A S.A. is 51% owned by B SA and 49% by C Corp. A S.A is active in development of energy efficiency projects. In 2015 A S.A took out loans from B and C at an annual interest rate of 3.22xEuribor 12 months, plus a spread of 14%. A S.A had also paid for services to related party D. The tax authorities issued an assessment related to the interest rate on the loan and the service purportedly received and paid for. A complaint was filed by A S.A. with the Administrative Tribunal (CAAD). Judgement of the CAAD The complaint of A S.A was dismissed and the assessment upheld. Excerpts regarding the interest rate “Now, regarding the first argument, it falls immediately by the base, since the Applicant has not proved that it had made any effort to finance itself with the bank and that this effort was unsuccessful. On the contrary, it seems to result from the request for arbitration award that the Claimant and its shareholders have immediately assumed that, given the financial situation that the country was still experiencing in 2014, any request for financing made by a newly created entity and without business expectations would be rejected outright by all banks. For that reason, the Claimant did not prove, nor could it, that the interest it contracted with its shareholders was more favourable to it than what the banks would demand from it. In short, it cannot but be stated that, in view of this, the Defendant could not assume any other position than to investigate whether the shareholders of the Claimant had taken advantage of the socio-financial context of the country to contract a fixed spread of 14%. … As the Respondent summarized very well in its allegations (no. 58) That is, if an independent bank agreed to provide financing to the Claimant, of similar amount and term to the shareholder loans, remunerated at an annual nominal interest rate (TAN) calculated according to the monthly average of the 6-month Euribor rate of the previous month, plus a spread of 3 percentage points, then nothing justifies that the partners require from the company a remuneration for the shareholder loans that includes a spread of 14 percentage points.” Excerpts regarding the services “But it was not only the formal issue that justified the position of the AT and that leads this Court to agree with it. The absence of material evidence that the work had been performed is further compounded by the fact that, during the inspection, the AT found invoices (which the Claimant has registered in its accounts under account “62213 – Specialized work”), issued by the accounting firm “H…, Lda, as well as other “Specialized work”, for services related to the execution and management of the contracts, issued by suppliers B… and I…, which indicates that entities other than D… were involved in the provision of services. The management services for the … and of …, which were ongoing in 2017, and whose invoicing started that year, were performed by B… and I… and not by D… . Thus, the association of all the facts necessarily leads to the non-deductibility of D…’s invoice, since it was up to the Claimant to prove that the work was performed by D… and it failed to do so. As recently decided by the South Administrative Central Court in its ruling of 27 May 2021 in case no. 744/11.1BELRA (available at www.dgsi.pt) I- Invoices are not only relevant documents for the purpose of exercising the right to deduct, but also relevant for the purpose of exercising the AT’s control powers. II- There is no hierarchy between the various requirements imposed on invoices. III- The CJEU has held that the right to deduct is admissible even if some formal requirements are not met by invoices, provided that the material situation is demonstrated. IV- The failure to scrupulously comply with the formalities required in terms of issuing invoices may not compromise the exercise of the right of deduction, provided that the substantive requirements have been complied with and that the AT has all the elements to substantively characterise the transaction, it being understood that the burden of proof will rest with the taxable person. V- As no documentary evidence has been submitted containing a content that enables the gaps in the invoices to be overcome, the right to deduct is not admissible. Therefore, as the Claimant has not complied with the provisions of nos. 3 and 4 of article 23 of the CIRC, by virtue of paragraph c) of no. 1 of article 23-A, the invoice for the provision of services in the amount of €30,000.00, which determines the correction of the taxable income in that amount, cannot be deductible.” “Based on these grounds, the Court decides to consider the request made by the Claimant as totally unfounded” Click here for English translation Click here for other translation ...

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. … 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 ...

“A Infrastructure S.A.” had granted loans related parties B and C. The average interest rate borne by A S.A. on its bank loans was lower than the one applied to loans passed on to B and C, but following an audit, the tax authorities observed that other financial expenses (bank commissions and stamp duty) had been deducted by A S.A as financial costs on its bank loans, but not recorded as financial income on the intra-group loans. On that basis an assessment was issued where deductions for these financial costs not passed on to B and C had been disallowed in the ratio of “loans granted to B and C” over “A S.A’s external bank loans”. A appeal was filed by A S.A. with the Administrative Tribunal (CAAD). Judgement of the CAAD The Tribunal granted the appeal and declared the annulment of the income tax assessment. Excerpt “The Court is not unaware that the application of rules, such as those on transfer pricing, which are essentially anti-avoidance and whose application is very much based on the concept of “comparability” of transactions – sometimes complex to put into practice – may give rise to some reluctance to use them as grounds for tax corrections. However, the law 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 of the use of the concept of “indispensability” in Article 23 of the CIRC. The latter (Article 23 of the CIRC) should not be applied systematically as an anti-abuse clause; it contains, above all, a general condition to be respected for the deductibility of expenses. If there are anti-abuse rules that are adapted to certain situations, they must first be the control tools used by the AT. Within this framework, the contested assessment suffers from an error of law and factual assumptions, due to the erroneous interpretation and application of the provisions of Article 23(1)(c) of the IRC Code, which constitutes a breach of law, for which reason they must be declared illegal and, consequently, annulled.” Click here for English translation Click here for other translation ...

A holding company of an international Group was established in Spain and in it and in the Group’s operating entity, which was made dependent on it and with which it was fiscally consolidated, intra group loans were requested, for the acquisition of shares in other Group companies, which were mere asset relocations without any economic or business substance, with the sole objective of reducing taxation in Spain: Both in the Spanish holding company and in the operating entity, financial expenses were deducted as a result of that indebtedness, which lead to a drastic reduction in profits in the operating company and losses in the holding company, with the final result that this income remains untaxed. On this background an assessment was issued by the tax authorities where the financial expenses were disallowed under Spanish “fraud by law” provisions. As stated in Article 6.4 of the Civil Code: “Acts carried out under the protection of the text of a rule which pursue a result prohibited by the legal system, or contrary to it, shall be considered to have been carried out in fraud of law and shall not prevent the due application of the rule which it was sought to circumvent“. This, transferred to the tax sphere, is equivalent to the text of Article 24 of the LGT, in the wording given by Law 25/1995, of 20 July 1995 (applicable to the case in question), which states: “In order to avoid tax evasion, it shall be understood that there is no extension of the taxable event when tax is levied on events, acts or legal transactions carried out for the purpose of avoiding payment of the tax, under the cover of the text of rules issued for a different purpose, provided that they produce a result equivalent to that derived from the taxable event. Fraud of tax law must be declared in special proceedings in which the interested party is heard. 2. Events, acts or legal transactions carried out in fraudulent evasion of tax law shall not prevent the application of the evaded tax rule nor shall they give rise to the tax advantages that were intended to be obtained through them. 3. In the settlements made as a result of the tax evasion case, the tax rule that has been evaded shall be applied and the corresponding late payment interest shall be paid, without the imposition of penalties for these purposes alone“. Decision of the TEAC The TEAC confirmed the existence of fraud by law and upheld the assessment. All the actions are legal and real; there is no simulation, but from the set of all the circumstances, without proof that there is a substance and economic business reality, it is concluded that it is a simple exchange of shares within the Group, with the sole purpose of generating the financial expenses in the Spanish entities of the Group, all of which is declared in fraud of law, and the situation is regularised by not admitting the financial expenses involved. There are no international tax reasons for the alleged fraud of law (application of DTAs, infringement of Community Law, etc.) as the application of the concept of fraud of law should have been applied in the same way in the case of a Group with a national parent company and article 24 of the LGT, the provision from which the application of fraud of law derives, does not contain any distinction or restriction depending on whether residents or non-residents are involved. The rules on related-party transactions or transfer pricing do not apply, as it is not disputed that the transactions were carried out at market value; indeed, it is acknowledged that this was the case. It is from the set of circumstances analysed that the existence of fraud by law can be concluded. If it were possible to correct it through the mere application of a specific rule (either related-party transactions or thin capitalisation, etc.) we would no longer be dealing with a case of fraud by law. Click here for English translation Click here for other translation ...