Process: 239/2017-T

Date: February 16, 2018

Tax Type: IRS

Source: Original CAAD Decision

Summary

CAAD Process 239/2017-T addressed the qualification of income from tourist exploitation contracts for IRS purposes. UK resident taxpayers A and B challenged IRS assessments totaling €21,156.70 for tax years 2012-2014, relating to their tourist apartment operation in Portugal. The claimants acquired an apartment in a tourist development and entered into a contract transferring exploitation rights to managing entity I...SA, which operated the tourist unit on their behalf. The central issue was whether income received constituted Category B business income (direct operation) or Category E capital income (assignment of exploitation rights). The claimants argued they directly operated the tourist apartment using I...SA merely as a service provider for operational management, while the Tax Authority apparently treated it as passive income from assignment of exploitation rights. The arbitration tribunal, constituted under arbitrator Dr. Suzana Fernandes da Costa, conducted witness examinations of the claimants' accountant and operations director. This case exemplifies the critical tax distinction between active tourist operation (Category B, subject to business income rules) versus passive assignment of exploitation rights (Category E, potentially subject to different rates and deductions), with significant implications for non-resident taxpayers operating tourist accommodation in Portugal.

Full Decision

ARBITRAL DECISION

1. Report

On 04-04-2017, A…, taxpayer no.…, and his wife B…, taxpayer no.…, residing in…–…, United Kingdom, hereinafter referred to as the Claimants, submitted to the Administrative Arbitration Centre (CAAD) a request for the constitution of an arbitral tribunal with a view to annulling the acts of assessment of Personal Income Tax (IRS) no. 2016… and the account reconciliation statement no. 2016…, for the year 2012, the assessment of IRS no. 2016…, the assessment of compensatory interest no. 2016… and the account reconciliation statement no. 2016…, for the year 2013, and the assessment no. 2016… and the account reconciliation statement no. 2016… for the year 2014, in the total amount of 21,156.70 €.

The request for constitution of the Arbitral Tribunal was accepted by His Excellency the President of CAAD on 05-04-2017 and notified to the Respondent on the same date.

The Claimants did not proceed with the appointment of an arbitrator, and therefore, in accordance with article 6, no. 2, subsection a) of the RJAT, Ms. Dr. Suzana Fernandes da Costa was appointed as arbitrator by the President of the Deontological Council of CAAD on 05-06-2017, with the appointment having been accepted within the legally prescribed timeframe and terms.

On the same date the parties were duly notified of such appointment and did not manifest any will to refuse the appointment of the arbitrator, in accordance with article 11, no. 1, subsections a) and b) of the RJAT, combined with articles 6 and 7 of the Deontological Code.

Thus, in accordance with the provisions of subsection c), no. 1, article 11 of the RJAT, the Arbitral Tribunal was constituted on 22-06-2017.

A ruling was issued on 22-06-2017, directing the Respondent to, within a period of 30 days, submit its response and, if it so wished, request the production of additional evidence and forward to the arbitral tribunal a copy of the administrative file within the period for submission of the response.

On 01-08-2017, the Claimants attached to the case file documents 10 and 11 which they had protested to attach when submitting the request for arbitral decision.

On 09-08-2017, the Claimants further attached the translation of document 4 attached to the arbitral request.

On 07-09-2017, the Respondent attached to the case file its response and the administrative file.

On 12-09-2017, a ruling was issued ordering the notification of the Claimants to inform which points of factual matters they intended to prove by way of witness examination.

The Claimants submitted, on 25-09-2017, a motion informing of the factual matters they intended to prove through the examination of each of the witnesses.

A ruling was issued on 04-10-2017, scheduling 13-11-2017 at 14:30 hours for the meeting of the arbitral tribunal, foreseen in article 18 of the RJAT, and for the examination of the witnesses indicated by the Claimants.

The Respondent, on 19-10-2017, submitted a motion requesting the change of the date of the meeting to 21-11-2017, at 16:00 hours.

On 20-10-2017, a ruling was issued adjourning the meeting and witness examination to 21-11-2017, at 16:00 hours.

On 21-11-2017, at 15:50 hours, the meeting of the arbitral tribunal took place. Present were Her Excellency Dr. C… and Her Excellency Dr. D…, in their capacity as representatives of the Claimants, and Her Excellency Dr. E… and Her Excellency Dr. F…, legal advisors representing the Director-General of the Tax Authority.

The witnesses called by the Claimants were examined: G…, certified accountant, and H…, operations and assets director.

The parties were also notified to, in this order and successively, submit written pleadings within a period of 10 days, with the period for the Respondent commencing from notification of the submission of the Claimants' pleadings.

The date of 21-12-2017 was also set for the issuance of the arbitral decision, and the Claimants were warned to, by that date, proceed with payment of the subsequent arbitral fee and attach the proof thereof to the case file.

At the meeting, the distinguished lawyers of the Claimants attached 14 documents to the case file.

On 04-12-2017, the Claimants sent their pleadings.

The Tax Authority and Customs Service chose not to submit any pleadings.

On 21-12-2017, a ruling was issued extending by 30 days the period for issuance of the arbitral decision, taking into account the complexity of the matter.

On 19-01-2018, the period for issuance of the decision was extended again, for two weeks, given the complexity of the matter.

On 26-01-2018, the Claimants forwarded to the case file the decision of case no. 237/2017-T.

On 05-02-2018, a new ruling extending the period was issued, setting 16-02-2018 for the issuance of the arbitral decision, given the complexity of the matter and because the analysis of the substantive issue and existing jurisprudence had not been concluded.

2. Cause of Action

The Claimants begin by stating that on 16-12-2009, they entered into a promise of purchase and sale agreement with the company I…, SA, legal entity no.…, having as its object the real property designated "Apartment…", registered in the urban property register of the union of parishes of … and … under article…, under the letter J, located in the development "…".

On the same date, the Claimants also signed with the same entity, I…, S.A., a contract for the transfer of the right to operate the tourist unit … referred to above.

On 08-02-2008, the constituent title of the "…" was deposited with the then General Directorate of Tourism.

And on 07-07-2008, the Municipal Chamber of … granted a license for tourist use of the development "…".

The Claimants allege that, from March 2010, the male Claimant began to exercise the activity of operating tourist apartments, being registered with CAE 55123 – tourist apartments without restaurant, and was within the normal regime with quarterly periodicity in VAT and in the regime of organized bookkeeping by option in respect of IRS (category B). As for the year 2012, it is stated that the male Claimant was within the simplified regime.

The Claimants allege that the managing entity I…, under the terms of the contract entered into, would operate the tourist apartments of the unit … on behalf of the respective owners, providing them with all the services necessary for carrying out such operation.

They further state that the operation of the referred tourist apartment was carried out directly by the Claimants, resorting to the managing entity I… to operationalize that tourist operation, such managing entity having accepted to provide the following services:

a) administer the tourist operation program, described in section 3 of the contract;

b) provide the property administration services described in section 4 of the contract;

c) provide the property maintenance services described in section 5 of the contract;

d) provide the cleaning and tidying services of the unit described in section 6 of the contract.

The Claimants affirm that the managing entity I… undertook to manage, on behalf of the Claimants, the operational aspects (current management) inherent to the tourist operation of the apartment in question, namely by handling the collection of payments due, collection of expenses, reservation management, determination of rates, etc., as provided in clauses 3.1 to 3.3 of the contract entered into.

It is further stated in the arbitral request that the managing entity I… was also responsible for the services of general administration of the unit, which include accounting, sales and marketing, costs of travel agencies and/or commissions of tour operators and respective incurred expenses, expenses with central services related to the tourist execution program and expenses of reception services and other related expenses, as provided in clause 4.1. of the contract entered into.

In exchange for the aforementioned services, the Claimants state that the managing entity I… would be entitled to receive as remuneration described in clauses 2.3. and 7. of the contract entered into, which would be 25% of the gross revenue from the tourist operation, or any other percentage that might be agreed upon periodically between the managing entity and the Claimants.

The Claimants allege that it was the responsibility of the male Claimant to carry out all operations not related to the operational management of the tourist operation, and that, in particular, he was responsible for all charges and expenses, pending or owed, related to the unit, including any taxes and charges levied by creditors or suppliers, namely the payment of any operating expenses, condominium charges, management and reserve costs, all applicable insurance premiums, auditor fees, telephone accounts and other expenses and all costs with basic services, such as electricity, oil, gas, water, in accordance with that stipulated in clause 4.4. of the contract entered into between the Claimants and the managing entity I….

The Claimants also allege that it was their responsibility to keep the unit completely operational, having borne the acquisition of furniture in the amount of 44,200 €.

For the Claimants, it was the male Claimant who was equipped with the means of control of the results of the operation of the unit, the managing entity I… being obliged to provide them with a monthly account report, within a period of 15 days from the end of the respective month, in addition to an annual audited report of the male Claimant's account.

The Claimants conclude that the managing entity I… always acted on behalf of and in the interest of the male Claimant while carrying out the operations necessary to accomplish the tourist operation of the apartment.

For the Claimants, the activity of operating tourist apartments is developed by the respective owners, with the transfer of business risk not occurring to the managing entity I… and this entity not participating in the exploitative activity with its own interest.

The Claimants were subject to a tax inspection procedure for the years 2012, 2013 and 2014, within the scope of which the Tax Authority understood that:

a) the income earned derives only from the provision to third parties of real property, with the owners having had no intervention in obtaining the licensing, so the income that the male Claimant earned in those years were earned in a merely passive manner, as a result of the pursuit of an activity by the managing entity I…, and therefore should be classified as category F income;

b) although the male Claimant bore all the operating expenses of the tourist operation program, part of such charges are not susceptible of being deducted from category F income and for that reason should be disregarded.

As for the inspection report, the Claimants point out the defect of lack, inconsistency or insufficiency of grounds, since the referred inspection report will be nothing more than a conclusive judgment that has no support in the concrete facts, nor in the law, but only in a circular, which is not above the law.

Thus, for the Claimants, the Tax Authority did not sustain, in the conclusions of the inspection report, in a clear and unequivocal manner, the facts on which it based itself to conclude that the income earned by the Claimants was category F income. And therefore, they understand that the tax acts which they now challenge should be annulled.

On the other hand, the Claimants understand that the income obtained is category B income, since all income determined within the scope of activities generating income from commercial activities, in particular those resulting from hotel and similar activities, is taxed in that category.

Thus the Claimants understand that they exercise a commercial activity (tourist operation), and the income obtained cannot be taxed in category F.

The Claimants further allege that Circular no. 5/2013 referred to in the inspection report only binds the organs of the Tax Authority and is not considered a source of tax law, and therefore has no external binding effect, and taxpayers are in no way obliged to comply with the provisions thereof, nor are courts.

Finally, the Claimants state that, should it be understood that the income obtained should be considered as category F income, the expenses of maintenance and conservation relating to cleaning, gardener's wages, electricity, water, gas, expenses with house rental with equipment, repairs and paintings, insurance premiums and costs of property administration should be deductible from the income. And on this matter, they refer to the CAAD decisions of cases no. 435/2014-T, 183/2015-T and 294/2015-T.

The Claimants requested the examination of two witnesses.

3. Response of the Respondent

The Respondent, in its response, alleges in summary that the income earned by the Claimants derives from the provision to third parties of real properties, which are managed and maintained by the company I…, which also manages short-term leases, collecting the amounts owed and providing all other associated services. And that the company I… makes available to the owners the amounts contractually agreed.

The Respondent contends that the owners, the Claimants, had no intervention in obtaining the licensing and earn income in a merely passive manner, as a result of the pursuit of a commercial activity by the company I….

Thus, the Tax Authority understands that the income obtained by the Claimants corresponds to real property income that can be classified under category F of the IRS, regardless of the fact that the amount received is not fixed.

With regard to the alleged lack of grounds of the inspection report, the Tax Authority argues that there is no lack of grounds, since it understands that the same is clear and unequivocal, given that the Claimants, through the request for arbitral decision, not only demonstrate, in the face of the arguments set forth throughout the pleading, to have fully understood the factual and legal framework on which the Tax Authority's decision was based.

The Respondent further contends for the rejection of the examination of the witnesses called by the Claimants, since, according to it, only a matter of law is under consideration. For the Respondent, the examination of the witnesses would be nothing more than a useless act for the performance of the task of determining the sense and scope in which the law should be applied.

4. Preliminary Ruling

This request for arbitral decision was submitted in a timely manner, in accordance with article 10, no. 1, subsection a) of Decree-Law no. 10/2011 of 20 January.

The Tribunal is competent to consider the request for arbitral decision formulated by the Claimants.

The parties have legal standing and capacity and are legitimate (articles 4 and 10, nos. 1 and 2 of the RJAT and article 1 of Order no. 112-A/2011 of 22 March).

The proceedings do not suffer from nullities and no preliminary matters were raised, with the exception of the joinder of claims, which will be decided hereinafter.

The Claimants request the joinder of claims relating to different tax assessment acts of IRS for the years 2012, 2013 and 2014, since in all years the same circumstances of fact and the same interpretation and application of the same principles or rules of law are at issue.

In this case the joinder of claims is admissible, in accordance with articles 104 of the CPPT and 3 of the RJAT, and is therefore admitted.

5. Factual Matters

5.1. Facts Proven:

Having analyzed the documentary and witness evidence produced, the following facts are considered proven and relevant for the decision of the case:

  1. On 08-02-2008, the constituent title of the "…" was deposited with the then General Directorate of Tourism;

  2. On 07-07-2008, the Municipal Chamber of … granted the license for use to such development, as shown in document 6 attached with the arbitral request.

  3. The male Claimant is registered for the exercise of the activity "Tourist apartments without restaurant", CAE 55123, since March 2010, being within the normal regime with quarterly periodicity in VAT and in the regime of organized bookkeeping, by option in respect of IRS, with the male Claimant being within the simplified regime in the year 2012;

  4. The Claimants are not residents in national territory, having as their legal representative the company J…, Lda, legal entity no.…, with headquarters at Rua…, …, …, …, …–…, …;

  5. On 16-12-2009, the Claimants entered into a promise of purchase and sale agreement with the company I…, SA, legal entity no.…, having as its object the real property designated "Apartment…", registered in the urban property register of the Union of Parishes of … and … under article…, under the letter J, located in the development "…", as shown in document 4 attached with the arbitral request;

  6. On 16-12-2009, a contract for the transfer of the right to operate the tourist unit referred to above was entered into between the Claimants and the company I…, SA, as shown in document 4 attached with the arbitral request;

  7. In accordance with the contract referred to in the preceding point, the Claimants acknowledged and accepted that "during the entire term of the contract, they would not operate, lease or in any other manner make the unit available to third parties in exchange for payment, rent, remuneration or any other form of payment (including non-pecuniary or gratuitous), and further acknowledged and accepted not to disclose nor to allow any other natural or legal person to disclose the unit as being, among others, available for occupation";

  8. It is the responsibility of the managing entity (I…) to "provide the services described in this Section 2.2 during the entire term of this Contract:

A- Administer the Operation Program (…) described in Section 3;

B- Provide the Property Administration Services described in Section 4;

C- Provide the Property Maintenance Services described in Section 5; and

D- Provide the Cleaning and Tidying Services of the Unit described in Section 6".

  1. In exchange for the management services, the managing entity I… shall be entitled to receive and will retain 25% (twenty-five percent) of the Gross Tourist Operation Revenue, or any other percentage that may be agreed upon periodically between the managing entity and the Claimants.

  2. It is stated in the referred contract that the male Claimant is responsible for all charges and expenses, pending or owed, related to the Unit, including, but not limited to, any taxes and charges levied by creditors or suppliers, namely, including but not limited to the payment of any operating expenses, 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). ("Direct Expenses of the Unit")".

  3. The contract entered into further states that the male Claimant accepts that, as a condition of participation in the Tourist Operation Program, he will have to furnish and equip the Unit with the standard package of furniture, furnishings and equipment selected by the Manager (…). The cost is EUR 44,200.00 (plus VAT at the applicable legal rate) (…)".

  4. The contract further provides that the managing entity I… is obliged to provide the Claimants with a monthly account report, within a period of 15 days from the end of the month in question and an annual audited report of their account, identifying, for the prior calendar year all receipts from the tourist operation of all participating units in the program, the amounts allocated to the Reserve Fund, operating expenses and condominium charges, the remuneration of the manager, the net receipt from tourist operation, the remuneration of the Claimants and all other expenses and charges for which the Claimants are responsible, provided in accordance with the terms of the contract.

  5. Under Service Order no. OI2016…/…/… of 06-10-2016, issued by the Finance Department of Faro, the Claimants were subject to an inspection action, in respect of IRS and for the years 2012, 2013 and 2014.

  6. In that inspection action, the tax inspection report was prepared, in which it is stated that, among other matters and with relevance:

"The taxpayer (TP) A…, Tax ID … (recorded as TP A in Model 3 of IRS in the years at issue), is registered in CAE 55123 – Tourist Apartments without Restaurant since 24-03-2010, currently being within the normal regime with quarterly periodicity in VAT and in the regime of organized bookkeeping by option in respect of IRS. In the year 2012 the TP was within the simplified regime.

The TP B is B… Tax ID … .

These are TPs not resident in national territory and in accordance with the computer system to which the Tax Authority and Customs Service (Tax Authority) has access, the company J…, Lda, Tax ID …, with headquarters at Rua …, …, …, … …-… … was appointed as representative.

The TPs are owners of an urban real property registered in the urban property register of the Union of parishes of … and … under article … fraction "J", located in the "…", which they acquired from K… SA Tax ID … .

Between the TPs and the selling company, a contract for the transfer of the right to operate the tourist unit… was signed, under the terms of which the company K… SA had the right to establish a commercial company for the management of the "…", a situation which was implemented with the establishment of the company I… SA Tax ID … (I…).

In this way, the new owners ensured the tourist operation of the real property in question through the services of the company I…, granting it exclusive authorization to operate, on its own account, the apartments of which they are owners.

Accordingly, the taxpayers in question mandated the company I… to, in its own name and on its own account, receive the remuneration relating to the operation of its real property, the same being entitled to retain 25% of the gross revenue from the respective operation.

The income earned by the TPs in question derives from the provision to third parties of real properties, which are managed and maintained by the company I…, which also manages short-term leases, collecting the amounts and providing all other associated services, such as for example cleaning.

Finally, this company makes available 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 TPs earn derives in a merely passive manner, as a result of the pursuit of a commercial activity by the company I…. The TPs of IRS do not demonstrate having any organization of an entrepreneurial character for obtaining the same.

For this reason, the income in consideration corresponds to real property income classifiable in category F of IRS (article 8 of the Personal Income Tax Code)".

  1. The Claimants, notified of the draft tax inspection report, through Official Letter no. … dated 06-10-2016, exercised their right to prior hearing on 18-10-2016.

  2. The Claimants were notified of the final tax inspection report through Official Letter no. … of 07-11-2016.

  3. Following the inspection action, the Tax Authority and Customs Service issued the IRS assessments relating to the periods of 2012, 2013 and 2014, as shown in documents 1 to 3 attached with the request for arbitral decision.

No other facts with relevance for the decision of the case have been proven.

5.2. Grounds for the Factual Matters Proven:

The factual matters proven were based on the documents attached to the case file, the administrative file, the examination of the witnesses called by the Claimants, and the facts admitted by agreement of the parties.

5.3. Facts Not Proven

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

6. Legal Matters:

6.1. Object and Scope of These Proceedings

The issues placed before this Tribunal are, fundamentally, the following:

a. whether the tax inspection report suffers from the defect of lack, inconsistency or insufficiency of grounds,

b. and to determine whether the income earned by the Claimants should be considered as category B income, as the Claimants advocate, or whether it should be classified in category F, as the Tax Authority contends,

c. In the event of dismissal of the main claim, decide whether the assessment acts suffer from illegality by virtue of the Tax Authority's refusal to accept the deduction, in category F, of all expenses borne by the Claimants with the real property generating the income in question.

6.2 On the Lack, Inconsistency or Insufficiency of Grounds in General of the Tax Inspection Report

The Claimants state that "the grounds of the Final Tax Inspection Report (…) are not consistent, nor are they clear", citing articles 268, no. 3 of the Constitution of the Portuguese Republic (CRP) and 77 of the General Tax Law (LGT). For the Claimants, the administration is under the legal duty to indicate all facts, in a clear and coherent manner, but also to indicate and support its conclusions with the corresponding legal provisions.

According to the Claimants, administrative acts must be subject to grounds.

Article 286, no. 3 of the CRP provides that "administrative acts are subject to notification to the interested parties, in the form provided by law, and require express and accessible grounds when they affect legally protected rights or interests".

The same duty of grounds is provided for in articles 152 and 153 of the Code of Administrative Procedure for administrative acts in general, and in article 77 of the General Tax Law for tax administrative acts.

In this sense, see what Diogo Freitas do Amaral states, in Course of Administrative Law, Volume II; Almedina, pages 352 and following: "the grounds of an administrative act consist in the explicit statement of the reasons that led its author to perform that act or to give it certain content".

With regard to no. 2 of article 77 of the LGT, the same provides that "the grounds of tax acts may be effected in a summary manner, and must always contain the applicable legal provisions, the qualification and quantification of the tax facts and the operations for determining the taxable matter and the tax".

On the other hand, and as a corollary of the obligation to provide grounds for administrative acts, there would be the exercise of the right to be heard which, ultimately will have the virtue that the administrated party may confront the arguments produced against him.

According to doctrine and jurisprudence, the grounds legally required must have the following characteristics:

  • officialism: must always proceed from the initiative of the administration, with grounds at request not being admissible,

  • contemporaneity; must be coeval with the performance of the act, with deferred or requested grounds not being permissible,

  • clarity: must be comprehensible by an average recipient, avoiding polysemic or deeply technical concepts,

  • completeness: must contain all essential elements that were determinative of the decision taken, this characteristic unfolding into the duty of justification (legal norms and factuality – domain of legality) and the duty of motivation (domain of discretion or opportunity, when a valuation is needed)

The Supreme Administrative Court has understood that the grounds of the administrative or tax act is a relative concept that varies according to the type of act and the circumstances of the specific case, but that the grounds are sufficient when they allow an average recipient to perceive the cognitive and evaluative itinerary followed by the author of the act to make the decision, that is, when the recipient can know the reasons why the author of the act decided as he did and not differently so as to be able to trigger administrative or contentious mechanisms of challenge.

In this sense, see the Decision of the STA of 10/09/2014, of case 01226/13, which states that: "I- The Tax Administration has the duty to ground the acts of official assessment of taxes in accordance with the principle embodied in art. 268 of the CRP and adopted in arts. 125 of the CPA, and 77 of the LGT. II. The act will be sufficiently grounded when the administrated party, placed in the position of an average recipient – the bonus pater familiae of which speaks art. 487, no. 2 of the Civil Code – can come to know the factual and legal reasons that are at its origin, so as to be able to decide, in an informed manner, whether to accept or not the act."

With regard to the tax inspection procedure, it follows from article 63, no. 1 of the RCPIT that the tax acts or in tax matters may ground their conclusions "through adhesion or agreement with these, the competent entity having in all cases to ground the divergence from the conclusions of the report".

In the present case, the Claimants became aware of the draft tax inspection report, and exercised their right to hearing, in accordance with article 60 of the LGT and article 60 of the RCPIT. Subsequently, the Claimants were notified of the tax inspection report.

The grounds for the corrections contained in the tax inspection report support the assessments of the tax in question.

Thus, we understand that the Claimants became aware of the cognitive path that led to the issuance of the assessments in the present case file.

Indeed, considering the specific context in which the assessment acts here under consideration were produced, the grounds contained in the Final Inspection Report that preceded them will be perceptible to an average recipient placed in the position of the actual recipient.

Thus, the grounds in question allowed the Claimants to act through an extensive request for arbitral decision, with no evidence that their defense rights have been placed in question or that the same did not allow them to perceive the reasoning adopted by the Tax Authority that led to the additional assessments of the years 2012, 2013 and 2014.

Accordingly, we understand that the duty of grounds of the tax assessment acts which are the object of the present arbitral proceedings has been fulfilled.

6.3. On Taxation Under Category B of the Personal Income Tax Code and the Concept of Activity

The parties' positions diverge as to the classification of the income earned by the Claimants under Personal Income Tax in the years 2012, 2013 and 2014. Such divergences were already evident during the draft tax inspection report and the exercise of the right to hearing that followed it, and are summarized in the fact that the Claimants understand that the income earned by them should be considered as business and/or professional income and as such classifiable in category B of the Personal Income Tax Code, while the Tax Authority understands that the income is of a real property nature and as such must be qualified in category F of the Personal Income Tax Code.

It is therefore important to know, for purposes of classifying income in category B or category F, whether the same derive from the exercise of a commercial activity or whether they result from the mere transfer of a real property.

On this matter, recent CAAD decisions nos. 211/2017-T of 30-11-2017, no. 235/2017-T of 20-11-2017, 270/2017-T of 03-01-2018, 271/2017-T of 1-11-2017, 273/2017-T of 03-01-2018 and no. 275/2017-T of 29-11-2017 have ruled in divergent senses.

Article 3, no. 1, subsection a) of the Personal Income Tax Code states that "business and professional income is considered: "that derived from the exercise of any commercial, industrial, agricultural, forestry or livestock activity;".

Article 4 of the Personal Income Tax Code in turn refers to what should be considered as commercial and industrial activities, agricultural, forestry and livestock activities.

For its part, article 8, in the wording in force at the date of the facts, provided that: "real property income is considered to be the rents of rural, urban and mixed real properties paid or made available to their respective holders".

And no. 2, subsection a) of the aforementioned article 8 of the Personal Income Tax Code provides that "the following are considered as rents: a) the amounts relating to the transfer of the use of the real property or part thereof and to the services related to that transfer".

The Decision of the STA of 11-01-2017, of case 01622/15, states that «the concept of commercial or industrial activity must be determined by the economic concept of commercial or industrial activity, which encompasses activities of mediation between supply and demand and activity of incorporation of new utilities in matter, in both cases with speculative ends, that is, with the objective of obtaining profits».

Taking into account these circumstances and the proven facts described above, we understand, from the outset, that the income earned by the Claimants constitutes income derived from a commercial activity classifiable in category B of the Personal Income Tax Code.

Notably, see that the Tax Authority considers the registration of the male Claimant, from 2010 to 2016, in the activity "Tourist apartments without restaurant", with CAE 55123, and within the normal regime with quarterly periodicity in VAT and in the regime of organized bookkeeping, by option in respect of Personal Income Tax, with the male Claimant being within the simplified regime in the year 2012. And only in 2016 was the tax inspection of the male Claimant initiated which culminated in the issuance of additional Personal Income Tax assessments for the years 2012, 2013 and 2014. Indeed, the Tax Authority assumes contradictory positions as to its understanding of the classification of the income of the male Claimant. Positions that are, in our view, violative of the principle of good faith and legal certainty.

The registration of start of activity, or its alteration, carried out by the taxpayer, does not oblige the Tax Authority to accept it in the terms required, if it considers them wrong, as follows from field 10 of the official form model itself.

Now, in the present case, the classification communicated by the male Claimant has always subsisted until the present date.

Thus, the Claimants not only acted in good faith and on the basis of a plausible interpretation of tax law, but acted in accordance with express indications of the Tax Authority that bind it, which correspond to the registration in force in the Taxpayer Registration Management System.

For the operation of their hotel unit, the Claimants resorted to a managing entity, so as to enhance revenues and optimize expenses.

Taking into account that the form of organization of the management of tourist operation adopted by the Claimants is configured as necessary by enhancing a higher level of income, even if the content of Circular no. 5/2013 were to be applied to the assessments in question, in the face of the proven factual matters, it is not clear that one should conclude that the operation of the lodging unit is not carried out directly by the Claimants, since there is very immediate (fortnightly) control of the holders of the lodging units over the evolution of receipts and expenses.

On the other hand, the management contract does not result in the entire activity of the tourist operation of the lodging unit being entrusted to the managing entity.

The Claimants committed themselves, through the contract entered into with the managing entity, that "during the entire term of the contract, they would not operate, lease or in any other manner make the unit available to third parties in exchange for payment, rent, remuneration or any other form of payment (including non-pecuniary or gratuitous), and further acknowledged and accepted not to disclose nor to allow any other natural or legal person to disclose the unit as being, among others, available for occupation".

And on the other hand, it is stated in the referred contract that the male Claimant is "responsible for all charges and expenses, pending or owed, related to the Unit, including, but not limited to, any taxes and charges levied by creditors or suppliers, namely, including but not limited to the payment of any operating expenses, 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). ("Direct Expenses of the Unit")".

The contract entered into further provides that the male Claimant "accepts that, as a condition of participation in the Tourist Operation Program, he will have to furnish and equip the Unit with the standard package of furniture, furnishings and equipment selected by the Manager (…). The cost is EUR 44,200.00 (plus VAT at the applicable legal rate) (…)".

The contract further stipulates that the managing entity I… is obliged to provide the Claimants with a monthly account report, within a period of 15 days from the end of the month in question and an annual audited report of their account, identifying, for the prior calendar year all receipts from the tourist operation of all participating units in the program, the amounts allocated to the Reserve Fund, operating expenses and condominium charges, the remuneration of the manager, the net receipt from tourist operation, the remuneration of the Claimants and all other expenses and charges for which the Claimants are responsible, provided in accordance with the terms of the contract.

From this set of clauses and from the contract as a whole results, in our view, the correct classification of the income of the male Claimant as category B income.

6.4. On the Principle of Freedom of Legal Configuration

In Portugal, the principle of contractual freedom and the principle of freedom of legal configuration are in force.

With regard to the former, the parties to any civil contract are free to fix the clauses they see fit, as long as the same are lawful and in accordance with good faith.

From the contract entered into between the Claimants and the managing entity does not result that the income must be configured as mere real property income, nor does it result that the undeniable commercial or business nature of the activity of I… excludes the business nature of the activity of the male Claimant.

It results from the contract and from the proven factual matters that the Claimants are not mere owners of the real property but rather are involved in the current management of the same, paying expenses for example, such as operating expenses, 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), control the results obtained by I… – in short, from the content of the contract does not result that the business nature of the activity exercised by the male Claimant is excluded.

On the other hand, the law permits the taxpayer who is the owner of a real property to lawfully opt for the configuration of his income as real property income or for the configuration as business income, and, within these, still permits him to opt for the simplified regime or for organized bookkeeping.

As Casalta Nabais states, in Tax Law, Almedina, 2010, pages 167 and 168, the principle of freedom of legal configuration implies that "individuals, as economic and social agents, have freedom to organize or structure themselves in the legal form they see fit, in particular to establish or not legal entities. Freedom of legal configuration which, as we have seen, being a corollary of the principle of the fiscal state, constitutes an important manifestation of the freedom of economic disposition of individuals and their organizations whose exercise is often associated with the tax planning that this freedom encompasses".

To correct after the fact an option that the taxpayer takes under the principle of freedom of legal configuration without the reclassification of income resulting from an express rule violates the said principle, as well as the principle of good faith and legal certainty.

It is thus manifest that the situation in question does not fall within subsections a) and b) of no. 2 of article 8 of the Personal Income Tax Code, and therefore cannot fail to be classified within articles 4, no. 1, subsection h) and 3, no. 1, subsection a) of the Personal Income Tax Code, since, as can be read in the decision of the Supreme Administrative Court of 24-02-2016, of case no. 580/15:

"Whenever there is an increase in value accruing to a patrimony 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 third parties in which, satisfying the economic needs of the latter, the patrimony of the former is increased (mediation between supply and demand) there will be a commercial activity".

For the reasons set forth, the claim formulated by the Claimants in the present tax arbitral proceedings is well-founded, and the additional Personal Income Tax assessments for the years 2012, 2013 and 2014 here in dispute must be annulled for the defect of violation of law.

Thus rendered without further consideration the knowledge of the remaining defects invoked by the Claimants, namely the deduction of other expenses from the income within the scope of category F.

6.5. On the Non-Binding Nature of Courts to Administrative Guidance Emanated by the Tax Administration

Without ignoring this Tribunal the function, scope, level of binding effect and recipients of administrative guidance, in particular circulars in tax matters of which the case file informs us, it will always be said that, prior to the guidance for the Tax Authority that results therefrom, particularly with respect to Circular no. 5/2013 of 2013-07-02, there will be a need to qualify the income earned by the Claimants in the strict factual framework in which the same is perceived, taking into account the nature and specifics of the operations carried out by these.

The same applies to the binding information (nos. 477 and 1369) which the Tax Authority reports that the company K…, S.A may have requested on the matter here under discussion.

Now, circulars consist of administrative guidance of a generic character, through which the organs of public administration proceed to an interpretation of tax rules, and it is necessary to refer to them for application to each specific situation.

Moreover, as embodied in no. 1 of article 55 of the CPPT, generic guidance aims at standardizing the interpretation and application of tax rules by the services.

And when issued by the head of the service or by the official to whom he has delegated that authority, they bind the Tax Authority (no. 2), although no. 3 of the provision provides for their application exclusively to the Tax Authority that proceeded to their issuance, with no rule being known to establish that the referred circulars apply to the relations of the Tax Authority with the administrated parties.

According to Casalta Nabais (in Tax Law, page 201) these are "internal regulations which, as they have as recipient only the tax administration, only this one is obliged to obey them, being thus obligatory only for the organs situated hierarchically below the organ author thereof. Therefore they are not binding either for private individuals or for courts. And this whether they are organizational regulations (…), whether they are interpretive regulations, which proceed to interpretation of legal provisions (or regulatory). It is true that they densify, make explicit or develop the legal provisions, previously defining the content of the acts to be performed by the tax administration in its application. But this does not convert them into a validity standard for the acts they support. In truth, the assessment of the legality of the acts of the tax administration must be carried out through direct comparison with the corresponding legal rule and not with the internal regulation, which has interponed itself between the rule and the act".

On the effects of circulars, see also SALDANHA SANCHES, J.L.: "The Quantification of the Tax Obligation – Duties of Cooperation, Self-Assessment and Administrative Assessment", 2nd edition, Lex, Lisbon, 2000, pages 155-167, MARTINS ALFARO: "Administrative Guidance, Accessory Obligations and Regulation of the Application of ADTs", Tax Doctrine Review, 3rd quarter of 2014, and TABORDA DA GAMA, J.: "Having doubts arisen about the value of circulars and other generic guidance…", Studies in memory of Prof. Doctor J.L. Saldanha Sanches, Volume III, Coimbra Editor, 2011, page 157 et seq.

We conclude by entirely subscribing to the position contained in the Decision of the Central Administrative Court South, of 09-11-2010, of case no. 04292/10, which states that:

"(…) VII)– Courts, as organs of sovereign power independent are not subordinated to decisions taken in tax matters by the administration, even though binding for this, insofar as they have the responsibility to interpret and apply tax law without any dependence on the criteria adopted by the administration and hence, if a judicial decision is handed down in a sense different from that followed in the binding information, the administration must respect it and have it executed.

VIII)- For it is certain that courts are only subject to the law, so no administrative guidance binds them from which a certain interpretation of the same results, administrative circulars (as well as prior information) do not bind taxpayers, but only their respective services and, in the face of the law, the procedures defined, "maxime" the "circulated right" of the Tax Administration cannot derogate from the principle of tax legality so that, in this light, it will be possible to affirm the non-conformity of the content of the challenged act with the referred legal rules and, in this way, that the actually existing circumstances imposed the administrative decision of opposite sign, it being certain that the Judge, even if he had knowledge of the binding prior information, was not bound by that administrative decision"

7. Decision

In light of the foregoing, it is determined that the claim formulated by the Claimants in the present tax arbitral proceedings is well-founded as to the illegality of the acts of assessment of Personal Income Tax (IRS) no. 2016… and the account reconciliation statement no. 2016…, for the year 2012, the assessment of Personal Income Tax no. 2016…, the assessment of compensatory interest no. 2016… and the account reconciliation statement no. 2016…, for the year 2013, and the assessment no. 2016… and the account reconciliation statement no. 2016… for the year 2014, in the total amount of 21,156.70 €.

8. Value of the Proceedings:

In accordance with the provisions of article 315, no. 2 of the CPC and 97-A, no. 1, subsection a) of the CPPT and 3, no. 2 of the Regulation of Costs in Tax Arbitration Proceedings, the value of the action is fixed at 21,156.70 €.

9. Costs:

In accordance with article 22, no. 4 of the RJAT and Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, the amount of costs is fixed at 1,224.00 €, owed by the Tax Authority and Customs Service.

Notify.

Lisbon, 16 February 2018.

Text prepared by computer, in accordance with article 138, no. 5 of the Code of Civil Procedure (CPC), applicable by reference of article 29, no. 1, subsection e) of the Tax Arbitration Regime, by myself revised.

The Arbitrator Judge

(Suzana Fernandes da Costa)

Frequently Asked Questions

Automatically Created

How are income payments from tourist exploitation contracts classified for IRS purposes in Portugal?
Income from tourist exploitation contracts for IRS purposes is classified based on the nature of the taxpayer's involvement. If the taxpayer directly operates the tourist activity, even using third-party management services, income is classified as Category B (business/professional income). However, if the taxpayer assigns or transfers exploitation rights to another entity that operates independently, income may be classified as Category E (capital income) or Category F (property income). The distinction depends on whether the contract constitutes active operation versus passive assignment of rights, as examined in CAAD Process 239/2017-T.
What is the CAAD arbitration process for challenging IRS tax assessments in Portugal?
The CAAD (Centro de Arbitragem Administrativa) arbitration process for challenging IRS assessments involves: (1) submitting an arbitration request within the legal deadline; (2) appointment of an arbitrator by the CAAD President if parties don't agree; (3) constitution of the arbitral tribunal; (4) Tax Authority's response within 30 days with administrative file; (5) preliminary hearing to define factual matters and evidence; (6) arbitral tribunal meeting with witness examination if requested; (7) written pleadings by both parties; and (8) issuance of arbitral decision within prescribed timeframes, which may be extended for complex matters.
Can non-resident taxpayers in Portugal dispute IRS liquidation acts through tax arbitration?
Yes, non-resident taxpayers in Portugal can dispute IRS liquidation acts through tax arbitration at CAAD. Process 239/2017-T demonstrates this right, where UK residents A and B successfully initiated arbitration proceedings to challenge IRS assessments for 2012-2014. Non-residents have the same arbitration rights as Portuguese residents under the RJAT (Legal Regime for Tax Arbitration), including the ability to contest tax assessments, challenge tax qualification decisions, and request annulment of liquidation acts, provided they meet procedural requirements and deadlines.
What were the IRS liquidation amounts and tax years contested in CAAD Process 239/2017-T?
In CAAD Process 239/2017-T, the contested IRS liquidation amounts totaled €21,156.70 across three tax years: Year 2012 (IRS assessment no. 2016... and account reconciliation statement no. 2016...); Year 2013 (IRS assessment no. 2016..., compensatory interest assessment no. 2016..., and account reconciliation statement no. 2016...); and Year 2014 (assessment no. 2016... and account reconciliation statement no. 2016...). The UK resident claimants challenged these assessments related to income from tourist apartment exploitation.
How does Portuguese tax law treat income from the assignment of tourist property exploitation rights?
Portuguese tax law treats income from assignment of tourist property exploitation rights differently depending on contract structure. If the owner assigns or transfers exploitation rights to a managing entity that operates independently and assumes business risk, income may be classified as Category E (capital income from assignment of rights) or Category F (property income). However, if the owner retains direct operation and merely contracts management services, income remains Category B (business income). The distinction is crucial as it affects applicable tax rates, deductible expenses, and compliance obligations. CAAD Process 239/2017-T examined this qualification issue where taxpayers argued for Category B treatment despite contracting with a managing entity.