“M Fastfood S.A” was incorporated as a subsidiary company of an entity not resident in Portuguese territory, M Inc., a company with registered office in the United States. “M Fastfood S.A” had obtained financing from M Inc. for investment in its commercial activity, which resulted in indebtedness totalling EUR 74,000,000.00.
The activity of “M Fastfood S.A” is “the opening, assembling, promotion, management, administration, purchase, sale, rental, leasing and cession of exploration of restaurants, for which purpose it may acquire or grant licenses or sub-licenses and enter into franchise contracts. It also includes the purchase, sale, rental, administration and ownership of urban buildings and the acquisition, transfer, exploitation and licensing of copyrights, trademarks, patents and industrial and commercial secrets and, in general, any industrial property rights”.
“M Fastfood S.A” was in a situation of excessive indebtedness towards that entity, in light of the average equity capital presented by it in 2004, on 27 January 2005 it submitted a request to the tax authorities for the purposes of demonstrating the equivalence of indebtedness towards an independent entity.
Following a tax audit concerning FY 2004 the authorities considered that the interest limitation rule should be applied, which resulted in corrections to the taxable amount in respect of excess interest paid.
“M Fastfood S.A” presented a report, which intended to demonstrate that the level and conditions of indebtedness towards M Inc. were similar to those that could be obtained if it had chosen to obtain financing from an independent financial institution. According to the report “M Fastfood S.A.” was, at the time, in a period of strong expansion, which resulted in the opening of 118 fast-food outlets in recent years. That within the scope of its implementation strategy in the national market, the location of the restaurants plays a fundamental role and constitutes a decisive factor for the success of the business. That the ideal or optimum location of the establishments is very costly and therefore substantial investment has become necessary.
According to “M Fastfood S.A.”, the conditions obtained were favourable, in particular the interest rates agreed with M Inc., which were lower than those that would be charged by an independent financial institution, presenting as proof financing proposals issued by B… Bank. Based on the report M Fastfood concludes are sufficient to constitute proof that the conditions of the financing considered excessive are similar, or even more favourable, to the conditions practiced by independent entities, the reason why no. 1 of article 61 of the Corporate Income Tax Code is applicable”.
The tax authorities found that, the evidence submitted by “M Fastfood S.A.” was insufficient to demonstrate that the debt obtained from M Inc. is at least as advantageous as it would have been had they used an independent financial institution.
Decision of Supreme Administrative Court
The Supreme Administrative Court set aside the the assessment issued by the tax authorities and decided in favour of “M Fastfood S.A.”.
Article 56 EC must be interpreted as meaning that the scope of that legislation is not sufficiently precise. Article 56 EC must be interpreted as precluding legislation of a Member State which, for the purposes of determining taxable profits, does not allow for the deduction as an expense of interest paid in respect of that part of the debt which is classified as excessive, paid by a resident company to a lending company established in a non-member country with which it has special relations, but allows such interest paid to a resident lending company with which the borrowing company has such relations, where, if the lending company established in a third country does not have a holding in the capital of the resident borrowing company, that legislation nevertheless presumes that any indebtedness of the latter company is in the nature of an arrangement intended to avoid tax normally due or where it is not possible under that legislation to determine its scope of application with sufficient precision in advance.
As it is up to the national judge faced with such an interpretation to decide on its application to the specific case, it is important to mention that the situation which this review intends to decide on is identical in its contours to the one assessed by the CJEU.
In fact, it is clear that the situation at issue in this review falls within the scope of the free movement of capital, and that it translates into less favourable tax treatment of a resident company that incurs indebtedness exceeding a certain level towards a company based in a third country than the treatment reserved for a resident company that incurs the same indebtedness towards a company based in the national territory or in another Member State.
What is at issue is deciding whether such discrimination may be justified as a means of avoiding practices the sole purpose of which is to avoid the tax normally payable on profits generated by activities carried on within the national territory.
However, although we agree with the CJEU that the provisions in question – Articles 61 and 58 of the CIRC – are appropriate as a means of preventing tax avoidance and evasion, we must agree with the Court that such a restriction is disproportionate to the intended aim.
As the court in question correctly states “as article 58 of the CIRC covers situations which do not necessarily imply a participation by a third country lending company in the capital of the resident borrowing company and as it can be seen that the absence of such a participation results from the company’s being a resident borrower”, the Court agrees with the Court. in the absence of such participation, it results from the method of calculation of the excess debt provided for in Article 61(3) that any debt existing between these two companies should be considered excessive, Article 61 consecrates a discriminatory measure which limits the free movement of capital as only non-resident entities are subject to the regime of Article 61 of the CIRC when IRC tax law does not distinguish between companies with resident shareholders and companies with non-resident shareholders for the purposes of determining taxable income for IRC purposes, there being no justification for this differentiated treatment”.
Therefore, only in situations where the general interest justifies this restriction to the freedom of movement guaranteed by article 63 of the TSFUE could this regime be admitted.
And while it is true that tax avoidance and the fight against tax fraud and the need to ensure the effectiveness of tax controls are situations provided for in Article 65 of the TFEU that allow Member States to take measures that in some way restrict freedom of movement, such measures may in no case constitute a means of arbitrary discrimination or concealment of the free movement of capital and payments (see Article 65(3) of the TFEU).
This implies that in order for such restrictive measures to be applied, reasons must be given to justify them, as only then can their adequacy and proportionality be controlled.
This is not the case here.
In this sense, see also the judgements of the Supreme Administrative Court of 4 June 2008 in Case 275/08 and 12 November 2008 in Case 0281/88.
The application of article 61/1 in the case under analysis violates article 63 of the TSFUE and the Convention on Double Taxation entered into between Portugal and the United States of America cfr article 26/4 and 6 international law rules that by virtue of the provisions of nºs 1, 2 and 4 of article 8 of the CRP are an integral part of Portuguese law”.
The detail, clarity and absolute identity of the two cases leave no room for doubt as to the outcome of this analysis, as we have already stated, stressing once again the circumstance that the analysis transcribed was made by the Supreme Administrative Court in a review appeal.
The contested tax act is illegal, as it breaches the rules best identified in the penultimate paragraph.