A SGPS S.A. is the parent company of Group A. In 2016, a subsidiary, B S.A., took a loan in a bank, amounting to 1,950,000.00 Euros, and incurred interest costs and Stamp Tax. However, the majority of the loan, an amount of €1,716,256.60, was transferred as an interest free loan to A SGPS S.A.
The tax authorities issued an assessment related to costs incurred on the loan and deducted by B S.A. The tax authorities disallowed B S.A.’s deduction of the costs as they were not intended to protect or obtain income, and therefore did not meet the requirements for deductibility under the general provisions of the Tax Code;
A complaint was filed by A SGPS S.A. with the Administrative Tribunal. According to A SGPS SA the tax authorities did not justify why it considered that the expenses incurred by B S.A. to an independent bank for a loan that was passed on to the parent company were not deductible. According to A SGPS SA, this was not an issue of requirements for deductibility , but rather a question of transfer pricing. Hence, the correct framework for an adjustment would be that of article 63 regarding pricing of controlled transactions and not the general provisions in Article 23 of the Tax Code. Therefore the tax authorities had erred in law.
Judgement of the CAAD
In regards of B S.A.s deductions of loan expenses, the complaint of A SGPS S.A was dismissed and the assessment upheld. According to the tribunal, expenses held by a subsidiary to grant a loan to a parent company could not be said to “protect or obtain income” of the subsidiary since it did not own the parent company.
“…the basic rule of deductibility of expenses is stated in article 23, no. 1 of the IRC Code, which, in its normative hypothesis, contains the respective constitutive assumptions, of a substantive nature, requiring a connection between the expenses and the activity generating income subject to IRC.
Note that this is not a requirement of a direct causal relation between expenses and income (see Judgments of the Supreme Administrative Court of 24 September 2014, Case No. 0779/12; of 15 November 2017, Case No. 372/16; and of 28 June 2017, Case No. 0627/16, of 28 June 2017 ). The latter judgement considers “definitively ruled out a finalistic view of indispensability (as a requirement for costs to be accepted as tax costs), according to which a cause-effect relation, of the type conditio sine qua non, between costs and income would be required, so that only costs for which it is possible to establish an objective connection with the income may be considered deductible”.
The causal connection should be made between the expenses and the activity globally considered (going beyond the strict expense-income nexus), and the Administration cannot assess the correctness, convenience or opportunity of the business and management decisions of the corporate entities. As highlighted by the Judgment of the Supreme Administrative Court of 21 September 2016, Case No. 0571/13 “[t]he concept of indispensability of costs, to which article 23 of the CIRC refers, refers to the costs incurred in the interest of the company or supported within the scope of the activities arising from its corporate scope”.
On the other hand, this construction requires a link of subjective imputation that is implicit in the relationship required between the expense and the activity. This link must be made with the specific activity of the taxpayer and not with any other activity, namely that of its partners or third parties.
It is in this framework that the corrections under analysis are based and not on the transfer pricing regime (see article 63 of the IRC Code), or on the “anti-abuse” regime, for which reason the assessment of the latter does not belong here. The Court is limited to the knowledge of the reasons expressed in the contemporaneous grounds of the tax act and if a correction has several valid grounds, only those that have been invoked as grounds for the contested act may be assessed.
In this case, the only basis of the addition to the taxable amount of the deducted financial costs respects to the non-compliance of the assumptions of article 23, no. 1 of the Corporate Income Tax Code. As the conditions that integrate the normative hypothesis are not met, one cannot but validly conclude, together with the Defendant, that the deduction is not admissible. This, without prejudice to the fact that the factual situation may possibly be subject to a concurrent framework in other rules, which, as said, it is not for us to assess if they are not part of the foundations of the tax acts. The point is that the legal-tax regime effectively applied is based on correct legal and factual assumptions.
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Taking into account the criterion described, the granting of free loans by B…, S.A. to the parent company [the Claimant] does not appear susceptible of being regarded as an activity of management of a financial asset by the former, since it is not the latter that holds shares in the parent company, but the opposite. In effect, there is no asset of which B…, S.A. is the holder that underlies this financing operation to the parent company. Nor can the argument regarding the exercise of significant influence over management, usually measured (in relation to subsidiary companies) by a percentage holding of at least 20%, be invoked in these circumstances to judge that the interest in the investment has been verified. Here, the significant influence is exercised in the opposite direction, since the parent company holds 92% of the capital of the Claimant.
Therefore, it is concluded that the non-interest bearing financing granted by B…, S.A. to the Claimant are not carried out within the scope of the activity of the former and in its economic interest, so, in agreement with the Defendant, the financial costs incurred do not pass the test of the necessary causal relation between the expenses incurred and the activity of the Claimant, provided for in article 23, no. 1 of the IRC Code and, consequently, should not be deducted for IRC purposes. Therefore, the addition to the taxable income of financial costs in the amounts of €43,720.94 (2016) and €43,082.94 (2017) remains valid.”
Dissenting vote
“Firstly, and analyzing the economic motivations of the operation in question, it should be noted that I agree with the content of the position of my fellow Arbitrators, in this ruling, regarding the fact that the Defendant has not duly demonstrated the operational and economic purpose of making the referred remunerated loan with the bank institution, for subsequent non-interest bearing loan to the parent company.
According to what it is possible to conclude from the analyzed elements, the concession of the free loan by B…, S.A. to the parent company, is only justified by the diffuse interest of the economic group in which both companies are part of. In fact, the only economic argument that can be identified in the records under analysis is that the loan was vital for the survival of Group A…’s companies, acquired in the context of a company recovery plan, without which the Group would possibly not exist today, as it was experiencing financial difficulties.
Now, although from the business model point of view and at an operational and economic level it is considered defensible to carry out operations with Banking Institutions by a Group entity, for the subsequent financing of other Group entities – behaviour that can be verified in the market, in similar situations, the fact is that all this economic argumentation is diffused in the argumentation presented, not being, for example, duly analysed and justified in the process of transfer pricing tax documentation (e. g. Transfer Pricing Tax Dossier”) or in other internal documentation capable of being analysed, carried out at an earlier time or during the present arbitration proceedings.
Therefore, and although from an economic point of view I consider that operations of this nature (bank financing for subsequent financing to related entities, with or without interest) may be defensible, provided they are duly justified based on economic and market criteria, and also because it has been proven that there were effectively accounting and tax expenses with the direct financing of B…, S.A. with banking institutions. with Banking Institutions, I understand that the economic motivation for the operation and the reasonability of the economic model used, the price methodology used and the potential present and future benefits with this operation were not duly justified, either by economic and tax documentation existing in the taxpayer, or during the litigation process itself and during the arbitration period.
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In that other arbitral proceeding, it is also considered that the substance and the model of the transaction might not be defensible from an economic and tax point of view (with the necessary adaptations to the present case under analysis), stating in its text “no interest of the applicant in the financing of the companies of the group, and in the establishment of remuneration conditions more disadvantageous than those borne to obtain the loans, by not having passed on the totality of the financial charges incurred, can be seen. In other words, it is not reasonable to admit that it would have carried out a transaction of this nature if the borrower had been a company outside the group. No company lends money to another, under worse overall conditions than those it had to bear to obtain those funds from the Bank. For that, it wouldn’t even get into debt.”
However, in that decision that won in arbitral proceeding no. 70/2018-T, of November 16, 2018, and in my opinion in the specific case of the present case, I understand that in this transaction and respective records the requirements for the application of art. 63 of the IRC Code are met. In other words, it is proven the existence of special relations, the establishment of conditions (even considering the non remuneration of the loan between related parties) diverging from those that would be applied between independent entities; and the existence of a causal link between the existence of special relations and those conditions diverging from those of the competitive market – i.e., if the parent company was not of the Group, B…, S. A. would certainly apply the same conditions as those of the competitive market. A. would certainly apply interest on the loan (unless there were obvious or comparable reasons in the market – which should have been duly justified in the transfer pricing documentation or in the course of the present arbitration proceedings).
Finally, I consider that the present Arbitral Tribunal is not unaware that the application of rules, such as those on transfer pricing, which are essentially anti-avoidance and whose application is based on the concept of “comparability” of transactions and business models between related vs. independent entities – sometimes complex to implement – may give rise to some reluctance in its use as a grounding element for tax corrections.
But it is my understanding that the Tax Law (and the Transfer Pricing Regime) exists to be used in the situations to which it should apply. And, as it is true that the concept of comparability is sometimes difficult to apply, the same is true with the use of the respective concepts of article 23 of the IRC Code, and in the latter case it may even lead to tax injustices for the taxpayers, as for example the real existence of financing expenses (which are accounting expenses) and which cannot be used by any company of the Group, as for example article 23 of the IRC Code prevents the realisation of “correlative adjustments”.