Process: 236/2018-T

Date: November 20, 2018

Tax Type: IRS

Source: Original CAAD Decision

Summary

CAAD arbitration process 236/2018-T addressed whether capital gains from the sale of company shares qualified for the 50% reduction under Article 43(3) of the Portuguese IRS Code (Personal Income Tax). The taxpayer sold shares in B... Ltd. in December 2016, realizing a substantial gain. The dispute centered on whether the company qualified as a 'small enterprise' under the Annex to Decree-Law 372/2007. The taxpayer argued that despite having more than 49 employees in 2015, the company met the small enterprise definition because its turnover was only €5,050,667.83, well below the €10 million threshold. The taxpayer contended that Article 2(2) of the Annex requires cumulative verification of both employee headcount AND financial criteria (turnover or balance sheet total), not just employee numbers alone. The Tax Authority (ATA) maintained that exceeding 49 employees automatically disqualified the company from small enterprise status, asserting the company was previously certified as a 'medium-sized enterprise' until August 2015. The ATA argued the taxpayer failed to prove the shares qualified for the reduced taxation rate. The arbitral tribunal was constituted to determine whether the IRS assessment should be annulled or maintained, with €20,251.88 in tax and interest at stake. This case highlights the critical importance of correctly classifying enterprises under Portuguese tax law for capital gains purposes, particularly the interpretation of cumulative versus alternative criteria in SME definitions affecting substantial tax benefits for shareholders disposing of qualifying investments.

Full Decision

ARBITRAL DECISION

I – REPORT

A... [TIN number]..., resident at Rua ... nº..., ..., ...-... – Braga, area of the ... tax office of the said city, submitted a request for arbitral ruling, under the provisions of paragraph a) of article 2(1), article 3(1) and paragraph a) of article 10(1), all of the LTAT[1], with the Tax Authority and Customs Service [ATA] being requested, with a view to the annulment of the income tax assessment and settlement no. ... and ... of 2018, relating to the tax year 2016 and respective interest, on the grounds that, contrary to the understanding of the ATA, the company whose shares were sold in the said tax year, is a small enterprise within the meaning of the Annex to DL[2] no. 372/2007 of 6 November and as such the capital gain realised with the sale should be taxed at only 50%, as provided in article 43(3) of the PIR[3].

That the request was made without exercing the option to appoint an arbitrator, and was accepted by His Excellency the President of CAAD[4] on 09/05/2018 and notified to the ATA on the same date.

In accordance with and for the purposes of article 6(2) of the LTAT, by decision of His Excellency the President of the Deontological Council, duly communicated to the parties within the legally applicable time limits, on 28/06/2018, Arlindo José Francisco was appointed as arbitrator of the Tribunal, who communicated acceptance of the assignment within the legally stipulated time limit.

The Tribunal was constituted on 18/07/2018 in accordance with the provisions contained in paragraph c) of article 11(1) of the LTAT, as amended by article 228 of Law no. 66-B/2012, of 31 December.

With its request, the applicant seeks the annulment of the said assessment, since the same violates, in its understanding, in a gross manner, the principles of tax legality and material justice.

It supports its point of view, in summary, on the fact that the ATA wrongly considered that the company from which it obtained the capital gain that gave rise to the taxation did not meet the requirements of SMEs[5] provided in article 2 of the annex to DL 372/2007 of 06/11, because it had more than 49 employees.

It considers that the company in question, both in the year 2015 and in the year 2016, should be classified as a small enterprise, in accordance with articles 2 and 4(2) of the Annex to DL 372/2007, already referred to.

In fact, the fact of having more than 49 employees is not a sufficient condition to cease to be a small enterprise, given that the financial requirement is not met (turnover in 2015 was only € 5,050,667.83), with article 2(2) of the Annex to DL 372/2007 requiring the cumulative verification of the employee number requirement and the turnover requirement.

It therefore considers that the capital gain obtained from the sale of equity stakes in the company in question should only be considered at 50% of its value, as prescribed in article 43(3) of the PIR, and therefore the taxation at issue should be declared illegal and consequently annulled.

In its reply, the respondent, and also in summary, states that the income tax assessment at issue should be maintained in the legal order since it is based on the facts ascertained in the verification of the respective tax return selected under divergence management.

In the understanding of the ATA, the company whose equity stakes were sold and which produced the capital gain in question does not meet the SME requirements provided in article 2 of the annex to DL 372/2007, because it had more than 49 employees.

The company was certified as a "medium-sized enterprise" until 13/08/2015, the date of expiry of the certification, and with the shares being sold on 29/09/2016, the material requirements contained in the Annex to DL 372/2007 of 6 November should be assessed, which, when examined, with respect to the last closed financial year (year 2015), it is verified in the Simplified Business Information [IES] submitted by the company that it had, in the said financial year, more than 50 employees.

From this perspective, it considers that the arbitral request should be declared without merit, since the understanding contained in the information provided in the divergence management procedure is in accordance with the legal norms in force, and the assessment produced should be maintained in the legal order.

II - CASE MANAGEMENT

The tribunal was duly constituted.

The parties have legal personality and capacity, are shown to be legitimate and are duly represented in accordance with articles 4 and 10(2) of the LTAT and article 1 of Ordinance no. 112-A/2011, of 22 March.

In view of the respondent's reply, the tribunal issued, on 01/10/2018, the following order: "Witness testimony is not required and there are no exceptions to be considered, thus we consider unnecessary the holding of the meeting provided for in article 18 of the LTAT.

Therefore, under the principles of autonomy of the Arbitral Tribunal in the conduct of proceedings, expedition, simplification and procedural informality (articles 19(2) and 29(2) of the LTAT), the holding of the said meeting is dispensed with and it is determined that the proceedings continue with optional written submissions for a period of 10 days, with the time limit for submissions by the Applicant commencing with notification of this order and the time limit for submissions by the Respondent commencing with notification of the Applicant's submissions.

20-11-2018 is set as the date for the pronouncement of the arbitral decision. By that date, the Applicant must provide proof to CAAD of payment of the subsequent court fees."

The applicant on 12/10/2018 submitted written submissions, in which it maintains the position already set out in the petition to the effect of arguing that B... Ltd., in the year 2016, the year of occurrence of the tax event, was a small enterprise within the meaning of the Annex to DL 372/2007 and that the capital gain obtained from the sale of its shares, by the applicant, can only be taxed, as provided in article 43(3) and (4) of the PIR (50% of its value).

On 22/10/2018, the respondent filed a counter-submission, maintaining, in essence, what was already stated in the reply, emphasizing the fact that in the IES relating to the year 2015 submitted by the company, it is recorded that it had more than 50 employees in its service, which in light of the cumulative requirements demanded in article 2(2) of the Annex to DL 372/2007, prevent the company from being considered as a "small enterprise" and that the reference to article 4 of the said annex is devoid of sense, while at the same time the applicant did not materially prove that the shares sold formed part of the capital of a small enterprise, as was incumbent upon it in accordance with article 74(1) of the LGT[6], concluding that the request can only be declared without merit with the absolution of the respondent.

Thus, the proceedings not being affected by any defects, it falls to decide.

III - REASONING

The issue to be resolved, with relevance for the proceedings, is as follows:

To determine whether the company whose equity stakes were sold is a micro and small enterprise or a medium-sized enterprise within the meaning of the Annex to DL no. 372/2007 of 06 November and thus determine whether the positive balance of the capital gain ascertained should be taxed at only 50% or in its entirety, with the consequent decision to annul the income tax assessment and settlement no. ... and ... of 2018 and relating to the tax year 2016 and respective interest, in the total value of € 20,251.88 or to maintain it in the legal order, according to the conclusion to be reached.

2 – Factual Matters

The applicant held equity interests in the Company B... Ltd., [Business ID]..., with the total value of € 44,000.00, acquired between 1987 and 2002, which it sold in December 2016, for the value of € 286,346.21;

On 25 May 2017, the applicant submitted by electronic data transmission the income tax return form 3 relating to the year 2016, which included Annex G where the said sale of equity interests in micro and small enterprises was recorded, having opted for non-aggregation.

On 01/06/2017, the income tax assessment for the year 2016 no. 2017... was issued, with tax payable in the amount of € 20,082.12, with payment deadline of 31 August 2017, which was settled.

On 27 May 2017, the said return was selected under divergence management procedures, for the purpose of controlling capital gains on securities of micro and small enterprises.

In its analysis, the ATA concluded that the said return should be amended, removing from Annex G, box 9A, the value of the sale of equity interests in the company with [TIN]..., given that the same did not meet the SME requirements provided in article 2 of the Annex to DL 372/2007 of 06 November, since it had more than 49 employees.

As the applicant did not proceed with the amendment as proposed by the ATA, the latter, on 12 March 2018, proceeded to prepare and collect, with Annex G box 9A showing the elimination of 50% of the value of the capital gain relating to the company in question, resulting in an additional assessment with tax payable of € 20,251.88, with payment deadline of 02 May 2018.

The company in question had, in the years 2013 and 2014, a turnover of less than € 10,000,000.00, and on 13 August 2015, the certification of medium-sized enterprise expired, a year in which its turnover also fell short of € 10,000,000.00.

The proof of these facts results from the documents attached to the proceedings which were not contested by the parties, as well as from the content of the attached administrative proceedings.

There are no facts relevant to the decision that have not been proven.

3 - Matters of Law

Gains obtained that are not considered business, professional, capital or real estate income and result from the sale for consideration of equity interests, are considered as capital gains, as provided in article 10(1)(b) of the PIR. The gain in question is constituted by the difference between the value of realization and the value of acquisition, net, in accordance with article 10(4)(d) of the PIR.

On the other hand, article 43 of the PIR, as then in force, in its paragraphs 1, 3 and 4, which are transcribed, provided:

1 - The value of income qualified as capital gains is the corresponding balance ascertained between capital gains and losses realized in the same year, determined in accordance with the following articles.

3 - The balance referred to in paragraph 1, relating to operations provided for in paragraph 1(b) of article 10, relating to micro and small enterprises not listed on the regulated or unregulated markets of the stock exchange, when positive, is equally considered at 50% of its value.

4 - For the purposes of the preceding paragraph, micro and small enterprises are understood to be entities defined in accordance with the annex to Decree-Law no. 372/2007, of 6 November.

The referral to the annex to DL 372/2007 relates to the electronic certification regime for micro, small and medium-sized enterprises, administered by IAPME[7], which this decree-law created, for the purposes of presentation and proof of its SME status with public entities that require it. It is in this sense that article 2 of this decree-law is stated, which is transcribed: "For the purposes of this decree-law, the definition of SMEs, as well as the concepts and criteria to be used to assess the respective status, are contained in its annex, which is an integral part thereof, and correspond to those provided for in Recommendation no. 2003/361/EC of the European Commission, of 6 May"

Articles 1, 2 and 4 of the annex to this DL provide that: "Article 1 Enterprise - An enterprise is understood to be any entity that, regardless of its legal form, carries out an economic activity. In particular, entities that carry out a craft activity or other activities on an individual or family basis, partnerships or associations that regularly carry out an economic activity are considered as such."

"Article 2

Headcount and financial thresholds defining enterprise categories

1 — The category of micro, small and medium-sized enterprises (SMEs) is composed of enterprises that employ fewer than 250 persons and whose annual turnover does not exceed 50 million euros or whose total annual balance sheet does not exceed 43 million euros.

2 — In the SME category, a small enterprise is defined as an enterprise that employs fewer than 50 persons and whose annual turnover or total annual balance sheet does not exceed 10 million euros.

3 — In the SME category, a micro enterprise is defined as an enterprise that employs fewer than 10 persons and whose annual turnover or total annual balance sheet does not exceed 2 million euros".

"Article 4

Data to be considered for the calculation of headcount and financial amounts and reference period

1 — The data considered for the calculation of headcount and financial amounts are those of the last closed accounting period, calculated on an annual basis. Data are taken into account from the date of closure of accounts. The amount of turnover considered is calculated excluding value added tax (VAT) and other indirect taxes.

2 — If an enterprise verifies, on the date of closure of accounts, that it exceeded or fell below, on an annual basis, the headcount threshold or the financial thresholds indicated in article 2, this circumstance does not cause it to acquire or lose the status of medium, small or micro enterprise, unless such a circumstance is repeated during two consecutive financial years.

3 — In the case of a recently formed enterprise, whose accounts have not yet been closed, the data to be considered shall be the subject of a good faith estimate during the financial year."

This is the legal framework that the Tribunal will use to render its decision, assessing whether, on the date of the sale of the equity interests, the company fulfilled or not the material requirements referred to in the Annex to DL 372/2007 of 06 November, for the purposes of article 43(3) of the PIR.

Now, having regard to the proven factual matters, namely paragraph g) of point 2, section III – Reasoning, of this decision, it is verified that the enterprise, despite having more than 50 employees, its turnover was always lower, in the years 2013, 2014 and 2015, than the € 10,000,000.00 required by article 2(2) of the Annex to DL 372/2007, and at the same time the company in question, at the time of the sale of the equity interests (December 2016) was not certified, which moreover articles 43(3) and (4) of the PIR do not require, being sufficient solely the fulfillment of the requirements contained in article 2(2) of the said Annex, which are cumulative, an understanding that the ATA itself came to accept, as evidenced by Circular no. 7/2014, of 29 July, which in its paragraph 5 states: "the qualification of micro or small enterprise for the purposes of applying paragraphs 2, 3 and 4 of article 43 of the PIR should be based on the material reality of the entities whose equity interests were the subject of onerous transmission, based on verification of the material requirements set out in the annex to Decree-Law no. 372/2007 of 6 November, on the date of sale, with the burden of proof resting on the taxpayers in accordance with article 74(1) of the General Tax Law".

The same circular, in paragraph 6 letter b), states that when the enterprise does not have certification as a micro or small enterprise, it is nonetheless necessary to assess whether on the date of sale it met that condition.

From the analysis being carried out and given the proven factual matters (expiry of medium-sized enterprise certification and turnover below € 10,000,000.00), the Tribunal concludes that the company in question was, at the time of the sale of the equity interests, a micro enterprise, within the meaning of the Annex to DL 372/2007 of 06 November, given that it did not cumulatively meet the requirements for being considered an SME, lacking the financial requirement.

In these circumstances, the balance of the ascertained capital gain should be considered at only 50% of its value for taxation purposes, as opportunely declared by the applicant.

Considering that the assessment at issue taxed the entirety of the ascertained balance, the said assessment should be annulled for violation of article 43(3) and (4) of the PIR.

IV – DECISION

Thus the tribunal decides:

To declare the request for arbitral ruling well-founded, with the consequent annulment of the income tax assessment and settlement no. ... and ... of 2018 and relating to the tax year 2016 and respective interest, in the total value of € 20,251.88.

To fix the value of the case at € 20,251.88, in accordance with the provisions contained in article 299(1) of the CPC[8], article 97-A of the CCPT[9], and article 3(2) of the RCAT[10].

To fix the costs, under article 22(4) of the LTAT, in the amount of € 1,224.00 in accordance with the provisions of Table I referred to in article 4 of the RCAT, which shall be borne by the respondent.

Lisbon, 20 November 2018

Text prepared by computer, in accordance with article 131(5) of the CPC, applicable by referral from article 29(1), paragraph e) of the LTAT, with blank lines and reviewed by the tribunal.

The Arbitrator

Arlindo José Francisco

[1] Acronym for Legal Framework for Arbitration in Tax Matters
[2] Acronym for Decree-Law
[3] Acronym for Personal Income Tax Code
[4] Acronym for Centre for Administrative Arbitration
[5] Acronym for Small and Medium-Sized Enterprises
[6] Acronym for General Tax Law
[7] Acronym for Institute for Support to Small and Medium-Sized Enterprises and Investment
[8] Acronym for Code of Civil Procedure
[9] Acronym for Code of Tax Procedure and Process
[10] Acronym for Rules of Costs in Tax Arbitration Proceedings

Frequently Asked Questions

Automatically Created

What is the 50% capital gains reduction under Article 43(3) of the Portuguese IRS Code for SME share sales?
Article 43(3) of the Portuguese IRS Code provides that capital gains from the sale of shares in micro and small enterprises are taxed at only 50% of their value, rather than the full amount. This beneficial tax treatment aims to incentivize investment in smaller Portuguese businesses. To qualify, the shares must be held in companies meeting the specific criteria defined in the Annex to Decree-Law 372/2007, which establishes formal definitions for enterprise size classification based on employee headcount and financial thresholds.
How does the Annex to Decree-Law 372/2007 define a small enterprise for IRS capital gains tax purposes?
The Annex to Decree-Law 372/2007 defines a small enterprise as one employing fewer than 50 employees and having either annual turnover or balance sheet total not exceeding €10 million. Article 2(2) of the Annex states these criteria must be verified cumulatively, meaning both the employee threshold and at least one financial threshold must be satisfied. This definition is critical for determining eligibility for the 50% capital gains reduction under Article 43(3) of the IRS Code when taxpayers dispose of shareholdings.
Are the employee headcount and turnover criteria cumulative for SME classification under Portuguese tax law?
Yes, under Article 2(2) of the Annex to Decree-Law 372/2007, the employee headcount and financial criteria are cumulative requirements for SME classification. A company must satisfy both conditions: it must have fewer than 50 employees AND have annual turnover or balance sheet total not exceeding €10 million to qualify as a small enterprise. This cumulative interpretation is central to the dispute in CAAD case 236/2018-T, where the taxpayer argued that meeting the financial threshold should suffice despite exceeding employee limits, while the Tax Authority interpreted the employee threshold as an absolute disqualifier.
Can a company with more than 49 employees still qualify as a small enterprise for IRS capital gains relief?
Under a strict interpretation of Article 2 of the Annex to Decree-Law 372/2007, a company with 50 or more employees cannot qualify as a small enterprise, regardless of its financial metrics. The definition requires fewer than 50 employees as a mandatory threshold. However, the taxpayer in case 236/2018-T argued for a cumulative interpretation where both criteria must be assessed together. The Tax Authority's position was that exceeding 49 employees automatically disqualifies a company from small enterprise status for IRS capital gains relief purposes, even if turnover remains below €10 million, making this a critical threshold for tax planning.
What was the outcome of CAAD arbitration process 236/2018-T regarding IRS taxation of capital gains from SME shares?
The arbitral decision text provided does not include the final ruling section (Section III continues but is cut off). However, the case involved a taxpayer challenging an IRS assessment of €20,251.88 for the 2016 tax year, arguing that capital gains from selling shares in B... Ltd. should be taxed at only 50% because the company qualified as a small enterprise despite having more than 49 employees, given its turnover of only €5,050,667.83. The Tax Authority maintained the full assessment, asserting the employee threshold was decisive. The tribunal was constituted in July 2018 with a decision date set for November 2018.