Process: 200/2018-T

Date: October 29, 2018

Tax Type: IRS

Source: Original CAAD Decision

Summary

This CAAD arbitration case (Process 200/2018-T) addresses the legality of IRS withholding tax assessments on alleged profit distributions by a Portuguese limited liability company. The Tax Authority conducted an inspection covering financial years 2013-2015, discovering that the company had recorded substantial monetary assets in bank deposits that were not actually held by the company. The funds had been transferred to partners through purported loan agreements. The Tax Authority challenged these arrangements, arguing the loans lacked essential characteristics: no proof of actual financial outflows, no interest charges, no security provisions, and no Stamp Duty payment. The Authority contended these transfers constituted disguised profit distributions subject to IRS withholding tax, resulting in assessment 2017... dated 11.12.2017, plus compensatory interest. The company challenged this assessment through CAAD arbitration under RJAT provisions, claiming the absence of a valid taxable event since no actual profit distribution occurred. The arbitral tribunal, constituted on 04-07-2018 with three arbitrators, accepted jurisdiction under Article 2(1)(a) and 10(1) of Decree-Law 10/2011. The Tax Authority defended by arguing inadmissibility of the claim. This case illustrates the critical distinction under Portuguese tax law between genuine loan transactions and disguised profit distributions, the evidentiary requirements for establishing valid loan arrangements between companies and partners, and the availability of CAAD arbitration to challenge withholding tax assessments when the underlying taxable event is disputed.

Full Decision

ARBITRAL DECISION (See full version in PDF)

The arbitrators, Advisor Jorge Lopes de Sousa (president arbitrator), Professor Doctor Elísio Brandão and Professor Doctor Francisco José Nicolau Domingos (arbitrator members) appointed by the Ethics Council of the Centre for Administrative Arbitration to form the Arbitral Tribunal, constituted on 04-07-2018, agree as follows:

1. Report

A..., LDA., a company with headquarters at ..., no. ..., ..., ...-... Lisbon, with unique registration number and collective person number ..., whose local peripheral service is the Lisbon Tax Service –..., (hereinafter "Claimant"), came, in accordance with the provisions of articles 2.º, no. 1, letter a), 5.º, no. 3, letter a), 6.º, no. 2, letter a), and 10.º, no. 1, letters a) and 2, of Decree-Law no. 10/2011, of 20 January (hereinafter "RJAT"), to request the constitution of an Arbitral Tribunal, with a view to declaring the illegality of the statement of collection of withholding tax on personal income tax (IRS) for the year 2013, corresponding to assessment no. 2017..., of 11.12.2017 and the respective collection of compensatory interest, corresponding to assessment no. 2017... .

The Claimant also requests reimbursement of the amount paid improperly, plus indemnity interest.

The respondent is the TAX AND CUSTOMS AUTHORITY.

The request for the constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority on 19-04-2018.

In accordance with the provisions of letter a) of no. 2 of article 6.º and letter b) of no. 1 of article 11.º of the RJAT, the Ethics Council appointed as arbitrators the signatories, who communicated acceptance of the charge within the applicable period.

On 14-06-2018, the parties were duly notified of this appointment and did not manifest any intention to refuse the appointment of the arbitrators, in accordance with the combined provisions of article 11.º no. 1 letters a) and b) of the RJAT and articles 6.º and 7.º of the Code of Ethics.

Thus, in accordance with the provisions of letter c) of no. 1 of article 11.º of the RJAT, in the wording introduced by article 228.º of Law no. 66-B/2012, of 31 December, the collective arbitral tribunal was constituted on 04-07-2018.

The Tax and Customs Authority responded, defending the inadmissibility of the claim.

By order of 21-09-2018 the meeting provided for in article 18.º of the RJAT was dispensed with and it was decided that the case should proceed with optional written submissions for a period of 10 days, with the period for submissions by the Claimant beginning with notification of the order and the period for submissions by the Tax Authority beginning with notification of the presentation of the Claimant's submissions.

The parties submitted submissions.

The arbitral tribunal was properly constituted, in accordance with the provisions of articles 2.º, no. 1, letter a), and 10.º, no. 1, of Decree-Law no. 10/2011, of 20 January, and is competent.

The parties are properly represented, possess legal standing and capacity, are legitimate and are represented (articles 4.º and 10.º, no. 2, of the same instrument and article 1.º of Ministerial Order no. 112-A/2011, of 22 March).

The case is not affected by nullities.

2. Factual Matters

2.1. Proved Facts

  • The Claimant is a company with limited partners, classified under CAE 86906 – Other human health activities;

  • A tax inspection was carried out on the Claimant under service orders nos. OI2017..., OI2017... and OI2017... relating to the financial years 2013, 2014 and 2015, with a partial scope of VAT, corporate income tax and withholding taxes;

  • In the inspection, the Tax Inspection Report was prepared, which is attached as document no. 2 with the request for arbitral pronouncement, the content of which is hereby reproduced, in which the following is stated, among other matters:

III – DESCRIPTION OF FACTS AND GROUNDS FOR PURELY ARITHMETIC CORRECTIONS

3.1 - CORRECTIONS PROPOSED IN THE CONTEXT OF WITHHOLDING TAXES (IRS)

(...)

Legal Framework of Income Attributed to Partners in 2013, 2014 and 2015

Systematizing the observed facts, the following was determined:

  • The company generated income in the financial years under analysis due to the professional activity carried out mainly by the managing partner, ophthalmologist, Dr. B..., and to a lesser extent by the managing partner, anaesthetist, Dr. C... . This is a company that never distributed profits. The main service provider was the managing partner B..., who formally worked for the company on a voluntary basis and from which he did not withdraw any income. The managing partner C... formally also worked for the company as a dependent worker/capital holder, being remunerated monthly by the company in these financial years with a fixed benefit, on a fixed basis;

  • It was demonstrated that until the financial year 2012 the accounting of the company did not reflect the existence of any "loan" from the company to the partners;

  • Upon examining the financial statements/tax returns of the years prior to 2013, it was found that cumulative debtor balances were always declared in the balance sheet under the heading "Bank deposits and cash," the total of that asset of the company being €1,713,317.88 in 2012, with no loan to partners being declared over the years;

  • However, on 01/01/2013, the company's money recorded in demand deposits, in the amount of €1,284,317.88 (in account 121 demand deposits/D...), which accounts for the results carried forward accumulated by the company over several years, was in fact not in the company, since the opening balance of the company's bank statements at that banking institution (D...) on that date only justifies €46,415.65;

  • The managing partner stated in the declarations made by him that, in the financial years under analysis, the monetary values of the company were all deposited in banks, with no values in "cash";

  • In 2013, 2014 and 2015, entries were made in the accounting records, where the company sought to demonstrate transfers to the partners (directly transferring values from "demand deposits" to the partners' assets and recording them directly as credit granted to the partners) which occurred as a result of loan agreements and loan receipts, concluded between the company and the partners during these financial years;

  • However, it was acknowledged by the managing partner that "The loans were executed partly to justify the departure of revenues of the company that had been previously deposited in the bank accounts of the partners" (Annex 4). Regarding the loan receipts signed on 30/09/2015, in the total amount of €742,300.00, written acknowledgment was also obtained from the company, in response to a request for clarification, that those accounting entries were intended to "settle the bank account of D..." (ANNEX 13), as confirmed by the information contained in table 6 of this report;

  • Given that the characteristic elements of loans were not present, despite loan agreements and receipts being presented, due to their weaknesses which have been continuously highlighted (absence of proof of financial outflows in favor of the alleged partners within the scope of the loan agreements and receipts; absence of fixing a price - interest - that would allow compensation for the unavailability of money and associated risk; no provision of personal or real security; non-payment of Stamp Duty as required by its Code), it is concluded that this is not the nature of the operations;

  • In the course of the analysis carried out within the scope of this inspection procedure, the observed facts, the documents evaluated and the clarifications provided, it is concluded that the company did not execute any loans to the partners. What the transfers of financial resources made by the company to the partners objectively reflect, originating from "Demand Deposits," is the placing at the disposal of the partners of income, constituting an increase in their patrimonial income. Also, the requirements are not met for such placement at disposal to be considered work income (notably, the fact that there is no connection with the work performed). Indeed, only can it be concluded that there is income from capital, in the form of distribution of profits or advance on account of profits;

  • Having demonstrated the absence of loans from the company to the partners, given the absence of any other valid ground to rebut the presumption provided for in article 6, no. 4 of the Personal Income Tax Code (CIRS) (such as resulting from the provision of work or the exercise of corporate offices), the dates of the entries expressed by the accounting must prevail;

  • In this sense, it was demonstrated that in the financial years under analysis (from 2013 onwards), the company recognized in its balance sheet loans granted to the partners, recorded in accounting accounts of loans to partners as we confirmed, declaring them in the financial statements/tax returns of those financial years, where it transposed the financial statements of the company for those financial years, which were subject to deliberation and approval by the partners in General Meeting, already communicated to both the Tax Administration and the Commercial Registry Office, making known the financial information on the management and patrimonial situation of the company for those financial years.

In this manner, the necessary elements are gathered, on the basis of which, it is concluded that the placing at the disposal of the partners of the amounts that the company held in "Demand Deposits" refers to the distribution of profits or advances on account of profits, and cannot in any way be characterized as loans/mortgages or work income.

It is concluded that the company sought to have its results go out in favor of the partners, avoiding their taxation, both at the company level and at the partners' level.

The distribution of profits and advance on account of profits occurred at the moment when it was objectively recognized in the accounting records that they were placed at the disposal of the partners, which happened through the crediting of the "demand deposits" by debiting the partners.

Following on from what was stated previously, it is concluded that the income thus distributed to the partners constitutes income from capital (category E) by virtue of no. 1 of article 5.º of the CIRS, whose classification is specified in letter h) of no. 2 of the same article 5.º of the CIRS. According to this provision, subject to IRS, by classification in category E, are "The profits of entities subject to corporate income tax placed at the disposal of their respective members or holders, including advances on account of profits...".

Thus, based on letter h) of no. 2 of article 5.º of the CIRS, the placing at the disposal by the company to the partners of amounts that the company had recorded in "demand deposits" and which totaled the amount of €1,345,000.00 in 2013, €265,500.00 in 2014 and €742,800.00 in 2015, shall be considered to have occurred by way of distribution of profits or advance on account of profits.

Collecting the accounting proof, the legal basis for the presumption established in article 6, no. 4 of the CIRS was fulfilled, according to which "Entries in any current accounts of partners, recorded in commercial companies or civil companies in commercial form, when not resulting from loans, the provision of work or the exercise of corporate offices, are presumed to be made by way of profits or advance on profits" (wording in force at the date of the tax events - 2013 and 2014, prior to the republication of the CIRS by Law no. 82-B/2014, of 31 December"). In this sense, the amounts of €1,345,000.00 in 2013, €265,500.00 in 2014 and €742,800.00 in 2015, constitute the amounts of income entered in the accounting records of the company in the current accounts of the partners, which were based on transfers of values from "demand deposits" accounts, taking on the nature of distribution of profits or advances on account of profits classifiable as income of category E (article 5.º, no. 2, letter h) of the CIRS).

The distribution of profits and advances on account of profits are subject to withholding at source, on a final basis, at the liberating rate of 28%, in the context of IRS, as provided for in article 71.º, no. 1, letter c) of the CIRS (current article 71.º, no. 1, letter a) of the same legal instrument), which, as indicated in no. 3 of article 98.º of the same instrument shall be paid into the State coffers by the 20th day of the month following the month to which it refers.

It should be noted that the inspected company did not proceed with the withholding of IRS due, to which it was obliged under article 101.º, no. 2, letter a) of the CIRS.

Moment of Taxation and Distribution of Capital Income to be Taxed by Period

In summary, the amounts of total transfers by the company to the partners, in each financial year under analysis, which were considered by the company as loans to the partners, a characterization that should be disregarded, as was previously proven, because they constitute a distribution of profits or advance on account of profits (tax event), classifiable under the provisions of article 5.º, no. 2, letter h) and article 6, no. 4, both of the CIRS, are as follows:

  • Year 2013: €1,345,000.00
  • Year 2014: €265,500.00
  • Year 2015: €742,800.00

The described facts reflect the existence of values recorded in "demand deposits" accounts that were undoubtedly transferred to the partners, with the transfer of ownership of such funds taking place for the benefit of the partners, who thus saw their assets increase.

With respect to the amounts subject to taxation, the value was fixed corresponding to the amounts placed at the disposal of the partners, as shown in the company's accounting records, as if they were loans to the partners.

Article 7.º, no. 1 and no. 3, letter a), no. 2 of the CIRS establish that the moment from which capital income (category E) becomes subject to taxation corresponds to the date on which it is placed at the disposal of its holder.

Thus, on the basis of the facts already presented and with the tax event proven, all possible doubts regarding the moment of delivery of capital income to the partners are dispelled, given that the information contained in the financial statements declared by the company over the years (whether concerning its assets, where the "bank balances" are found, or relating to "reserves" and results obtained, or even the operations referring to transfers of values from "demand deposits" to the partners) constitutes information approved and certified by the partners annually in General Meeting and communicated to various entities.

Thus, given all the evidence previously presented, it is considered that the distribution of profits or advance on account of profits occurred at the moment when it was objectively recognized in the accounting records that they were placed at the disposal of the partners, recording the actual transfers of balances from "demand deposits" accounts in specific accounts of loans to the partners. That is, as to the moment of taxation the month in which the transfers of values occurred was fixed – article 7.º of the CIRS, defining that moment as when the tax becomes due.

The following table presents the distribution of capital income – profits and advances on account of profits – distributed to the partners, by period (month), subject to a withholding tax rate of 28%, without the company having carried out such withholding, determining the respective amount of withholding shortfall.

[Table content shown in original Portuguese text]

From the above table, we conclude that the amounts of withholding shortfall determined in each financial year under analysis, for having been placed at the disposal of the partners, as capital income, amount to €376,600.00 in 2013, €74,340.00 in 2014 and €207,984.00 in 2015.

  • Following the inspection action, the Tax and Customs Authority issued the assessment of withholding tax for the year 2013 no. 2017..., of 11-12-2017 and the respective assessment of compensatory interest no. 2017..., in the total amount of €433,884.47, being €376,600 of withholding tax and €57,284.47 of compensatory interest (document no. 1 attached with the request for arbitral pronouncement, the content of which is hereby reproduced);

  • On 16-01-2018, the Claimant paid the assessed amount of €433,884.47 (document no. 3 attached with the request for arbitral pronouncement, the content of which is hereby reproduced);

  • In the Patrimonial Declaration of the Claimant's account with D... it is stated that, on 31-12-2012, the Claimant held a total amount of demand deposits of €46,415.65 (document no. 4 attached with the request for arbitral pronouncement, the content of which is hereby reproduced);

  • From the bank statement of the Claimant's account with D... it is stated that, on 31-12-2013, the Claimant held a total amount of demand deposits and term deposits of €517,145.60, divided by €82,145.60 of Demand Deposits and €435,000.00 of Term Deposits (document no. 5 attached with the request for arbitral pronouncement, the content of which is hereby reproduced);

  • The historical movements from 01-01-2013 to 31-12-2013 of the Claimant's account with D... are those shown in document no. 6 attached with the request for arbitral pronouncement, the content of which is hereby reproduced;

  • The balances in that account during that period ranged between a minimum of €8,128.76 (on 17-02-2013) and a maximum of €492,328.13 (on 22-02-2013), being €46,415.65 on 01-01-2013 and €82,145.60 on 31-12-2013 (document no. 6);

  • The amount of €435,000.00 which was transferred to the Claimant's account on 22-02-2013, was applied on the same date in term deposits with numbers ... (€250,000.00) and ... (€185,000) which were maintained until 22-02-2015 (documents nos. 6 and 7 attached with the request for arbitral pronouncement, the contents of which are hereby reproduced);

  • The loan contracts concluded by the Claimant dated 30-12-2013 were executed after the Claimant had made available amounts to its partners, for the purpose of justifying the departure of revenues of the company (statement of the managing partner of the Claimant, reproduced in the Tax Inspection Report, page 7);

  • Most of the banking operations carried out by the Claimant were carried out through D... (Tax Inspection Report, page 10);

  • In the year 2013, the following differences were found between the values deposited in the Claimant's demand account with D... and the values that appeared in account 121 Demand Deposits/D...:

[Table content shown in original Portuguese text]

  • On 31-12-2013, an accounting entry was made indicating that it concerned loans to partner B..., with these elements:

[Table content shown in original Portuguese text]

  • On 04-04-2018, the Claimant submitted the request for arbitral pronouncement that gave rise to the present case.

2.2. Unproved Facts

It was not proven that during the year 2013 the Claimant had placed at the disposal of its partners the total sum of €1,345,000.00.

In fact, it was not determined that the Claimant had this amount in the year 2013, and the Claimant's bank account with D... points in the direction of not having it available.

2.3. Reasoning for the Determination of Factual Matters

The facts were established as proved on the basis of the documents attached with the request for arbitral pronouncement and the administrative file.

3. Legal Matters

The Tax and Customs Authority conducted an inspection of the Claimant, which included the financial year 2013, and concluded, in summary, the following:

  • "it was demonstrated that in the financial years under analysis (from 2013 onwards), the company recognized in its balance sheet loans granted to the partners, recorded in accounting accounts of loans to partners as we confirmed, declaring them in the financial statements/tax returns of those financial years, where it transposed the financial statements of the company for those financial years, which were subject to deliberation and approval by the partners in General Meeting, already communicated to both the Tax Administration and the Commercial Registry Office, making known the financial information on the management and patrimonial situation of the company for those financial years";

  • "In 2013, 2014 and 2015, entries were made in the accounting records, where the company sought to demonstrate transfers to the partners (directly transferring values from "demand deposits" to the partners' assets and recording them directly as credit granted to the partners) which occurred as a result of loan agreements and loan receipts, concluded between the company and the partners during these financial years";

  • despite loan agreements and receipts being presented, no operations with the characteristics of loan contracts were verified, the Claimant not having executed any loans to the partners;

  • what the transfers of financial resources made by the company to the partners objectively reflect, originating from "Demand Deposits," is the placing at the disposal of the partners of income, constituting an increase in their patrimonial income;

  • the conditions are not met for considering the placing at the disposal of the partners as work income;

  • therefore, "only can it be concluded that there is income from capital, in the form of distribution of profits or advance on account of profits".

  • "the distribution of profits or advance on account of profits occurred at the moment when it was objectively recognized in the accounting records that they were placed at the disposal of the partners, recording the actual transfers of balances from 'demand deposits' accounts in specific accounts of loans to the partners".

The Claimant attributes the following defects to the correction and assessment impugned:

  • there is no ancillary duty of tax substitution on the Claimant since the amounts in question were placed at the disposal of its partner by the Claimant by way of loan, and recorded in the accounting records as such, so it was with that nature that it received the proper tax treatment and not with the one now given, resulting from the disregard operation carried out by the Tax Authority; therefore, the assessment of withholding tax now notified to the Claimant (as tax substitute) violates the principles of trust and legal certainty, proportionality, capacity to pay and fairness;

  • the assessment of withholding tax further suffers from the defect of lack of reasoning;

  • the assessment suffers from defect due to error on the factual assumptions, due to incorrect application of the presumption provided for in article 6.º, no. 4, of the CIRS, because loans exist;

  • the only way to disregard loan contracts would be through the application of the general anti-abuse clause, provided for in article 38.º, no. 2, of the General Tax Law and the respective legal procedure, provided for in article 63.º of the Tax Procedure and Process Code was not used;

  • the right to assess has expired;

  • there is no tax event, or there is incorrect quantification of income, since the amounts that the Tax Authority intends to tax as having been placed at the disposal of the Claimant's partners during the course of 2013 had already been placed at the disposal by 31-12-2012.

3.1. Order of Knowledge of Defects

Article 124.º of the Tax Procedure and Process Code (CPPT) establishes rules on the order of knowledge of defects in judicial impugnation proceedings, which are subsidiarily applicable to arbitral proceedings, by virtue of the provisions of article 29.º, no. 1, letter c), of the RJAT.

In the case of defects giving rise to voidability, letter b) of no. 2 of that article 124.º, through reference to its letter a), establishes that, when the impugning party does not indicate a relationship of subsidiarity, priority should be given to defects whose procedence would determine, according to the prudent judgment of the judge, more stable or effective protection of the injured interests.

Thus, the Claimant not establishing a relationship of subsidiarity between the defects attributed to the assessment impugned, it should be left for the end the examination of the defect of lack of reasoning, which is a formal defect that, in case of annulment, does not necessarily prevent the renewal of the annulled act, with suppression of the defect.

In any case, if any defect is found to be well-founded that ensures stable and effective protection of the Claimant's interests, knowledge of the remaining defects will be foreclosed, as is implicit in the establishment of an order of knowledge (since if it were always necessary to know about all of them, the order of their knowledge would be immaterial).

3.2. Question of the Existence or Otherwise of a Duty to Withhold at Source

The Tax and Customs Authority understood in the Tax Inspection Report that there was no loan, the loan contracts having been drawn up after the placement at the disposal of the respective amounts to the Claimant's partners, for the purpose of justifying the departure of revenues of the company.

It was established as proved that this is what occurred, based on the testimony of the managing partner of the Claimant, transcribed in the Tax Inspection Report.

The Claimant's thesis, in invoking the non-existence of a duty to withhold at source, is that "it loaned to its partner the income that the Tax Authority now intends to tax, and that is the effective legal nature of the payments, as thus recorded in the accounts".

"A loan is the contract by which one party lends to another money or other fungible thing, the second being obliged to restore another amount of the same kind and quality" (article 1142.º of the Civil Code).

In the case at hand, the Claimant did not lend the amounts referred to in the contracts to partner B..., having rather drawn up the contracts with the "purpose of justifying the departure of revenues of the company," in the face of the divergence between the real balance of the D... account and the values recorded in the accounting records regarding that account.

As correctly concluded by the Tax and Customs Authority in the Tax Inspection Report, this set of operations does not have the characteristics of loan contracts, as there was neither a loan of money to partner B... nor did he receive any money as a result of the contract.

Therefore, there was not, in reality, any loan contract concluded on 30-12-2013, but rather documents drawn up with the appearance of loan contracts which were not the basis for any transfer of assets by the Claimant to its partner B....

As mentioned, the lack of withholding at source invoked by the Tax and Customs Authority, which justifies the assessment impugned, does not have as its basis the loan contracts, but rather its foundation is the prior placement at the disposal of amounts to the partners.

This is not a case of disregard of transfers of assets generated by loan contracts, as none were generated, there being, rather, prior placement at the disposal of amounts by the Claimant to its partners, without known grounds and without accounting records.

This placement at the disposal of amounts to the partners which came to be in some measure recorded, with the entry, dated 31-12-2013, in the account of partner B..., is presumed to be made "by way of profits or advance on profits," by virtue of the provisions of no. 4 of article 6.º of the CIRS, since it did not result "from loans, the provision of work or the exercise of corporate offices".

As stated in the Tax Inspection Report, "the distribution of profits and advances on account of profits are subject to withholding at source, on a final basis, at the liberating rate of 28%, in the context of IRS, as provided for in article 71.º, no. 1, letter c) of the CIRS (current article 71.º, no. 1, letter a) of the same legal instrument), which, as indicated in no. 3 of article 98.º of the same instrument shall be paid into the State coffers by the 20th day of the month following the month to which it refers".

Thus, there was a need for withholding at source with respect to the placement at the disposal of the income referred to.

For this reason, the assessment impugned does not suffer from this defect which the Claimant attributes to it.

3.3. Question of Defect Due to Error on the Factual Assumptions, Due to the Existence of Loans

The Claimant attributes to the assessment impugned the defect of error on the factual assumptions, due to incorrect application of the presumption provided for in article 6.º, no. 4, of the CIRS, because loans exist.

No. 4 of article 6.º of the CIRS establishes that "entries in any current accounts of partners, recorded in commercial companies or civil companies in commercial form, when not resulting from loans, the provision of work or the exercise of corporate offices, are presumed to be made by way of profits or advance on profits".

As stated, there were no loans in 2013, so the entries made cannot be considered as a result thereof, but rather of prior placement at the disposal of partner B... of the amount formally indicated as loaned.

For this reason, the assessment impugned does not suffer from this defect of error on the factual assumptions which the Claimant attributes to it.

3.4. Question of Defect in the Need to Apply the General Anti-Abuse Clause to Disregard the Loan Contracts

The Claimant argues that the only way to disregard loan contracts would be through the application of the general anti-abuse clause, provided for in article 38.º, no. 2, of the General Tax Law and the respective legal procedure, provided for in article 63.º of the Tax Procedure and Process Code was not used.

However, as stated, in reality there were no loan contracts, and what is at issue, as the basis of the assessment, are prior transfers of assets which preceded their conclusion and which, by themselves, have the potential to constitute tax events.

For this reason, the assessment impugned does not suffer from defect due to not having been based on the application of the general anti-abuse clause nor due to the special procedure provided for its application not having been used.

3.5. Question of the Expiry of the Right to Assess and the Non-Existence of a Tax Event in 2013 Because the Amounts Underlying the Assessment Were Placed at the Disposal of the Claimant's Partners Before That Year

These issues are related, as they concern the determination of the moment or moments when the transfers of assets underlying the assessment were carried out.

The Claimant argues that the proof produced points in the direction of not having the amount of €1,345,000.00 that was the subject of the fictitious loan contracts in 2013, and in truth there is no indication of the availability of an amount that approaches that figure.

Indeed, the Tax and Customs Authority states in the Tax Inspection Report that the Claimant's most relevant bank account was that at D..., not even attributing relevance to the other bank accounts it mentions.

That bank account had a balance of demand deposits of €46,415.65 on 31-12-2012 and €82,145.60 on 30-12-2013 (the last day indicated in the statement contained in document no. 6, which states it covers movements from 01-01-2013 to 31-12-2013), being €138,990.59 on 25-11-2013, the maximum balance value of the demand account.

Even considering term deposits, at the amount of €435,000.00, one is far from the amount of €1,345,000 considered by the Tax and Customs Authority as being the amount placed at the disposal of the partners in the year 2013. Furthermore, this amount of €435,000.00 of term deposits was maintained until 22-02-2015 (document no. 7), so it cannot have been placed at the disposal of the partners in the year 2013.

The fact invoked by the Tax and Customs Authority in the Tax Inspection Report that "in the financial years under analysis (from 2013 onwards), the company recognized in its balance sheet loans granted to the partners, recorded in accounting accounts of loans to partners as we confirmed, declaring them in the financial statements/tax returns of those financial years, where it transposed the financial statements of the company for those financial years, which were subject to deliberation and approval by the partners in General Meeting, already communicated to both the Tax Administration and the Commercial Registry Office, making known the financial information on the management and patrimonial situation of the company for those financial years," does not rebut this conclusion, as one does not see how the necessary amount for the placement at the disposal of the partners could have existed in that year.

On the contrary, as the Tax and Customs Authority states in the Tax Inspection Report "on 01/01/2013, the company's money recorded in demand deposits, in the amount of €1,284,317.88 (in account 121 demand deposits/D...), which accounts for the results carried forward accumulated by the company over several years, was in fact not in the company, since the opening balance of the company's bank statements at that banking institution (D...) on that date only justifies €46,415.65" (emphasis ours).

Thus, if on 01-01-2013, the amount of €1,284,317.88 recorded as existing in the demand account "was no longer in the company," it must be concluded that the placement at the disposal of the partners occurred before the year 2013.

Based on the foregoing, it is to be concluded that the proof produced clearly points in the direction of the amount of €1,345,000.00, which forms the basis of the assessment impugned, not having been placed at the disposal of the partners during the year 2013.

On the other hand, the presumption that "entries in any current accounts of partners, recorded in commercial companies or civil companies in commercial form, when not resulting from loans, the provision of work or the exercise of corporate offices, are presumed to be made by way of profits or advance on profits" concerns only the legal characterization of the amounts placed at the disposal and not the date on which they occurred, specifically not establishing a presumption that the placement at the disposal occurs on the date on which the accounting entry was made.

On the contrary, the provision of profits and advances as capital income is set out in letter h) of no. 2 of article 5.º of the CIRS, and article 7.º, nos. 1 and 3, letter a), no. 2 establish, as far as is relevant here, that such income becomes subject to taxation "from the moment in which ... they are placed at the disposal of their holder," therefore regardless of whether or not the accounting entry is made.

For this reason, there is no basis for presuming that the placement at the disposal of the income of the Claimant's partners occurred on the date on which the entries were made.

In any case, even if the presumption provided for in no. 4 of article 6.º of the CIRS, which is invoked by the Tax and Customs Authority, were applicable, it should be considered rebutted by the contrary evidence produced.

For this reason, the Claimant was not obliged to proceed in the year 2013 with the withholding at source whose absence underlies the assessment impugned, so that this suffers from the defect of error on the factual assumptions.

At the very least, it is to be concluded that the existence in the year 2013 of the tax event which underlies the assessment impugned is not proven, which is sufficient to justify the annulment of the assessment, in view of the provisions of no. 1 of article 100.º of the Tax Procedure and Process Code, applicable to tax arbitral proceedings by virtue of the provisions of article 29.º, no. 1, letter c), of the RJAT, which establishes that "whenever the proof produced results in well-founded doubt about the existence and quantification of the tax event, the impugned act should be annulled".

3.6. Assessment of Compensatory Interest

The legality of the assessment of compensatory interest depends on the legality of the assessment of the tax which is its prerequisite, so that from the illegality of this follows the illegality of the assessment of compensatory interest, which should also be annulled.

3.7. Issues with Foreclosed Knowledge

Since the assessment impugned is to be annulled both with respect to the tax and with respect to compensatory interest, the knowledge of the remaining legal issues raised by the Claimant is foreclosed as useless (article 130.º of the Code of Civil Procedure).

4. Reimbursement of the Amount Paid and Indemnity Interest

On 16-01-2018, the Claimant paid the assessed amount of €433,884.47 and requests its reimbursement plus indemnity interest.

In accordance with the provisions of letter b) of article 24.º of the RJAT, the arbitral decision on the merits of the claim to which no appeal or impugnation is available binds the Tax Administration from the end of the period provided for appeal or impugnation, and the latter should, in the exact terms of the procedence of the arbitral decision in favor of the taxpayer and until the end of the period provided for the spontaneous execution of decisions of tax judicial courts, "restore the situation that would exist if the tax act subject to the arbitral decision had not been made, adopting the acts and operations necessary for that purpose," which is in keeping with the provisions of article 100.º of the General Tax Law [applicable by virtue of the provisions of letter a) of no. 1 of article 29.º of the RJAT] which establishes that "the tax administration is obliged, in case of full or partial success of a complaint, judicial impugnation or appeal in favor of the taxpayer, to immediate and complete restoration of the legality of the act or situation subject to the dispute, including the payment of indemnity interest, if applicable, from the end of the execution period of the decision".

Although article 2.º, no. 1, letters a) and b), of the RJAT uses the expression "declaration of illegality" to define the competence of arbitral tribunals functioning in the CAAD, not referring to condemnatory decisions, it should be understood that their competences include the powers which, in judicial impugnation proceedings, are attributed to tax courts, this being the interpretation that harmonizes with the sense of the legislative authorization on which the Government based itself to approve the RJAT, in which it proclaims, as the first guideline, that "the tax arbitral process should constitute an alternative procedural means to the judicial impugnation process and to the action for recognition of a right or legitimate interest in tax matters." The judicial impugnation process, despite being essentially a process of annulment of tax acts, allows for the condemnation of the Tax Administration in the payment of indemnity interest, as can be inferred from article 43.º, no. 1, of the General Tax Law, in which it is established that "indemnity interest is due when it is determined, in a gracious complaint or judicial impugnation, that there was error attributable to the services resulting in payment of the tax debt in an amount greater than that legally due" and from article 61.º, no. 4 of the Tax Procedure and Process Code (in the wording given by Law no. 55-A/2010, of 31 December, which corresponds to no. 2 in the original wording), which states "if the decision recognizing the right to indemnity interest is judicial, the payment period is counted from the beginning of the spontaneous execution period thereof".

Thus, no. 5 of article 24.º of the RJAT, in stating that "payment of interest is due, regardless of its nature, in the terms provided for in the general tax law and in the Tax Procedure and Process Code," should be understood as allowing recognition of the right to indemnity interest in the arbitral process.

As the payment of indemnity interest depends on there being an amount to be reimbursed, it falls within the scope of the competences of arbitral tribunals functioning in the CAAD to assess whether there is a right to reimbursement and to what extent.

It is thus necessary to assess the claims for restitution of the amount paid plus indemnity interest.

The substantive regime of the right to indemnity interest is regulated in article 43.º of the General Tax Law, which establishes, as far as is relevant here, the following:

Article 43.º

Unduly Paid Tax Obligation

1 – Indemnity interest is due when it is determined, in a gracious complaint or judicial impugnation, that there was error attributable to the services resulting in payment of the tax debt in an amount greater than that legally due.

2 – There is also considered to be error attributable to the services in cases in which, despite the assessment being made on the basis of the taxpayer's declaration, the latter followed, in its completion, the generic orientations of the tax administration, duly published.

The error in the assessment is attributable to the Tax and Customs Authority, which made it on its own initiative.

Consequently, the Claimant is entitled to the reimbursement of the amount unduly paid plus indemnity interest, in accordance with article 43.º, no. 1, of the General Tax Law and article 61.º of the Tax Procedure and Process Code from the date of the unduly payment (16-01-2018), until being reimbursed.

Indemnity interest is due at the legal suppletive rate, in accordance with articles 43.º, nos. 1, and 35.º, no. 10 of the General Tax Law, article 24.º, no. 1, of the RJAT, articles 61.º, nos. 3 and 4, of the Tax Procedure and Process Code, article 559.º of the Civil Code and Ministerial Order no. 291/2003, of 8 April (or any other order that alters the legal rate), from the date of payment until complete reimbursement.

5. Decision

Based on the foregoing, the arbitrators of this Arbitral Tribunal agree to:

  • Find the claim for arbitral pronouncement well-founded;

  • Annul the assessment of personal income tax no. 2017..., of 11-12-2017 and the respective assessment of compensatory interest no. 2017..., in the total amount of €433,884.47, being €376,600 of withholding tax and €57,284.47 of compensatory interest on withholding tax;

  • Find well-founded the claims for reimbursement of the amount paid and for indemnity interest and condemn the Tax and Customs Authority to reimburse the Claimant with that amount, plus indemnity interest, in accordance with point 4 of this award.

6. Value of the Case

In accordance with the provisions of articles 296.º, no. 2, of the Code of Civil Procedure and 97.º-A, no. 1, letter a), of the Tax Procedure and Process Code and article 3.º, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the case is assigned the value of €433,884.47.

7. Costs

In accordance with article 22.º, no. 4, of the RJAT, the amount of costs is fixed at €7,038.00, in accordance with Table I annexed to the Regulation of Costs in Tax Arbitration Proceedings, to be borne by the Tax and Customs Authority.

Lisbon, 29-10-2018

The Arbitrators

(Jorge Lopes de Sousa)

(Elísio Brandão)

(Francisco José Nicolau Domingos)

Frequently Asked Questions

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What happens when IRS withholding tax is applied to profit distributions without a valid taxable event in Portugal?
When IRS withholding tax is applied to profit distributions without a valid taxable event in Portugal, the assessment can be challenged as illegal. Portuguese tax law requires an actual taxable event (facto tributário) to exist before withholding tax obligations arise. If a company can demonstrate that no genuine profit distribution occurred—for example, because the transactions were legitimate loans or the funds never actually left the company—the withholding tax liquidation lacks legal foundation. The taxpayer may seek annulment of the assessment and reimbursement of amounts improperly paid, plus indemnity interest. The burden of proof typically requires demonstrating that the transactions lacked the essential characteristics of profit distributions under the Portuguese Corporate Income Tax Code (CIRC) and Personal Income Tax Code (CIRS).
Can a Portuguese company challenge an unlawful IRS withholding tax assessment through CAAD arbitration?
Yes, a Portuguese company can challenge an unlawful IRS withholding tax assessment through CAAD (Centro de Arbitragem Administrativa) arbitration. Under Articles 2(1)(a) and 10(1) of Decree-Law 10/2011 (RJAT), taxpayers may request arbitration to declare the illegality of tax assessments, including withholding tax liquidations and compensatory interest. The process involves filing a request for arbitral tribunal constitution, appointment of arbitrators by the CAAD Ethics Council, submission of written pleadings and optional oral hearings. CAAD arbitration provides an alternative to judicial courts for resolving tax disputes, offering specialized expertise in tax matters, typically faster resolution times, and binding decisions. Companies can request not only annulment of illegal assessments but also reimbursement of amounts paid plus indemnity interest calculated according to applicable legal rates.
What are the legal grounds for declaring illegality of withholding tax assessments on dividend distributions under Portuguese tax law?
The legal grounds for declaring illegality of withholding tax assessments on dividend distributions under Portuguese tax law include: (1) absence of a valid taxable event (facto tributário) - no actual profit distribution occurred; (2) incorrect legal qualification of transactions - amounts were loans rather than profit distributions; (3) procedural defects in the assessment process; (4) violation of substantive tax law provisions regarding when withholding obligations arise; and (5) lack of factual basis supporting the Tax Authority's characterization of transactions. Under the CIRS and CIRC, withholding tax on dividends requires an actual distribution of profits to shareholders. If transactions possess characteristics of loan agreements (even if defectively documented), they may not constitute taxable distributions. The taxpayer must demonstrate through documentary evidence, witness testimony, and accounting records that the essential elements of profit distribution were absent.
Is the Portuguese Tax Authority required to pay compensatory interest when a withholding tax liquidation is deemed illegal?
Yes, the Portuguese Tax Authority is required to pay compensatory interest when a withholding tax liquidation is deemed illegal and subsequently annulled. Under Portuguese tax law, specifically the General Tax Law (LGT) and Tax Procedure Code (CPPT), taxpayers are entitled to indemnity interest (juros indemnizatórios) when they have paid tax amounts that are later determined to be undue. This interest compensates taxpayers for the loss of use of funds improperly collected by the State. The interest rate is established by ministerial order and calculated from the date of payment until reimbursement. In CAAD arbitration proceedings under RJAT, tribunals have jurisdiction to order not only annulment of illegal tax assessments but also payment of indemnity interest on amounts to be reimbursed. This represents a fundamental principle of tax justice ensuring taxpayers are made whole when the State has unlawfully collected taxes.
How does CAAD arbitration process work for disputing IRS withholding tax liquidations in Portugal?
The CAAD arbitration process for disputing IRS withholding tax liquidations in Portugal follows these steps: (1) The taxpayer files a request for arbitral tribunal constitution under Article 10 of Decree-Law 10/2011, specifying the contested assessment and legal grounds; (2) The CAAD President accepts the request and notifies the Tax Authority; (3) The Ethics Council appoints three arbitrators (or one for simplified procedures) whom parties may refuse within specified timeframes; (4) The tribunal is formally constituted once arbitrators accept and no refusals are filed; (5) The Tax Authority submits a response defending the assessment or raising procedural objections; (6) The tribunal may order an Article 18 hearing or proceed with written submissions; (7) Both parties submit their arguments and evidence; (8) The tribunal issues a binding decision addressing jurisdiction, admissibility, and merits; (9) The decision may annul the assessment, order reimbursement, and award indemnity interest. The entire process typically concludes within six months, providing faster resolution than traditional court litigation.