Process: 238/2017-T

Date: February 14, 2018

Tax Type: IRS

Source: Original CAAD Decision

Summary

CAAD Decision 238/2017-T addresses the critical issue of how income from tourist apartment exploitation contracts should be classified for Portuguese IRS purposes. UK-resident taxpayers challenged additional IRS assessments for 2012-2014, disputing the Tax Authority's reclassification of their income from Category B (business/commercial income) to Category F (passive rental income). The taxpayers had contracted a management company to operate their tourist apartment but argued they retained the business risk and economic activity characteristics, making it Category B income under Article 3(1)(a) of the IRS Code. The Tax Authority relied on Circular 5/2013 to support treating managed tourist rentals as passive income. The claimants contested this on multiple grounds: (1) inadequate reasoning in the tax inspection report violating constitutional requirements for clear administrative decisions; (2) the income constitutes commercial activity generating economic utility through hotel-like services, not mere passive rental; (3) Circular 5/2013 is administrative guidance without force of law and cannot override statutory provisions; and (4) alternatively, if Category F applies, significantly more expenses should be deductible under Article 41 of the IRS Code, including maintenance, utilities, staff costs, and property administration expenses. This case has significant implications for non-resident property owners in Portugal's tourist rental market, clarifying when tourism exploitation contracts constitute active business activity versus passive investment income, and establishing the primacy of statutory law over administrative circulars in tax classification disputes.

Full Decision

ARBITRAL DECISION

I – Report

  1. On 4.04.2017, the Claimants, A…, tax identification number … and B…, tax identification number …, married, resident in…, …, …, London …, United Kingdom, requested the CAAD to establish an arbitral tribunal, in accordance with article 10 of Decree-Law no. 10/2011 of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter referred to as LFATM), with the Respondent being the Tax and Customs Authority, with a view to annulling the additional IRS assessment act no. 2016… for the year 2012, as well as the additional IRS assessment act no. 2016…; the compensatory interest assessment act no. 2016…, and account settlement statement no. 2016…, all relating to the year 2013, and furthermore, the additional IRS assessment no. 2016…; the compensatory interest assessment act no. 2016… and the account settlement statement no. 2016…, relating to the year 2014.

  2. The request for establishment of the arbitral tribunal was accepted by the Honourable President of the CAAD and notified to the Tax and Customs Authority.

In accordance with and for the purposes of the provisions of section 1 of article 6 of the LFATM, by decision of the President of the Ethics Council, duly communicated to the parties within the legally applicable periods, Mrs. Dr. Andrea Firmino was appointed as arbitrator, who communicated to the Ethics Council and the Administrative Arbitration Centre her acceptance of the appointment within the regularly applicable period.

The Arbitral Tribunal was constituted on 22-06-2017.

On 29.12.2017, the undersigned was appointed arbitrator in substitution of Mrs. Dr. Andrea Firmino, having communicated to the Ethics Council and the Administrative Arbitration Centre his acceptance of the appointment within the regularly applicable period.

  1. The grounds presented by the Claimant in support of their claim were, summarily, the following:

  • The reasoning of the final tax inspection report, which constitutes the rationale for the tax acts that are the subject of the present arbitral request, is neither congruent nor clear, and upon the Tax Authority rests the legal duty not only to indicate all facts in a clear and coherent manner, but also to indicate and sustain its conclusions with the corresponding legal provisions.

  • Only with the indication of all reasons of fact and law can the challengers, in conscience, assess the lawfulness of the acts practised by the Tax Administration and thus opt for their contestation or acceptance.

  • In the case at hand, the Tax Authority understood that the Claimants' conduct is passive and for that reason the income that they declared as being income of category B should be taxed as income of category F, in accordance with Circular no. 5/2013 of 2 July 2013.

  • Being the Claimant the holder of the tourism operation of the apartment and having transferred the operation thereof to C… SA, NIPC … (hereinafter referred to only as "C…"), maintaining, however, in his sphere the business risk, it is not understood in what way the Claimant exercises the tourism operation in a passive manner.

  • It appears from the reading of the Tax Inspection Report that the understanding of the Tax Inspection Services is nothing more than a conclusive judgment that has no support in the facts nor in law, but only in a circular, which does not stand above the law and it should be concluded that the Tax Authority did not comply with the legal duty, constitutionally enshrined, of express, clear and comprehensive reasoning of the decisions for which it is responsible, and therefore the contested tax acts should be annulled.

  • On the other hand, unless better understood, it is manifest that the income earned by the Claimants is income of category B of the IRS Code and not income of category F.

  • On 18 February 2008, the Claimants signed with D…, S.A. a contract for transfer of tourism operation of the … identified above, appointing this entity, C… company, for management functions.

  • From this contract it results that the manager always acted on account and in the interest of the Claimants while exercising the operations necessary to accomplish the tourism operation of the apartment identified above.

  • It is settled case law that "provided that there is an increase in value accruing to an asset by virtue of the exercise of an economic activity (even if expressed in a single act) translated into creation of economic utility, resulting from any relationship of the agent/taxpayer with a third party in which, satisfying the economic needs of the latter, the asset is increased (mediation between supply and demand) there will be a commercial activity" (Supreme Administrative Court Decision, of 24.02.2016, case no. 580/15).

  • It is manifest that all income earned within the scope of activities generating income from commercial activities, namely those resulting from hotel and similar activities, are taxed in category B.

  • Although the Tax Authority advocates, in the tax inspection forum, a restrictive interpretation of the concept of "activity", considering that for the purposes of taxation in category B only profits arising from direct operation of the Unit are admissible, the Claimants understand that this interpretation finds no support in the literal wording of subsection a) of section 1 of article 3 of the IRS Code, and therefore all results obtained throughout the fiscal year attributable to the activity of operating a tourism enterprise should be considered, whether they are results arising from direct operation, or through the contracting of services from an entity to operate the unit.

  • If the legislator intended to exclude from the scope of subsection a) of section 1 of article 3 of the IRS Code the income resulting from operation arising from the contracting of services, as the Tax Administration understands, it would have been necessary for it to expressly determine that only results arising from direct operation were subject to taxation within category B of the IRS Code, which is not the case, and therefore the income in question should be taxed within subsection a) of section 1 of article 3 of the IRS Code.

  • Circular no. 5/2013 of 2 June 2013, invoked by the Respondent, like any other administrative guidance only binds the organs of the Tax Administration and are not considered a source of tax law, and therefore have no binding external effect of their own, not even being subject to publication, and therefore taxpayers are in no way obliged to comply with their provisions, nor are the Courts.

  • Thus, because the contested tax acts are grounded in a circular against the law, they should be annulled as manifestly unlawful.

  • Even if it were admitted – which is done merely as a precaution and duty of representation – that the income obtained by the Claimant is effectively income of category F of the IRS Code, the reality is that the taxable income of the Claimant would never be in the amount established by the Tax Inspection Services in the course of the tax inspection, for contrary to the position of the Tax Authority, in accordance with and for the purposes of article 41 of the IRS Code, should be understood as deductible expenses from income of category F of the IRS the expenses for maintenance and conservation referring to cleaning staff, gardener's salary, electricity, water and gas, costs of renting a house with equipment, repairs and painting, insurance premiums and costs of administration of the property, insofar as they are essential for obtaining the income in question.

  1. The Tax and Customs Authority, called upon to respond, contested the Claimants' claim, defending itself by objection, in summary, with the following grounds:

  • With regard to the alleged lack of reasoning of the corrections now being reviewed, it must be disagreed with such understanding, not least because from the reading of the inspection report it results that an average person, placed in the position of recipient, can grasp its meaning and conclusion.

  • In the case in question, the reasoning is sufficiently clear and unequivocal, especially since the Claimants, through the present arbitral pronouncement request, not only demonstrate, in light of the arguments they have explained throughout their pleading, to have fully understood the factual and legal framework on which the Respondent's decision was based, as they attempt to refute, point by point, all of its actions.

  • As in reality also they had fully understood the same factual and legal framework in the course of prior hearing, the defect of lack of reasoning is deemed not to be verified.

  • Between the now Claimants and the selling company was signed a contract for transfer of tourism operation of the unit …, under which the company D… SA obtained the right to establish a commercial company for the management of the "…", a situation that came to pass with the establishment of the company C… SA, NIPC….

  • In this way, the Claimants ensure the tourism operation of the property in question, through the services of the company C…, granting it exclusive authorization to operate tourism-wise and on its own account the apartment of which they are owners.

  • Thus, the Claimants mandated the company C… to in its own name and on its own account receive the remuneration relating to the operation of its property, with the latter obtaining the right to retain 25% of the gross revenue from the respective operation.

  • The income earned by the Claimants thus derives from the provision to third parties of the properties, which are managed and maintained by the company C…, which also manages short-term rentals, collecting the amounts due and providing all other associated services, such as for example cleaning.

  • Finally, this company provides to the owners the amounts contractually agreed.

  • It should be noted that the owners had no intervention in obtaining the licensing.

  • In this way the income that the Claimants earn arises in a merely passive manner, as a result of the pursuit of a commercial activity by the company C….

  • The Claimants did not demonstrate having any organization of an entrepreneurial nature for obtaining the same.

  • The law expressly refers that business income is understood as that arising from the exercise of any commercial activity.

  • And, considering both the meaning of the concept used in the legal norms in question, as well as the interpretation that the jurisprudence of the superior courts has made of it, one can only conclude that the Claimants have no reason.

  • Effectively, searching in the Portuguese dictionary the meaning of the word "exercise", it is found that this corresponds to the act of exercising or practising, to the practice and use of something, and therefore, for what here matters to us, to the performance of a professional activity.

  • That is, the use of the word "exercise" in the wording given to the norm, by contrast with the words used in article 8 of the CIRS, to define what are category F income, has underlying the practice of acts with a certain purpose, which in this case will be the obtaining of profit.

  • Thus, to pretend, as the Claimants do in the request for arbitral pronouncement, that the fact of having declared commencement of activity, affirming the intention to exercise an activity of tourism operation (when, effectively, nothing more was done than to acquire a property), should be valued as sufficient for the qualification of the income as attributable to category B, when then effectively the declared activity is not exercised, would be to give primacy to form over substance, contradicting the most elementary principles of tax law.

  • From the reading of the contract for transfer of operation, it clearly results that the Claimants never assume the functions of those responsible for the operation of the accommodation, being those assumed by the Manager in its different aspects.

  • For this very reason, the Tax Inspection Services (hereinafter "TIS") considered that the income in question corresponds to property income falling within category F of the IRS (article 8 of the Income Tax Code of Individuals).

  • Since what is in issue is income relating to the transfer of use of the property or part of it, the amounts received by the owners, as consideration for the transfer of use of the apartments, are considered property income, in accordance with what is provided in subsection a) of section 2 of article 8 of the IRS Code independently of the fact that the amount received is not fixed.

  • As for the pretension, on the part of the Claimants, that the totality of expenses with staff salaries, cleaning, electricity be accepted, in accordance with article 41 section 1 of the IRS Code, in the wording in force at the date of the facts, "From the gross income referred to in article 8, deducted are the expenses for maintenance and conservation incumbent on the taxpayer, borne by him and found to be documented, as well as the municipal property tax and the stamp duty that applies to the value of the properties or part of properties whose income is subject to taxation in the fiscal year (Wording given by law no. 66-B/2012, of 31 December)."

  • It must therefore be evaluated whether those expenses referred to in abstract by the Claimants have the character of maintenance and/or conservation expenses incumbent on the taxpayer.

  • Thus, by means of these concepts, it is immediately verified that the expenses mentioned by the Claimants do not constitute conservation expenses nor, either, of maintenance.

  • On the other hand, and with regard to expenses with salaries and cleaning, it results from the contract of transfer that these charges are the responsibility of the Manager, which means that neither are they the responsibility of the Claimants.

  • And therefore, also on this point, the Claimants lack reason in what is petitioned.

  1. Verifying the non-existence of any situation provided for in article 18, section 1, of the LFATM, that would make necessary the arbitral meeting provided for therein, the holding of the same was dispensed with, on the basis of the prohibition of performance of useless acts.

The performance of pleadings was also dispensed with, in accordance with article 18, section 2, of the LFATM, "a contrario".

  1. The tribunal is materially competent and is regularly constituted in accordance with the LFATM.

The parties have legal personality and capacity, are legitimate and are legally represented.

The process is not afflicted with defects that would invalidate it.

  1. It is necessary to resolve the following issues:

a) Unlawfulness of the tax acts subject to the process due to lack, incongruence or insufficiency of reasoning.

b) Unlawfulness of the tax acts subject to the process, due to defect of violation of law.

II – Relevant Factual Matter

  1. The following facts are deemed proved:

  2. By Service Orders numbers O12016…/…/… of 2016-08-18, determined by order of the Director of Finances of Faro, a partial scope internal inspection action in IRS was opened with a view to the control of property rental, with the Claimants being inspected, with extension to the years 2012, 2013 and 2014, the inspection acts having been initiated on 2016-09-20 and concluded on 2016-09-23.

  3. As a result of the inspection procedure, the Respondent determined corrections to IRS taxable income, of a purely arithmetical nature, in the amounts of €53,053.51, €17,323.25 and €26,722.48 for the years 2012, 2013 and 2014, respectively, arising from rents received relating to property located in national territory, which gave rise to the following tax acts, with the Claimants as taxpayers:

a) Relating to the year 2012:

Additional IRS assessment act no. 2016…, from which resulted a total and net collection of €7,244.73, with the value of €11,567.58 of withholding taxes effected on the taxpayers.

b) Relating to the year 2013:

Additional IRS assessment act no. 2016…, from which resulted a total and net collection of €1,038.33; compensatory interest assessment act no. 2016…, and account settlement statement no. 2016…, which having regard to the additional and compensatory interest assessments, withholding taxes effected and the reimbursement made to the taxpayers as a consequence of the original assessment, results in an amount payable of €1,129.66.

c) Relating to the year 2014:

Additional IRS assessment no. 2016…, from which resulted a total and net collection of €5,532.60; compensatory interest assessment act no. 2016… and account settlement statement no. 2016…, which having regard to the additional and compensatory interest assessments, withholding taxes effected and the reimbursement made to the taxpayers as a consequence of the original assessment, results in an amount payable of €5,790.98.

  1. From the tax inspection report that preceded and serves as the basis for the tax assessment acts of collection which are the subject of the present process, in particular, the following appears:

"III. Description of Facts and Grounds of Corrections of a Purely Arithmetical Nature to Taxable Income

The Taxpayers are owners of a property registered in the urban property matrix of the Parish Union of … and … under article … …, located at "…" - …- …- …- …, which they acquired from D… SA, NIPC….

Between the Taxpayers and the selling company was signed a contract for transfer of tourism operation of the unit, under which the company D… SA obtained the right to establish a commercial company for the management of the "…", a situation which came to pass with the establishment of the company C… SA NIPC … (hereinafter referred to only as C…).

In this way, the new owners ensured the tourism operation of the properties in question through the services of the company C…, granting it exclusive authorization to operate tourism-wise, on its own account, the apartments of which they are owners.

Thus, the taxpayers in question mandated the company C… to in its own name and on its own account receive the remuneration relating to the operation of its properties, with the latter obtaining the right to retain 25% of the gross revenue from the respective operation.

The income earned by the taxpayers in question derives from the provision to third parties of the property.

Properties which are managed and maintained by the company C…, which also manages short-term rentals, collecting the amounts due, and providing all other associated services, such as for example cleaning, etc.

Finally this company provides to the owner the amounts contractually agreed.

It should be noted that the owners had no intervention in obtaining the licensing.

In this way the income that the taxpayers earn arises in a merely passive manner, as a result of the pursuit of a commercial activity by the company C…. The IRS taxpayers do not appear, nor allege, to have any organization of an entrepreneurial nature for obtaining the same.

Thus the income in question corresponds to property income falling within category F of IRS (article 80 of CIRS).

Circular no. 5/2013 of 02-07-2013 states:

'1 - The activity of operating a tourism enterprise when exercised directly by the owner, an individual, is considered a commercial activity provided that the taxpayer has requested the registration of the enterprise in the National Register of Tourism Enterprises'

3 - When, by contract for transfer of tourism operation, the owner of a property suitable for such operation refrains from carrying out such operation, transferring, in exchange for remuneration, to another such activity and the transfer being prior to the registration of the tourism enterprise in the National Register of Tourism Enterprises, the income earned shall be deemed to be property income, in accordance with article 8, section 2 subsection a) of the Code of Income Tax of Individuals (CIRS).'

(…)

'16. In IRS, business and professional income (category B) is considered to be that arising from the exercise of any commercial, industrial, agricultural, forestry or cattle-raising activity, that is, all activities that consist of the carrying out of economic operations of an entrepreneurial nature, including those concerning the provision of services, exercised, on own account, even if connected with any of the activities mentioned previously (article 3, section 1, subsections a) and b) of CIRS).

  1. On the other hand, income subject to IRS in category F (property income) constitutes, in particular, rents arising from the transfer of use of property or part of property and services related to that transfer, as well as amounts relating to the rental of machinery and furniture installed in the leased property (article 8, section 2, subsections a) and b), of CIRS).

  2. In the case in analysis, the owners merely limit themselves to transfer the use of the apartments for operation of the same to an entity, receiving, as consideration, a proportionate share, corresponding to the number of units participating in the tourism operation program and to the number of days the unit was available for use within the scope of the program, minus the amount corresponding to the costs and expenses borne by the manager, on account of the owners.

  3. In this respect, it seems to us that the fact that the owners receive a remuneration that is not fixed, which depends on the number of days the unit was available for use within the scope of the program, does not constitute reason to consider that the owners are directly operating the apartments, nor does it remove that remuneration from the concept of rent.

  4. In fact, having analyzed the nature and specificities of the underlying operations, the owners merely transfer the use and enjoyment of the tourism apartments, equipping them and furnishing them with the standard package of furniture, delivering the management and operation of the same to an operating entity, D…, which provides all necessary services for the functioning of the enterprise, namely, the commercial efforts necessary for the promotion of the apartments, accounting, sales, marketing, contacts with travel agencies and tourism operators, maintenance services, cleaning and tidying services, garden and landscape maintenance, etc.

  5. In this sense, it seems to us that the amounts received by the owners, as consideration for the transfer of use of the apartments, do not constitute income arising from the exercise of a business activity, as this was previously described, but rather should be considered Property Income.'

(…)

'In the scope of Income Tax of Individuals (IRS) and in accordance with section 1 of article 13 of CIRS, taxpayers of IRS are '(...) individuals who reside in Portuguese territory and those who, not residing there, obtain income here'.

The tax is charged on '(...) the annual value of income of the following categories, even when arising from unlawful acts, after the corresponding deductions and reductions have been made'.

  • section 1 article 1 of CIRS.

The expenses capable of being deductible from property income are provided for in article 41 of CIRS 'From the gross income referred to in article 8, deducted are the expenses for maintenance and conservation incumbent on the taxpayer, borne by him and found to be documented, as well as the municipal property tax and the stamp duty that applies to the value of the properties whose income is subject to taxation in the fiscal year' (Wording in force in the years under consideration).'

(…)

Taxpayer A emitted invoices for accommodation to C… SA which were recorded in account SNC 7816401 - Other Supplementary Income - Accommodation - Domestic which total €60,882.05 (invoices nos. 2012t1 and 201212) in 2012 €6,979.20 (invoice no. 2013/01) in 2013 and €28,226.99 (invoices nos. 201412 and 201414) in 2014.

In accordance with an email sent by C… in the scope of order no. D12013…: 'With regard to accommodation revenue generated by the apartments … it is distributed daily among all apartments that are available for rental based on the percentage of each apartment, with the base being able to change daily depending on the sum of the percentages of units available for rental in the ….'

In account SNC 62211 - Specialized Work - Domestic., the invoices issued by C… SA are recorded with the description 'Costs of accommodation operation carried out in our name for your account 51301', which total €46,046.46 (invoices no. Ft20120046 and no. FI2O12O19B) in 2012, and €7,777.27 in 2013 (invoice no. F120130125) and €22,155.96 in 2014 (invoices no. F120140084 and no. F120140235) '...under the contract the respective costs are distributed among all units that make up the … on the basis of the percentage of each unit in the universe of 154 apartments that make up the …, with the sole exception for the condominium value which is calculated on the basis of the percentage of each apartment against the percentage of all units that make up the resort ….' - As stated in an email sent by C… in the scope of order no. Dt2013….

Analyzing section 3.11 of the Contract for Transfer of Tourism Operation, it was verified that the expenses for operation of the tourism operation program include the following charges:

A – Service of Administration of Property (4.4) which include services of general administration (Section 4.1) corresponding to '...without being limited to this, accounting, sales and marketing, costs of travel agencies and/or commissions of tourism operators and respective incurred expenses, expenses with central services related to the tourism operation program and expenses of reception services and other expenses related to it.' And Direct Expenses of the Unit (Section 4.4), including '...condominium charges, management and reserve costs, all applicable insurance premiums, auditor fees, telephone accounts and other expenses and all costs with basic services (electricity, oil, gas, water).'

B - Services of Property Maintenance (Section 5), described in document C where routine maintenance of the property and its equipment and furniture are included so as to maintain the unit suitable for guest occupancy, interior and exterior painting of the unit, maintenance of garden and landscape.

D - Cleaning and Tidying Services (Section 6), described in annex D '...including, but not limited to, steam cleaning of carpets and upholstery, waxing of floors, external cleaning of windows and other cleaning services necessary to maintain the unit suitable for receiving guests.'

E - Equipment Expenses

F - Insurance Premiums.

Section 7 further provides for the remuneration of the manager, 'For the administration of the tourism operation program relating to the unit, the manager shall be entitled to receive and shall retain 25% (twenty-five percent) of the Gross Revenue from Tourism Operation, which includes the Costs of accommodation operation'

Verifying that some charges that are included in the 'operation costs' may constitute expenses capable of being deductible from property income provided for in article 41 of CIRS and the value not being itemized in the invoices issued by C… to the Taxpayer, the entity issuing the invoices was requested to itemize the accommodation operation costs, the table that comprises annex 1 being provided, from which it is concluded that the items capable of integrating what is provided for in article 41 and the binding information in no. 1369 are:

  • Expenses with condominium (condo charges), which in the case of the Taxpayer amounted to €1,022.60 in 2012, €1,033.29 in 2013 and €930.11 in 2014.

  • Remuneration of the manager (Operator Commission 25%)

  • Security

  • Insurance

The remaining items, which include staff salaries, cleaning, electricity, gas and water and due to their current characteristics do not meet the conditions to be considered maintenance or conservation expenses'

(…)

The remuneration of the manager corresponds to 25% of the rents (in accordance with invoices issued by the taxpayer to C…).

Also not considered are expenses with the Municipal Property Tax (IMI) given that the Taxpayers benefited from exemption in the years 2012 and 2013 and the IMI assessment notices for 2014 were paid in 2015.

The remaining expenses that are recorded in the accounting, namely depreciation, accounting, financial costs, are also not subsumed in the concept of specific deduction of category F.

As provided for in the contract executed (clause 3.10), the owners may reserve the unit for their personal use (…).'

'For purposes of calculating specific deductions of category F, 92% in the year 2012, 91% in the year 2013 and 90% in the year 2014 shall be accepted, of the expenses for condominium, security and insurance, described in table 3, excluding the period of personal use, as well as the amount corresponding to the remuneration of the manager.'

(…)

'Due to the fact that these are non-resident taxpayers, the property income is taxed at the rate of 16.5% in the year 2012 in accordance with section 1 of article 72 of CIRS and at 28% in the years 2013 and 2014 as provided for in section 7 of article 72 of CIRS, legislation in force at the date of the facts:

Withholdings at source were effected by the entity C… SA NIPC…, in the amounts of €13,089.65, €1,744.80 and €7,056.75 with respect to income from 2012, 2013 and 2014, which shall be taken into account in the assessment.

Thus, from the present inspection action result corrections to taxable income that correspond to the difference between the taxable income declared and now established (…)'

  1. Claimant husband A… is registered for the exercise of the activity "Tourism Apartments without restaurant" since 2008-01-01, being framed in the normal regime of quarterly periodicity in VAT and in the regime of organized accounting, by option in IRS with the Claimant wife, B…, as the taxpayer.

  2. Between the Claimant husband and the company D…, S.A. was executed the contract for transfer of tourism operation contained in the file and whose contents are deemed to be fully reproduced for all legal purposes.

  3. Facts Not Proved

There are no facts not proved with interest for the decision of the case.

  1. The Tribunal's conviction regarding the decision of the factual matter was based on the documents contained in the file, as well as the pleadings presented, with no disagreement by the parties regarding the factual matter deemed proved.

III – Applicable Law

  1. As the challengers have imputed various defects to the tax acts challenged, it is necessary to determine the order of consideration of the same, and the order of article 124 of the Code of Administrative Procedure (CPPT) should be observed, as applicable by virtue of article 29, section 1, subsection a) of the LFATM (Cfr. Jorge Lopes de Sousa, Commentary on the Legal Framework for Arbitration in Tax Matters, in GUIDE TO TAX ARBITRATION, Coord. Nuno Villa-Lobos and Mónica Brito Vieira, 2017, Almedina, page 205).

The success of any of the defects invoked by the Claimants would lead to the annulment of the tax acts. However, the defect of violation of law is that which will lead to the "more stable or effective protection of the offended interests" in that its possible success would prevent the renewal of the acts, which does not occur with the annulment resulting from the other defects.

Accordingly, the Tribunal shall first examine the defect of violation of law.

  1. The legal issue to be resolved, first of all, relates to the question of whether the commercial hotel activity in question, exercised with reference to the apartment of which the Claimants were owners at the date of the facts, is exercised by the company C… SA, as the Respondent argues, or, differently, by the owners of the fraction, as the Claimants argue.

The Respondent argues that the income obtained by the owners was in a merely passive manner and that the direct exercise of the activity was carried out by the company C…, the latter not bearing the business risk, nor having entrepreneurial organization.

The Claimants, by contrast, understand that the activity was exercised by them through the contracting of the company C…, whose services they paid for, with the owners bearing the business risk.

Furthermore, they understand that subsection a), section 1, article 3, of the IRS Code provides for the exercise of commercial activity but does not require that such exercise be direct, and therefore such exercise may be done through the contracting of another entity for that purpose.

They further allege that Circular no. 5/2013 of 2 June 2013, in requiring that the activity be exercised directly, excluding the exercise indirectly through the contracting of another entity for that purpose, performs a restrictive interpretation of the mentioned norm, having an innovative character and, like any other administrative guidance, only binds the organs of the Tax Administration and is not considered a source of tax law, and therefore has no binding external effect of its own, not even being subject to publication, and therefore taxpayers are in no way obliged to comply with its provisions, nor are the Courts.

Thus, because the contested tax acts are grounded in a circular against the law, they should be annulled, as manifestly unlawful.

Let us examine.

Article 3 of CIRS provides the following:

'1 - Business and professional income is considered to be:

a) That arising from the exercise of any commercial, industrial, agricultural, forestry or cattle-raising activity; […];'

For its part, in accordance with article 4 of CIRS:

'1 – Commercial and industrial activities are considered, in particular, the following:

(…)

h) Hotel and similar activities, catering and beverages, as well as the sale or operation of the real right of periodic dwelling;'

On the other hand, the following was the wording of article 8 of the same Code, at the date of the facts, in the part relevant to the case at hand:

'1 - Property income is considered to be rents from rural, urban and mixed properties paid or made available to their respective holders.

2 - Rents are considered to be:

a) Amounts relating to the transfer of use of property or part thereof and services related to that transfer;

b) Amounts relating to the rental of machinery and furniture installed in the leased property; […]'

Article 8, section 1, of CIRS, in the wording at the date of the facts, mandatorily categorized in category F the remuneration (rent) arising to the lessor of rural, urban and mixed properties.

José Guilherme Xavier de Basto tells us that 'The law, in section 2 of article 8, defines rent, better said, redefines rent, for the purposes of IRS. The redefinition is necessary, all the more so since today, the General Tax Law, in article 11, section 2, contains the principle whereby, whenever in tax laws are employed terms peculiar to other branches of law (…) such terms shall be valid with the meaning they have in that branch of law, except if the law provides otherwise. The principle thus leads to the tax legislator having to be cautious when using words that may have a technical sense in another branch of law, in the present case in civil law and frequently proceeding to redefinitions for tax purposes.

We are not obviously going to discuss here the concept of rent in civil law, in the law of leasing. The tax concept of rent, the only one that concerns us here, is broader than the civil law concept.

The six subsections of section 2 of article 8 delimit the tax concept of rent.'[1]

In abstract, the situation in question could only be categorized under subsections a) and b) of section 2 of article 8 of CIRS, this appearing to be the position of the Respondent.

Under these subsections, Xavier de Basto further tells us[2]:

'Subsection a) contains the basic concept: rent is the amount relating to the transfer of use of property or part thereof and services related to that transfer. Note that the law refers to the transfer of use of property, without troubling to distinguish between the different causes of transfer. In most cases, the cause will be the leasing contract, but the norm undoubtedly covers other legal situations.

(…)

Subsection b) equates with rent 'amounts relating to the rental of machinery and furniture installed in the leased property'. This is elementary caution on the part of the legislator, intended to avoid temptations of fraud, separating from rent, taxable in category F, the price of the leasing of machinery and furniture.(…)'

In the case before us, it is manifest that we are not in the presence of a leasing contract (nor is this even alleged by the Respondent).

Let us then examine whether the income in question results from transfer of use of property, services related to that transfer and/or amounts relating to the rental of machinery and furniture installed in the leased property.

The answer cannot fail to be negative.

In truth, it is inherent in subsections a) and b) of section 2 of article 8 that the transfer of use of property or the rental of machinery is done to a third party who pays to the grantor or lessor, in exchange for that use.

Now, the Operator Company, in accordance with the Tax Inspection Report, in substance, pays nothing to the owners, but rather receives from them a remuneration for the services it provides to them.

The amounts that C… makes available to the owners are not amounts of which it is the holder, but rather that are in its custody as mandatory of those.

The degree of success of the business is reflected fundamentally in the legal sphere of the owners and not of the manager, although the latter is also interested in the results of the business insofar as its remuneration for the services it provides amounts to 25% of the gross revenue from operation.

On the other hand, the costs of the activity carried out also run, essentially, at the account of the owners, have specific components, notably very different from the normal charges of a fraction intended for mere transfer of use and are in a significantly higher value.

The revenues are also, in line with what happens with expenses, in a value significantly higher than what is common in remuneration for simple transfer of use.

In truth, according to the Tax Inspection Report:

'Thus, the taxpayers in question mandated the company C… to in its own name and on its own account receive the remuneration relating to the operation of its properties, with the latter obtaining the right to retain 25% of the gross revenue from the respective operation.

The income earned by the taxpayers in question derives from the provision to third parties of the property.

Properties which are managed and maintained by the company C…, which also manages short-term rentals, collecting the amounts due, and providing all other associated services, such as for example cleaning, etc.

Finally this company provides to the owner the amounts contractually agreed.

(…)

Taxpayer A emitted invoices for accommodation to C… SA which were recorded in account SNC 7816401 - Other Supplementary Income - Accommodation - Domestic which total €60,882.05 (invoices nos. 2012t1 and 201212) in 2012 €6,979.20 (invoice no. 2013/01) in 2013 and €28,226.99 (invoices nos. 201412 and 201414) in 2014.

(…)

In account SNC 62211 - Specialized Work - Domestic., the invoices issued by C… SA are recorded with the description 'Costs of accommodation operation carried out in our name for your account 51301', which total €46,046.46 (invoices no. Ft20120046 and no. FI2O12O19B) in 2012, and €7,777.27 in 2013 (invoice no. F120130125) and €22,155.96 in 2014 (invoices no. F120140084 and no. F120140235) '(…).

Analyzing section 3.11 of the Contract for Transfer of Tourism Operation, it was verified that the expenses for operation of the tourism operation program include the following charges:

A – Service of Administration of Property (4.4) which include services of general administration (Section 4.1) corresponding to '...without being limited to this, accounting, sales and marketing, costs of travel agencies and/or commissions of tourism operators and respective incurred expenses, expenses with central services related to the tourism operation program and expenses of reception services and other expenses related to it.' And Direct Expenses of the Unit (Section 4.4), including '...condominium charges, management and reserve costs, all applicable insurance premiums, auditor fees, telephone accounts and other expenses and all costs with basic services (electricity, oil, gas, water).'

B - Services of Property Maintenance (Section 5), described in document C where routine maintenance of the property and its equipment and furniture are included so as to maintain the unit suitable for guest occupancy, interior and exterior painting of the unit, maintenance of garden and landscape.

D - Cleaning and Tidying Services (Section 6), described in annex D '...including, but not limited to, steam cleaning of carpets and upholstery, waxing of floors, external cleaning of windows and other cleaning services necessary to maintain the unit suitable for receiving guests.'

E - Equipment Expenses

F - Insurance Premiums.

Section 7 further provides for the remuneration of the manager, 'For the administration of the tourism operation program relating to the unit, the manager shall be entitled to receive and shall retain 25% (twenty-five percent) of the Gross Revenue from Tourism Operation, which includes the Costs of accommodation operation'.

Furthermore, one also cannot consider that there is 'transfer of use of property or rental of machinery' to the clients using the property since the sums paid by the clients relate to the accommodation service provided to them, with the owners of the fraction being bound to a wide and costly array of expenses with a view to the provision of such services, which they bear in their legal sphere, nothing preventing, moreover, that any commercial activity be exercised, even entirely, through the contracting of external services to the entity, which, moreover, follows from the principle of freedom of management, constitutionally enshrined.[3][4]

Add to this that, contrary to what is sustained by the Respondent, from the contractual clauses of the tourism operation contract emerge that the owners maintain in their sphere the business risk, as is demonstrated by the contractual clauses invoked by the Respondent in the tax inspection report, mentioned above.

As Pedro Pais de Vasconcelos writes 'The tourism operation contract, as a non-legal social type, as recognized by case law and doctrine, typically has accommodations as its object. (…)

Tourism operation contracts clearly differ from leasing and approach the provision of services, and have a participatory aspect, characteristic of the association in participation, which may be more or less pronounced depending on the cases'[5]

It is, then, manifest that the situation in question is not subsumed in subsections a) and b), section 2, of article 8 of CIRS, and therefore cannot fail to be categorized in articles 4, section 1, subsection h) and 3, section 1, subsection a) of CIRS, since, as can be read in the decision of the Supreme Administrative Court, of 24.02.2016, case no. 580/15, cited by the Claimant:

'Provided that there is an increase in value accruing to an asset by virtue of the exercise of an economic activity (even if expressed in a single act) translated into creation of economic utility, resulting from any relationship of the agent/taxpayer with a third party in which, satisfying the economic needs of the latter, the asset is increased (mediation between supply and demand) there will be a commercial activity'

Thus, it is concluded that the capital increases in question constitute income of category B of IRS.

And this conclusion is not impeded, as is good to see and uncontroversial, by Circular no. 5/2013 of 2 June 2013, for as can be read in the decision of the Supreme Administrative Court, of 21-06-2017, delivered in case 0364/14, in line with settled case law and doctrine:

'With effect administrative guidelines conveyed in the form of a circular from the Tax Administration do not constitute provisions of legislative value (…).

As CASALTA NABAIS clarifies (Tax Law, 6th ed., Almedina, page 197), 'the so-called administrative guidelines, traditionally presented in the most diverse forms such as instructions, circulars, office circulars, circulated-offices, normative orders, regulations, opinions, etc.', which are very frequent in tax law constitute 'internal regulations which, because their recipient is only the tax administration, only it owes obedience to them, being thus binding only for the organs hierarchically situated below the organ author of the same.

Therefore they are not binding either for private individuals or for the courts. And this is whether they are organizational regulations, which define rules applicable to the internal functioning of the tax administration, creating methods of work or ways of acting, or interpretative regulations, which proceed to the interpretation of legal (or regulatory) provisions.

It is true that they densify, make explicit or develop the legal provisions, previously defining the content of the acts to be practised by the tax administration when applying them. But this does not convert them into a standard of validity of the acts they support. In truth, the assessment of the lawfulness of the acts of the tax administration should be effected through direct comparison with the corresponding legal norm and not with the internal regulation, which interposed itself between the norm and the act'.[6]

Thus, the assessments which are the subject of the present process cannot fail to be annulled due to violation of law, thus rendering unnecessary the consideration of the other defects invoked by the Claimants.

IV – Decision

Thus, the arbitral tribunal decides to uphold the request for arbitral pronouncement and, in consequence, to annul the tax acts which are the subject of the present process.

Value of the action: €14,165.37 (fourteen thousand one hundred and sixty-five euros and thirty-seven cents) in accordance with the provisions of article 306, section 2, of the Code of Civil Procedure and article 97-A, section 1, subsection a), of the Code of Administrative Procedure and article 3, section 2, of the Regulation of Costs in Arbitration Proceedings.

Costs payable by the Respondent, in the amount of €918 (nine hundred and eighteen euros) in accordance with section 4 of article 22 of the LFATM.

Let notification be made.

Lisbon, CAAD, 14 February 2018

The Arbitrator

Marcolino Pisão Pedreiro

Frequently Asked Questions

Automatically Created

How are income from tourist exploitation contracts classified for IRS purposes in Portugal?
Income from tourist exploitation contracts in Portugal is classified based on the taxpayer's level of active involvement and business risk. If the owner directly operates the tourist unit or retains significant business risk despite contracting management services, the income may qualify as Category B (commercial/business income) under Article 3(1)(a) of the IRS Code, which covers hotel and similar activities. However, if the arrangement is purely passive with a management company handling all operations and the owner bearing minimal risk, the Tax Authority may classify it as Category F (rental income), particularly following guidance in Circular 5/2013. The key distinction lies in whether the taxpayer exercises an economic activity creating utility through mediation between supply and demand, or merely receives passive returns from property rental.
What is the difference between Category B and Category F income in Portuguese IRS tax law?
Category B income encompasses profits from commercial, industrial, or agricultural activities, including hotel and similar tourism operations, taxed under a business income regime that allows deduction of expenses necessary for generating that income. Category F income consists of passive rental income from urban or rural property, subject to more limited expense deductions. The fundamental difference is the nature of the taxpayer's involvement: Category B requires active exercise of economic activity with business risk, while Category F involves passive receipt of rent without significant operational involvement. This classification significantly impacts tax liability, as Category B allows broader expense deductions related to business operations, whereas Category F under Article 41 of the IRS Code permits only specific expenses like maintenance, conservation, and property administration costs, often subject to stricter requirements.
How does Circular 5/2013 affect the taxation of passive rental income from tourist apartments?
Circular 5/2013 of July 2, 2013, provides administrative guidance indicating that income from tourist apartments managed by third-party companies should generally be treated as passive rental income taxable under Category F, rather than Category B business income. However, as administrative guidance, this circular only binds Tax Authority organs and does not constitute a source of tax law with external binding effect. Taxpayers and courts are not legally obligated to follow circular provisions that contradict statutory law. In cases where the property owner retains substantial business risk despite contracting management services, the income may still qualify as Category B under the IRS Code's provisions on commercial activities, regardless of the circular's guidance. This creates potential disputes between taxpayers claiming Category B treatment based on their retained business risk and the Tax Authority applying Circular 5/2013 to classify such arrangements as passive Category F income.
Can non-resident taxpayers challenge additional IRS tax assessments through CAAD arbitration?
Yes, non-resident taxpayers can challenge additional IRS tax assessments through CAAD (Centro de Arbitragem Administrativa) arbitration under the Legal Framework for Arbitration in Tax Matters (Decree-Law 10/2011 of January 20). The case demonstrates that UK residents with Portuguese-source income successfully initiated arbitration proceedings to contest IRS assessments for multiple tax years. Non-residents have the same rights as residents to seek administrative arbitration for tax disputes, including challenges to assessment acts, compensatory interest, and account settlement statements. The arbitration process provides an alternative to judicial courts, offering faster resolution of tax disputes. Non-residents must follow the same procedural requirements, including proper establishment of the arbitral tribunal through CAAD and compliance with applicable deadlines, but their non-resident status does not preclude access to this dispute resolution mechanism.
What are the legal grounds for annulling additional IRS tax assessments and compensatory interest in Portugal?
Legal grounds for annulling additional IRS tax assessments in Portugal include: (1) violation of the constitutional duty of express, clear, and comprehensive reasoning - administrative acts must provide sufficient factual and legal basis for taxpayers to assess their lawfulness; (2) misapplication or misinterpretation of tax law, such as incorrectly classifying income categories based on administrative circulars rather than statutory provisions in the IRS Code; (3) reliance on administrative guidance (like circulars) that contradicts or extends beyond enabling legislation; (4) errors in calculating taxable income, including improper denial of deductible expenses; (5) lack of factual support for conclusions reached in tax inspection reports; and (6) procedural irregularities in the assessment process. Compensatory interest assessments depend on the underlying tax assessment's validity - if the principal assessment is annulled for being unlawful, the related compensatory interest assessment typically falls as well. Taxpayers must demonstrate specific legal violations rather than mere disagreement with the Tax Authority's factual or legal conclusions.