Process: 220/2015-T

Date: September 4, 2015

Tax Type: IRS

Source: Original CAAD Decision

Summary

This CAAD arbitration case (Process 220/2015-T) addresses the deductibility of restoration expenses from real estate capital gains for IRS purposes. The taxpayer sold two properties in 2013 (urban and rustic) for €49,000 and €1,000 respectively, after extensive restoration work on properties abandoned for 40 years. The taxpayer declared €41,681.39 in expenses and charges, but the Tax Authority only accepted €24,894.53, rejecting €16,786.86 in documented costs. The disputed expenses included invoices from suppliers C... Ltd (€4,565.88 for kitchen equipment, wardrobes, and doors), D... Ltd (€1,608.88 for construction materials), and labor costs from contractor E... (€10,161.40). The Tax Authority rejected these expenses primarily because the invoices lacked the work address. The taxpayer argued that: (1) all expenses genuinely related to the restored properties; (2) the absence of work addresses was supplier oversight, not fraud; (3) supporting documentation (delivery guides and budgets) presented during the hearing proved the connection to the properties; and (4) no legal provision mandates work addresses on invoices for capital gains expense deduction. The case illustrates the evidentiary requirements for deducting restoration costs from capital gains, the Tax Authority's verification procedures, and taxpayers' rights to use CAAD arbitration to challenge IRS assessments when the Tax Authority rejects legitimate expenses based on formal documentation deficiencies rather than substantive analysis.

Full Decision

ARBITRAL DECISION

I. REPORT

A..., TAX ID NO. ..., resident at ... Street, ... - ...th, ...-..., in Lisbon, came, pursuant to Article 10 of Decree-Law No. 10/2011, of January 20 (Legal Framework for Arbitration in Tax Matters, hereinafter referred to as LFATM), to request the establishment of a sole arbitral tribunal, in which the Tax and Customs Authority, hereinafter TA or Respondent, is named, with a view to obtaining the annulment of the assessment act for Personal Income Tax No. 2014 ..., in the amount of €4,023.57 (four thousand and twenty-three Euros and fifty-seven cents).

The request for establishment of the Arbitral Tribunal was accepted by the President of CAAD and automatically notified to the TA on March 31, 2015.

In accordance with the provisions of sub-paragraph c) of paragraph 1 of Article 11 of the LFATM, as amended by Article 228 of Law No. 66-B/2012, of December 31, the sole Arbitral Tribunal was established on June 11, 2015.

The TA responded, arguing that the request should be dismissed, with arguments briefly reproduced below.

The meeting referred to in Article 18 of the LFATM and the filing of final submissions were dispensed with, given the nature of the matters contained in the case file.

The Arbitral Tribunal is duly constituted and is materially competent, pursuant to sub-paragraph a) of paragraph 1 of Article 2 of the LFATM.

The parties have legal personality and capacity, are legitimate and are represented (Article 4, and paragraph 2 of Article 10 of the LFATM and Article 1 of Ordinance No. 112/2011, of March 22).

There are no irregularities, exceptions or preliminary issues that prevent immediate examination of the merits of the case.

II. STATEMENT OF FACTS

Based on the elements contained in the case file and the administrative file attached thereto, the following facts are considered proven:

A) In 2013, the Claimant disposed of an urban property and a rustic property registered in the property tax roll under articles ... and ..., respectively in the parish Union of Parishes of ... and ..., in the municipality of ... and district of ...;

B) The properties, with assessed values of €6,569.97 and €1.50 respectively, were disposed of in November 2013 to B..., a citizen of German nationality for amounts of €49,000.00 and €1,000.00, following deep restoration works, duly reported to the Municipal Council of ...;

C) In the IRS declaration form 3, for the year 2013, filed on 24/05/2014, the Claimant presented the respective Schedule G, where in field 401 the disposal of the urban property for the amount of €49,000.00 was recorded, with "Expenses and charges" in the amount of €41,681.39;

D) Within the scope of a discrepancy proceeding, the Claimant was called upon to justify the declared expenses, having presented a set of invoices that form part of the administrative file, with the TA only considering eligible, for the purposes in question, expenses in the amount of €24,894.53.

E) Both the urban property and the rustic property (an open lot), had been abandoned for approximately 40 years and were therefore in an advanced state of decay;

F) After the restoration of the properties reported to the Municipal Council of ..., which involved mainly the urban property, the result was a practically new property as can be seen in the photograph (see Annex 3, attached with the arbitral petition), given that from the original property only the original walls remained, and only partially.

G) The Tax Office of Lisbon 10 did not accept the expenses recorded by the Claimant, which include the following specific situations:

a. Invoices issued by commercial company C..., Ltd. – €4,565.88 relating to countertops, cabinets and other kitchen equipment, as well as built-in wardrobes in the bedrooms and exterior and interior doors of the respective property;

Budgets exist regarding these items with indication of the work address, which were presented during the right to be heard;

b. Invoices issued by commercial company D..., Ltd. – €1,608.88 - relating to cement, iron, bricks and other construction materials, supplied by this company with head office in the Municipality of ..., where the disposed property is located.

Delivery guides for the materials at the work address exist, presented during the right to be heard;

c. Labour cost invoices from E... – €10,161.40.

Budgets exist presented during the right to be heard, with indication of the work address.

H) The TA issued the IRS assessment act contained in Annex 1, for the year 2013, in the amount of €4,023.57.

There are no facts with relevance to the consideration of the merits of the case that have not been proven.

This Tribunal formed its conviction on the basis of the documents attached to the case file by the Parties.

III. LEGAL ANALYSIS

The principal question raised in this case comes down to determining whether the correction to income declared by the Claimant, in 2013, regarding real estate capital gains, on the basis of non-acceptance of part of the restoration expenses indicated, is or is not legally admissible.

In this regard, the Claimant alleges in its request for establishment of the Arbitral Tribunal the following:

  1. All corrections made by the TA, in the total amount of €16,319.26, relate to materials and services intended for the restoration of the disposed properties and which only by oversight of the suppliers and service providers did not include the work address;

  2. Nevertheless, during the right to be heard, delivery guides and/or budgets were presented that attest that the expenses relate to the disposed properties, which were not considered by the Tax Office of Lisbon 10;

  3. The invoices C..., Ltd. (see Annex 5) – €4,565.88 - relate to countertops, cabinets and other kitchen equipment, as well as built-in wardrobes in the bedrooms and exterior and interior doors of the respective property, which were, by oversight of the supplier to whom responsibility should be attributed, issued with an address in Lisbon, to which they were sent for payment purposes, not making reference to the delivery location.

However, there is no doubt that they relate to the disposed property, especially since, as the tax inspection may, if it so wishes, confirm their existence on location, it should be noted that budgets exist regarding these items with indication of the work address, which were presented during the right to be heard, but which the Tax Office ignored (see Annex 10).

  1. The invoices from company D..., Ltd. (see Annexes 6 and 7) – €1,608.88 - relating to cement, iron, bricks, etc., supplied by a company with head office in the Municipality of ..., to which belongs the village of ..., where the disposed property is located. It should be noted that in the Municipality of ..., this is the only village with the name of ... (former parish of ..., current Union of Parishes of ... and ...).

The failure to indicate the address is due to an oversight that can only be attributed to the company and not to the purchaser, who certainly would not purchase these materials in ... to bring them to Lisbon, where he resides.

In this case, delivery guides for the materials at the work address exist, presented during the right to be heard, but which were ignored by the Tax Office (see Annex 11);

  1. The labour cost invoices from E... (see Annexes 8 and 9) – €10,161.40 – relate to the work of Mr. E..., who is a small contractor of German origin and who resides in a small property approximately 2.5 km from the village of ..., where the property is located, only does work in the area, so the failure to include the address in said invoices was merely an oversight of said contractor.

Here too budgets exist presented during the right to be heard with indication of the work address (see Annex 12), which were also ignored by the Tax Office.

  1. There is no provision in the Personal Income Tax Code that defines the obligation for invoices relating to the acquisition of materials and provision of services to include the address of the respective properties, especially since we are dealing with a sporadic sale, outside the scope of an economic activity, as such considered for purposes of Personal Income Tax and VAT;

  2. It should be noted that even for Corporate Income Tax taxpayers who are required to keep organized accounts, there was also no specific requirement regarding the supporting documents of expenses considered for purposes of calculating taxable profit, with such requirement only being required from the 2014 fiscal year onwards (see wording of paragraphs 3 and 4 of Article 23 of the Corporate Income Tax Code, as amended by Law No. 2/2014, of 16/1), closely following the requirements provided for VAT purposes. However, in the Personal Income Tax Code, there continues to be no similar regulation.

  3. The dispensability of invoice formalities for purposes of Corporate Income Tax, until 2013, is moreover recognized by the Supreme Administrative Court Decision No. 0658/2011, which considers that the requirements of Article 36 of the VAT Code, within the scope of invoices, could only be invoked within the scope of operations of charging/deduction of such tax, not being required for purposes of calculating taxable profit for Corporate Income Tax;

  4. In these terms, the restoration of expenses inherent to the restoration of the disposed properties, in the amount of €16,319.26, which were illegally disallowed, and the annulment of the corresponding additional Personal Income Tax assessment in the amount of €4,023.57, whose payment has already been made, is requested.

For its part, the TA alleges, in summary, the following:

  1. At the time of the facts, sub-paragraph a) of Article 51 of the Personal Income Tax Code provided that for the determination of capital gains subject to tax, to the acquisition value are added "Costs for valorization of assets, demonstrably incurred in the last five years and expenses necessary and actually incurred, inherent to acquisition and disposal, in the situations provided for in sub-paragraph a) of paragraph 1 of art. 10";

  2. The substantiation of valorization costs falls on the taxpayer, as the burden of proof of facts constituting rights falls on whoever invokes them (cf. Articles 74, paragraph 1 of the General Tax Code and 342, paragraph 1 of the Civil Code).

  3. In this matter, Article 128 of the Personal Income Tax Code provides that With regard to the obligation to substantiate the elements of declarations, the Personal Income Tax Code establishes that "Persons subject to Personal Income Tax must present, within the time fixed for them, the documents proving the income earned, deductions and exemptions and other facts or situations mentioned in their respective declaration, when the Tax and Customs Authority requests them".

  4. However, when called upon to do so, the Claimant failed to demonstratively prove, unequivocally, that some of the expenses presented were intended for the work of valorization/restoration of the urban property in question;

  5. Indeed, with regard to the invoices from C..., Ltd., the delivery location of the materials and equipment to which they relate is indicated as being at an address on ... Street, ..., in Lisbon, which does not correspond to that of the restored property, located in the village of ..., ..., ....

The budgets are private documents, without material probative force, and the Claimant has not presented any other evidence to demonstrate that the equipment listed in said invoices was actually intended for the house in the village of ...;

  1. As regards the invoices from company D..., Ltd., these do not allow determining the destination location of the goods listed therein, and the Claimant has not presented another piece of evidence that could confirm what is claimed.

Indeed, the delivery guides presented at the prior hearing do not make reference to the mentioned invoices, leaving it unclear what acquisitions they relate to.

  1. With respect to the invoices from E..., these do not indicate the destination location of the goods, and the Claimant has not presented additional evidence to fill this gap;

  2. Contrary to what is sustained by the Claimant in the petition, it is not exactly the lack of invoice requirements that is at issue and supported the TA's decision;

  3. What is at issue is the lack of probative elements, which actually flow from the invoices presented, but which could have been supplied through others, which do not demonstratively prove, unequivocally, that the declared expenses were intended for the restored property;

  4. And the claimant failed to prove, for purposes of the provision in sub-paragraph a) of Article 51 of the Personal Income Tax Code, that the declared expenses were intended for the valorization/restoration of the property subject to capital gains.

In light of the foregoing, as regards the position of the Parties and the arguments presented, in order to determine whether the Personal Income Tax assessment act sub judice is or is not illegal, it will be necessary to verify whether the expenses indicated by the Claimant in Schedule G of the Personal Income Tax declaration form 3, for the year 2013, should or should not be considered in determining the calculated capital gain.

Let us see what should be understood.

Pursuant to sub-paragraph a) of paragraph 1 of Article 10 of the Personal Income Tax Code, "Capital gains consist of gains obtained which, not being considered business and professional income, capital income or real estate income, result from: a) Onerous disposal of real rights over immovable property".

In accordance with paragraph 4, sub-paragraph a) of the same legal provision, the gain subject to Personal Income Tax is constituted by the difference between the realization value and the acquisition value, net of the part qualified as capital income, as the case may be.

In turn, at the time of the facts, sub-paragraph a) of Article 51 of the Personal Income Tax Code provided that for the determination of capital gains subject to tax, to the acquisition value are added "Costs for valorization of assets, demonstrably incurred in the last five years and expenses necessary and actually incurred, inherent to acquisition and disposal, in the situations provided for in sub-paragraph a) of paragraph 1 of art. 10".

In the case sub judice, the Claimant intends that to the acquisition value of the properties be added the costs for valorization of assets, corresponding to the following invoices:

· Invoices C..., Ltd. (see Annex 5) – €4,565.88;
· Materials invoices from company D..., Ltd. (see Annexes 6 and 7) – €1,608.88;
· Labour cost invoices from E... (see Annexes 8 and 9) – €10,161.40.

These invoices constitute suitable documents, and their truthfulness is not contested by the TA (See Articles 26 and 27 of the response presented).

With respect to the invoices from C..., Ltd., it appears from the same that construction materials were sold, which are properly described, whose purchaser was the Claimant, with the pickup location at the industrial park of ... and the delivery address at "customer premises", and it is true that the invoices were sent to the Claimant's address in Lisbon.

Furthermore, the budget presented by C... to the Claimant includes reference to the locality of ..., where the properties are located.

Consequently, taking into account the truthfulness of the invoices and budget submitted by the Claimant, it is understood that from those documents it is proven that the Claimant actually incurred the said expenses with the disposed properties, which are moreover located in the same geographic area as C....

In the case of invoices from D..., Ltd., it appears from the same that construction materials were sold, which are properly described, whose purchaser was the Claimant, with the pickup location in ...-... and the delivery address to the customer address.

Moreover, from the delivery guides attached it appears that the delivery of the materials took place in ..., where the properties are located, with the description of the materials showing that the delivery guides correspond to the invoices issued in question, although this is not expressly indicated.

Consequently, taking into account the truthfulness of the invoices and delivery guides submitted by the Claimant, it is understood that from the same it is proven that the Claimant actually incurred the said expenses with the disposed properties, which are moreover located in the same geographic area as D....

With respect to the labour cost invoices from E... it appears from the same that building restoration services were provided, whose purchaser was the Claimant, with the location of provision not indicated, and it is true that the activity of Mr. E... is carried out in ..., in the same geographic area where the properties are located.

Moreover, the budget presented by Mr. E... includes reference to ..., where the properties are located.

Consequently, taking into account the truthfulness of the invoices and budget submitted by the Claimant, it is understood that from those documents it is proven that the Claimant actually incurred the said expenses with the disposed properties.

Contrary to what is argued by the TA, it is understood that the Claimant succeeded in substantiating the expenses incurred and their relationship between those payments and the valorization of the properties in question, in light of Article 74, paragraph 1 of the General Tax Code and Article 342 of the Civil Code.

In fact, just as in the case of Corporate Income Tax, in matters of Personal Income Tax, supporting documents of costs do not have to assume the essential formalities required for invoices under VAT, being sufficient the presentation of a document that reveals the fundamental characteristics of the operation carried out (See Supreme Administrative Court Decision rendered in the context of case No. 0658/2011, of July 5, 2012).

Moreover, if the TA considered that the evidence produced by the Claimant was insufficient, it should have requested supplementary information from the taxpayer, including even carrying out inspections of the contractors, to determine whether the invoices in question related or not to works carried out on the disposed properties, under the inquisitorial principle. As the inquisitorial principle lies upstream of the problem of burden of proof (Cf. Supreme Administrative Court Decision rendered in the context of case No. 0583/09, of 21.10.2009).

In light of the foregoing, it is considered that the documents submitted by the Claimant constitute suitable documents for substantiating the expenses incurred with the valorization of assets, and such expenses should be considered for purposes of determining the capital gain subject to Personal Income Tax.

IV. DECISION

In these terms, this Arbitral Tribunal decides:

A) To find the request for annulment of the Personal Income Tax assessment act and compensatory interest No. 2014 ... to be entirely well-founded;

B) To order the Respondent to pay the costs of this proceeding, as the losing party.

V. VALUE OF THE CASE

In accordance with the provisions of Article 306, paragraph 2 of the Code of Civil Procedure, Article 97-A of the Code of Tax Procedure and Article 3, paragraph 2 of the Regulation of Costs in Tax Arbitration Proceedings, the value of the claim is fixed at €4,023.57.

VI. COSTS

Pursuant to the provisions of Articles 12, paragraph 2 and 22, paragraph 4, both of the LFATM, and Article 4, paragraph 4 of the Regulation of Costs in Tax Arbitration Proceedings, the value of the arbitration fee is fixed at €612, pursuant to Table I of the mentioned Regulation, to be borne by the Respondent, given the complete rejection of the request.

Let notification be made.

Lisbon, September 4, 2015

The Arbitrator

Magda Feliciano

(The text of this decision was drawn up by computer, pursuant to Article 131, paragraph 5 of the Code of Civil Procedure, applicable by reference to Article 29, paragraph 1, sub-paragraph e) of Decree-Law No. 10/2011, of January 20 (LFATM), with its writing governed by the spelling prior to the Orthographic Agreement of 1990.)

Frequently Asked Questions

Automatically Created

What expenses and costs are deductible from capital gains on property sales under Portuguese IRS?
Under Portuguese IRS law, expenses deductible from capital gains on property sales include acquisition costs, improvement and restoration expenses, and charges necessarily incurred for the sale. Article 51 of the IRS Code allows taxpayers to deduct documented expenses that increased the property's value. In this case, the taxpayer claimed €41,681.39 in restoration expenses for properties abandoned for 40 years, including construction materials (cement, iron, bricks), built-in fixtures (kitchen cabinets, wardrobes, doors), and labor costs. The Tax Authority must verify that expenses are genuine, properly documented with invoices, and directly relate to the sold property. The key requirement is substantive proof of the expense's connection to the property, not merely formal invoice details like work addresses.
How does the Portuguese Tax Authority (AT) assess eligible expenses in capital gains calculations?
The Portuguese Tax Authority assesses eligible expenses in capital gains calculations through documentary verification procedures. In this case, the AT initiated a discrepancy proceeding when the taxpayer declared significant expenses, requiring justification through invoices. The AT scrutinizes whether invoices demonstrate a clear connection to the sold property, often requiring invoices to include the work address. When the AT rejected €16,786.86 in expenses, it was primarily because invoices lacked property addresses. However, taxpayers have the right to present additional evidence during the hearing phase (direito de audição), including delivery guides, budgets, and other supporting documentation. The case demonstrates that the AT's assessment should consider substantive evidence beyond formal invoice requirements, particularly when suppliers' administrative oversights can be remedied with corroborating documentation.
Can renovation and restoration costs be deducted from real estate capital gains for IRS purposes?
Yes, renovation and restoration costs are fully deductible from real estate capital gains for IRS purposes under Portuguese tax law. The IRS Code allows deduction of improvement expenses that enhance property value. In Process 220/2015-T, the taxpayer undertook deep restoration of properties abandoned for 40 years, transforming them into practically new structures while retaining only original walls. These restoration expenses included construction materials (cement, iron, bricks), kitchen equipment, built-in wardrobes, doors, and labor costs totaling €41,681.39. The properties sold for €49,000 and €1,000, meaning restoration costs significantly impacted taxable capital gains. The deductibility principle recognizes that capital gains tax should apply only to real economic gains, not to amounts reinvested in property improvement. However, taxpayers must maintain proper documentation—invoices, delivery guides, budgets—proving expenses relate to the sold property and were actually incurred.
What is the CAAD arbitration procedure for disputing an IRS capital gains tax assessment?
The CAAD (Centro de Arbitragem Administrativa) arbitration procedure for disputing IRS capital gains assessments follows the Legal Framework for Arbitration in Tax Matters (Decree-Law 10/2011). Taxpayers can request establishment of an arbitral tribunal under Article 10, naming the Tax Authority as respondent. In this case, the request was filed seeking annulment of IRS assessment No. 2014... for €4,023.57. The process involves: (1) submission of arbitration request to CAAD President; (2) automatic notification to the Tax Authority; (3) establishment of sole or collective arbitral tribunal; (4) Tax Authority's response defending the assessment; (5) optional hearing under Article 18; and (6) final decision. The tribunal has material competence under Article 2(1)(a) of the LFATM. This arbitration alternative offers taxpayers faster, more specialized resolution than judicial courts, particularly valuable for technical tax disputes involving documentary evidence and expense verification.
How are capital gains on urban and rustic property sales taxed under Portuguese IRS law?
Capital gains on urban and rustic property sales are taxed under Portuguese IRS as Category G income. The taxable gain equals the sale price minus acquisition costs, improvement expenses, and transaction charges. In this case, the urban property (assessed value €6,569.97) sold for €49,000, and the rustic property (assessed value €1.50) sold for €1,000. The properties were registered under separate property tax articles in the Union of Parishes. After declaring expenses of €41,681.39 in Schedule G (field 401) of the IRS Model 3 declaration, the Tax Authority accepted only €24,894.53, creating additional taxable gains of €16,786.86 and resulting in the €4,023.57 assessment. The key legal framework involves proper expense documentation and substantiation. Both urban and rustic properties follow the same capital gains taxation principles, though restoration expenses typically apply more significantly to urban properties given their higher improvement potential and values.