Process: 234/2017-T

Date: October 23, 2017

Tax Type: IRS

Source: Original CAAD Decision

Summary

CAAD arbitration process 234/2017-T addresses a critical question in Portuguese tax law: whether taxpayers can combine the 50% capital gains exclusion under Article 43(2) of the Personal Income Tax Code (CIRS) with the special 5% IRS rate for urban rehabilitation properties under Article 71(5) of the Tax Benefits Statute (EBF). The taxpayers challenged an IRS assessment of €28,642.02 for 2015, seeking a refund of €8,209.70. They had sold a fully rehabilitated urban property located in Porto's urban rehabilitation area, with rehabilitation works completed in 2014 in accordance with municipal rehabilitation strategies. The central legal dispute concerns whether these two tax benefits can operate simultaneously. The taxpayers argued that no legal provision explicitly excludes the combined application of both benefits, and that denying this combination violates constitutional principles of legality and tax law specificity under Articles 103 and 165 of the Portuguese Constitution. The Tax Authority countered with a teleological interpretation: the 50% exclusion exists specifically to mitigate the burden of progressive tax rates on capital gains. When taxpayers opt for the special proportional 5% rate instead of aggregating income under progressive rates, the rationale for the 50% exclusion disappears. The Tax Authority maintained that applying both benefits would contradict the legislative intent behind Article 43(2) CIRS. This case illustrates the importance of teleological interpretation in Portuguese tax law, where the purpose and underlying rationale of provisions can determine their scope of application, even when statutory language does not explicitly exclude certain interpretations.

Full Decision

ARBITRAL DECISION

The request for constitution of the arbitral tribunal was accepted by the Honourable President of the CAAD and notified to the Tax and Customs Authority on 19-04-2017. Pursuant to the provisions of paragraph a) of section 2 of article 6 and paragraph b) of section 1 of article 11 of Decree-Law no. 10/2011, of 20 January, as amended by article 228 of Law no. 66-B/2012 of 31 December, the Deontological Council appointed the undersigned as arbitrator of the sole arbitral tribunal, who communicated acceptance of the appointment and notified the parties of such appointment on 05-06-2017.

Thus, in accordance with the provisions set out in paragraph c) of section 1 of article 11 of Decree-Law no. 10/2011, of 20 January, as amended by article 228 of Law no. 66-B/2012, of 31 December, the Arbitral Tribunal was constituted on 21-06-2017, followed by the regular procedure.

I – REPORT

1. On 03-04-2017, A… and B…, (Claimants), taxpayers no. … and …, respectively, domiciled at …, no…, Porto, filed a request for constitution of a sole arbitral tribunal, in accordance with the combined provisions of articles 2 and 10 of Decree-Law no. 10/2011, of 20 January (Legal Regime for Arbitration in Tax Matters, hereinafter referred to as LRAT), with the Tax and Customs Authority as the Respondent.

2. The Claimants hereby submit this request for constitution of an Arbitral Tribunal, challenging the dismissal order dated 30.12.2016 of the Finance Directorate of Porto, which dismissed the Administrative Complaint filed against the Personal Income Tax (IRS) assessment, no. 2016…, dated 23.07.2016, relating to the year 2015, in the total amount of Euro €28,642.02.

They request the partial annulment, for illegality, of the aforementioned assessment, with the consequent refund of the tax improperly assessed and overpaid, in the amount of €8,209.70, and compensatory interest, in accordance with the law.

3. To this end, the Claimants invoke a defect of violation of law, based on the provisions of, among others, articles 43, section 2 of the Personal Income Tax Code (CIRS) and 71, section 5 of the Tax Benefits Statute (TBS).

4. They briefly argue in their favour:

The balance resulting from capital gains and losses derived from the transfer of real property rights relating to real estate undergoing urban rehabilitation should be taxed at only 50% of its value, whether the taxpayer chooses to apply the special rate of 5% provided for in article 71, section 5 of the TBS, or whether the taxpayer chooses to aggregate all income.

In fact, they argue, neither from article 71, section 5 of the TBS, nor from any other legal provision, can it be inferred that the application of the reduced IRS rate of 5% provided for in that legal rule excludes the balance, positive or negative, between real property gains and losses, from being subject to taxation at only 50% of its value, as established in article 43, section 2 of the CIRS.

And nothing in the law, they add, prevents the combined consideration of the benefits provided for in both rules, given that a capital gain resulting from the transfer of real estate located in an "urban rehabilitation area", recovered in accordance with the respective rehabilitation strategies, is at issue.

The interpretation made by the TA of articles 43, section 2 of the CIRS and 71, section 5 of the TBS does not respect the Constitution, violating principles such as legality and specificity of provisions on tax benefits, one of the "essential elements" of taxes, and likewise violating the principle of reserve of law (articles 103, sections 2 and 3 and 165, section 1, i) of the CRP [Constitution of the Portuguese Republic]).

5. In turn, the TA… understands that the Claimants have no merit.

In fact, the TA understands

The Claimants' arguments constitute a biased interpretation of the applicable rules to the case and are entirely wrong from the point of view of the logic and mechanics of the entire Personal Income Tax Code and its underlying taxation regime, particularly as regards the taxation of capital gains.

The reason why the legislator established this exclusion from taxation, determining that capital gains resulting from the onerous transfer of real property rights should only be considered at 50% of their value, was to avoid, or at least limit, the burden that would result from the application of the general IRS rates, given their progressivity, to the entirety of aggregated income.

Now, the TA maintains, if the establishment of the aforementioned tax exclusion was motivated by the burden of taxation resulting from the application of progressive rates, then, by contraposition, in cases where the legislator determines the application of autonomous and special rates, of a proportional nature and not progressive (as is the case with the special rate of 5% applicable provided for in article 71, section 5 of the TBS), this exclusion from taxation does not apply, since the underlying reason for it has disappeared, namely, the burden resulting from the application of progressive rates.

It concludes that the use of systematic elements in legal interpretation cannot be dissociated from the consideration of a truly essential aspect in the search for the meaning of the rule, its teleology. In this way, the determination of what those interests are proves decisive for the understanding of its verbal expression. Whereby, in the case at hand, the teleological element cannot but prove absolutely decisive.

6. The proceedings are not affected by any nullities.

7. Considering the disputed matter – having regard to the provisions set out in paragraphs c) and e) of article 16 and article 19 of the LRAT, as well as the principles of procedural economy and the prohibition of useless acts – the holding of the meeting referred to in article 18 of the LRAT was dispensed with, as well as the hearing of witnesses and the presentation of arguments by the parties.

8. There is no obstacle to the examination of the merits of the case.

II - FACTUAL MATTERS

1. The Claimants submitted, on 30.05.2016, the personal income tax return for the year 2015, with the identification no. …-… -… .

However, they were notified by the Tax Authority of the respective assessment statement, from which resulted a payment amount of €28,642.02, which was effectively paid by the Claimants in full.

2. On 27.10.2016, an Administrative Complaint was filed, which was dismissed pursuant to the order under challenge.

3. Claimant A… was the owner of the urban property, registered in the urban land register under article…, of the parish …- Union of Parishes of …, …, …, …, … and …, which was located in an urban rehabilitation area of the city of Porto.

4. The property was fully rehabilitated in accordance with and pursuant to the respective rehabilitation strategies for the rehabilitation area in which it was and is located, with those rehabilitation works having been started after 1 January 2008 and completed during 2014.

5. In 2015, the Claimant transferred the entire urban property at issue.

6. The property had been acquired by the Claimant at two distinct times: (i) in September 1979, acquired 1/3 of the ownership right; (ii) in January 1989 acquired the remaining 2/3 of the ownership right.

7. The Claimants presented Annexes G ("Capital Gains and Other Property Increases") and G1 ("Capital Gains - Not Taxed"), which they attached to their Personal Income Tax Return Form 3 for the year 2015.

They did not opt for the aggregation of capital gains income, marking for this purpose field 02 of table 15 of the respective Annex G of the Declaration presented.

8. The Personal Income Tax assessment under challenge taxed the capital gain resulting from the onerous transfer of the property without taking into account the provisions of section 2 of article 43 of the CIRS, calculating a tax relating to autonomous taxation in the amount of €16,419.41.

III - JUSTIFICATION OF PROVED FACTUAL MATTERS

With respect to the factual matters, the Tribunal does not have to rule on everything alleged by the parties; rather, it has the duty to select the facts relevant to the decision and to distinguish between proved and unproved facts (see article 123, section 2 of the Tax Procedure Code and article 607, section 3 of the Civil Procedure Code, applicable pursuant to article 29, section 1, paragraphs a) and e) of the LRAT).

In this way, the facts relevant to the judgment of the case are selected and determined based on their legal relevance, which is established with regard to the various plausible solutions to the legal question(s) at issue (see former article 511, section 1 of the Civil Procedure Code, corresponding to current article 596, applicable pursuant to article 29, section 1, paragraph e) of the LRAT).

Thus, taking into account the positions assumed by the parties, in light of article 110/7 of the Tax Procedure Code, and the documentary evidence attached to the proceedings, the facts listed above were considered proved and relevant to the decision.

IV - ON THE LAW

The essential question in the present case is whether the balance resulting from capital gains and losses derived from the transfer of real property rights relating to real estate undergoing urban rehabilitation, for the purposes and effects of article 71 of the TBS, should be taxed at only 50% of its value (applying section 2 of article 43 of the CIRS), whether the taxpayer chooses to apply the special rate of 5% provided for in article 71, section 5 of the TBS, or whether the taxpayer chooses to aggregate all income earned.

LET US CONSIDER

As has been stated on other occasions, it is understood that the rules of interpretation of tax provisions are exactly the same as those applied to provisions of other branches of law: "In determining the meaning of tax provisions and in qualifying the facts to which they apply, the general rules and principles of interpretation and application of laws are observed."

But precisely for this reason (or notwithstanding), it must be borne in mind that in Tax Law the principle of specific typicity applies, an element of the principle of legality, which, for present purposes, requires the exhaustive enumeration of facts or realities that, "within each generic type of the normative object of incidence, are indicated by law as object of incidence".

By virtue of the principle of legality provided for in article 106, section 2 of the Constitution of the Republic and of the principles of typicity and determinacy in which it unfolds, the rules of incidence must be predetermined in their content, and the elements constituting them must be formulated in a precise and determined manner.

"The determination of the content of the tax rule of incidence excludes the use of indeterminate concepts, as well as determined normative concepts, whose application to the specific case is based on a subjective or personal evaluation of the applying authority, on pain of postponing legal certainty".

…As the letter of the law is the maximum limit of the interpretative task,

However, in the present case, it does not appear that we are facing an interpretation that invokes any issue involving the literal element or the "letter of the law", namely to conclude, as the Claimants intend, that if it had been the case, the legislator would certainly have stated it clearly and explicitly – if it did not, it is because it clearly did not intend to tax 100% of the capital gain on real estate whenever the reduced IRS rate of 5% provided for in article 71, section 5 of the TBS is applicable.

Furthermore, it appears with manifest clarity that we are not facing any phenomenon of analogical or extensive integration of taxation and/or restriction of tax benefit, as the Claimants also state.

What is understood to be happening in the present situation is as follows:

The rule regarding the taxation of capital gains is the taxation of the full value, so that in cases where there is a possibility of choice for a beneficial taxation regime and that regime is chosen, there is a binding commitment to the rules of that regime without, naturally, being able to invoke potentially conflicting rules of the general regime, which is set aside, by choice, for its benefit.

THUS, the limit imposed by the literal element not standing out – which in the case does not apply, as has been stated – recourse must be had to other elements to be taken into account in the task of interpreting tax provisions, such as the systematic combination and orientation of the spirit and purpose of the same, that is, their underlying rationale.

And, in that respect and for that reason, we must agree with the considerations and arguments of the TA (as well as the authors cited in support of its understanding).

In fact, it is not considered that there can be, as the Claimants argue, a successive and combined application of the two legal provisions: article 43 (et seq.) quantifies, in general, the capital gain subject to IRS; article 71, section 5 of the TBS specifies the reduced IRS rate applicable to it.

The interpreter... should reconstruct, from the texts, the legislative thinking, taking into account the unity of the legal system in its entirety, the circumstances in which the law was drafted and the specific conditions of the time in which it is applied (VASQUES, SÉRGIO, Manual of Tax Law, Almedina, Coimbra p. 307).

As is rightly stated in the TA's Response, as an instrument of tax policy, tax benefits constitute a manifestation of the political orientations pursued by the State, since they prevent or postpone in time the birth of the material obligation to pay the tax, being granted and limited according to the objectives pursued.

Assuming that the legislator provided for the granting of the "tax benefit" by considering it a pressing necessity for social and economic policy, the provisions relating to these should not be interpreted in the sense of limiting their benefit by the taxpayer, but rather the intention of the legislator underlying the provision and granting of the said benefit should be sought, and interpreted in the sense that best manifests it.

NOW, we agree that the reason why the legislator determined that capital gains resulting from the onerous transfer of real property rights should only be considered at 50% of their value was to avoid, or at least limit, the burden that would result from the application of the general IRS rates, given their progressivity, to the entirety of the aggregated income.

As the TA argues, if the establishment of the aforementioned tax exclusion was motivated by the burden of taxation resulting from the application of progressive rates, then, by contraposition, in cases where the legislator determines the application of autonomous and special rates, of a proportional and non-progressive nature (as is the case with the special rate of 5% applicable provided for in article 71, section 5 of the TBS), this exclusion from taxation does not apply, since the underlying reason for it has disappeared, namely, the burden resulting from the application of progressive rates.

In these terms, it should be emphasized that what is provided for in article 71, section 5 of the TBS materializes into an important tax benefit, which by definition constitutes a measure of specific and exceptional character, whose own rules naturally set aside those of the general regime that may conflict with them.

It must be mentioned, finally, that it is not possible to see in what way the understanding advocated could conflict with the constitutional principles of legality and tax specificity (articles 103, section 2, 165, section 1 i) and 266, section 2 of the CRP).

It must therefore be considered that the balance resulting from capital gains and losses derived from the transfer of real property rights relating to real estate undergoing urban rehabilitation, for the purposes and effects of article 71 of the TBS, should be taxed at the full value when the taxpayer chooses to apply the special rate of 5% provided for in article 71, section 5 of the TBS.

There will only be taxation of 50% of that value (to which section 2 of article 43 of the CIRS refers) if the taxpayer chooses to aggregate all income with consequent application of the general rates of article 68 of the CIRS.

WHEREBY, the request for an arbitral award is therefore without merit, since the contested tax assessment does not suffer from a defect of error regarding the factual and legal premises, making its maintenance in the legal order necessary and not its annulment, as requested.

As for the request for refund of the tax paid and compensatory interest formulated by the Claimants, article 43, section 1 of the General Tax Law establishes that compensatory interest is owed when it is determined that there was an error attributable to the services resulting in payment of the tax debt in an amount greater than legally due.

In the present case, for the reasons stated, there is obviously no entitlement to any refund or payment of compensatory interest.

V - DECISION

Terms in which it is decided to judge the arbitral request filed as without merit:

a. Not declaring the annulment of the order dismissing the Administrative Complaint and the contested tax assessment;

b. Not granting the request for a finding of unconstitutionality formulated;

c. Not ordering the refund of the amount of tax paid and the payment of compensatory interest;

d. Ordering the Claimant to pay the costs of the proceedings.

Value of the case

The value of the case is fixed at €8,209.70, pursuant to article 97-A, section 1, a) of the Code of Tax Procedure and Process, applicable by virtue of paragraphs a) and b) of section 1 of article 29 of the LRAT and section 2 of article 3 of the Regulation of Costs in Tax Arbitration Proceedings.

Costs

The arbitration fee is fixed at €918.00, pursuant to Table I of the Regulation of Costs in Tax Arbitration Proceedings, to be paid by the Claimant – given that the request was deemed totally without merit – pursuant to articles 12, section 2, and 22, section 4, both of the LRAT, and article 4, section 4 of the aforementioned Regulation.

Lisbon, 23-10-2017

The Arbitrator,

(Fernando Miranda Ferreira)

Frequently Asked Questions

Automatically Created

Can the 50% capital gains exclusion under Article 43(2) CIRS be combined with the 5% reduced IRS rate for urban rehabilitation properties under Article 71(5) EBF?
The central legal question is whether Article 43(2) CIRS, which allows only 50% of capital gains to be taxed, can be combined with Article 71(5) EBF, which provides a special 5% IRS rate for rehabilitated properties. Taxpayers argued both benefits should apply together as no law explicitly prevents this. The Tax Authority argued the 50% exclusion was designed to mitigate progressive tax rates, so when the special 5% proportional rate applies, the exclusion's rationale disappears and it should not apply.
How are capital gains from the sale of urban rehabilitation properties taxed under Portuguese IRS rules?
Capital gains from urban rehabilitation properties can be taxed under two regimes: (1) aggregation with other income subject to progressive IRS rates, potentially with the 50% exclusion under Article 43(2) CIRS; or (2) separate taxation at the special 5% rate under Article 71(5) EBF for properties in urban rehabilitation areas that were rehabilitated according to official strategies. The property must be located in a designated urban rehabilitation area and rehabilitated after January 1, 2008, in compliance with applicable rehabilitation strategies.
What was the outcome of CAAD arbitration process 234/2017-T regarding IRS capital gains on rehabilitated real estate?
Process 234/2017-T involved taxpayers challenging an IRS assessment after selling a rehabilitated property in Porto. The arbitral tribunal was constituted on June 21, 2017, following the taxpayers' request filed on April 3, 2017. The case centered on whether the 50% capital gains exclusion and 5% special rate could be combined. The Tax Authority defended its position using teleological interpretation, arguing the 50% exclusion's purpose was to offset progressive rate burdens, which do not exist when the 5% proportional rate applies.
What legal grounds can taxpayers invoke to challenge IRS assessments on capital gains from urban rehabilitation properties in Portugal?
Taxpayers can invoke Article 43(2) CIRS regarding the 50% capital gains exclusion, Article 71(5) EBF concerning the 5% rate for urban rehabilitation properties, and constitutional principles under Articles 103(2-3) and 165(1)(i) of the Portuguese Constitution regarding legality and specificity of tax benefit provisions. They can challenge assessments through administrative complaints followed by arbitration under Decree-Law 10/2011 (LRAT). Arguments may include violation of law, improper interpretation of tax benefit statutes, and constitutional violations.
How does the CAAD arbitral tribunal process work for disputing IRS capital gains tax assessments in Portugal?
The CAAD arbitration process for IRS disputes begins with filing a request for constitution of an arbitral tribunal under Decree-Law 10/2011 (LRAT). The President of CAAD notifies the Tax Authority, and the Deontological Council appoints an arbitrator. The tribunal is constituted when the arbitrator accepts and notifies parties. Taxpayers must first exhaust administrative remedies (file an administrative complaint). The arbitration provides a judicial alternative to traditional tax courts, with specific procedures under Articles 2, 6, 10, 11, 16, 18, and 19 of LRAT, offering a streamlined process for resolving tax assessment disputes.