Reverse Merger Financing Costs Deductibility in Corporate Tax (IRC) – CAAD Case 92/2015-T

ARBITRAL DECISION

The Arbitrators José Pedro Carvalho (Presiding Arbitrator), Tomás Castro Tavares and João Menezes Leitão (who voted against the principal decision, as per attached dissenting vote), appointed as arbitrators at the Centre for Administrative Arbitration, to constitute an Arbitral Tribunal:

I – REPORT

On 13 February 2015, A…, S.A., NIF …, of the Tax Office of …, with registered office at …, submitted a request for the constitution of an arbitral tribunal, pursuant to the combined provisions of articles 2nd and 10th of Decree-Law no. 10/2011, of 20 January, which approved the Legal Framework for Arbitration in Tax Matters, as amended by article 228 of Law no. 66-B/2012, of 31 December (hereinafter, abbreviated as RJAT), seeking the declaration of illegality of the following tax acts:

Assessment of Corporate Income Tax ("IRC") no. 2013 … and compensation no. 2013 …, relating to the fiscal year 2009, dated 31 October 2013, from which resulted a total amount payable of € 597,067.43; and

Self-assessment of IRC for the fiscal year 2010, corresponding to Model Declaration 22 of replacement identified by no. …, submitted on 19 December 2013 and accepted, from which resulted tax payable in the amount of € 718,441.36.

To support its request, the Claimant alleges, in summary, that, by means of a merger by incorporation, the acquiring company (Claimant) assumed, by effect of law and immediately, all of the assets of the acquired companies, including the financing expenses incurred by the acquired company to acquire its equity interests, whereby the deductibility of the expenses in the Claimant's legal sphere cannot be questioned, unless there is proof of fraud or abuse.

On 16-02-2015, the request for constitution of the arbitral tribunal was accepted and automatically notified to the Tax Authority.

The Claimant proceeded to appoint an arbitrator, having designated His Excellency Professor Doctor Tomás Castro Tavares, pursuant to article 11/2 of the RJAT. Pursuant to paragraph 3 of the same article, the Respondent indicated as arbitrator His Excellency Doctor João Menezes Leitão.

By the Claimant, an incident regarding refusal of the appointment of the arbitrator designated by the Respondent was raised, which incident was dismissed by order of His Excellency the President of the Deontological Board of CAAD, dated 29-04-2015.

The arbitrators designated by the parties were appointed and accepted their respective duties. Pursuant to article 6, paragraph 2, subsection b) of the RJAT and article 5 of the Regulation for Selection and Appointment of Arbitrators in Tax Matters, the herein Rapporteur was appointed to preside over this Arbitral Tribunal, who, within the applicable period, also accepted the duty.

On 15-05-2015, the parties were notified of this last appointment, having manifested no intention to refuse it.

In compliance with the provision in subsection c) of paragraph 1 of article 11 of the RJAT, the collective Arbitral Tribunal was constituted on 01-06-2015.

On 03-07-2015, the Respondent, duly notified for that purpose, submitted its reply defending itself solely by impugnation, alleging, in summary, that the deduction by the Claimant of expenses of a financial nature related to its own acquisition, resulting from the merger with the company that acquired it, cannot be accepted fiscally, as not indispensable for the realization of income or gains subject to tax or for the maintenance of the source of income, pursuant to the provision in paragraph 1 of article 23 of the IRC Code.

On 25-09-2015, the meeting referred to in article 18 of the RJAT took place, where oral arguments were presented by the parties, commenting on the evidence produced and reiterating and developing their respective legal positions.

A deadline of 45 days was set for the rendering of the final decision, which was extended, pursuant to legal terms, with notification to the parties, given the complexity and breadth of the subject matter. For the same reasons, the deadline referred to in article 21/1 of the RJAT was extended by 60 days.

The Arbitral Tribunal is materially competent and is regularly constituted, pursuant to articles 2, paragraph 1, subsection a), 5 and 6, paragraph 1, of the RJAT.

The parties have legal capacity and standing, are legitimate and are legally represented, pursuant to articles 4 and 10 of the RJAT and article 1 of Order no. 112-A/2011, of 22 March.

The case is not affected by any nullities.

Thus, there is no obstacle to the examination of the merits of the case.

Everything considered, it is appropriate to render

II. DECISION

A. FACTUAL MATTERS

A.1. Facts found as proven

1- Until 19 September 2008, the Claimant was part of the B… Group, and its share capital was entirely held by B… – Partnership Management Company for Equity Interests, S.A.

2- The Fund "C… - …" decided to acquire the Claimant, in the expectation that it could generate sufficient cash-flow to settle the financing debt and also remunerate investors, for which purpose the company D…, SA was incorporated in September 2008.

3- The company D…, SA raised financial resources from the banking sector and its sole shareholder to acquire all shares of the Claimant, executed this acquisition in 2009 and began to share with the acquired company the corporate purpose and administrators, while also having direct interference in the management of the target.

4- In the complex of companies involved in the operation, the one that had the assets, the know-how, the clientele, the market position and that carried out activities capable of generating sufficient cash-flow to cover the costs of investment incurred and serve as collateral to creditors was the Claimant, whereas the acquirer (D…) had as its main asset the shares of the Claimant and its income resulted almost entirely from management services provided to the latter, whereby it did not meet sufficient conditions to serve as collateral to the banking creditor.

5- It was absolutely decisive in the realization of the merger by incorporation (reverse merger) the fact that the banking entity that granted the loan to D… imposed, as consideration for the loan, that the Claimant be the beneficiary of the merger.

6- In compliance with Service Order no. OI2013…, complemented by the external Orders DI2013…, DI2013… and DI2013…, an inspection action was promoted against the Claimant, in the area of IRC and VAT, subsequently expanded to general scope, by reference to fiscal year 2009.

7- Within the scope of the inspection procedure, the following was determined, in summary:

i. On 19-09-2008, through a purchase and sale agreement executed for that purpose, the entities "B… Partnership Management Company for Equity Interests S.A.", in the position of seller, the Fund C… - …, represented by Management Company E… - …, S.A, in the position of "promise to purchase" and "D…", in the position of "buyer", celebrated a purchase and sale agreement of shares.

ii. According to the referred agreement, the promise to purchase ("C…"), indicated "D…", company dominated by "C…", of which it holds an indirect participation of 100% of its share capital, as the purchasing entity of shares representing 100% of the share capital of "A…".

iii. The referred agreement also established the company "F…" wholly owned by "A…" as the buyer of a quota representing 0.003% of the share capital of "G…" of which "B…" was also a holder.

iv. "A…", at the date of the referred agreement, was the holder of quotas representing 99.997% of the share capital of "G…", of shares representing 100% of "H…, INC", a North American company, of shares representing "I…, LTD", an English company and of shares representing 100% of the share capital of "F…", whereby all these equity interests were likewise acquired by "D…" through the referred agreement.

v. The companies "J…", and "D…" were incorporated in 2008, in the same year in which "A…" was acquired by the Venture Capital Fund – C…, via the company "D…" (see diagram of equity interests). As a consequence of that acquisition it resulted that:

• The company "A…" came to be held 100% by the company "D…";

• The company "D…" came to be held 100% by the company named "J…" which, in turn, was also held 100% by "E…";

• The administrators/managers were common to the various companies that subsequently participated in the merger process that came to be realized.

vi. With respect specifically to the company "A…", it was verified that:

• The company always had considerable operational activity in the sector of production and commercialization of plastic products and their transformations;

• The financial statements as of 31-12-2008, and those relating to previous fiscal years, reflect this reality, as they showed quite significant positive net results;

• The medium and long-term liabilities and debts to credit institutions presented a value balanced by current assets.

vii. With respect to the company "D…", the following was verified:

• The company was incorporated with the corporate purpose "Production and Commercialization of Chemical Products and Transformed Plastics";

• In its results structure, in operational terms it only presented operations at the level of service provisions, which corresponded entirely to the provision of administration and management services to "A…" and, especially, at the financial level;

• Model Declaration 10 was presented, whereby the personnel costs presented did not evidence employees in its service related to its corporate purpose;

• In the financial statements prepared with reference to 31-12-2008, the assets consisted essentially of "Financial Investments", corresponding to the acquisition value of 100% of the shares of company "A…", for €56,086,000.00;

• Equity included the value of €4,750,000.00 of supplementary contributions and liabilities the value of bank financing, in the total amount of €23,200,000.00 contracted with Bank … and supply contracts granted by its shareholder "J…", in the amount of € 19,200,000.00 and € 10,500,000.00.

viii. With respect to "J…", the following was verified:

• The entity "J…" was incorporated on 21-07-2008, at the same time as the incorporation of the company "D…" (11-09-2008) and the purchase of shares of "A…" by "D…" (19-09-2008);

• Its corporate purpose was also "Production and Commercialization of Chemical Products and Transformed Plastics", with no operational activity or structure evident for the declared corporate purpose;

• In assets were Financial Investments - loans to group companies: € 34,450,000.00 (to finance part of the price of shares of "A…");

• In equity were Supplementary Contributions of € 4,750,000,000;

• In Liabilities were the loans granted to "D…" in the amount of € 19,200,000.00 and € 10,500,000.00.

ix. In the year 2009, there was a process of merger by incorporation of the companies "F…" and "D…" into "A…" as a result of which the incorporated companies "F…" and "D…" were extinguished.

x. As a result of this process, the financial statements of "A…" came to reflect the assets, liabilities and results obtained by the various companies during 2009, as the merger operation project was registered in the Commercial Registry Office of Lisbon on 22-12-2009, with effects, from the accounting perspective reported to 01-01-2009.

xi. The following was the diagram of equity interests at the date of the referred merger:

[Diagram reference]

xii. From the text of the "Merger Project", the intervening companies had the following corporate purposes:

• The company "F…", the management of equity interests in other companies, as an indirect form of exercise of economic activities;

• The companies "A…" and "D…", the production and commercialization of plastic products and their transformations.

xiii. In the text of the "Merger Project", the following were pointed out as reasons for the realized operation:

• The companies A… and D… had as corporate purpose the production and commercialization of plastic products and their transformations;

• F… was a company wholly owned by A…;

• The existence of three separate companies was implying a set of efforts (administrative and service costs), with increased expenses;

• The management of companies with the same corporate purpose and centralized in a single company would generate considerable synergies, through greater flexibility in management and planning;

• The companies participating in the merger process were, directly and indirectly dependent on the company named J…, SA, with registered office at Avenue …, …, …, in Lisbon;

• The ACQUIRING company was held 100% by the incorporated company D…, which in turn held 100% of the share capital of the incorporated company F….

xiv. Given the accounting for the merger by incorporation operation, the balance sheet of company "A…" as of 31-12-2009 came to show "the sum of assets and liabilities", where it was verified that:

• In Assets was the item of Intangible Fixed Assets "goodwill", in the amount of € 37,395,166.00, which corresponds to the difference of assets and liabilities transferred to the legal sphere of "A…" in the merger operations previously referred to;

• In Liabilities was the item of debts to credit institutions (…), and within this the amount of €23,200,000.00, of which €1,660,000.00 accounted in the item short-term loans", account "23114 Senior Debt Tranche A", and €21,540,000.00 in the account medium/long-term loans "Account 23124 - Senior Debt Tranche A", corresponding to the bank loan previously contracted by "D…", in the total amount of €23,200,000.00. There was also the debt to shareholder "J…", in the amount of €19,200,000.00 relating to supply contracts provided.

xv. The income statement came to show, in addition to operating results, which registered an increase of approximately 20% compared to the previous year (RO for 2009 = € 2,013,640.00 and RO for 2008 = € 1,673,665.00), also a negative financial result of (€-5,269,325.00), compared to that obtained in 2008 (€-629,968.00), which resulted essentially from financial costs related to interest borne, resulting from the accounting by company "D…" of financial charges arising from the bank loan contracted with Bank… and supply contracts celebrated in 2008 with the shareholder ("J…"), in the amounts of €19,200,000.00 and €10,500,000.00.

xvi. From the financial statements of "A…" it resulted that interest costs in 2009 amounted to €5,963,438.00, compared to an amount of interest borne in fiscal year 2008 of €1,433,111.00.

xvii. As a result of the merger operation, which occurred in 2009, the now Claimant came to present from that point forward and until 2011 tax losses, the value of the tax loss for fiscal year 2009 of €3,354,296.53, a value that deviates significantly from a history of tax profits presented by the company in the three-year period prior to 2009, as per the following table:

[Table reference]

8- In the scope of the reverse merger, in which the Claimant was the acquiring company, its shares, which were part of the assets of D…, were delivered, in exchange for the equity interests of this company, to its partner – the company J….

9- The Inspection thus concluded that:

a. "through the merger, what is verified is that "A…" came to hold a liability, corresponding to the assumption of responsibility for a bank financing and respective interest rate coverage contracts, and financing from its shareholder "J…", previously contracted by "D…", precisely for the acquisition of an asset that is embodied in its own equity interests.";

b. "In this way and based on the analysis of elements related to the matter at issue, it is verified that the company "A…" is, since the merger, responsible for the said bank loan and respective interest rate coverage contract, and supply contract made available by "J…" and consequently for the payment of the owed interest, loans which were contracted by "D…" in 2008 for the acquisition of 100% of the equity interests of "A…" for €56,086,000.00.";

10- Thus, corrections of a merely arithmetic nature were made to the taxable matter in the amount of €5,340,452.33, consisting of the deduction by the Claimant of expenses of a financial nature not accepted fiscally, as not indispensable for the realization of income or gains subject to tax or for the maintenance of the source of income, pursuant to the provision in paragraph 1 of article 23 of the IRC Code.

11- Following that inspection action, another was triggered, authorized by Service Orders nos. OI2013…, OI2013… and OI2013…, of general scope for the fiscal years 2010, 2011 and 2012.

12- Within the scope of the first of those referred to in the previous point, corrections of a merely arithmetic nature were proposed to the taxable matter in the amount of €4,351,420.28, by reference to fiscal year 2010, likewise consisting of the deduction by the Claimant of expenses of a financial nature not accepted fiscally, as not indispensable for the realization of income or gains subject to tax or for the maintenance of the source of income, pursuant to the provision in paragraph 1 of article 23 of the IRC Code, as well as the corresponding correction of the declared tax losses.

13- In order to benefit from the regime of Decree-Law no. 151-A/2013, of 31 October, the Claimant submitted, on 2013-12-19, a periodic IRC declaration of replacement, relating to the fiscal year in question, where it proceeded to the regularization and correction of the declared values, in accordance with the proposed corrections.

14- Regarding the year 2009 a total of €536,963.87 was paid, whereas regarding the year 2010 a total of €718,441.36 was paid.

15- The referred payments were made on 27 December 2009, by the company J…, under a subrogation regime duly authorized by the competent entities.

16- The tax assessment act relating to fiscal year 2009, as well as the self-assessment relating to fiscal year 2010 were subject to administrative appeal, which were dismissed by order of 2014-11-14 of the Head of the Administrative and Contentious Justice Division, by sub-delegation of the Tax Director ….

17- The referred acts were notified to the Claimant, via facsimile, by Office Letters nos. …/0403 and …/0403, of 2014-11-17.

A.2. Facts found as not proven

With relevance to the decision, there are no facts that should be considered as not proven.

A.3. Justification of the proven and not proven factual matters

Regarding factual matters, the Tribunal does not have to pronounce on everything that was alleged by the parties, but rather the duty of selecting the facts that are important for the decision and discriminating the proven matter from the not proven matter (cfr. art. 123, paragraph 2, of the CPPT and article 607, paragraph 3 of the CPC, applicable pursuant to article 29, paragraph 1, subsections a) and e), of the RJAT).

Thus, the facts pertinent for the judgment of the case are chosen and cut out based on their legal relevance, which is established in attention to the various plausible solutions of the legal question(s) (cfr. previous article 511, paragraph 1, of the CPC, corresponding to the current article 596, applicable pursuant to article 29, paragraph 1, subsection e), of the RJAT).

Thus, having in consideration the positions taken by the parties, in light of article 110/7 of the CPPT, the documentary evidence and the administrative procedure files attached to the case, the facts above enumerated were considered proven, with relevance to the decision.

B. ON THE LAW

The situation at issue in the present case is of relatively simple configuration and may be, summarily and in its essential features, described as follows:

• The Claimant, in 2009, was the acquiring company in a merger by incorporation operation (known as a reverse merger), in which was incorporated, among other things, the company that held 100% of its equity interests;

• The referred incorporated company held in its liabilities, debts arising from financing and supply contracts, whose amounts had been applied to the acquisition of equity interests of the acquiring company;

• By effect of the merger operation, the company resulting from the same (now Claimant) succeeded to the incorporated company in said obligations (financing and supply debts), and had, in the years (now at issue) 2009 and 2010, to bear the corresponding expenses, and it is certain that, by effect of that same operation, the Claimant's equity interests that were part of the assets of the incorporated company (its participant), did not pass to its ownership, and equity interests of the now Claimant were attributed to the partner entity of that incorporated company, in exchange for the equity interests it held in this, and which also by force of the same operation, were extinguished.

The question that arises is, equally, of simple configuration, and relates solely to assessing whether, as the Tax Authority contends, the expenses corresponding to the charges with financing and supply contracts borne by the now Claimant meet the requirements of article 23/1 of the CIRC, relating to their indispensability for realization of income or gains subject to tax or for the maintenance of the source of income, and, consequently, whether they can be deducted in determining the taxable profit thereof.

It is, fundamentally, this that is presented to this Tribunal to decide.

Let us see then.

From a general point of view, Claimant and Respondent converge on what has been the trajectory established by national doctrine and case law on the matter of indispensability of expenses, whose essential features can be synthesized as follows:

• The judgment on the indispensability of expenses incurred implies that its contribution to obtaining income or gains subject to tax or maintaining the source of income be verified (cfr. article 43 of the Respondent's Response);

• "The legal notion of indispensability is shaped, therefore, from an economic-business perspective, by direct or indirect fulfillment of the ultimate motivation of contributing to obtaining profit" and "the fiscal deductibility of the cost depends solely on a causal and justified relationship with the company's activity." (Court of Audit decision, rendered on 30-11-2011, in case no. 0107/11, cited in the Respondent's Response);

• "the costs (...) cannot fail to respect, from the outset, the taxpayer company itself. That is, for a given sum to be considered a cost thereof it is necessary that the respective activity be developed by it itself, not by other companies." (Court of Audit decision, rendered on 30-05-2012, in case no. 0171/11, cited in the Respondent's Response);

• "a concept of indispensability that, moving definitively away from the idea of causality between expenses and income, places emphasis on the relationship of expenses with the activity pursued by the taxpayer, that is, considering that the said concept of indispensability is verified whenever expenses are incurred in the interest of the company, in pursuit of its respective activities." (Court of Audit decision, rendered on 04-09-2013, in case no. 0164/12, cited in the Respondent's Response);

• the concept of indispensability is of case-by-case application, and the nexus of economic causality cannot be disconnected from the factuality of the specific case (cfr. articles 118 of the Initial Request, and 77 of the Response);

• "the Tax Authority cannot assess the indispensability of costs in light of criteria related to the opportunity and merit of the expense. A cost is indispensable when it relates to the company's activity, whereas costs unrelated to the company's activity will be only those in which it is not possible to discern any causal nexus with the income or gains (or with the income, in the current expression of the code - cfr. art. 23, no. 1, of the C.I.R.C.), explained in terms of normality, necessity, congruence and economic rationality." (Court of Administrative Appeal – South decision, rendered on 16-10-2014, case no. 06754/13, cited in the Initial Request);

• "The indispensability of the cost must result simply from its connection to business activity. If the cost is not unrelated to the company's activity, that is, if it relates to the normal activity of the company (regardless of whether the degree of intensity or proximity is greater or lesser), and if its existence is accepted (one is not facing an apparent or simulated cost), the cost is indispensable." (Court of Administrative Appeal – North decision, rendered on 20-11-2011, case no. 01747/06.3BEVIS, cited in the Initial Request);

• "from the legal notion of cost provided by art. 23° of the CIRC it does not follow that the Tax Authority can put in question the principle of freedom of management, scrutinizing the soundness and opportunity of the company's management decisions and considering that only those from which directly result profits for the company or that prove to be convenient for the company can be assumed fiscally. The indispensability to which art. 23° of the CIRC refers as a condition for a cost to be deductible does not refer to necessity (the expense as a sine qua non condition of income), nor even to convenience (the expense as convenient for business organization), under penalty of intolerable interference by the Tax Authority in the autonomy and freedom of management of the taxpayer, but requires, only, a relationship of economic causality, in the sense that it is enough that the cost be incurred in the interest of the company, in order, directly or indirectly, to obtain profits.

The legal notion of indispensability is shaped, therefore, from an economic-business perspective, by direct or indirect fulfillment of the ultimate motivation of contributing to obtaining profit. The indispensable costs are equivalent to expenses incurred in the interest of the company or, in other words, in all acts abstractly subsumable in a profitable profile. This objective brings, intentionally, the economic and fiscal categories closer, through a primarily logical and economic interpretation of legal causality. The necessary expense is equivalent to any cost incurred in order to obtain income and that represents an economic decline for the company. As a rule, therefore, the fiscal deductibility of the cost depends solely on a causal and justified relationship with the company's activity. And outside the concept of indispensability will only remain the acts contrary to the corporate purpose, those that do not fit in the interest of the company, especially because they do not aim at profit." (Court of Audit decision, rendered on 30-11-2011, case no. 0107/11, cited in the Initial Request);

• "The rule is that correctly accounted expenses are fiscal costs; the criterion of indispensability was created by the legislator, not to allow the Administration to meddle in the management of the company, dictating how it should apply its resources, but to prevent the fiscal consideration of expenses that, even if accounted for as costs, do not fall within the scope of the company's activity, were incurred not for its pursuit but for other interests unrelated to it. Strictly speaking, these are not true costs of the company, but expenses that, having in view their object, were abusively accounted as such. Without the Administration being able to assess the indispensability of costs in light of criteria related to their opportunity and merit.

The concept of indispensability not only cannot be equated with a strict judgment of imperative necessity, as has been said, but also cannot be based on a judgment about the convenience of the expense, made necessarily a posteriori. For example, expenses made with an advertising campaign that proved fruitless cannot, solely on the basis of that result, be said to be dispensable.

The judgment on the opportunity and convenience of expenses is exclusive to the businessman. If he decides to make expenses with a view to pursuing the company's purpose but is unsuccessful and those expenses prove ultimately unproductive, they nevertheless remain fiscal costs. But any expense that is accounted for as a cost and proves unrelated to the company's purpose is not a fiscal cost, because it is not indispensable.

We understand (...) that, under penalty of violation of the principle of taxpaying capacity, the Administration can only exclude expenses not directly excluded by law under strong motivation that convinces that they were incurred beyond the corporate objective, that is, in pursuit of another interest that is not business-like, or, at least, with clear excess, deviating from the objective needs and capacities of the company." (Court of Audit decision, rendered on 29-03-2006, case no. 01236/05, available at www.dgsi.pt);

Thus, the decision criteria being consensual, there remains, solely, the operation of application of such criteria to the specific case, a task that, this one indeed, rises to other levels of difficulty.

This operation of applying the referred criteria to the type of situation at issue in the present case was already attempted in arbitral cases nos. 14/2011-T, 101/2013T, 87/2014-T and, more recently, no. 42/2015T, all of the Centre for Administrative Arbitration.

Given the particular interest for the solution to be given in the present case, the analysis of each of those referred decisions will follow below.

In case 14/2011-T, the Tribunal, among other matters, addressed itself then to a question identical to that which now arises sub iudice.

From the very learned exposition in the referred decision, the following is highlighted:

• "to decide on the deductibility of financial charges arising from the loan in question, what matters at the point is the objectivity of the operation documentally proven in the case and its relationship with the topics contained in paragraph 1 of article 23 of the CIRC, it is incumbent here only to verify, as the Claimant itself refers, whether the funds obtained were concretely applied to purposes unrelated to the activity of the company that is their debtor. Hypothetical elements, such as are the options, very often copious and diverse, that the company could have taken, or the possibilities of structuring the operations in other ways, also often numerous, are not relevant to the assessment of the matter sub judice, given that we are not dealing here with virtual situations, situations that could have happened but did not, but rather with occurrences verified in the reality of life, as considered proven. Effectively, what it is incumbent upon this Tribunal to develop is the scrutiny of the legality of the tax act challenged having in view the concrete elements of the case submitted to its consideration and the complex of evaluations made and justifications presented by the Tax Authority.";

• "the fiscal deductibility of interest borne depends on a judgment as to its indispensability for the realization of income or gains subject to tax or for the maintenance of the source of income (body of paragraph 1), explicitly with subsection c) of paragraph 1 of this provision clarifying that such interest on third-party capital is "applied in the operation".";

• "Thus, it is strictly in relation to the entity whose costs are under consideration, having regard to the business activity it develops, that the fiscal deductibility of financial charges must be assessed. This fiscal deductibility presupposes, therefore, that the costs incurred with financial charges possess a causal connection with the business activity developed, especially serving the development of the activity of the company indebted to them. Consequently, as observed by MARIA DOS PRAZERES LOUSA, "The problem of the deductibility of interest for purposes of determining taxable profit" in Studies in honor of Dr. Maria de Lourdes Correia e Vale, Lisbon, 1995, p. 349, interest borne by a company cannot be accepted as deductible in relation to loans in which it is manifestly proved that the funds obtained are "diverted from the operation and applied to purposes unrelated to it". In another formula that we find in RUI DUARTE MORAIS, Notes to the IRC, Coimbra, 2007, p. 87, "if the charge was determined by other motivations (personal interest of shareholders, administrators, creditors, other companies in the same group, business partners, etc), then such cost should not be considered indispensable";

• "to proceed with the application to the case at hand of the requirement of indispensability of costs, it is necessary to verify, on the basis of all relevant facts and circumstances, the effective and concrete allocation of the loan for which the interest borne is the remuneration, in other words, it is important to consider the destination or use of funds obtained in relation to which the taxpayer intends to fiscally deduct, for purposes of determining its taxable profit, the interest and other associated charges it bore.";

• "it is evident from the proven factual matter that the funds at issue have as purpose, destination and use the acquisition of the Claimant's own equity interests by the company D... SGPS, whereby the allocation of the loan is not related to the activity nor to assets held by the company that is indebted to it, the here Claimant, but rather to assets held by its own partner.";

• "The equity interests in question are thus part of the assets of D..., partner of the Claimant, and not of the Claimant itself (case in which they would constitute treasury shares), whereby the ownership and use of such asset, to whose acquisition the occurred financing and the financial charges borne by the Claimant without any consideration are imputable, results exclusively in benefit of the partner D... and not of the Claimant.";

• "Precisely, it is verified in the case that the entity that can benefit, in its own interest, as a source of income from this asset is not the entity that bears, exclusively, the costs related to the financing of the acquisition of the asset (the Claimant), but rather a distinct entity, in this case its sole partner (D...).

An asset which, it is important to note, is constituted by the Claimant's own shares, incurring it thus in costs with a loan that served for the acquisition of its own capital by another entity. It is not possible, therefore, to fail to recall here the disfavor with which the legislator itself looks at this type of situation in the terms that flow from art. 322 of the Commercial Companies Code, which provides in its paragraph 1 that: "A company cannot grant loans or in any other way provide funds or provide guarantees for a third party to subscribe to or otherwise acquire shares representing its capital".

We have, therefore, that the costs incurred with the loan in question are not applied in the operation of the Claimant itself, in its business activity, nor do they serve the maintenance of the source of income. Such costs, although entered in the accounting of the Claimant, do not benefit its activity nor the respective business interest, but rather benefit a third party, in this case its sole partner D... SGPS.

There is not, therefore, here the "balancing or matching" between the costs borne with financial charges and the respective income, which should be considered relevant in the context of the requirement of indispensability of costs for fiscal purposes as provided by art. 23 of the CIRC".

This judgment also includes a dissenting vote, from which the following is highlighted:

• "The first question is whether the indispensability of financial charges should be judged in relation to the merged company or in relation to the company benefiting from the merger. Such judgment must be made, at first, in the perspective of the company that contracted the financial charge and cannot be made in the individualized perspective of the company benefiting from the merger. It is not questioned that the charges assumed by the merged company are deductible by it, pursuant to art. 23, no. 1 subsection c) of the CIRC (interest on third-party capital applied in the operation).";

• "From the moment in which the assets of the merged company are globally transferred to the company benefiting from the merger (ex-art. 67, no. 1 subsection a) of the CIRC, applicable to the case) with extinction of the merged companies, the fiscal deductibility of the financial charges assumed must be evaluated, for legal-fiscal purposes, in the context of the merger.

The merger implies the transfer of rights and obligations to the benefiting company (art. 112 a) of the CSC), and in this case we have two possible interpretive lines to judge the requirement of indispensability of a cost: one line is to consider that as long as the cost was considered deductible in the sphere of the merged company, it continues, in principle, to be deductible in the sphere of the company benefiting from the merger, given that the debt is transferred to the latter company and the merged company lost its existence; and this will only not happen if there was abusive conduct or a transfer of debt that violates the law (for example, because the principle of untouchability of the capital of the benefiting company is not observed). The other interpretive line implies considering the perspective of the commercial exploitation of the complex of entities involved, in an interpretation that values substance over form (art. 11, no. 3 of the LGT). The relationship of economic causality between the assumption of a cost and its realization in the interest of the company should take into account the joint purposes of the entities involved in the merger.

In cases of leveraged acquisitions, both referred lines have been followed in other legal systems: the first line, the application in principle of the general rule, followed by correction based on abuse, is adopted by the tax administration and the application of the general anti-abuse clause controlled by French courts (V. Cases with leveraged acquisitions: see for example a case of exchange of shares, with exceptional distribution of dividends: Conseil D'État no. 320313, of 27.1.2011, Rapporteur Mme Cécile Isidoro; LBO et abus de droit, Fiscal Procedures, Review of Tax Law, no. 15, of 14.4.2011, pp. 36-42; cfr. Also, a case of exchange of shares: Conseil D'État no. 301934, 08.10.2010, Rapporteur M. Jean-Marc Anton; and a case of asset entry: Conseil D' État no. 313139, of 8.10.2010, Rapporteur M. Patrick Quinqueton);

The second interpretive line is explicitly adopted in the German legal system for cases of reverse merger: as long as the share capital is safeguarded, it is understood that there is no hidden distribution of dividends and the debt is transferred to the company benefiting from the merger (the affiliated company): see in this regard Thomas Rödder/Peter Wochinger "Downstream Merger mit Schuldenübergang", DStR, 2006, pp. 684-689, and the case law and doctrine cited therein).

In the case before us, I understand that interest borne by corporate income taxpayers as remuneration of loans contracted and other associated financial charges are, in principle, deductible as costs in determining taxable profit in accordance with the provision in art. 23 of the CIRC, no. 1, subsection c), according to which, in the wording in force in 2007, "costs or losses are considered that are comprovedly indispensable for the realization of income or gains subject to tax or for the maintenance of the source of income", namely "charges of a financial nature, such as interest on third-party capital applied in the operation". In the case before us, the "indispensability" and "application in the operation" were associated with the merger operation, given that this operation was agreed with the financing bank (cfr. nos. VII and VIII of the decision on proven facts), whereby the interpretation in the perspective of commercial exploitation of the complex of entities involved implies the recognition of the debt and interest as fiscal costs of the company benefiting from the merger.

In general, in the reverse merger, even if the indispensability of interest relating to a loan had originally been evaluated only at the level of the mother company (which was not the case), they should henceforward be evaluated, for fiscal purposes, in the context of the overall business complex of the company (V. Thomas Rödder/Peter Wochinger "Downstream Merger mit Schuldenübergang", DStR, 2006, p. 685).";

• "Admitting then that art. 23, no. 1 subsection c) of the CIRC must take into account the activity of the complex of companies participating in the merger operation and not just the benefiting company (the Claimant), it would then be necessary to ascertain whether the motivations for the reverse merger were essentially or mainly fiscal, applying art. 38, no. 2 of the LGT to the deductibility of interest.".

In the case now at hand, it was considered that "the entity that can benefit, in its own interest, as a source of income from this asset is not the entity that bears exclusively the costs related to the financing of the acquisition of the asset (the Claimant), but rather a distinct entity, in this case its sole partner (D...).", and that "the costs incurred with the loan in question are not applied in the operation of the Claimant itself, in its business activity, nor do they serve the maintenance of the source of income. Such costs, although entered in the accounting of the Claimant, do not benefit its activity nor the respective business interest, but rather benefit a third party".

Subject to (great) respect, it appears that the position which prevailed in the judgment under analysis is susceptible to criticism in some aspects that are structural to it.

Thus, the consideration that "the costs incurred with the loan in question are not applied in the operation of the Claimant itself, in its business activity, nor do they serve the maintenance of the source of income", will suffer, from the outset, from some imprecision with relevant consequences for the conclusions to be drawn.

That is, unless better advised – and always subject to great respect – "costs" are not, ontologically, susceptible to "application". That which will indeed be susceptible to application is the counterpart of these costs, which, in the case and in the terminology of subsection c) of paragraph 1 of the CIRC, will be the "third-party capital" obtained via financing and supply contracts. It happens that in the argumentative framework in which the consideration at issue is situated, the mention of "costs" is not – it is believed – interchangeable with the mention of "third-party capital".

Effectively, the third-party capital obtained by the incorporated company, by way of financing and supply contracts, was fully applied (exhausted) when the equity interests of the company, subsequently, its acquiring company were acquired. In the case or cases, that is the reality: the amounts obtained through financing and supply contracts did not endure until a post-merger moment, being then redirected in their purpose, but when that occurred, they were already fully applied.

The finding that the pecuniary obligations of payment of interest on the borrowed capital endure in the post-merger moment, which is a fact, will not obstruct the conclusion formulated, which is in question, precisely the deductibility thereof. Effectively, the application to which subsection c) of paragraph 1 of article 23 of the CIRC refers is directed to "third-party capital", and not to any obligations.

Thus, it is believed that in any of its possible meanings, the statement above referred to is not susceptible to acceptance. Effectively, in its literal tenor, costs will not be susceptible to application. Referring it to "third-party capital" remunerated by the pecuniary obligations of interest payment, these same were already fully applied, whereby it cannot be considered valid the statement that "third-party capital" remunerated by "the costs incurred with the loan in question are not applied in the operation of the Claimant itself, in its business activity, nor do they serve the maintenance of the source of income", since there was no alteration in the application thereof.

Thus, it is believed that it will not be susceptible to validation the judgment according to which there was a deviation in the application of the counterpart of the expenses whose deductibility is questioned, given that this application, at the moment in which the expenses are accounted for, was, as just seen, completely consumed.

It could then be questioned whether the mediate product of the expenses (the equity interests of the company subsequently acquiring) were "diverted", and in some way, the statement that "the entity that can benefit in its own interest as a source of income from this asset is not the entity that exclusively bears the costs related to financing the acquisition of the asset" may point to argumentation in that sense, which should nevertheless be considered substantially distinct from the previous one.

It is not subscribed in any case to the above-referred statement, from the outset, given that it is considered that there is no identity (although there is a similarity) between the "asset" that was held, pre-merger, by the incorporated company and the "asset" that passed, post-merger, to the acquiring company of that one, given that the effect of the merger by incorporation is not the transmission of the equity interests held by the incorporated company to its respective shareholder(s), but the attribution by the acquiring company of its own shares to the shareholder(s) of the incorporated company.

From this it follows then, among other things, that the acquisition of equity interests of the acquiring company by the shareholder(s) of the incorporated company is not consideration of the product of the financing contracted by it, but – rather – of the equity interests it held in that one and of which it becomes deprived by force of its extinction, effect of the merger.

The understanding of what has just been explained also points to another conclusion, with which the decision in the case now under analysis will be incompatible: the circumstance that the attribution of shares of the company resulting from the merger to the shareholder(s) of the merged company does not have as its cause the product of the financing and supply contracts contracted by it implies that there was no "diversion" whatsoever of the mediate product of those financing and supply contracts to the shareholder(s) of the merged one.

Possibly, it could be questioned – and it is not – the amount of shares of the acquiring company attributed to the shareholder(s) of the incorporated company. However, even there it is possible to detect a principle balance, translated in the circumstance that the value attributed to it is precisely the same that it held before. Indeed, pre-merger, the shares of the incorporated company would have, roughly, the value corresponding to the shares of the acquiring company (which, to the extent that it holds all of the share capital thereof, is precisely equivalent to its value), deducted from the liability constituted for its acquisition. Post-merger, the equity interests attributed to the shareholder(s) of the incorporated company have therefore precisely the same value.

It will not be exact then, for all that has been set forth, to assert fundamentally that there will be a company that owns and benefits from the asset and another that bears the expenses, at least not in a sense different from what already occurred before the merger, in which the shareholder(s) of the incorporated company are that, ultimately, via the appreciation of its equity interests, benefited from the payment by it of the cost of acquisition of the acquiring company, being the incorporated company the one who bore the expenses that provided such appreciation. This will be precisely the situation post-merger, in which the equity interests attributed to the shareholder(s) of the acquiring company have – exactly as will be seen below – the same value as the equity interests that it previously held in the incorporated company, and will be appreciated, just as before the merger, as the financing contracted is being reimbursed.

Thus, in sum and by what has been set forth, the conclusions of the Judgment in question cannot be ratified in that, in the situations that concern us, it is verified that:

• the entity that can benefit in its own interest as a source of income from this asset is not the entity that exclusively bears the costs related to financing the acquisition of the asset (the Claimant), but rather a distinct entity, in this case its sole partner;

• the costs incurred with the loan in question are not applied in the operation of the Claimant itself, in its business activity, nor do they serve the maintenance of the source of income;

• the costs incurred with the loan rather benefit a third party.

The overall consideration underlying the decision in question remains to be addressed, regarding the Claimant, when it incurs them, no longer having in its possession the mediate product of the expenses it bears, which is a distinct question from that on which the judgment under analysis was based, in understanding that there exists a third party as the beneficiary of that product (which, as is seen, will not be what occurs), and which will be assessed further below.

With respect to the dissenting vote of Member Ana Paula Dourado, it is noted that its synthetic character also leaves, for it, room for criticism.

Indeed, referring that "the fiscal deductibility of the financial charges assumed must be evaluated, for legal-fiscal purposes, in the context of the merger", associating it with the need to "consider the perspective of commercial exploitation of the complex of entities involved", and specifying that "the "indispensability" and "application in the operation" were associated with the merger operation, given that this operation was agreed with the financing bank", suggests that in the evaluation to be made one should open the doors to the consideration of perspectives that are not restricted to those of the companies directly participating in the merger process (acquiring or incorporated), which, as will also be seen, is understood not to be the case.

In case 101/2013-T, the Tribunal was likewise charged with rendering a decision on a question identical to that which now arises.

From the also very learned exposition in the referred decision, the following is highlighted:

• "The possibility that the company could continue its activity without carrying out certain expenses does not detract from a conclusion in the sense of such indispensability. It only detracts a judgment to the effect that the expenses in question do not have the potential to positively influence obtaining income.

A conclusion in the sense of dispensability of expenses for obtaining taxable profit will have to be based on a demonstration that even if the expenses in question had not been carried out, the income or gains that were effectively obtained could have been obtained.

This means that a conclusion in the sense of indispensability of expenses for obtaining income or gains must be rejected only if one can assert that those expenses had no potential to positively influence them.

Thus, it is not necessary to demonstrate that they produced an effectively positive result in order to attribute fiscal relevance to financial charges.

It suffices that they be acts that can be accepted as management acts, acts of the type that a company would perform with the objective of increasing income and with potential tendency to provide such increase.

In this matter, the scrutiny by the Tax Authority must be a scrutiny by the negative, rejecting as costs only those that clearly have no potential to generate increase in gains, and the competent administrative agent for determining the taxable matter cannot "set itself up as a manager and qualify indispensability at the level of good and bad management, according to its feeling or personal sense; it suffices that it be an operation conducted as a management act, without entering into the assessment of its effects, positive or negative, of the expenditure or charge assumed for the results of the realization of income or for the maintenance of the source of income»";

• "what is at issue becomes only ascertaining whether a hypothetical lack of indispensability of those charges for the realization of the clinical analysis activity carried out by the Claimant in the year 2008 can lead to the irrelevance of such costs for the determination of the company resulting from the merger.";

• "the interpretation adopted by the Tax Authority and Customs, in making the correction of the taxable matter of the Claimant, which consisted in ascertaining the relevance of financial charges for the clinical analysis activity carried out by the Claimant in the year 2008, would be reduced to the fact that income obtained by D..., S.A, during the year 2008 were relevant to the formation of the taxable profit of the Claimant, without the corresponding negative relevance of the costs borne to obtain them, which is manifestly contrary to the principle of relevance of the "net result of the fiscal year".

Thus, immediately one concludes by this route that the interpretation carried out by the Tax Authority and Customs is wrong and materialized in the determination of the taxable profit of the Claimant in the sense that the indispensability of the financial charges borne by D..., S.A. should be assessed in the face of the activity of the Claimant and not that of the latter.";

• "This transfer of results is, by force of article 17 of the CIRC, that of the net results of the company or companies to be merged, whereby it is clear that the costs that are to be considered indispensable for the incorporated company to obtain the respective income or maintain its source of income are transferred to the acquiring company, being treated as costs thereof, for purposes of determining the taxable profit thereof in the year in which the merger occurs.

It is said, finally, that this is also the interpretation imposed by the constitutional principle that "the taxation of companies is fundamentally based on their real income" (article 104, no. 2 of the Constitution of the Portuguese Republic) and the principle that income taxes are essentially based on taxpaying capacity (article 4, no. 1 of the General Tax Law), whereby this is the interpretation to be adopted in a perspective conforming to the Constitution and which keeps in mind the unity of the legal system, which is the primary element of legal interpretation (article 9, no. 1 of the Civil Code).

It is concluded, therefore, that the correction made, in understanding that the relevance of the financial charges borne by D... S.A. for the year 2008 should be assessed in face of its relevance to the clinical analysis activity carried out by the Claimant in that year and in not considering as costs of the Claimant the costs of D..., S.A. relevant to the determination of its own taxable profit, is tainted by a defect of violation of law, namely article 23, no. 1 of the CIRC, which justifies its annulment [article 135 of the Code of Administrative Procedure, subsidiarily applicable by force of the provision in article 2, subsection c), of the General Tax Law]."

With respect to what was decided in this case, it must be noted from the outset that the situation here at issue is restricted to the year in which the merger occurs, a situation that explains the tenor of the fundamental decision criterion there chosen, which relates to the understanding that "the interpretation adopted by the Tax Authority and Customs (...) would be reduced to the fact that income obtained by D..., S.A, during the year 2008 were relevant to the formation of the taxable profit of the Claimant, without the corresponding negative relevance of the costs borne to obtain them, which is manifestly contrary to the principle of relevance of the "net result of the fiscal year»" and that, as such, "costs that are to be considered indispensable for the incorporated company to obtain the respective income or maintain its source of income are transferred to the acquiring company, being treated as costs thereof, for purposes of determining the taxable profit thereof in the year in which the merger occurs."

This latter conclusion, disconnected from the specific case, is susceptible to criticism in that it seems to profile itself on a simplistic line, set aside in the dissenting vote of case 14/2011-T, and which is profiled here, according to which once the deductibility of an expense in the sphere of the incorporated company is ascertained, one will automatically have to recognize such deductibility in the sphere of the acquiring company.

Moreover, the referred fundamental decision criterion presents, itself, as a requirement of its internal coherence, limitations. Thus, on the one hand, the justification of the relevance of the expenses incurred by the merged one, as a function of the parallel relevance of the gains obtained by it, in the sphere of the company resulting from the merger, will only be appropriate until the moment in which the merger was executed; that is, the expenses borne by the merged one are justified, still while such, with the gains generated by it, also still while such, one not being able to directly transpose such criterion to the post-merger phase (which, note, in the case under analysis was limited to little more than a week), since there one is already dealing with expenses that have no correspondence in gains in the sphere of the company resulting from the merger.

In case 87/2014-T, the Tribunal was once more called to render a decision on a question identical to that which now arises.

From the also very learned exposition in the referred decision, the following is highlighted:

• "the fact that financing with the respective charges and responsibilities was the subject of transmission in the context of a merger by incorporation (...) does not imply that its fiscal treatment in the acquiring company has to be without further ado the exact mirror of what occurred in the incorporated company.

Note, from the outset, that to reach any conclusion about the deductibility of financial charges in the acquiring company, no element is obtained from the conception one adopts, in general terms, regarding the legal nature of the merger, whether one considers it to be a phenomenon of universal succession of the incorporated company to the acquiring company or whether one considers it to be the modification of the companies involved through transformation. (...)

But also no conclusion is drawn from the fiscal neutrality regime itself (...) given that this regime did not contemplate, at any moment, the transmissibility to the acquiring company of the fiscal treatment given to costs in the incorporated company";

• "the fiscal deduction of financial charges incurred in the year 2009 has to be assessed in the context of the Claimant's own business, paying attention to the normative criteria resulting from no. 1 of art. 23 of the CIRC, which is effectively the decisive legal framework in light of which the matter of the case must be resolved.

Hence, in compliance with the provision in no. 1 of art. 23 of the CIRC, it is entirely appropriate to verify, as the Tax Authority did in the tax inspection of fiscal year 2009 to which it proceeded and which is here under consideration, whether the requirements for fiscal deductibility of costs with interest were satisfied in attention to the activity of the Claimant and the period of taxation in question (cfr. art. 18 of the CIRC), independently of what occurred in the incorporated company.(...)

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

Indeed, it is such that the Claimant itself recognizes that the maintenance of the deductibility of interest on certain financing initially contracted depends on the presupposition that "the financing remains allocated to the same purpose"(...)

Therefore, the matter that effectively matters to decide for the solution of the case sub judice concerns the verification in the year 2009, in attention to the situation of the Claimant, of the nexus of economic causality between the assumption of the financial charges in question and its realization in the interest of the company.";

• "Having in view this direction, to proceed with the application to the case at hand of the requirement of indispensability of costs, it is decisive to ascertain, on the basis of all relevant facts and circumstances, the effective and concrete allocation of the financing for which the interest borne is the remuneration or, in other words, it is important to verify the destination or use of funds obtained in relation to which the taxpayer intends to fiscally deduct, for purposes of determining its taxable profit, the interest and other associated charges it bore.(...)

As such, the Claimant bore in the year 2009 financial charges in relation to all of the financing in question (...), but the equity interests relating to the capital of the Claimant itself, to which this financing was also destined (...), do not belong, naturally, to the Claimant, but are rather the property of "B" BV, which does not bear the corresponding costs of this financing (...)."

• "This means that the financial charges borne in fiscal year 2009 attributable to the acquisition of the capital of "A" find no nexus of economic causality with the interest and activity of the Claimant itself, having no potential for the generation of profits in the legal sphere thereof.

These equity interests, in fact, can only generate taxable income (dividends in the face of distribution of profits by the company with the interest, capital gains in the face of the disposition of the equity interests) in the legal sphere of the company holding the equity interests ("B" BV), not in the legal sphere of the debtor of the financial charges (the here Claimant). As such, the financial charges in question do not have as their destination the financing of the business activity of the Claimant itself, namely the investment in equity interests of its ownership, but rather respect equity interests in the ownership of others.

Now, as above stated (no. 14), the fiscal deductibility of costs, by force of the principle of indispensability provided by art. 23 of the CIRC, presupposes an economic causality nexus between the costs in question and their realization in the interest of the company.

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

In this sequence, also convene what is referred to in the judgment of the Central Court of Administrative Justice North of 14.3.2013, case no. 01393/06.1BEBRG: "only costs of the fiscal year that were comprovedly indispensable for the realization of income or gains or for the maintenance of the source of income but of the company itself and not of a third party should be considered. That is, costs must be related to the activity developed by the company in question and not by another company".".

• "the financial charges indicated have as purpose, destination and use the acquisition of the Claimant's own equity interests by the company "C", SGPS, whereby in that part the allocation of the loan is not related to the activity nor to assets held by the company that is debtor of such charges, the here Claimant, but rather to assets that came to be held by "B" BV as sole shareholder of the Claimant.".

In this case, the decision line of case 14/2011-T was resumed, developing it.

Thus, adding to what was set forth there, it is referred to in the decision now under analysis that "the fact that financing with the respective charges and responsibilities was the subject of transmission in the context of a merger by incorporation (...) does not imply that its fiscal treatment in the acquiring company has to be without further ado the exact mirror of what occurred in the incorporated company.", that "to reach any conclusion about the deductibility of financial charges in the acquiring company, no element is obtained from the conception one adopts, in general terms, regarding the legal nature of the merger" and that "also no conclusion is drawn from the fiscal neutrality regime itself", conclusions that are entirely subscribed.

One also subscribes to the conclusion that "the fact that certain financial charges were previously fiscally deductible in the context of determining the taxable matter of a certain company does not mean, in itself, that they are necessarily deductible in the same terms in the context of the company which, by merger, incorporated that one", not subscripting however, and as will be seen further below, the presuppositions on which the same rests, not from an abstract point of view, agreeing that "the fiscal deduction of financial charges incurred (…) has to be assessed in the context of the Claimant's own business, paying attention to the normative criteria resulting from no. 1 of art. 23 of the CIRC", and that "to proceed with the application to the case at hand of the requirement of indispensability of costs, it is decisive to ascertain (…) the effective and concrete allocation of the financing for which the interest borne is the remuneration or, in other words, it is important to verify the destination or use of funds obtained in relation to which the taxpayer intends to fiscally deduct, for purposes of determining its taxable profit, the interest and other associated charges it bore", but from a point of view of its application to the specific case, where it was understood that "the Claimant bore in the year 2009 financial charges in relation to all of the financing in question (...), but the equity interests relating to the capital of the Claimant itself, to which this financing was also destined (...), do not belong, naturally, to the Claimant, but are rather the property of "B" BV, which does not bear the corresponding costs of this financing (...)." that "These equity interests, in fact, can only generate taxable income (dividends in the face of distribution of profits by the company with the interest, capital gains in the face of the disposition of the equity interests) in the legal sphere of the company holding the equity interests ("B" BV), not in the legal sphere of the debtor of the financial charges (the here Claimant).", that "the financial charges in question do not have as their destination the financing of the business activity of the Claimant itself, (…) but rather respect equity interests in the ownership of others.", and that "the allocation of the loan is not related to the activity nor to assets held by the company that is debtor of such charges, the here Claimant, but rather to assets that came to be held by "B" BV as sole shareholder of the Claimant."

That is, as was already seen, regarding case 14/2011-T, the equity interests of the acquiring company held ultimately by the shareholder(s) of the incorporated company are not consideration of the (do not have their cause in the) financing contracted by it, but rather are consideration of (have their cause in) the equity interests of the incorporated company, which are extinguished in the merger process.

Whereby it cannot be subscribed to the understanding that the company resulting from the merger is bearing the charges of financing that are consideration of benefits obtained by third parties.

In the same way, and as also explained above, it is not considered that the situation sub judice is a case of application of the criterion cited to MARIA DOS PRAZERES LOUSA, according to which "interest borne by a company cannot be accepted as deductible in relation to loans in which it is manifestly proved that the funds obtained are "diverted from the operation and applied to purposes unrelated to it", since – manifestly – the funds obtained were not "diverted" from the sphere of the company resulting from the merger, since the same were already fully applied (exhausted) when the merger process was operated.

There remains still, here as previously regarding case 14/2011-T, to ascertain the decisive relevance, in light of the criteria already established, of the finding that the Claimant no longer has in its possession the mediate product of the financial expenses it bears, which will be done below.

Having in view everything that has been said, and not forgetting that – consensually and as results from the factual matter – only interest on third-party capital is in question, it is considered then that the starting point of the decision process of the dispute which it now falls to this Tribunal to settle is situated in the framework of art. 23/1/c) of the CIRC.

Such provision provides, among other things and in what concerns what now matters, that "Expenses are considered (...) namely: c) interest on third-party capital applied in the operation.".

Thus, and before proceeding in the direction of ascertaining whether from the normative provision in question results, or not, a limitation of the deductibility of interest on third-party capital to its application in the operation, or whether, as concluded in the Decision 42/2015T, interest on third-party capital applied for other purposes will within its scope be deductible, it is necessary to assess whether in the case, this is, or is not, the situation that is verified.

In such judgment, and without prejudice to better opinion, one should take into account, as decision referents, in addition to what has already been properly dealt with, four aspects that are considered fundamental, namely:

• The first – incontrovertible, as has been said already – is the circumstance that the equity interests of the acquiring company, which were 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 incontrovertible as the previous one, is that the "third-party capital" to which the interest borne refers and whose deductibility is questioned are found, at a moment prior to the merger, already fully applied;

• The third, much less evident, but equally incontrovertible and relevant, is that the company resulting from the merger process does not materially identify itself (from the perspective of economic reality) with the acquiring company as configured previously to the same;

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

In light of these referents, it is considered to be correct the conclusion that indeed, in the case, the requirements of the above-referred subsection c) of paragraph 1 of art. 23 of the CIRC are fulfilled, given that the expenses with interest in question correspond to third-party capital that was applied in the operation of the entity that bears them.

This statement, which at first glance might constitute itself as counter-intuitive, will be assimilable if one duly has present the third of the fundamental decision criteria above enumerated.

Indeed, and as was written in the Decision of the Court of Audit of 13-04-2005, rendered in case 01265/04:

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

That is, with the merger by incorporation the merged company does not disappear in economic and business reality, but persists in a modified form. From the economic and business point of view, the merger represents a reorganization of production resources, not their disappearance. The corporate reorganization contemplates the maintenance of the same productive capacity, now under conditions potentially more favorable to the economic interests of those involved in the company."

Thus, from the perspective of economic reality, the company resulting from the merger by incorporation is not a different company, but rather a reorganization of the companies that participated in the process. This understanding permits that one assess whether the financing contracted prior to the merger, when applied to the operation of any of the merged entities, continues to be applied to the operation of the acquiring company after the merger.

In this framework, and in attention to the factuality found as proven, the financing in question was contracted by the incorporated company D… for the purpose of acquiring the equity interests of the company, subsequently and finally, in economic terms, the acquiring company. With the merger, such equity interests did not pass into the acquiring company, but rather the merged company transferred all of its assets and liabilities to the acquiring company. Among those assets and liabilities, those financing obligations were transferred. And what is relevant is that, in the sphere of the resulting company, the operational assets corresponding to those equity interests (which in the incorporated company were reflected only as financial investments) came to be directly reflected.

In other words: in the incorporated company D…, the financing was used to acquire financial assets (the equity interests in A…); in the resulting company, those assets are reflected operationally in the set of productive means, that is, in the real assets that generate the income of the resulting company.

Thus, from the perspective of economic reality, the capital financed by the financing in question continues to be applied to the operation of the resulting company, even though the form of its manifestation in the balance sheet changed (from financial assets to operational assets).

It is therefore concluded that the provision in subsection c) of paragraph 1 of article 23 of the CIRC, requiring that third-party capital be "applied in the operation", is satisfied in the present case.

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