Deductible Expenses on Rental Income (IRS) - CAAD Arbitration Decision 230/2017-T

ARBITRAL DECISION

I. REPORT

A... and B..., married, taxpayers no. ... and ..., respectively, residents at Rua do ..., n.º..., ...- ... ..., (hereinafter referred to as Claimants), filed, on 02/04/2017, a request for the constitution of a single arbitral tribunal, (hereinafter referred to as the arbitral request) in accordance with articles 2.º and 10.º of Decree-Law no. 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter referred to as RJAT), in conjunction with the provisions of article 99.º of the Code of Tax Procedure and Process (CPPT), in which the Tax and Customs Authority is requested to appear (hereinafter referred to as Respondent).

The Claimants request the declaration of illegality of the tax acts for the assessment of Personal Income Tax (IRS) for the years 2012, 2013 and 2014, formalized, respectively (i) by the statement of assessment of Personal Income Tax ("IRS") no. 2016…, of 18 April 2016, statement of assessment of compensatory interest no. 2016…, as well as by the respective statement of account adjustment no. 2016…, these two of 2 May 2016, (ii) by the statement of assessment of IRS no. 2016…, of 18 April 2016, statement of assessment of compensatory interest no. 2016…, as well as by the respective statement of account adjustment no. 2016…, both of 2 May 2016, and (iii) by the statement of assessment of IRS no. 2016…, of 7 April 2016, statement of assessment of compensatory interest no. 2016…, as well as by the respective statement of account adjustment no. 2016…, both of 11 April 2016; as well as the declaration of illegality of the act of partial acceptance of the Gracious Complaint which the now Claimant filed against those.

The request for constitution of the arbitral tribunal was accepted by His Excellency the President of CAAD on 19/04/2017 and automatically notified to the Tax and Customs Authority.

In accordance with the provisions of paragraph a) of no. 2 of article 6.º and paragraph b) of no. 1 of article 11.º of the RJAT, the Deontological Council appointed the undersigned as arbiter of the single arbitral tribunal, who communicated acceptance of the appointment within the applicable deadline.

On 05/06/2017 the Parties were duly notified of this appointment, having manifested no intention to refuse the appointment of the arbiters, in accordance with the combined provisions of article 11.º no. 1, paragraphs a) and b) of the RJAT and articles 6.º and 7.º of the Code of Ethics.

In compliance with the requirement set out in paragraph c) of no. 1 of article 11.º of the RJAT, the single arbitral tribunal was constituted on 21/06/2017.

On 04/07/2017, the order provided for in article 17.º, no. 1 of the RJAT was issued.

On 18/09/2017 the Respondent filed its response and attached to the case file the Administrative Process, for the purposes of the provisions of no. 1 and 2 of article 17.º of the RJAT.

By order of 27/09/2017 the meeting provided for in article 18.º of the RJAT was dispensed with, given the reduced complexity of the case, the non-invocation of exceptions and the fact that no testimonial evidence was adduced. The parties were also invited to submit arguments, if they so wished, within 20 days.

Having been notified, the parties submitted no arguments.

By order of 21/12/2017 the parties were notified of the extension of the deadline for issuing the arbitral decision, for two months, in accordance with the provisions of article 21.º, no. 2 of the RJAT.

The Claimants allege, briefly, that the acts of assessment and the decision of partial acceptance of the Gracious Complaint are vitiated by illegality and, as such, should be annulled on the grounds of: i) defect of form due to lack of reasoning and ii) error regarding the factual and legal premises.

They further invoke the illegality of the acts of assessment of compensatory interest and conclude by requesting indemnification interest for the payment of an undue tax obligation.

As to the first defect invoked, they argue that the Tax Authority, in the Tax Inspection Report, refrains from "indicating which expenses are specifically non-deductible when the description does not allow the asset/service provided to be classified, those that are not deductible because they are 'current expenses' or other non-deductible expenses".

They further contend that, having provided all evidence of the charges (invoices) for the expenses incurred with the maintenance and conservation of the property, "they therefore find no reason why the AT should presume that, by failing to rent their properties, the maintenance and conservation expenses underlying the same would not be deductible for tax purposes".

With regard to the second defect, the Claimants argue the illegality of the corrections on the grounds that the AT has no legal basis to require the deductibility of maintenance and conservation charges proportional to the days of rental of the property, invoking the wording of the rule contained in article 41.º of the IRS Code, in the version in force during the years in question (2012 to 2014).

As to the illegality of the acts of assessment of compensatory interest, the Claimants defend the thesis that without fault on the part of the Claimants, which they understand was not even invoked by the Tax Authority, the requirements imposed by law are not met (cfr. article 35.º, no. 1 of the General Tax Law).

They conclude by requesting indemnification interest for payment of an undue tax obligation, in accordance with the provisions of article 100.º of the General Tax Law.

In response, the Respondent contested, invoking briefly the following:

Regarding the lack of reasoning, it invoked settled case law and doctrine to conclude that "the Claimants' thesis regarding the lack of reasoning of the tax act has no merit whatsoever".

It argued that the act is reasoned when, by the reasoning provided, it is capable of revealing to a normal recipient the factual and legal reasons that determined the decision, enabling them to react effectively through legal means against its prejudicial nature and that it is demonstrated by the legal-argumentative exercise of the Claimants, in the arbitral request, that they understood perfectly the meaning and scope of the corrections made by the Tax Authority.

As regards the application of the proportionality test for the deduction of expenses in relation to the property occupancy rate, the Respondent referred to the arguments set forth in the inspection report and in the decision of the gracious complaint, having briefly stated that its position is based on higher instructions, without identifying the administrative doctrine underlying it, but stating the following:

"Since, for the purposes of taxation under Category F of the IRS Code, account is taken of the net income obtained, i.e., the rents received minus the expenses and charges incurred to produce the rental property income included and to maintain the source of such income intact, or, in other words, the rented properties, it seems that such expenses should be proportionally considered based on the number of months of rental."

"As eligible deductions, article 41.º, numbers 1 and 2, of the same legal instrument establish that the following shall be considered: Maintenance and conservation expenses that are the responsibility of the taxpayer, borne by them and documented, as well as the Municipal Property Tax that applies to the value of the properties or part of properties whose income has been included.

In that same vein and in a situation of partial rental, that is, where the property is rented only for part of the year, only those expenses that, proportionally, appear to be attributable to the number of months of rental may be considered as eligible for the purposes of what is established in article 41.º of the IRS Code."

Finally, it concludes that "The correction of the deductible amounts with reference to the expenses that actually fall within the deductible charges for this type of income took into account that the property was only occupied for part of the year, so that not all expenses could be deducted, therefore the number of nights in which the property was occupied by clients was recorded".

Regarding the alleged illegality of the acts of assessment of compensatory interest, the Respondent did not pronounce itself.

As to the request for indemnification interest, the Respondent argued that there was no reason to compensate the taxpayer, due to the absence of error attributable to the services.

II. PROCEDURAL DETERMINATION

The Arbitral Tribunal has been duly constituted and is competent.

The parties have legal personality and capacity and are legitimate (arts. 4.º and 10.º, no. 2, of the same instrument and art. 1.º of Order no. 112-A/2011, of 22 March).

There are no preliminary questions or exceptions to decide, therefore the merits of the claims should be examined.

III. REASONING

Of the Proven Facts

There is no contested matter of fact alleged, and notably the following essential facts are proven:

The Claimants, in the years to which the assessment acts in question relate, were non-resident entities in Portugal and at the date to which the income relates, had no declared activity, which was only initiated on 01/01/2015.

Since 2003, the Claimants (married under the regime of separation of property) were co-owners of an urban property, intended for housing, located at ..., Golf Development, ..., registered in the urban property matrix of the parish of ..., municipality of Loulé, under article ....

In the years in question, the Claimants received rents resulting from the rental to tourists of the property identified above, having declared to the Tax Authority the following:

| Items | Year 2012 | Year 2013 | Year 2014 |
|---|---|---|---|
| Rents (€) | 23,823.17 | 32,530.10 | 27,686.47 |
| Expenses (€) | 20,2012.18 | 29,172.79 | 19,221.74 |
| Taxable Income (€) | 3,610.99 | 3,357.31 | 8,464.73 |

(cfr. annexes 7, 8 and 9 of document no. 1 of the arbitral request)

In each of the three years in question, the property was rented for the following periods:

| Year | Rental Period (nights) |
|---|---|
| 2012 | 37 |
| 2013 | 49 |
| 2014 | 38 |

(cfr. annexes 1 and 2 of document no. 1 of the arbitral request)

In the context of Service Orders no. OI2015…/…/…, of 17 September 2015, the Tax and Customs Authority ("AT") conducted an internal inspection action on the Claimants, relating to the years 2012, 2013 and 2014, of limited scope, concerning the determination of taxable income under the Personal Income Tax heading.

As a result of the said inspection action, the Claimant was notified, on 17 February 2016, of the Draft Conclusions of Tax Inspection, by which the AT services proposed the following corrections in the Personal Income Tax assessment:

| Values in euros | 2012 | 2013 | 2014 |
|---|---|---|---|
| Arithmetic Corrections | 19,347.46 | 27,924.85 | 18,087.92 |
| IRS | 3,192.33 | 7,818.96 | 5,064.62 |

(cfr. annex 1 of document no. 1 of the arbitral request)

The Claimants did not exercise the right of prior hearing on the Draft Conclusions.

The Claimants were notified of the Inspection Report, through Office Letter no.…, of 14 March 2016 ("Inspection Report"), reporting the following corrections:

| Values in euros | 2012 | 2013 | 2014 |
|---|---|---|---|
| Arithmetic Corrections | 19,347.46 | 27,924.85 | 18,087.92 |
| IRS | 3,192.33 | 7,818.96 | 5,064.62 |

(cfr. annex 2 of document no. 1 of the arbitral request)

On 7 and 18 April 2016, the Claimants were notified of the acts of assessment of Personal Income Tax, and were subsequently notified of the statements of assessment of compensatory interest and the corresponding statements of account adjustment, relating to the years 2012, 2013 and 2014, which are all identified in Section I. Report and which reflect the corrections resulting from the inspection action. (cfr. annexes 3, 4 and 5 of document no. 1 of the arbitral request)

The Claimants proceeded to pay the tax and respective compensatory interest, on 18 May 2016:

| Values in Euros | 2012 | 2013 | 2014 |
|---|---|---|---|
| IRS | 3,192.33 | 7,818.96 | 5,064.62 |
| Compensatory Interest | 376.88 | 583.72 | 157.42 |
| Total | 3,569.21 | 8,402.68 | 5,222.04 |

(cfr. annex 6 of document no. 1 of the arbitral request)

In the context of the inspection procedure in question, the Tax Authority made three corrections to the taxable income in Personal Income Tax for the years 2012, 2013 and 2014, merely arithmetic and without recourse to indirect methods of determining the taxable base.

It corrected the amount of expenses presented by the taxpayer, in accordance with what it considered to be expenses falling within article 41.º of the IRS Code:

| Year | Expense Incurred (€) | Expense Accepted (€) |
|---|---|---|
| 2012 | 20,167.72 | 8,647.20 |
| 2013 | 29,082.80 | 9,599.57 |
| 2014 | 19,435.03 | 11,338.20 |

(cfr. annex 2 of the tax inspection report, attached as annex 1 of document no. 1 of the arbitral request)

To the amount of expenses that it considered to fall within article 41.º of the IRS Code and better identified above, the Inspection Services applied the following occupancy rates to determine the amount of expenses to accept for calculating the net income to be taxed:

| Years | 2012 | 2013 | 2014 |
|---|---|---|---|
| % occupancy | 10% | 13% | 10% |
| Expenses Accepted | 8,647.20 | 9,599.57 | 11,338.20 |
| Corrected Deductible Expense | 864.72 | 1,247.94 | 1,133.82 |

(cfr. annex 1 of document no. 1 of the arbitral request)

In summary, the following corrections were made by the Tax Inspection Services, which gave rise to the acts of assessment of Personal Income Tax and compensatory interest, which are the subject of the present arbitral request:

| Years | 2012 | 2013 | 2014 | Total |
|---|---|---|---|---|
| Expenses Accepted | 864.72 | 1,247.94 | 1,133.82 | |
| Final Result after AT Correction | 22,958.45 | 31,282.16 | 26,552.65 | |
| Additional Tax to Pay | 3,192.33 | 7,818.96 | 5,064.62 | 16,075.91 |

Following the final decision of partial acceptance of the Gracious Complaint, in light of the evidence presented by the Claimants, the AT came to accept the tax deductibility of all maintenance and conservation expenses, with the exception of water charges, arguing that these are current expenses, maintaining the application of a coefficient of proportionality of expenses based on the property occupancy rate.

As a result of the partial acceptance of the Gracious Complaint, the following expenses were considered fiscally deductible, in the proportion described below:

| Years | 2012 | 2013 | 2014 |
|---|---|---|---|
| % occupancy | 10% | 13% | 10% |
| Expenses Accepted | 20,167.72 | 27,595.51 | 18,341.29 |
| Corrected Deductible Expense | 2,016.77 | 3,587.42 | 1,834.29 |

Of the Essential Facts Not Proven

There are no relevant facts alleged or known ex officio that have not been proven.

Of the Motivation

For the Arbitral Tribunal's conviction regarding the proven facts, the documentary elements to which reference is made above in the various items were relevant, and in general all other documents filed with the case, as well as the administrative process, all analyzed critically and in conjunction with the pleadings in which the absence of controversy regarding the facts alleged by the Claimants is evident.

Of the Law

Questions to be Decided

These are, in summary and if we understand correctly, the following questions to be examined and decided:

1st Whether the assessment acts suffer from illegality due to lack of reasoning of the corrections contained in the tax inspection report;

2nd Whether the assessment acts suffer from illegality due to error regarding the factual and legal premises;

3rd Whether the acts of assessment of compensatory interest are illegal due to the absence of fault on the part of the Claimants;

4th Whether the Claimants are entitled to indemnification interest.

These questions and/or defects shall be examined in light of the provisions of article 124º of the CPPT and in the order determined thereby.

Let us see then,

Whether the assessment acts suffer from illegality due to lack of reasoning of the corrections contained in the tax inspection report?

As the Respondent states in its defense: "And following closely the settled case law, which states: 'The density of reasoning varies according to the legal type of act and its circumstances, less dense reasoning of certain types of acts being acceptable, such reasoning being considered sufficient insofar as it corresponds to a minimum threshold that does not deprive it of its character, that is, the "quantum" indispensable to the fulfillment of the minimum requirements of formal reasoning is guaranteed: the revelation of the existence of reflection and the indication of the main reasons that moved the agent', in the Decision of the Supreme Administrative Court in case no. 31616 of 13-04-2000."

And "Given the doctrine which states that a certain act, in casu, the administrative-tax act, is found to be duly reasoned whenever it is possible, through it, to discover which cognitive process was used by its author to reach the final decision, in A. Varela and others Manual of Civil Procedure, Coimbra Publisher, 2nd edition, 1985, p. 687 et seq., Alberto dos Reis, Annotated Code of Civil Procedure, Coimbra Publisher, 1984, V, p. 139 et seq."

In the case at hand, it is evident that there is no lack of reasoning of the tax acts, which is clear from the draft corrections and the final tax inspection report, which integrate the reasons that underlay the corrections made and from which much of the factuality contained in items 1) to 16) of the established facts in this arbitral decision was drawn.

Furthermore, the decision of partial acceptance of the gracious complaint is conclusive proof that the Claimants were able to understand the logical-deductive path of the Tax Authority, which led it to make the corrections effected and to take the acts which are the subject of the present arbitral request. Otherwise, the Claimants would not have been able to substantiate their complaint in fact and in law.

Citing more recent case law, which is nonetheless unanimous in the sense supported by the Respondent, see the summary of the decision issued on 23/04/2014, by the Supreme Administrative Court, in case no. 1690/13, to which we refer:

"I - The Tax Administration has the duty to reason the acts of assessment challenged in accordance with the principle set forth in article 268º of the Constitution of the Portuguese Republic and adopted in articles 125º of the Administrative Procedure Code and 77º of the General Tax Law.

II - The act will be sufficiently reasoned when the administered party, placed in the position of a normal recipient – the bonus pater familiae mentioned in article 487º no. 2 of the Civil Code – can come to know the factual and legal reasons that are at its origin, so as to enable them to choose, in an informed manner, between acceptance of the act or the activation of legal means of challenge, and so that, in the latter circumstance, the court may also exercise effective control of the legality of the act, assessing its legal accuracy in light of its contextual reasoning."

It happens that, contrary to what the Claimants argue and regardless of whether or not they agree with the corrections made by the Inspection Services, on the one hand, it is evident that the former understood the reasons why the AT did not accept some expenses, as they attached to the gracious complaint process the evidence that was lacking for the AT to be able to frame the expenses incurred in the rule contained in article 41.º of the IRS Code, which determines which expenses are to be deducted from the rental property income to determine the taxable income.

On the other hand, the Claimants also understood the reasons why the Tax Authority only accepted part of the expenses that would be deductible according to their nature as charges for the maintenance and conservation of the property.

In their arbitral request, it is evident that the Claimants disagree with the method used by the inspection services to determine the amount of deductible expenses, since they object to the use of the occupancy percentage and the calculation of expenses in accordance with that percentage.

Now, given this factuality, there is no lack or insufficiency of reasoning invoked by the Claimants, therefore this part of the claim does not succeed.

Whether the assessment acts suffer from illegality due to error regarding the factual and legal premises?

Having the AT accepted, in the course of the gracious complaint, that all expenses incurred by the Claimants, save those relating to water consumption, fell within the concept of maintenance and conservation expenses contained in article 41.º of the IRS Code, it is only regarding these that a decision is required, since as to the nature of the others it is established and accepted by the Tax Authority that they fall within the rule.

Did the Tax Authority correctly decide to maintain the correction regarding water charges?

Let us see.

In the year 2012, the wording of article 41.º of the IRS Code was as follows:

"1 - From the gross income referred to in article 8.º there shall be deducted the maintenance and conservation expenses that are the responsibility of the taxpayer, borne by them and documented, as well as the municipal property tax that applies to the value of the properties or part of properties whose income has been included.

2 - In the case of an autonomous part of a property under horizontal property ownership, the conservation, enjoyment and other expenses that, under the terms of civil law, the condominium owner must necessarily bear, borne by them, and documented, shall also be deducted.

3 - In the case of sub-lease, the difference between the rent received by the sub-lessor and the rent paid by the latter does not benefit from any deduction."

In the years 2013 and 2014, the wording of the rule in question was as follows:

"1 - From the gross income referred to in article 8.º there shall be deducted the maintenance and conservation expenses that are the responsibility of the taxpayer, borne by them and documented, as well as the municipal property tax and the stamp tax that applies to the value of the properties or part of properties whose income is subject to taxation in the fiscal year.

2 - In the case of an autonomous part of a property under horizontal property ownership, the conservation, enjoyment and other expenses that, under the terms of civil law, the condominium owner must necessarily bear, borne by them, and documented, shall also be deducted.

3 - In the case of sub-lease, the difference between the rent received by the sub-lessor and the rent paid by the latter does not benefit from any deduction."

Since it is not, in the case at hand, a question of an autonomous part of a property under horizontal property ownership, but of a single-family home, number 1 of article 41.º of the IRS Code contains the rule of incidence that must be analyzed.

The question is: are water, electricity, and gas expenses maintenance and conservation expenses that are the responsibility of the taxpayer?

How to integrate this concept, not defined by the IRS Code?

In accordance with the rules on interpretation contained in article 11.º of the General Tax Law, and especially in no. 2, which establishes that "Whenever, in tax rules, terms specific to other branches of law are used, they should be interpreted in the same sense as they have there, unless otherwise directly provided by law.", it is necessary to resort to the concepts specific to civil law contained in the Urban Rental Regime regarding which expenses for maintenance and conservation are the responsibility of the landlord.

The Central Administrative Court for the Southern Region has already defended the same position, as evidenced by the summary of the decision issued in case no. 05310/12, on 15/12/2016, which is transcribed and to which we refer:

"I. Under article 40º, no.º1 of the IRS Code (in its original wording) «From the gross income referred to in article 9º there shall be deducted, in accordance with the following numbers, the maintenance and conservation expenses that are the responsibility of the taxpayer and borne by them.».

II. Since the IRS Code does not define the concepts of "conservation expenses" and "maintenance expenses", the civil law notions contained in the Urban Rental Regime (RAU) - (approved by Decree-Law no. 321-B/90, of 15 October) regarding the definition thereof and the determination of which are the responsibility of the landlord shall apply."

At the date of the tax facts now under analysis, the New Urban Rental Regime (cfr. article 1074º, no. 1 of the Civil Code) established the following regarding works on rented properties: "It is the responsibility of the landlord to carry out all works of conservation, ordinary or extraordinary, required by the laws in force or by the purpose of the contract, unless otherwise provided."

See, to this end, the Decision of the Supreme Administrative Court, of 06/07/2016, issued in case no. 088/16, from which it follows that: "Maintenance and conservation expenses shall be expenses that are necessary for the conservation and maintenance of the properties that generate income. They may be, as previously defined in the Urban Rental Regime, article 11.º, expenses incurred with ordinary conservation works - repair and general cleaning of the property, works required by the Public Administration, and, in general, those intended to maintain the property in the conditions required by the purpose of the contract and existing at the time of its celebration; extraordinary conservation works – for the repair of construction defects of the property or supervening defects; or even for the improvement of the property, but always with a direct impact on the property and on its capacity to generate income".

Now, since the Claimants have not raised or provided evidence that it was their responsibility to bear the expenses for water consumption of the tenants, it appears to us that the correction made by the Tax Authority and maintained in the decision of the gracious complaint does not suffer from illegality.

As for the remaining expenses, which in the decision of the gracious complaint came to be considered by the Tax Authority as "theoretically deductible", it is important to assess whether their limitation, proportional to the occupancy rate, has legal support.

It is necessary to decide whether the restrictive interpretation of the rule of article 41.º of the IRS Code, which the Tax Authority has been defending since the inspection process to the present, suffers from the defects that the Claimants attribute to it.

It is evident that from the text of the rule, i.e., from a literal interpretation of the rule, no limitation to the charges for maintenance and conservation results.

Nor can it be inferred from the text of the rule that in rentals for periods shorter than one year, a consideration of the expenses incurred proportionally to the periods during which the rental took place and, consequently, gave rise to income, must be made.

The principle of annuality of the tax, provided for in article 1.º, no. 1 of the IRS Code should resolve this question. Now, if the tax is levied on the value of the annual income of the various categories, in this case Category F, the deductible expenses or charges will also be those determined in the year, as indeed results from the expression "fiscal year" of no. 2 of article 41.º of the IRS Code.

Notwithstanding the foregoing, in accordance with the rules of legal hermeneutics and interpretation, let us examine what the spirit of the rule is, which is determined according to three elements: logical, systematic, historical.

Let us begin with the historical element.

It is important to note that the wording of no. 1 of article 41º of the IRS Code has remained practically unchanged since the entry into force of this code on 01/01/1989, with doctrine and case law on limitations to expenses being almost non-existent, inasmuch as the Tax Authority has never previously made an interpretation different from the literal one, with the consequence of the absence of litigation.

Since its entry into force, the rule of deductibility of costs from the gross income of Category F has been associated with the maintenance costs necessary to obtain the taxable rental property income, which the legislator never intended to typify, not even in exemplary terms, leaving to the interpreter the integration of the concept of conservation and maintenance charges.

In these terms, in accordance with the historical element, it does not seem to us that there has been any change that would justify a change in interpretation, such as the one that is now being maintained by the Tax Authority.

Let us examine the systematic element, which indicates that "laws are interpreted by one another because the legal order forms a system and the rule should be taken as part of a whole, part of the system".

The rule in question is part of the rules of IRS incidence, or, more specifically, in a rule for determining the taxable income of Category F (rental income).

Now, in all income categories, deductions from the gross income of each category are provided, with the objective of obtaining a net income, purged of the charges indispensable for obtaining the income – this is the spirit of the system of taxation of income of individuals.

To impose restrictions on such deductions contradicts the system in which article 41.º of the IRS Code is integrated.

Let us now move on to the logical or teleological element, which leads to consideration of the purpose or objective that the rule aims to achieve and which, in the case at hand is related to the fulfillment of legal and constitutional impositions on the premises of taxation.

First of all, article 104.º, no. 1 of the Constitution of the Portuguese Republic establishes that "The tax on personal income aims at the reduction of inequalities and shall be unique and progressive, taking into account the needs and income of the family unit", which presupposes a taxation of net income.

On the other hand, we can draw from the premises of taxation contained in article 4.º, no. 1 of the General Tax Law, the following: "Taxes are essentially based on contributive capacity, revealed, in accordance with the law, through income or its use and assets", a premise that is incompatible with taxation on gross income.

Additionally, and since there are already several CAAD decisions on this matter, we cannot fail to refer to the said decisions, which we endorse.

The case law of the CAAD has considered that the income (of this category) is on an annual basis and the eligible expenses are also on an annual basis. Moreover, many of the expenses referred to in article 41.º are always incurred, whether or not the asset produces income (see Proc. no. 157/2017-T).

In particular, we highlight and refer to the following decisions of the CAAD, cited in Proc. no. 42/2017-T of the CAAD:

Proc. no. 201/2015-T:

"the (gross) income obtained in each year constitutes the positive elements that contribute to determining the annual taxable income, and there is also a need to consider the negative elements of the same period, which are the deductions and allowances. It must therefore be concluded that the general rule of the IRS states that the tax has an annual nature and it is with respect to each calendar year that the elements that allow determining the incidence should be considered, namely gross income, deductions and allowances".

"It does not seem that this article 41.º [of the IRS Code], or any other, can lead to an exception regime with respect to the said general rule of annuality of the IRS. Indeed, this provision does nothing more than state the general rule: from the gross income there are deducted the maintenance and conservation expenses (...) Clearly nothing is said as to the period to be considered, as this was already stated in article 1.º; it is the annual period".

"There is therefore no doubt that there is no need for any other temporal correspondence between the gross income and the expenses to be deducted. There is only a need to ensure that the deductions relate to the calendar year in which the rental property income was paid or made available".

Proc. no. 294/2015-T:

"As regards the reduction of expenses and charges by applying an 'occupancy coefficient', such a procedure cannot be accepted, since all expenses incurred, such as cleaning of homes and swimming pool and their respective health treatment, water, electricity, insurance, IMI [municipal property tax] and others, will always have to be borne, regardless of the occupancy rate".

"Such 'occupancy coefficient', as mentioned, an 'sui generis' reason that apparently had not until now been used by the inspection, has, in the view of this court, no legal basis whatsoever".

Proc. 434/2016-T:

(…) With regard to the deductibility of the said expenses depending on an "occupancy coefficient" (especially, the proportional reduction thereof based on the number of days of rental), it is found that nothing exists in the law that allows concluding that such reduction can occur; quite the contrary: knowing, from what has been said, that these are expenses (necessary) of a fixed nature (i.e., expenses whose realization and corresponding amount do not depend on actual occupancy of the property) – and that, if not carried out, would inevitably result in loss of income for its owner...

In the same sense, see, e.g.: "As regards the reduction of expenses and charges by applying an 'occupancy coefficient', such a procedure cannot be accepted, since all expenses incurred, such as cleaning of homes and swimming pool and their respective health treatment, water, electricity, insurance, IMI and others, will always have to be borne, regardless of the occupancy rate(…).

In the case the cost-benefit ratio shows, it is true, an apparent imbalance in terms of economic rationality. Nevertheless, we do not find in the case file sufficient reasons or pertinent arguments, (whether factual or legal) that would allow us to conclude in favor of the exclusion of any of the expenses presented".

From all of the foregoing, the assessment acts now in question cannot be maintained in the legal order, as they are based on an incorrect interpretation of a rule of tax incidence.

The said interpretation, as it has no adherence to the text or spirit of the rule, violates the principle of tax typicality, provided for in article 103.º of the Constitution of the Portuguese Republic and in article 8.º of the General Tax Law, which determines the illegality of the acts of assessment of tax and compensatory interest that underlie it.

Therefore this part of the arbitral claim succeeds.

Without prejudice to what has been decided as to the defect referred to above, which has as a consequence the annulment of the compensatory interest calculated on the tax that was not due, it is important for us to pronounce ourselves on the compensatory interest on the unsuccessful part of the claim.

Indeed, since the correction made by the Tax Authority, in the part concerning current expenses, namely the expenses with water, which do not qualify as deductible expenses under article 41.º of the IRS Code, does not suffer from any illegality, it is necessary to determine whether such amount of tax is subject to compensatory interest.

We understand that it is, insofar as the deduction of such expenses, without any legal basis, on the part of the now Claimants, cannot but be considered a behavior attributable to the taxpayer, as provided for in article 35.º, no. 1 of the General Tax Law.

Whether the Claimants are entitled to indemnification interest?

From all the factuality given as proven and the conclusions regarding the error of the Tax Authority in the qualification and quantification of the taxable income of Category F, due to incorrect interpretation of the rule on deductions (cfr. article 41.º of the IRS Code), it is necessary to conclude that the prerequisites for the indemnification provided for in article 43.º of the General Tax Law are met and resulting from the principle inherent in article 100.º of the General Tax Law. Therefore, this part of the arbitral claim should also succeed.

IV. DECISION

Accordingly, the claim for annulment of the acts of assessment of tax and compensatory interest is found to be meritorious, in the part relating to the application of a limit to the amount of maintenance and conservation expenses, proportional to the property occupancy rate, with the consequent return of the tax and interest unduly paid, increased by indemnification interest.

As to the non-acceptance of current expenses, such as those relating to water consumption, the Claimants' claim does not succeed, either as to the tax or as to the compensatory interest, which are considered to be due.

Value of the Case: In accordance with the provisions of article 315.º, no. 2 of the Code of Civil Procedure and article 97.º-A, no. 1, paragraph a) of the CPPT and 3.º, no. 2 of the Regulation of Costs in Tax Arbitration Proceedings, the value of the case is set at € 16,036.92 (sixteen thousand and thirty-six euros and ninety-two cents).

Costs: In accordance with article 22.º, no. 4 of the RJAT, the amount of costs is set at € 1,224.00 (one thousand two hundred and twenty-four euros), in accordance with Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, to be borne by the Tax and Customs Authority.

Lisbon, 21 February 2018,

Susana Soutelinho