Process: 184/2013-T

Date: March 14, 2014

Tax Type: IRS

Source: Original CAAD Decision

Summary

Process 184/2013-T addresses the critical question of whether formal SME certification is required to benefit from favorable capital gains taxation under Article 43 of the Portuguese IRS Code. Taxpayers A and B sold their shareholding in C, Unipessoal, Lda in June 2010, generating capital gains subject to IRS assessment of €908,460.43. The Tax Authority taxed 100% of the capital gain, but the claimants contested this, arguing that only 50% should be taxable under Article 43(3) and 43(4) CIRS, as amended by Law 15/2010. The company demonstrably met the substantive SME criteria set forth in the Annex to Decree-Law 372/2007: annual turnover of €2,628,770.59 (well below the €10 million threshold) and fewer than 50 employees. However, no SME certificate was obtained from IAPMEI in 2010 or 2011 because new management took control after the sale, and the former shareholders lacked authority to request certification. The claimants argued that Article 43(4) references only the Annex to DL 372/2007 (substantive criteria), not the certification requirements in the body of that decree-law. They contended that imposing a formal certification requirement violates constitutional principles of equality, tax capacity, and substance over form, especially when former shareholders cannot compel a third party (the new company management) to obtain certification. The Tax Authority maintained that the favorable tax treatment constitutes an exceptional regime requiring strict compliance with formal requirements, including presentation of the SME certificate. This case has significant implications for determining whether Portuguese tax law prioritizes substantive economic reality or formal administrative compliance in capital gains taxation.

Full Decision

ARBITRATION DECISION

I – REPORT

A and B (hereinafter the "Claimants"), taxpayers no. ... and no. ... respectively, with address ..., have requested the constitution of an Arbitration Court, under the provisions of articles 10(1) and 10(2) of the Legal Regime of Tax Arbitration, provided for in Decree-Law no. 10/2011, of 20 January, hereafter designated "LRTA", and of articles 1 and 2 of Regulation no. 112-A/2011, of 22 March, having as its object the annulment of Personal Income Tax for 2010, embodied in the illegality of the act dismissing the hierarchical appeal, in the illegality in the dismissal of the administrative complaint, in the illegality of the act of additional Personal Income Tax assessment under number ..., illegality of the assessment of default interest under number ... and, finally, illegality of the Account Settlement Statement, by means of which they were fixed the duty to pay the amount of 908,460.43€ (nine hundred and eight thousand, four hundred and sixty euros and forty-three cents), as tax and default interest.

  1. The TAX AND CUSTOMS AUTHORITY (hereinafter designated as TCA or Respondent) is summoned, which succeeded the Directorate-General for Taxation.

  2. The request for constitution of an arbitration court was validated and accepted on 28 July 2013 by His Excellency the President of the Administrative Arbitration Centre (hereinafter designated as "AAC"), the TCA having been notified of the presentation of the said request on the same date.

  3. The Claimants did not proceed to nominate an arbitrator, therefore, under the provisions of article 6(2)(a) of the LRTA, the undersigned were designated by the President of the Deontological Council of the AAC to make up the present arbitration court, having accepted the designation as legally provided for.

  4. The Arbitration Court was regularly constituted in the AAC, on 4 October 2013 to assess and decide upon the object of the present case.

  5. In summary, the Claimants support their claim on the following:

• The contested assessment, which taxes the capital gain resulting from the sale of the shareholding interests of the Claimant in the company "C, Unipessoal, Lda", shall have disregarded the circumstances that the annual turnover and the total balance sheet of that company did not exceed 10 million euros and that it did not employ 10 or more persons.

• It is true that the sale of the equity interests occurred in June 2010 and in that year the new management of the company, which came to be designated as D, Lda, did not request from IAPMEI, did not request the SME certificate from that entity, which, moreover, also would not happen in 2011, only doing so again in 2012.

• However, such omission did not result from any negligence on the part of the Claimants, since they no longer had competence to do so, being certain, however, and as stated above, in substantive terms the company met in 2010 the substantive requirements that would allow it to be qualified as an SME.

• It is further added that the TCA acknowledged, in its draft decision regarding the administrative complaint filed by the Claimants, that in the year 2010 the annual turnover of the company C, Unipessoal, Lda, Tax ID no. ..., was 2,628,770.59€, having employed fewer than 50 persons (see Doc. 8 of the request for arbitration pronouncement).

• In light of the aforementioned circumstances, the Claimants understand that the requirements of the Annex to Decree-Law no. 372/2007, of 6 November, are satisfied, therefore, under articles 43(3) and 43(4) of the Personal Income Tax Code (PITC), as amended by Law no. 15/2010, of 26 July, the capital gain obtained by them should only be taxed at 50%, since the company whose shareholding interests were sold by them would be integrated into the concept of small enterprise, in light of that Annex.

• The Claimants consider, therefore, that article 43(4) of the PITC, as amended by Law no. 15/2010, of 26 July, refers exclusively to the Annex to Decree-Law no. 372/2007, of 6 November, and not to the entirety of that same decree-law.

• On the other hand, article 72(4) of the PITC provides that the positive balance between capital gains and losses provided for in article 10(1)(b) of the same act is taxed at an autonomous rate of 20% or, alternatively, such capital gains, if considered at the moment when the transaction took place (1.6.2010) and not at the end of the tax period (31.12.2010), would be subject to a tax rate of 10%;

• Not having followed that understanding, the Claimants consider that the TCA incurs in the error of considering that the regime described above is an exceptional regime for taxation of capital gains, to which the taxpayer may have access, once certain conditions are verified, since, the claimants continue, the regime resulting from article 9(1)(a), article 10(1)(b), articles 43(1) and 43(3), and article 72(4), all of the PITC, does not represent, in the current legal framework, an exceptional regime that the legislator has conditioned to the presentation of a document issued by a third entity.

• Moreover, since article 43(4) of the PITC, in the wording in question, expressly refers to the Annex, it is manifestly not possible to invoke that it is a reference to the application of Decree-Law no. 372/2007, as suggested by the TCA in the report of conclusions of the inspection action that gave rise to the Personal Income Tax assessment contested.

• The Claimants argue that the provision of article 43 of the PITC applicable aims to tax financially the gains, when obtained by individuals, resulting from capital gains obtained from the sale of shareholding interests in companies that are not micro, small and medium enterprises, and, conversely, to provide a less onerous tax burden when such companies can be qualified as such.

• The Claimants further point out that the TCA disregards the circumstance that the entity with legitimacy to request the certification (that is, the micro, small or medium enterprise itself) is a completely different entity from its former shareholder (the individual subject to Personal Income Tax), being unable, in the perspective of the Claimants, taxation under article 43(3) of the PITC to be dependent on an act or impulse, merely formal, of a third party, manifestly outside the effects of such a requirement.

• The Claimants also note that the certification will be required from companies in their relationship with the entities identified in article 3(3) of the said decree-law, and that it will not be required from individuals who do not coincide with the company and may no longer have any relationship with the company, therefore to these latter the regime provided for in article 43(3) of the PITC will always be applicable, as long as it is verified, in substantive terms, that the company whose shareholding interests were sold was a micro, small or medium enterprise.

• The Claimants conclude by arguing that the position of the TCA in the contested assessment (which is embodied in the Account Settlement Statement) shall be in violation of the principles of equality and tax capacity, inherent in the provisions of articles 103 and 104 of the Constitution of the Portuguese Republic and in article 4(1) of the General Tax Law, as well as the principle of the prevalence of substance over form.

  1. In its reply, the TCA comes to make the following considerations:

The TCA begins by invoking the exception of illegal cumulation of claims, which, in its view constitutes a dilatory exception that prevents the merits of the case from being known and entails the dismissal of the claim, inasmuch as the Claimants request that be declared the illegality of the act dismissing the hierarchical appeal, of the administrative complaint, of the illegality of the additional Personal Income Tax assessment, as well as of default interest and finally of the account settlement.

By contestation, it invokes the following arguments:

• The Claimants endorse an interpretation of the law that does not take into account the systematic element, violating the unity of the applicable legal regime as a whole, as well as an interpretation that ignores the ratio of the regime enshrined in the PITC, founding itself on a strictly literal interpretation of the law.

• From the applicable provisions it will result unequivocally that, for the purposes of applying the regime contained in article 43(3) of the PITC, the tax legislator requires the verification of two cumulative requirements: one of a material nature and another of a formal nature.

• The material requirement shall be translated into capital gains obtained resulting from sales of shareholding interests in companies that effectively constitute small enterprises and the formal requirement shall be translated into the entities in question enjoying the said status certified, through the Institute for Support of Small and Medium Enterprises and Innovation, I.P. (IAPMEI), under the terms provided in the respective Decree-Law no. 327/2007, of 6 November, valid at the date of the sales.

• The regime provided for in article 43(3) of the PITC shall be a tax exclusion, as such, being an exceptional standard provision, since it constitutes a provision for exceptional removal from the general rule regime that would be taxation at 100% of the balance between capital gains and losses obtained with the sale of equity interests, it becomes necessary to surround said exception with particular precautions, so as to avoid abusive situations, of application to companies that do not prove such quality or the granting of an excessive advantage against the objectives aimed at, being subordinate to the verification of a set of conditions, relating to the purpose of said exception, some of a material nature and another of a formal nature.

• The principle of the prevalence of substance over form, emanation of the principle of material justice, shall not have the virtue of allowing legal rules that enshrine presuppositions of a formal nature to be rendered null, when the law expressly enshrined them.

• With respect to the principles of equality and tax capacity, they are not affected by requirements related to the diligence and compliance with the legal obligations of taxpayers.

• The TCA further came in a petition to request that be withdrawn from the case the documents joined by the Claimants by which they intend to demonstrate that the company met the legal requirements to be considered a micro or small enterprise, under the terms of the Annex to Decree-Law no. 372/2007, namely the single report relating to 2009, the Annual Accounts Reporting relating to the same year, the Balance Sheet relating to 2009, the Annual Accounts Reporting relating to 2008 and the Balance Sheet relating to this same year, since, from the point of view of the TCA, the Arbitration Court may not substitute itself for IAPMEI in the qualification of an entity as a micro or small enterprise.

  1. A meeting was held on 11 December 2013, at 3.00 p.m., as referred to in article 18 of the LRTA, from which the respective minutes were drawn up and are attached to the case file. At such meeting it was decided that with respect to the exception invoked by the Respondent in its reply, the Court shall pronounce upon the same in the final decision and a new meeting was scheduled for questioning of the witness called by the Claimants, as well as for the production of arguments.

  2. On 14 January 2014, at 11:30 a.m., a new meeting was held, as scheduled, with witness E being questioned, after which the parties proceeded to the production of successive written arguments.

  3. It should be further added that the Claimants requested the joining to the case file of the equity interest transfer deed, executed on 1.6.2010, as well as of the Supreme Administrative Court Judgment of 12-4.2013, case 01582/13. The Arbitration Court, by order joined to the case file, decided to admit, the joining of such documents based on the principle of the establishment of the principle of full inquisitorial procedure and material truth, contained in articles 16(c) and (e) and 19 of the LRTA.

Having seen all of this, it is appropriate to render

II. DECISION

A. FACTS

A.1. Facts Determined as Proven

1- The Claimants submitted two Personal Income Tax declarations (model 3) for the year 2010, not declaring, however, the capital gains resulting from the sale of the equity interests carried out by deed of company C, Unipessoal, Lda, in June 2010, by the value of 4,830,635.00€.

2- The tax authority conducted an inspection procedure of the taxpayer now Claimant, having been found that he had omitted in his income statement the capital gain achieved.

3- On 1 June 2010, a purchase and sale contract of the equity interest of the above-mentioned company was concluded, by effect of which the Claimant declared to sell to company F, SA., the equity interest of which he was holder at the nominal value of 500,000€, by the total price of 4,830,635.00€.

4- In the course of the action carried out by the tax inspection, it was found that the Claimants did not declare the gain obtained and, consequently, the now Claimants, for the purposes of correcting the tax situation, produced before the conclusion of the inspection a replacement declaration of Personal Income Tax for 2010, not properly filling in, in their view, the declaration by which there resulted an assessment in which the reduction to 50% of the balance of capital gains and losses resulting from the sale sub judice was not considered.

5- From this resulted the determination of the omitted gain (realization value - updated acquisition value) in the amount of 4,330,635.00€, which was decided to be taxed at the special rate of 20%, under article 72(4) of the PITC, from which resulted a tax to be paid of 866,127.00€, to which was added 136,331.13€ of default interest, in a total amount of 934,362.68€.

6- The claimants lodged an administrative complaint relating to the tax assessment, which was to be dismissed and subsequently presented a hierarchical appeal of such dismissal.

7- The turnover of company C, Unipessoal, Lda, was, in 2010, less than €10,000,000.00 and the number of workers less than 50 persons.

8- Company D, Lda, did not request, for reasons beyond the Claimants, the electronic certification provided for in Decree-Law no. 327/2007, of 6 November, by reference to the year 2010.

9- The Finance Directorate, within the scope of the draft report dismissing the administrative complaint, acknowledged that company C, Unipessoal, Lda., in the year 2010 had a turnover of less than 10 million euros and employed fewer than 50 persons.

A.2. Facts Determined as Not Proven

Nothing to report.

A.3. Grounds for the Facts Determined as Proven

The facts determined as proven, which are peacefully acknowledged and accepted by the parties, are based on the documentary and witness evidence presented.

B. ON THE LAW

The relevant legal framework. Assessment of the issues raised.

B.1- Defence by Exception

The Respondent TCA came to defend itself by exception arguing that:

The claims presented by the Claimants are incompatible with each other.

That is, a possible success of the claim for illegality of the act of additional Personal Income Tax assessment no. ... empties of content and procedural utility the assessment of the claim for illegality of the dismissal of the administrative complaint and the hierarchical appeal.

The illegal cumulation of claims constitutes an unnamed dilatory exception that prevents the merits of the case from being known and entails the dismissal of the instance of the opposing party, under the terms of articles 577 and 288 of the Code of Civil Procedure (CPC) applicable ex vi article 29(1)(c), of the Legal Regime of Voluntary Arbitration (LRTA).

The Claimants came to reply to the exception arguing in the sense of its lack of merit.

The Claimants requested, in substance, the declaration of illegality of the act dismissing the Hierarchical Appeal, of the act dismissing the Administrative Complaint and of the acts of additional Personal Income Tax assessment no. ..., of assessment of default interest no. ... and of account settlement no. ... .

It is appropriate to bear in mind here the provision of article 16 of the LRTA namely in its paragraph (a), in the sense that the procedural process should aim to obtain a pronouncement on the merits of the claims formulated. Article 3(1) of the LRTA provides that "The cumulation of claims, even if relating to different acts and the joinder of claimants are admissible when the success of the claims depends essentially on the assessment of the same factual circumstances and on the interpretation and application of the same principles or rules of law".

The Code of Administrative Procedure (CPTA) also established the principle of free cumulation of claims in its article 4 and in this sense goes the jurisprudence of the Supreme Administrative Court namely that cited by the Claimants.

Judgment rendered in case 0723/11, dated 16/11/2011 (2nd CHAMBER):

"I - The judicial challenge of dismissal of an administrative complaint has as its immediate object the decision of the complaint and as its mediate object the defects attributed to the tax act.

II - Once the dismissal of the complaint is annulled due to a procedural defect thereof, it is incumbent upon the court to know of the remaining defects attributed to the tax act, since this is competent to know in such challenge, both of the dismissal of the complaint and of the defects attributed to the tax act" (...)

"From this it results then that, once a judicial challenge of the dismissal of an administrative complaint is lodged, of the two one:
a) either the court confirms the dismissal, maintaining the contested tax act;

b) or the court annuls such dismissal, namely due to a procedural defect; in this case, the court must assess the defects attributed to the tax assessment act, since the challenge has as its object, both the decision of the complaint, as the defects of the tax assessment act itself";

and the Judgment rendered in case 01138/12, dated 11/09/2003, (2nd CHAMBER):

"I - Although the administrative act of dismissal of the hierarchical appeal is the immediate object of the judicial challenge, it is, however, the tax assessment act - its immediate object - that is truly contended in the challenge".

Still in the sense of permitting the cumulation of claims for reasons of economy of means and uniformity of decisions see also the Judgments of the Supreme Administrative Court in cases 0608/11 of 16/11/2011 albeit in different situations and 0496/12 of 11/10/2012 and also the Judgment of the Administrative Court of the South in case 03271/09 of 03/11/2009 and the Judgment of the Administrative Court of the North in case 00373/04.6BEVIS of 13/09/2012.

In consequence, the exception invoked by the Respondent is judged to lack merit.

The Respondent further invokes that, with the joining to the case file of the Supreme Administrative Court Judgment, the Claimants would intend the expansion of the cause of action at a date subsequent to that of the defence, therefore the Court must analyse the claim of the mentioned Claimants in the terms and with the grounds that the same petition was initially presented.

Neither does the exception invoked here proceed, since the mere joining to the case file of a Supreme Administrative Court judgment does not alter the grounds of the claim, all the more so since the judgment is published and the same in no way alters the underlying material reality and the said judgment could always be taken into account by the Court at the moment of rendering the respective decision.

B.2- Defence by Contestation

The first issue that needs to be resolved has to do with the legal framework at the date of the equity interest transfer operation, that is, 1.6.2010 in the field of capital gains taxation: that is, whether article 10(3) of the Personal Income Tax Code in the wording at the date was then in force, combined with article 72(4) of the same Code, which mandated the taxation of the positive balance between capital gains and losses resulting from the sale of equity interests at the rate of 10% or, alternatively, the taxable event occurs only at the end of the year, since taxation is among the positive balance of capital gains and losses and, consequently, whether the legal regime already established by Law no. 15/2010, of 26 July was already in force, which established, among other aspects, a 20% rate for the taxation of the positive balance between capital gains and losses.

It is to be said that we subscribe entirely to the point of view expressed in Judgment 01582/13, by means of which and we transcribe the relevant part of its summary:

"II- In capital gains resulting from the onerous alienation of assets subject to Personal Income Tax as patrimonial increases the taxable event occurs at the moment of alienation (article 10(3) of the Personal Income Tax Code), being that the moment relevant for the purposes of application in time of the new law, in the absence of express provision of the legislator in a different sense (articles 12(1) of the General Tax Law and of the Civil Code)".

In fact, for us it is clear that under article 10(3) combined with article 10(1)(b), the moment at which the taxable event occurs is that of the alienation of the equity interests and that is universally accepted to have occurred on 1.6.2010. Therefore, the logical consequence is that taxation takes place at the special rate of 10% (in the case the taxpayer does not opt for aggregation). The taxable event occurred with the sale of the equity interests. The rest, that is, the determination of the balance at the end of the year relates exclusively to the manner in which the taxable matter is determined, but such determination does not constitute the true taxable event. Indeed, nothing prevents the establishment of a pro rata temporis mechanism in which the balance of capital gains is calculated up to 26.7.2010 in one manner and from 27.6.2010 onwards in another. It may be impractical, but that is not relevant in legal terms, especially when it is a matter of the retroactive application of a rule of incidence.

Indeed, in this sense also goes the Supreme Administrative Court Judgment that we have been citing when it says:

"It is that article 12(2) of the General Tax Law clearly provides that "if the taxable event is of successive formation, the new law only applies to the period elapsing after its entry into force". That is, only the balance between the capital gains and losses relating to the period elapsing from 27.7.2010 can be taxed at the rate of 20%".

It is further added that the arbitration decision 25/2011-T of the AAC goes exactly also in this direction.

In the grounds of the judgment rendered, it is expressly stated as follows:

"Having the new law entered into force on 27 July [of 2010], the same can only be applied, by force of article 12(2) of the General Tax Law, with respect to capital gains obtained from such date and not before".

By consequence, to the extent it was possible for us to ascertain, the understanding now endorsed concites unanimity within the jurisprudence of the Supreme Administrative Court and, equally, of the AAC.

For all these reasons, it ceases to be relevant to know which regime is applicable to SMEs and whether the regime provided for in articles 43(3) and 43(4) of the PITC refer to Decree-Law no. 372/2007 in its entirety or only to the annex of the same with respect to the requirements to consider a given entity as an SME and whether, in the case at hand, proof was made that the company whose equity interests were sold met or did not meet such requirements.

C. Decision

It is hereby decided in this Arbitration Court:

To judge the claim for arbitration pronouncement well-founded and, in consequence, to declare illegal the additional Personal Income Tax assessment no. ... relating to the financial year 2010 and the consequent acts of assessment of default interest no. ... and of account settlement no. ... .

D. Value of the Case

The value of the case is fixed at € 454,230.22, under the terms of article 97-A(1)(a), of the Tax Procedure Code, applicable by force of articles 29(1)(a) and (b) of the LRTA and of article 3(2) of the Regulation of Costs in Tax Arbitration Cases.

E. Costs

The value of the arbitration fee is fixed at 7,344€, under the terms of Table I of the Regulation of Costs in Tax Arbitration Cases, to be paid in full by the Respondent, since the claim was fully granted, under the terms of articles 12(2) and 22(4), both of the LRTA, and article 4(4) of the said Regulation.

Let it be notified.

Lisbon, Administrative Arbitration Centre, 14 March 2014

The Arbitrators

(Manuel Macaísta Malheiros)
(President)

(Vasco Valdez)

(Carlos Baptista Lobo)

Frequently Asked Questions

Automatically Created

How are capital gains from the sale of shares in micro and small enterprises taxed under Portuguese IRS?
Under Portuguese IRS law, capital gains from selling shares in micro and small enterprises receive favorable tax treatment under Article 43 of the CIRS. If the company qualifies as an SME according to the criteria in Decree-Law 372/2007 (annual turnover and balance sheet not exceeding €10 million, fewer than 50 employees), only 50% of the capital gain is included in taxable income under Article 43(3) and 43(4) CIRS. The remaining 50% is excluded from taxation. If the company does not qualify as an SME, 100% of the capital gain is taxable. The taxable portion is then subject to either aggregation with other income or an autonomous rate of 20% under Article 72(4) CIRS.
What is the tax exclusion provided by Article 43 of the Portuguese IRS Code for SME share disposals?
Article 43 of the Portuguese IRS Code provides a 50% tax exclusion for capital gains arising from the sale of shareholdings in micro, small, and medium enterprises. Specifically, Article 43(3) and 43(4) CIRS stipulate that when shares or quotas in companies qualifying as SMEs (as defined in the Annex to Decree-Law 372/2007) are sold, only 50% of the resulting capital gain is included in the taxpayer's taxable income. This represents a significant tax benefit compared to the full taxation of capital gains from non-SME share sales, effectively reducing the tax burden by half for qualifying transactions.
Is a PME certificate from IAPMEI required to benefit from the capital gains tax reduction on SME shares?
This is the central legal question in Process 184/2013-T. The Tax Authority's position requires presentation of a formal PME (SME) certificate issued by IAPMEI to benefit from the 50% capital gains exclusion. However, taxpayers argue that Article 43(4) CIRS references only the substantive criteria in the Annex to Decree-Law 372/2007, not the certification procedures in the decree-law itself. The claimants contend that requiring certification creates an impossible burden when former shareholders no longer control the company and cannot compel new management to obtain the certificate. They argue this interpretation violates constitutional principles of equality and substance over form, as the company indisputably met all substantive SME criteria.
Can taxpayers claim the SME capital gains exemption if the company meets substantive criteria but lacks formal certification?
Process 184/2013-T directly addresses whether substantive compliance with SME criteria suffices absent formal certification. Claimants argued that when a company objectively meets the substantive requirements in the Annex to Decree-Law 372/2007 (turnover under €10 million, fewer than 50 employees, balance sheet under €10 million), the Article 43 tax benefit should apply regardless of certification status. They emphasized that the Tax Authority itself acknowledged the company met these criteria. The claimants contended that former shareholders cannot be penalized for a certification omission by third parties (new management) occurring after the share sale, and that requiring certification would elevate form over substance. They argued this violates Articles 103 and 104 of the Portuguese Constitution and Article 4(1) of the General Tax Law.
What was the outcome of CAAD arbitration process 184/2013-T regarding the additional IRS tax assessment on share sale proceeds?
The document excerpt provided contains only the Report section (Part I) of the arbitration decision, which outlines the facts, procedural history, and arguments from both parties. The actual decision, reasoning, and outcome are not included in the text provided. The case involved a contested IRS assessment of €908,460.43 in tax and default interest on capital gains from a 2010 share sale. The arbitration court was constituted on October 4, 2013, at the Administrative Arbitration Centre (CAAD) to decide whether the Tax Authority properly denied the 50% capital gains exclusion for lack of SME certification despite the company meeting substantive SME criteria. To determine the outcome, one would need to review the complete decision document including the court's legal analysis and ruling.