variations' should be understood negative patrimonial variations not reflected in the net result of the tax period, as defined in article 24.

They will not thus be included within the scope of the rule in question, facts qualifiable as 'expenses', in the light of the IRC Code, even if relating to capital shares or other components of equity.

(…)

Moreover, and if there were any doubt, if the legislator, upon entry into force of Decree-Law no. 159/2009, of 13 December, intended to encompass the situations listed in article 18/9/a) of the IRC Code, within the scope of article 45/3 of the same, would have: included 'expenses resulting from the application of fair value in financial instruments', not in article 23, but in article 24 of the IRC Code, or referred to such situations as 'losses resulting from the application of fair value in financial instruments' and not as 'expenses'.

(…)

Thus, and in sum, in obedience to the hermeneutical requirements of article 9 of the Civil Code, according to which 'interpretation should not confine itself to the letter of the law, but reconstruct from the texts the legislative intent, having especially in account the unity of the legal system, the circumstances in which the law was elaborated and the specific conditions of the time in which it is applied' (paragraph 1), and 'in fixing the meaning and scope of the Law, the interpreter will presume that the legislator sanctioned the most correct solutions and knew how to express its intent in adequate terms' (paragraph 3), it is understood that article 45/3 of the IRC Code should be interpreted in the sense that in its provision are not included expenses resulting from the application of fair value in financial instruments, which are relevant to the formation of taxable profit pursuant to paragraph (a) of paragraph 9 of article 18.

In these terms, considering that the applicable article 18/9/a) of the IRC Code imposes the contribution, 'to the formation of taxable profit', without reservations or limitations, of 'income or expenses' that '(…) relate to financial instruments recognized at fair value', 'provided that' they are recognized 'through profit or loss'; they are 'equity instruments'; 'have a price formed on a regulated market'; and 'the taxpayer does not hold, directly or indirectly, a participation in capital exceeding 5% of the respective capital stock', with article 45/3 of the said Code not applying in these cases, in that they are not covered by the normative provision thereof, it is understood that the petition merits granting".

1. In another aspect, the Claimant also raised the violation of the principles of legality, taxpaying ability, and taxation of income by actual profit, "additionally, it will still be said that the assessments here at issue violate the principle of legality in that they are based on interpretations of rules by the TA in instructions and understandings disclosed in specific cases.

No tax or fee is due if it is not clearly and directly provided for and fixed in the Law or in a regulation in accordance with the Law.

(…)

Moreover: by the prohibition of discretionary power as to the elements of the tax, the taxable fact must conform in all elements to the abstract type described in the law: the failure to verify one of them is sufficient for there to be, due to the absence of typicality, place for taxation and aspects relating to it, for example liability and the obligation to pay tax.

The decision to assess the tax in the manner in which it was made disregards still the principle of taxation of actual income (…).

And taking into account the taxpaying ability of each one, in turn, allows treating (from the perspective of contribution to public expenditures) the equal, equally, and the unequal, unequally, to the extent of the inequality (…)."

1. Finally, the Claimant also invoked the illegality of the compensatory interest borne, in the context of the assessment previously referred to, as follows.

2. "The decision of the Tax Administration to require the now Claimant to pay the allegedly due tax and based on arithmetic corrections, on the basis of unclear grounds, evidencing error in legal premises and formal defects, must be annulled, for which reason it is understood that there should also be no payment of the corresponding interest".

3. The Claimant thus concludes its petition, requesting the declaration of illegality of the additional IRC assessment previously identified, and that it be reimbursed in the amount already borne, i.e., €63,409.11, plus compensatory interest.

4. In turn, the Respondent, after being duly notified for such purpose, submitted its response in which, first of all, it considered the Claimant's accusation of lack of reasoning to be very imprecise.

5. Indeed, "(…) such argument very imprecise, especially in the manner in which it is presented. In this context, it is first necessary to note that in the Tax Inspection Report, particularly in point III.1.1 Positive Patrimonial Variations (Transitional Regime), it was by the Tax Inspection Services of … argued that '1. According to article 5, paragraph 1, of Decree-Law no. 159/2009, of 13/07 (…)'.

Now, by reading the transcription above, it is possible to observe that in the drafting of the conclusions of the Tax Inspection Report were not only mentioned all the legal rules that supported the arithmetic correction made, but also, clearly and coherently, the accounting justification (transition from POC to SNC) was explicitly stated, which, in fact, substantiated it.

Notwithstanding, here arrived, even if this had not been the case, that is, even if the Respondent's Services had based the aforementioned arithmetic correction solely and exclusively (…), it will still be said that, pursuant to article 77 of the General Tax Law, 'the procedural decision is always reasoned by means of a brief statement of the factual and legal reasons that motivated it, the reasoning being able to consist of a mere statement of agreement with the reasons of previous opinions, information or proposals, including those that are part of the tax inspection report.'

(…)

Also as regards the alleged lack of reasoning for the arithmetic correction, relating to losses from fair value reduction and losses in financial instruments at fair value, including those in the discretionary portfolio, the alleged defect of lack of reasoning has no basis.

Having analyzed the content of the Tax Inspection Report – whose textual transcription is found in article 41 of the rules of procedure -, first it is concluded that those arithmetic corrections are perfectly reasoned, given that all the legal provisions that supported them are again listed (…).

That is, in the case at hand the reasoning is sufficiently clear and unequivocal (…) in view of which, the aforementioned defect of lack of reasoning should be dismissed, and the tax acts that are being challenged should be maintained in the legal system (…)".

1. Subsequently, the Respondent also addressed the validity of the arithmetic corrections, a question raised by the Claimant, in order to challenge the express denial of the Gracious Complaint submitted with respect to the aforementioned additional assessment.

2. With respect to the accounting loss generated by the liquidation of company B…, S.A., the Respondent argued, by way of introduction, that despite the alleged absence of extension of the inspection procedure that would legitimize the Inspection Services to make the arithmetic correction relating to these losses in financial instruments, as raised by the Respondent, "it should be said that the order of service issued and signed by the taxpayer is of general scope,

(…)

That is, if it is true that what was at the basis of the triggering of the inspection procedure in question was the objective of validation resulting from fair value adjustments – being able, for example, such a campaign to have been inserted in a process of selection of taxpayers, this in strict compliance with the objectives defined for inspection -, such a selection process does not confuse itself, much less has the power to restrict the scope of the orders of service, which, in casu, assumed the nature of general or multipurpose, legitimizing, as stated, the scrutiny of the overall tax situation of the now Respondent.

Furthermore, even if, by hypothesis, the notification of the change in the scope of the inspection procedure had been omitted – which it was not – such violation of formality would be degraded to non-essential, because, in the context of the right to be heard (...), the now Claimant said nothing, limiting itself to pure silence…".

1. As to the arithmetic correction proper, in the case of the loss generated by liquidation, the Respondent considered that since "1) the said capital shares were valued at acquisition cost, 2) were held for more than 1 year, 3) and given that the Claimant is a holding company, it results that the only applicable regime that was imposed was that of article 32, paragraph 2 of the EBF.

(…)

The wording of the said rule is clear, indicating the requirements necessary for holding companies to benefit from the tax benefit.

Now, in casu, the Claimant meets all those requirements, and that capital loss did not contribute – under the principle of neutrality underlying the exemption of article 32, paragraph 2 of the EBF -, to the formation of its own taxable profit.

(…)

Moreover, (…), we have that the expression 'through onerous transfer' - which was in effect in our legal system until the entry into force of Law no. 67-A/2007, having been eliminated by it -, no longer was part of the content of the said rule as of the date of the facts in question.

Thus, given the teleology of the rule and, as well, the principle of neutrality inherent to it, such a capital loss, apart from the capital losses occurring in the remaining financial instruments held by the now Claimant, cannot contribute to the formation of the taxable profit for the year 2010.

(…)

(…) article 32, paragraph 2 of the EBF, as is well known, was, as of the date of the facts, a tax rule of a special nature, applicable to the universe of holding companies, which, absolutely, ruled out the application of the general regime for acceptance of expenses, embodied in article 23 of the IRC Code".

1. In parallel, the Respondent likewise argued, because in its opinion, why the correction made by reference to the gains from fair value increase recognized in retained earnings appeared correct.

2. Indeed, in its understanding, "with the adoption of the SNC, the legislator then considered that conditions had been created to alter the IRC Code and complementary legislation, in order to adapt the rules for determining taxable profit to the IFRS.

Thus, (…), Decree-Law no. 159/2009, of 13 July, was published (…).

Safeguarding the tax impact resulting from that adaptation (…), the legislator established, forthwith, in article 5 of Decree-Law no. 159/2009, a transitional regime, pursuant to which the effects on equity of the adoption for the first time of the new accounting rules that are fiscally relevant are distributed over five years, in equal parts (…)

(…)

Here arrived, and as a consequence of the change in the measurement policy of financial investments described above, having positive adjustments been made, the value of those adjustments must be fully taxed (…) deferred over the period of 5 consecutive years, that is, materialized in 1/5 in each year, beginning in 2010.

Which is what is recorded in the conclusions of the Tax Inspection Report (…)

And let the Claimant not argue that there is a duplication in the taxation of the said positive patrimonial variation, for as is stated in the Gracious Complaint 'it is observed from the law that a transition adjustment should have been made on 2009-12-31, without that having occurred. Fiscally, such adjustment was made, which has repercussions in the following years, so there is no double taxation whatsoever'.

(…)

Everything considered and weighed, the Tax Inspection Report does not merit censure – and, consequently, the assessment at issue – in the part in which it promoted the correction concerning the accounting adjustments of transition resulting from the introduction of the SNC".

1. The Respondent also addressed the arithmetic correction relating to losses from fair value reduction of capital shares valued at fair value and losses from disposal of capital shares valued at fair value.

2. Thus, and in order to counter the arguments set out in the arbitral decision relating to process no. 108/2013, support of the Claimant in this matter, the Respondent brought to the discussion the arbitral decision relating to process no. 25/2015 which, among others, questions the understanding advocated in the first decision.

3. Now, in the context of that decision, the following was sanctioned: "('(…) as to the relationship between accounting and tax law, recognized in the law itself – IRC is an accounting-based tax (…) the rules for determining taxable profit are inscribed in a context of partial dependence of taxation on accounting (…).

From 2010 onwards, paragraph 9 of article 18 of the IRC Code came to allow some income or expenses, even if not realized, to contribute to the formation of taxable profit, namely those provided for, directly or indirectly, in paragraphs (a) and (b) of that provision.

(…)

Given the characteristics above recalled of the relationship between accounting and taxation and some criticisms or perplexities raised by paragraph (a) itself of paragraph 9 of article 18 of the IRC Code, we do not consider evident either the Claimant's thesis, nor the learned considerations and conclusions of the decision of CAAD in process 108/2013-T.

That is, we do not have it as fully demonstrated that despite the legislator having provided, in paragraph (a) of paragraph 9 of article 18 of the IRC Code, that income or expenses contribute to the formation of taxable profit, without reservations or limitations, which (…) relate to financial instruments recognized at fair value, provided that they are recognized through profit or loss; are equity instruments; have a price formed on a regulated market; and the taxpayer does not hold, directly or indirectly, a participation in capital exceeding 5% of the respective capital stock, it intended, in that case, to put an end to the unequal treatment of positive and negative patrimonial variations, provided for in paragraph 3 of article 45 of the IRC Code.

For that, regardless of a judgment of equity or rationality of tax policy on the maintenance of such a rule, justification can be found for the legislator maintaining such unequal treatment.

(…)

As for the argument based on the dichotomy between expenses and losses, it seems to rest on an unjustified overvaluation of the distinction between these concepts. For in the process of adaptation to the new concepts of SNC, it is possible to identify various terminological imprecisions.

(…)

The position of the Tax Administration came to be exposed in the Binding Information in process no. 39/2011 (…) to the effect that: being the fair value reductions of these capital shares qualified as losses should be considered, pursuant to the said article 45, paragraph 3 of the IRC Code, at 50% of their value.

(…)

1. Concluding, once again, the Respondent that "the Tax Inspection Report merits no censure (…) in the part in which it promoted the correction concerning the losses from fair value reduction of capital shares and losses from disposal of capital shares, valued at fair value".

2. Finally, and with respect to the violation of the principles of legality, taxpaying ability, and taxation of income by actual profit, evoked by the Claimant, the Respondent came to advocate that, in its opinion, such understanding did not merit any granting.

3. In conclusion, the TA requests that the claim be judged unfounded and, as a consequence, that it be absolved of the petition.

C) Appreciation of the Collective Arbitral Tribunal

1. By way of a preliminary matter, it falls to the Collective Arbitral Tribunal to determine the timeliness of the request for arbitral pronouncement in question.

2. In this respect, the express denial of the Gracious Complaint previously mentioned, the mediate object of the arbitral challenge analyzed, was notified to the Claimant on 23 November 2015.

3. Now, pursuant to article 10, paragraph 1, paragraph (a) of the RJAT, the request for constitution of an Arbitral Tribunal is presented "within the period of 90 days, counted from the facts provided for in paragraphs 1 and 2 of article 102 of the Code of Tax Procedure and Process, as for acts susceptible to autonomous challenge and, as well, from the notification of the decision or the end of the legal period for decision of the hierarchical appeal (…)", so that period would end on 21 February 2016.

4. Now, having the present initial petition been delivered on 17 February 2016, it is timely.

5. Having determined timeliness, and in order to better structure the present decision, it is necessary to state that the present Tribunal will opt to analyze the various corrections made to the Claimant's taxable profit in a compartmentalized manner, considering that such a procedure will enable a better understanding of the matters.

C.1) Accounting Loss Resulting from the Liquidation of Company B…, S.A.

1. By way of introduction, the present Tribunal considers that there is no limitation to the scope of the inspection carried out by the Respondent, understanding that it is normal, and even common, in the Portuguese tax legal system that inspections, triggered by one reason (in the present case, adjustments resulting from the application of fair value), due to their generalized nature and typically circumscribed to the taxes indicated, can be extended to other equally pertinent matters.

2. Now, having the order of service a generic character, it is not understood how the inspection could have gone beyond its scope, especially since this matter concerns the same tax, i.e., IRC.

3. Having said that, it is clarified, forthwith, that, in the eyes of the present Tribunal, it is established that the Claimant recorded, in its results relating to the tax period of 2010, an expense in the accounts relating to the liquidation of company B…, S.A., in the amount of €200,000.10.

4. A less established question, and which gave rise to the divergence between the Claimant and the Respondent, rests on the fact that the first considers that that expense is not considered, for tax purposes, a capital loss, and cannot, as such, be analyzed in the light of article 32 of the EBF.

5. Thus, the Claimant argues that "what is at issue is a loss recorded by dissolution and liquidation of the company, and not an accounting capital loss", relying, for such purpose, on the decision handed down by the Central Administrative Court of the South in process no. 5097/11, of 31 December 2012, previously cited.

6. It is, however, the opinion of the present Tribunal that such a decision does not meet the Claimant's claim, as the same frames the loss resulting from a liquidation as a capital loss.

7. In fact, "(…) the capital loss resulting from the dissolution and liquidation of the companies above pointed out cannot be disregarded on the basis of the cited article 23 of the IRC Code".

8. Indeed, this understanding, here demonstrated by the aforementioned decision, is substantially transversal throughout all relevant tax jurisprudence and doctrine, it being established that the result of a distribution arising from a liquidation, in the sphere of the partners, is a capital gain or capital loss, if a positive or negative difference is identified, respectively, as compared to the acquisition cost.

9. Such is the case for the purposes of Personal Income Tax ("IRS"), as follows from article 10, paragraph 1, paragraph (b), paragraph 3 of the IRS Code, and it is so for the purposes of IRC, as will be demonstrated below.

10. It is also worth recalling that, notwithstanding article 23 being the first major filter that allows testing the deductibility of an expense or loss for tax purposes, it is not the only one. And, forthwith, it is clarified that it is not intended to question the deductibility of that expense in light of article 23 of the IRC Code.

11. However, one must go further, and analyze the specific rules relating to this matter, not only article 32 of the EBF referred to by the Respondent, but also article 81 of the IRC Code, which addresses this subject.

12. Relevant, in this context, was the presentation of the Respondent which sought, with success, to clarify the meaning of that rule (i.e., article 32 of the EBF), demonstrating that there were valid arguments for extending its application to capital losses resulting from a liquidation of a company.

13. "Moreover, in order to corroborate everything that has been argued up to here, note also that by resorting to an updated interpretation of the rule of article 32, paragraph 2 of the EBF, we have that the expression 'through onerous transfer' - which was in effect in our legal system until the entry into force of Law no. 67-A/2007, having been eliminated by it -, no longer was part of the content of the said rule as of the date of the facts in question.

Thus, given the teleology of the rule and, as well, the principle of neutrality inherent to it, such a capital loss (…), cannot contribute to the formation of the taxable profit for the year 2010".

1. It seems, however, that both parties overlooked, forthwith, the very regime of liquidations, provided for in the IRC Code (the aforementioned article 81), which qualifies as a capital loss the loss resulting from the liquidation of a company, contradicting the Claimant's argument.

2. For the very regime of liquidations itself, before the EBF, the present Tribunal understands that this problem finds its solution in article 81 of the IRC Code, which provides as follows: "(…) this difference, when negative, is considered a capital loss, being deductible only when the capital shares have remained in the ownership of the taxpayer during the three years immediately preceding the date of dissolution (…)" (emphasis ours).

3. Note that, after passing the filter of article 23 of the IRC Code, this expense must be assessed in light of article 81 of the same code, as the latter rule has a more generalist character than article 32 of the EBF.

4. Thus, while in the first we could frame all capital losses generated by the liquidation of companies, regardless of whether the partner is an SGPS or not, in the latter, there is no doubt that only SGPSs could benefit.

5. Thus, it is possible to structure a chain of rules that must be respected until the acceptance of this expense is assessed, in the following order: i) article 23 of the IRC Code; ii) article 81 of the IRC Code; and, finally, iii) article 32 of the EBF.

6. In light of the above, having the capital shares in the liquidated company been acquired in May 2008 and the respective dissolution thereof occurred in September 2010, the minimum holding period that could eventually permit the deductibility, for purposes of IRC, of that capital loss had not yet been completed.

7. That is, even before proceeding to assess the acceptance for tax purposes of the capital loss, pursuant to article 32 of the EBF, which is a special regime, the present Tribunal understands that it could not be accepted, forthwith, by virtue of what is provided for in article 81 of the IRC Code, as the minimum temporal requirement (i.e., 3 years) was not met.

8. Thus, there is no doubt that the correction of the TA should be upheld, at least with respect to this part.

C.2) Gains from Fair Value Increase Recognized in Retained Earnings

1. First and foremost, it is stated that, in the eyes of the present Tribunal, the Respondent legally substantiated its position in the Tax Inspection Report ("RIT"), mentioning, whenever applicable, the law to which it was drawing its understanding.

2. Indeed, there are several demonstrations of such concern, of which we cite a passage, by way of example: "according to article 5, paragraph 1 of Decree-Law no. 159/2009 of 13/07, a transitional regime was established in the context of IRC for the effects of adoption (…)", so the issue raised by the Claimant is not granted, of the lack of reasoning for the correction made.

3. From the outset, it must be emphasized that, in the present case, the merit or relevance of Decree-Law no. 159/2009, of 13 July will not be assessed.

4. Indeed, the concern of this Tribunal will be solely to determine whether, in light of the relevant legislation, the correction made by the TA was made in accordance with the Law, in line with its function as adjudicator and law enforcer.

5. Now, it is stated, forthwith, that the Claimant only questioned the correction made to its taxable profit, never questioning the amounts indicated by the Respondent. Truly, its concern centered on explaining why it did not proceed with the aforementioned fiscal adjustment required by that rule, and not contesting the value presented by the Respondent.

6. Thus, this Tribunal cannot follow the point of view advocated by the Claimant in its initial petition. For, notwithstanding the references made, both to doctrine and to jurisprudence, the Claimant failed to prove the illegality of the correction made.

7. Indeed, as a result of the adoption of NCRF 27, and following the transition from POC to SNC in accordance with NCRF 3 – first-time adoption of NCRF, which provided that accounting adjustments of transition should be recognized directly in retained earnings of 2009, the Claimant altered its accounting policy for the recognition of financial instruments traded on a regulated market, namely equity instruments, from the cost model to the fair value model.

8. Thus, it is important to note that, from 2010 onwards, fair value adjustments, framed in article 18, paragraph 9, paragraph (a) of the IRC Code, situation in casu, contribute to the formation of taxable profit of companies.

9. Indeed, with the introduction of article 18, paragraph 9, paragraph (a) of the IRC Code, the legislator intended to ensure that adjustments associated with the fair value of financial instruments, namely financial investments traded on a regulated market (whose fair value is easy and reliably determinable) that are not held by the taxpayer, directly or indirectly, in a percentage exceeding 5%, were immediately taxed in the year in which they occurred.

10. Moreover, as a result of the transition from POC to SNC in accordance with NCRF 3 – first-time adoption of NCRF, Decree-Law no. 159/2009, of 13 July, in particular in its article 5, came to establish that "The effects on equity resulting from the adoption, for the first time, of international accounting standards adopted pursuant to article 3 of Regulation no. 1606/2002 of the European Parliament and of the Council, of 19 July, which are considered fiscally relevant pursuant to the IRC Code and its complementary legislation, resulting from the recognition or non-recognition of assets or liabilities, or from changes in their measurement, shall contribute, in equal parts, to the formation of taxable profit of the first tax period in which such standards apply and of the four following tax periods" (emphasis ours).

11. Whereby, in light of the above, in the same tax period of 2010, the Claimant should have followed what is set out in the cited article 5 of the said decree, combined with the application of the aforementioned article 18, paragraph 9, paragraph (a) of the IRC Code, subjecting to taxation 1/5 of the gain resulting from the application, for the first time, of the fair value method pursuant to the transitional regime previously set out.

12. It is thus understood, in conclusion, that the TA proceeded correctly, subjecting to taxation the said gain in accordance with the transitional regime indicated above.

13. Thus, the Claimant's challenge with respect to this matter should not be upheld.

C.3) Losses from Fair Value Reduction of Capital Shares Valued at Fair Value and Losses from Disposal of Capital Shares Valued at Fair Value

1. First of all, and referring to what was said above with respect to fair value adjustments resulting from the transitional regime, the present Tribunal considers that the Respondent succeeded in substantiating its correction, and therefore the duty to assess the position of the parties falls.

2. With respect to the last correction made, namely the acceptance, for purposes of determining taxable profit, of losses from fair value reduction of capital shares valued at fair value and losses from disposal of capital shares valued at fair value only in 50% of their value, the parties chose to bring to the discussion two arbitral decisions that are diametrically opposed.

3. Indeed, the Claimant presented the arbitral decision relating to process no. 108/2013-T, while the Respondent extensively cited the arbitral decision relating to process no. 25/2015.

4. It is considered that the question sub judice is solely to determine whether the fiscally relevant expenses, by application of article 18, paragraph 9, paragraph (a) of the IRC Code, in casu, the losses from fair value reduction of capital shares valued at fair value and the losses from disposal of capital shares valued at fair value,

5. Are, after all, only considered, for purposes of determining taxable profit, in half of their value, by virtue of what follows from article 45, paragraph 3 of the IRC Code.

6. From a legal point of view, this framework is, perhaps, controversial, as there is a clear discrepancy in the treatment afforded to expenses and income resulting from the application of fair value, the former being accepted only at 50% of their value and the latter being taxed in full.

7. However, it is not within the purview of the present Tribunal to assess the merit of the rules it applies. Indeed, it falls to it solely to judge the case before it in accordance with what emanates from the said rules.

8. Thus, to attempt, as the Claimant desires, to remove the losses under analysis from what is set out in article 45, paragraph 3 of the IRC Code, is to go in the direction contrary to the letter of the Law, with mere support in conceptual imprecisions.

9. If not, let it be seen,

10. It results from article 18, paragraph 9 of the IRC Code, as of the date of the drafting of the facts, that "adjustments arising from the application of fair value shall not contribute to the formation of taxable profit, being allocated as income or expenses in the tax period in which (…)" (emphasis ours).

11. Expense, for purposes of this rule, corresponds to the totality of the accounting entries (which may or may not have tax relevance) considered as negatively affecting the net result of a company, which include, in particular, losses, capital losses, depreciations, operating expenses, among others.

12. Now, to affirm that expense and loss are watertight and distinct concepts is, in the understanding of the present Tribunal, fallacious. Indeed, loss is a typology of expense.

13. The Respondent brought to the discussion the understanding of C… with respect to this matter, which, for its relevance, we now cite "C… accounts for the attempts to overcome these imprecisions and hesitations about solutions for fear of increasing the disturbance in the legal system. As an example, it cites the headings of articles 20 and 23 of the IRC Code. As to the first (…), and as to the second, 'expenses and losses', observes that expense is a concept that, in accounting, already includes losses".

14. In light of the above, it is clear that the deductibility of that loss, which is, naturally, an expense, must be analyzed in light of article 45, paragraph 3 of the IRC Code, in order to determine to what extent it may fall within the scope of that rule.

15. The rule under discussion provides that "the negative difference between capital gains and capital losses realized through the onerous transfer of capital shares, including their redemption and amortization with capital reduction, as well as other losses or negative patrimonial variations relating to capital shares or other components of equity, designedly supplementary contributions, shall contribute to the formation of taxable profit in only half of its value" (emphasis ours).

16. Now, from the simple interpretation of the relevant normative texts, in their wording as of the date, it can be peacefully concluded that the losses resulting from the reduction of fair value of financial instruments, namely capital shares, and, as well, the losses associated with the disposal of capital shares valued at fair value (which, pursuant to article 46, paragraph 1, paragraph (b) of the IRC Code, are not considered as capital gains) fall within the scope of article 45, paragraph 3 of the IRC Code, whereby, in that sense, they should only be considered, for purposes of determining taxable profit, in half of their value (in the tax period under analysis).

17. Thus, the correction made by the Respondent should be upheld.

18. It is to be noted, in this regard, that the loss is considered in a value greater than that recorded in the Claimant's accounts.

19. Indeed, starting from the fair value of the financial instruments in 2009, and not from their acquisition cost, the difference to fair value at the end of the tax period of 2010 was greater.

20. Upon conclusion of the present Tribunal's analysis, it is important to make a caveat with respect to the violation of certain principles of tax law, duly listed, raised by the Claimant.

21. As was amply demonstrated, the corrections made by the Respondent result from the correct interpretation of the normative texts, the latter limiting itself to applying the Law in the manner normally provided for.

22. Thus, and in light of the express reasoning, the present Tribunal understands that the assessment in question did not violate the principles of legality, typicality, taxpaying ability, and taxation by actual income, to the contrary of what the Claimant argues.

23. Thus, the Tribunal concludes that the corrections made by the Respondent to the Claimant's taxable profit, in the year 2010, do not suffer from any illegality, considering, accordingly, the petition made by the latter, for annulment of the express denial of the Gracious Complaint under discussion and, consequently, of the additional assessment previously mentioned, to be entirely unfounded.

24. In line with the above, the compensatory interest charged by the Respondent should also be maintained.

V. Decision

1. Therefore, this Collective Arbitral Tribunal decides:

A) To judge entirely unfounded the request for arbitral pronouncement and, as a consequence, to declare legal the express denial of the Gracious Complaint previously mentioned and likewise the additional assessment referred to above, by reference to 2010, from which resulted tax payable (and compensatory interest) in the total amount of €63,409.11;

B) To condemn the Claimant in the costs of the proceeding.

VI. Value of the Proceeding

1. The value of the proceeding is fixed at €63,409.11, pursuant to article 97-A, paragraph 1, paragraph (a), of the Code of Tax Procedure and Process, applicable by virtue of paragraphs (a) and (b) of paragraph 1 of article 29 of the RJAT and of paragraph 2 of article 3 of the Regulation of Costs in Tax Arbitration Proceedings ("RCPAT").

VII. Costs

1. In accordance with the provisions of article 22, paragraph 4, of the RJAT, the amount of the arbitration fee is fixed at €2,448.00 in accordance with Table I of the mentioned Regulation.

Notification is hereby given.

Lisbon, CAAD, 26 October 2016

The Arbitrators

(Counselor Dr. José Baeta Queiroz – Presiding Arbitrator)

(Professor Doctor Luís Menezes Leitão – Adjunct Arbitrator)

(Dr. Sérgio Santos Pereira – Adjunct Arbitrator)

(Text prepared by computer, pursuant to article 138, paragraph 5, of the Code of Civil Procedure (CPC), applicable by referral of article 29, paragraph 1, paragraph (e), of the Legal Regime for Tax Arbitration, with blank verses and reviewed by us).