It was a grey rainy morning in October 2022. A group of like-minded sustainability champions and purpose-driven alumni of the Centre for Responsible Business & Leadership were visiting Veolia's Waste Management Unit in Loures. During the (very!) insightful guided tour, we came upon palettes of foodstuffs in good order and within validity that were there waiting for destruction under Tax Office control. "Why destroy?" was the question on everyone's minds. In very broad terms, the context provided was that the items had been in a minor car crash during transport so that the company could deduct the cost for tax purposes through impairment loss as per the Corporate Income Tax ("CIT") rules destruction was the way to go about it.

A sense of the incentives needing to be adjusted sunk in. And gave way to looking into the matter further and writing this newsletter. How (un)sustainable is the tax regime on this particular aspect, and how may the lawmaker, in its conforming vests, contribute to promoting a circular economy?

The CIT rules on impairment losses for the purpose of deduction to the taxable income determine that stock losses are deductible up to the limit of the difference between the acquisition or production cost of the inventories and the respective net attainable value as of the balance sheet date when the latter is lower than the former. When these impairments result from damaged goods or difficult sales, even though there is no express legal provision for it, many still consider destruction the most logical scenario.

In fact, the Portuguese Tax Authorities ("PTA") indicated in official guidelines that there is a high degree of certainty on the acceptance of impairment losses recorded as a result of stock destruction, although recognising, without specifying, the possibility of deducting those losses in scenarios other than destruction. When faced with a certain cost deduction scenario, with clear official instructions on documentation and procedure to avoid tax inspection issues, compared with another possibility with no certain outcome, what option does a responsible finance manager choose?

In addition, regarding tangible fixed assets, CIT rules accept impairment losses due to proven abnormal causes, namely disasters, natural phenomena, exceptionally fast technical innovations, or significant alterations, the effect of which will be an exceptional devaluation of the assets, and for this end, the company may also proceed with the physical destruction of the assets.

However, donations are also a possible destination for obsolete stock or assets. If such donations are made to entities covered by existing patronage rules and for the purposes provided therein, the loss inherent in the donation of such inventories is accepted as a tax expense.

For VAT purposes, a solution like a donation to the State or PSSI whose final end is for use by people in need is already possible and tax efficient - the donation is exempt, and deduction on input VAT is not jeopardized (a so-called complete VAT exemption regime). Nevertheless, its scope should also be enlarged for other uses of donated goods, for example.

These patronage donations are considered costs with uplifts of up to 140% of their amount, provided certain conditions are met. It should, nonetheless, be noted that when donations are made to Private Social Solidarity Institutions ("PSSI"), they are only considered costs or losses for the year up to a limit of 0.8% of the volume of sales or services rendered by the donor. When goods to be disposed of exceed this limit for the donor entity, what would a responsible finance manager choose? Donate the remainder with no tax deduction or destroy the remainder, following official PTA guidelines, and get a full tax deduction? It is reasonable to conclude that the CIT and patronage rules and PTA official guidelines incentivize an option for destruction.

Tax law nudges should provide incentives for developing circular business models to extend the useful life of goods. To that end, we believe that changing the above-described regime could be a good departure point, as it might not even require structural changes to the CIT Code.

Would it be necessary just for the PTA to issue official guidelines on acceptable uses and procedures for recognizing those uses other than destruction? Would it have the necessary impact, for example, in the context of donations to private entities, an increase of the threshold of 0.8% of the donor's turnover? If there is damaged stock in re-usable condition, would it not be possible to transfer such stock to the production process of another good? More so, in the case of tangible fixed assets, instead of expressly providing for its destruction, could a donation for PSSI entities that use these assets in their activities not lead to the possibility of a total deduction of the residual value of the asset (such as, for example, social reinsertion PSSI entities that seek to provide practical training for their users)?

Whether the solution for the problem we chose as test-tube is one of the above pointed as open questions or not, what is clear is the need to place tax law and policy, even in the smallest details, into perspective as key instruments for the promotion of the transition to more sustainable production and consumption, reducing waste and in turn, contributing to a needed and efficient circular economy functioning within planetary borders.

Have a great and impactful week!

Maria Figueiredo
CMS Rui Pena & Arnaut 
Lourenço do Vale e Vasconcelos Quintão
Intern Lawyer
CMS Rui Pena & Arnaut