Process: 240/2017-T

Date: February 22, 2018

Tax Type: IRS

Source: Original CAAD Decision

Summary

CAAD Process 240/2017-T addresses the critical tax classification dispute concerning income from tourist exploitation assignment contracts under Portuguese IRS law. Two taxpayers challenged IRS assessments for years 2012-2014, contesting the Tax Authority's reclassification of their tourism-related income from Category B (business and professional income) to Category F (property income). The claimants operated under a tourist exploitation assignment contract and were registered with the appropriate CAE economic activity code. They argued that income derived from tourism business activities should be classified as Category B due to the principle of preponderance of business income over other categories when obtained through commercial activity. The taxpayers contested the Tax Authority's reliance on administrative circulars rather than substantive legal analysis, asserting that the AT failed to meet its burden of proof under Article 74 of the General Tax Law to demonstrate reasonable indications justifying Category F classification. The case was processed under the Legal Regime of Tax Arbitration (RJAT - Decree-Law 10/2011), with the sole arbitrator appointed by CAAD's Ethics Council. The proceedings included witness examination and written arguments, with claimants expanding their claim to include indemnity interest under Article 43 GTL. This decision has significant implications for taxpayers engaged in tourism property exploitation, clarifying the tax treatment boundary between business income and property income, and reinforcing procedural safeguards regarding the Tax Authority's burden of proof in income reclassification cases.

Full Decision

ARBITRAL DECISION

I - Report

  1. A..., taxpayer no..., and B..., taxpayer no..., resident at the address of ..., ..., ...-... Faro (hereinafter referred to as "Claimants"), presented, on 04-04-2017, under article 2, no. 1, paragraph a) and article 10, nos. 1 and 2 of the Legal Regime of Tax Arbitration, provided for in Decree-Law no. 10/2011, of 20 January, as amended by article 228 of Law no. 66-B/2012, of 31 December (hereinafter abbreviated as "LRTA") and articles 1 and 2 of Ordinance no. 112-A/2011, of 22 March, a request for arbitral decision in which they request the annulment of the following tax acts: (i) act of assessment of Personal Income Tax ("PIT"), no. 2016..., relating to the year 2012; (ii) act of assessment of PIT no. 2016..., act of assessment of compensatory interest no. 2016..., and Statement of Account Adjustment no. 2016..., relating to the year 2013; (iii) act of assessment of PIT no. 2016..., act of assessment of compensatory interest no. 2016..., and Statement of Account Adjustment no. 2016..., relating to the year 2014.

  2. The Tax and Customs Authority (hereinafter referred to as "Respondent") is the respondent.

  3. The request for establishment of the arbitral tribunal was accepted by the President of the CAAD and automatically notified to the Tax and Customs Authority on 19-04-2017.

  4. In accordance with paragraph a) of no. 2 of article 6 and paragraph b) of no. 1 of article 11 of the LRTA, as amended by article 228 of Law no. 66-B/2012, of 31 December, the Ethics Council of CAAD appointed as arbiter of the sole arbitral tribunal His Excellency Dr. Olívio Mota Amador, who, within the applicable period, communicated acceptance of the appointment.

  5. The parties were notified on 05-06-2017 of the appointment of the arbiter, and did not manifest any will to refuse the appointment of the arbiter, in accordance with the combined provisions of article 11, no. 1, paragraphs a) and b) of the LRTA and articles 6 and 7 of the Code of Ethics.

  6. In accordance with the provisions of paragraph c) of no. 1 of article 11 of the LRTA, as amended by article 228 of Law no. 66-B/2012, of 31 December, the Arbitral Tribunal was established on 22-06-2017.

  7. The Respondent, duly notified through the arbitral order of 28-06-2017, presented, on 15-09-2017, its Reply and submitted the Administrative File.

  8. The Claimants, on 28-07-2017, filed documents nos. 10 (copy of the letter from the Tax Inspection Services of the Tax Department of Faro no..., of 29-07-2010) and 11 (copy of the letter from the Tax Inspection Services of the Tax Department of Faro no..., of 03-11-2010) which they had protested to file in the request for establishment of the Arbitral Tribunal.

  9. The Arbitral Tribunal, through an order of 17-08-2017, notified the Respondent of the filing of the documents referred to in the previous number and granted it a period of 15 days to, if it so wished, exercise its right of contradiction.

  10. The Arbitral Tribunal, through an order of 23-10-2017, notified the Claimants to, within 10 days, indicate the facts on which they requested witness examination. The Claimants on 06-11-2017 proceeded to indicate the facts on which they intended to produce witness evidence.

  11. The Arbitral Tribunal, through an order of 19-12-2017, determined: (i) to extend, in accordance with no. 2 of article 21 of the LRTA, the arbitration period by two months and set 22-02-2018 as the deadline for issuance of the arbitral decision; (ii) to waive the holding of the meeting provided for in article 18 of the LRTA, under the principle of the autonomy of the Tribunal in the conduct of proceedings and in order to promote speed, simplification and informality thereof (article 19 and 29, no. 2, of the LRTA), given that no objection was raised nor questions raised that would prevent the tribunal from considering the merits of the claim; (iii) to set the date for the examination of the two witnesses listed by the Claimant (12-01-2018 at 11h), despite the relevant objections raised by the Respondent to the examination of witnesses, it was not intended to limit the production of evidence presented by the Claimants; (iv) if the parties wish to submit written arguments, these should be produced within 10 days from the date of the witness evidence, granting the Respondent the option to, if it so wishes, submit its arguments in succession to those produced by the Claimants.

  12. The Tribunal, on 12-01-2018, proceeded to examine the witnesses C... and D..., in accordance with the minutes which are in the present arbitral file and which are, for all purposes, given as fully reproduced. In the said session the Claimants requested the admission of the following documents: (i) copy of the certificate of commencement of activity of the Claimant; (ii) copy of the property deed; (iii) copy of the inspection report draft relating to three owners of the same development; (iv) copy of binding information no. 3626, of 09/10/2012 from the VAT Services Department; (v) copy of binding information of 01/09/2014 from the VAT Services Department. The documents were admitted by the Arbitral Tribunal with the Respondent having the possibility to exercise the review period in written arguments.

  13. The Claimants presented their arguments on 23-01-2018. In the said arguments the Claimants, considering the provisions of article 265, no. 2, of the Code of Civil Procedure ex vi paragraph e) of article 29 of the LRTA, expanded the claim to request that the Respondent, if the action is deemed well-founded, be condemned to pay indemnity interest at the maximum rate in force, in accordance with the provisions of no. 1 of article 43 and no. 10 of article 35 of the General Tax Law (GTL), no. 5 of article 61 of the Code of Tax Procedure and Process (CTPP) and article 559 of the Civil Code and in Ordinance no. 291/2003, of 8 April.

  14. The arguments of the Respondent were presented on 29-01-2018.

  15. The position of the Claimants, in accordance with the provisions of the request for establishment of the Arbitral Tribunal and in written arguments, is, in summary, as follows:

15.1. As a preliminary matter, it should be noted that the reasoning of the Final Tax Inspection Report, which forms the basis of the motivation of the tax acts which are the subject of the present arbitral claim, is neither congruent nor clear. Indeed, the understanding of the Tax Inspection Services is nothing more than a conclusive judgment that has no support in the facts or in law, but only in a Circular. Furthermore, they did not demonstrate, with respect to the Claimants, especially to the male Claimant, the existence of "reasonable indications" demonstrating that the income in question is income of Category F and not of Category B. Thus, the Tax Administration did not fulfill the burden of proof of verification of the respective indications or prerequisites of taxation that falls upon it, in accordance with no. 1 of article 74 of the GTL, that is, the legal prerequisites of its action, in light of the legal presumption of truthfulness of taxpayer declarations (article 75 of the GTL), and therefore the tax acts should be annulled.

15.2. The Claimants understand that the tourism-related activity they carried out and the respective income generated are derived from the pursuit of a business activity (even though they result from the exploitation of a property) and consequently should be treated within Category B of the PIT, by virtue of the principle of the preponderance of this Category in relation to income that falls within other categories of income, but which are obtained in connection with a business activity (in this case, a commercial activity).

15.3. According to the legal norms in force, in order for income to be attributable to activities generating business or professional income, where the taxpayer is registered with the respective CAE, it is sufficient that the income earned is related to that activity. Which clearly happened in the present case.

15.4. Where income arising from tourism-related exploitation, which is the activity carried out by the male Claimant, is concerned, it cannot be taxed as income of Category F, completely disconnected from the said commercial activity carried out.

15.5. If the legislator intended to exclude from the scope of paragraph a) of no. 1 of article 3 of the PIT Code income resulting from exploitation arising from the hiring of services, it was necessary for the legislator to expressly determine that only results arising from direct exploitation were subject to taxation within Category B of the PIT Code, which did not occur. In this rule the legislator uses the word "activity" without delimiting (restrictively) its scope, and it is therefore evident that it intended to include all income obtained, in any way, from direct exploitation or through the hiring of services to generate the income in question. If at no time the law makes any limitation, it is not the responsibility of the Tax Administration to make that limitation.

15.6. The position and restrictive interpretation made by the Tax Administration lacks legal foundation, because, considering the legal concept of activity, it must be concluded that the income in question should be taxed under paragraph a) of no. 1 of article 3 of the PIT Code and not in accordance with no. 2 of article 8 of the same statute.

15.7. The Tax Inspection Services understood that it was necessary to requalify the income of the Claimants based on the understanding contained in Circular no. 5/2013, of 2013-07-02. Notwithstanding the fact that the Tax Administration is bound by compliance with administrative guidelines, in accordance with no. 1 of article 68-A of the GTL, the reality is that these guidelines must always be subject to a test of legality, and therefore will only be valid insofar as their intrinsic legality is concerned.

15.8. It therefore appears to be illegitimate and illegal for the Tax Administration to seek to tax the income earned by the Claimants, in accordance with paragraph a) of no. 2 of article 8 of the PIT Code (Category F), through its own interpretation and contra legem.

15.9. The income earned by the Claimants arising from the tourism-related exploitation contract entered into is subsumable to the typology of income from a commercial activity, in particular from the pursuit of an activity of a hotel and similar nature, provided for in paragraph a) of no. 1 of article 3 and paragraph h) of no. 1 of article 4 of the PIT Code and, as a result, the additional PIT assessments relating to the years 2012, 2013 and 2014 should be annulled, in accordance with paragraph a) of article 99 of the CTPP.

15.10. Even if it were admitted that the income obtained by the Claimants was income of Category F of the PIT Code, in no case would the taxable income of the Claimant be in the amount determined by the Tax Inspection Services. Indeed, the following should be understood as expenses deductible from Category F income of the PIT: expenses for maintenance and upkeep relating to cleaning staff, gardener's salary, electricity, water and gas, costs of housing rental with equipment, repairs and paintings, insurance premiums and property administration costs. Such expenses were disregarded by the Tax Inspection Services, but should be deducted from the taxable income insofar as they are essential expenses for obtaining the income in question.

15.11. Thus, expenses with personnel salaries, cleaning, electricity, gas and water, incurred by the Claimants in the year 2012, 2013 and 2014 should be considered, in accordance with and for the purposes of article 41 of the PIT Code.

  1. The position of the Respondent, expressed in the reply and in written arguments, can be summarized as follows:

16.1. Regarding the topic of substantiation, the jurisprudence of the Supreme Administrative Court has uniformly understood that the substantiation of an act is a relative concept that varies according to the type of act and the circumstances of the specific case. There is deemed to be sufficient substantiation when it allows a normal recipient to understand the cognitive and evaluative path followed by the author of the act, that is, when the recipient can know the reasons that led the author of the act to decide in that way and not another. In the present case, the substantiation is sufficiently clear and unequivocal, all the more so because the Claimants, through the present request for arbitral decision, demonstrate that they have fully understood the factual and legal framework on which the Respondent's decision was based. Indeed, from reading the inspection report, it appears that an ordinary person, placed in the position of recipient, is able to understand its meaning and conclusion. Therefore, there is no defect of lack of substantiation.

16.2. However, if there were a situation of lack or insufficiency of substantiation – a hypothesis that is admitted only in theory and without conceding – it was up to the Claimants to use the mechanism provided for in article 37 of the CTPP and request the respective notification or issuance of the certificate in accordance. Now, the Claimants not having used the faculty conferred by law, it is necessary to conclude that the acts referred to contained, as they indeed do, all the elements necessary for their full understanding and that the alleged defect they might have suffered was remedied.

16.3. The law expressly states that income derived from the exercise of any commercial activity is understood as business income. Considering the meaning of the concept used in the legal norms and the interpretation that has been made thereof by the jurisprudence of the superior courts, it is concluded that the Claimants have no reason whatsoever. The use of the word "exercise" in the wording given in article 3 of the PIT Code, as opposed to the words used in article 8 of the PIT Code to define what constitutes Category F income, has underlying the carrying out of acts with a certain purpose which, in this case, would be the pursuit of profit.

16.4. Thus, it is not in accordance with the law to claim, as the Claimants do, that the fact of having declared commencement of activity, stating the intention to exercise a tourism-related exploitation activity (when, in fact, nothing more was done beyond acquiring a property), should be valued as sufficient for the qualification of income as attributable to Category B, when in fact the declared activity was not exercised.

16.5. In this way, the income that the Claimants earn derives in a merely passive manner, as a result of the pursuit of a commercial activity by the company R.... Being that the Claimants do not appear, nor claim, to have any organization of a business character for obtaining such income.

16.6. In that sense, the Tax Inspection Service considered that the income in question corresponds to real estate income classified in category F of the PIT (article 8 of the PIT Code). Where income relating to the granting of use of the property or part thereof is concerned, the amounts received by the owners, as consideration for the granting of use of the apartments, are considered real estate income, in accordance with the provisions of paragraph a) of no. 2 of article 8 of the PIT Code, regardless of the fact that the amount received is not fixed.

16.7. The mere act of purchasing a property and its consequent and immediate transfer of exploitation to a third party must be subsumed to simple acts of management of private patrimony, not constituting, in themselves, signs of the exercise of property exploitation activity by the person who transferred the exploitation.

16.8. It thus appears evident that the Claimants do not carry out, nor can they carry out any action of free use and enjoyment of the property of which they are only owners.

16.9. As for the Claimants' claim that all expenses with personnel salaries, cleaning, electricity, gas and water, which were not accepted in the analysis carried out in the inspection procedure, should be accepted, it is important to note that it must be evaluated whether those expenses, referred to in the abstract by the Claimants and not demonstrated in arbitral proceedings, have the character of maintenance and/or upkeep expenses that fall to the taxpayer.

16.10. As the PIT Code does not define the concept of "maintenance expenses," the civil law notion contained in the Urban Rental Regime-URR (approved by Decree-Law no. 321-B/90, of 15 October) relating to the definition of conservation works and the determination of which are the responsibility of the landlord contained in article 11 of the URR (see, Court of Appeal (South) Decision in case 05310/12, of 15.12.2016) should apply here. Taking this legal framework into account, the expenses mentioned by the Claimants do not constitute maintenance expenses nor, furthermore, upkeep expenses.

16.11. With regard to expenses for salaries and cleaning, it appears from sections 5 and 6 of the assignment contract that these charges are the responsibility of the Manager, which means that they are not the responsibility of the Claimants. Therefore, also on this point, the Claimants have no reason in what was requested.

II - Sanity of the Proceedings

  1. The parties have legal standing and capacity, are duly legitimate and are regularly represented (articles 4 and 10, no. 2, of the LRTA and article 1 of Ordinance no. 112-A/2011, of 22 March).

The tribunal is competent and regularly established.

The proceedings do not suffer from any defects.

No objections were raised.

There are no other circumstances that prevent the tribunal from considering the merits of the case.

Therefore, the Arbitral Tribunal is regularly established to appreciate and decide the subject matter of the proceedings.

III - Merits

III.1. Factual Matter

18. Proven Facts

18.1. With relevance for the assessment and decision of the issues raised, the following facts are established and proven:

  • The Claimants are non-resident taxpayers in national territory and, since 22-08-2011, have as their tax representative, for VAT purposes, the company "F..., Lda.", tax ID ... (as per Document no. 1 attached to the minutes of the Arbitral Tribunal meeting, of 12-01-2018, and which is given as fully reproduced for all legal purposes);

  • The Claimant, A..., has been registered, since 28-08-2011, with CAE 55123, exercising the activity "tourist apartments without restaurant," and is framed in the normal quarterly periodicity regime for VAT purposes and in the organized accounting regime, by choice, for PIT purposes (as per Document no. 1 attached to the minutes of the Arbitral Tribunal meeting, of 12-01-2018, and which is given as fully reproduced for all legal purposes);

  • The Claimants concluded, on 21-06-2011, a promise of sale and purchase contract with the company G..., S.A., tax ID ..., with registered office at ... no..., Lisbon, relating to the autonomous fraction identified by the letter A of Unit ..., located on the left ground floor of ... (see Whereas A of Document no. 4 attached to the request for arbitral decision);

  • The property referred to in the previous paragraph is registered in the urban property register, under article ..., fraction A, located at...–..., ..., of the Union of Parishes of ... and ..., County of ..., District of Faro (as per Document no. 2 attached to the minutes of the Arbitral Tribunal meeting, of 12-01-2018, and which is given as fully reproduced for all legal purposes);

  • The Claimants, on 21-06-2011, concluded with E..., S.A., tax ID..., with registered office at ..., ..., and with G..., S.A., tax ID..., with registered office at ... no..., Lisbon, a contract for the transfer of tourism-related exploitation of unit ... (as per Document no. 4 (pages 1 to 33) attached to the request for arbitral decision and which is given as fully reproduced for all legal purposes);

  • From the contract for the transfer of tourism-related exploitation, identified in the previous paragraph, the following clauses are important to highlight:

F.1) The duration of the contract for the transfer of tourism-related exploitation is 10 years renewable (see clause 2.4, page 3 of the contract);

F.2) The Claimants, as property owners, designate as Managing Company E..., S.A.. (hereinafter abbreviated as "Manager"). The Manager shall provide, on an exclusive basis, the services provided for in said contract, also ensuring the management of the property Unit ... (see clause 2.1, page 2 of the contract);

F.3) The Claimants ensure the tourism-related exploitation of Unit ... through the services of the Manager (see clause 2.1, page 2 of the contract);

F.4) The Manager intends to exploit Unit ... for tourism purposes, for account of the Claimants, to the general public, on a temporary basis and as part of its activity (see clause 2.1, page 3 of the contract);

F.5) The Manager throughout the entire duration of the Contract provides the following services:

"A. Administer the Tourism Exploitation Program (Exploitation 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." (see clause 2.1, page 3 of the contract);

F.6) With respect to the tourism-related exploitation of the unit, clause 3.1 provides: "In exchange for the remuneration described in Section 7 below, the MANAGER accepts to make reasonable commercial efforts, in accordance with the provisions of this Contract, to exploit the Unit for tourism purposes to Guests, for account and for the benefit of the FIRST PARTY." (see page 3 of the contract);

F.7) As for the collection of payments due from tourism-related exploitation, clause 3.2 provides as follows: "THE FIRST PARTY authorizes the MANAGER to make reasonable commercial efforts to collect all payments relating to the tourism-related exploitation of the Unit, when these become due." (see page 4 of the contract);

F.8) With respect to reservations, clause 3.4 states: "Without prejudice to the rights of the FIRST PARTY described in Section 3.10 below, the FIRST PARTY authorizes the MANAGER to accept reservations for the occupation of the Unit by Guests, for any period of time and at any time, until the end of this contract, but not after that." (see page 4 of the contract);

F.9) With regard to tariffs, clause 3.5 provides: "THE FIRST PARTY hereby grants to the MANAGER exclusive authorization to exploit the Unit for tourism purposes, and for its account, according to the tariffs that it freely establishes and sets, in accordance with its free discretion, based on various factors, (...) THE MANAGER shall also have the right to freely alter the tariffs in force at any time (...)" (see page 4 of the contract);

F.10) As for the reservation system, clause 3.9 provides: "The reservations of the Unit for guests shall be handled through the reservation system managed and maintained by the MANAGER and in accordance with the policies and procedures that regulate the reservation system." (see page 5 of the contract);

F.11) According to clause 13.3, the Claimants "(...) acknowledge and accept that the Manager has control of the keys to the Unit during the duration of the Contract" (see page 19 of the contract);

F.12) In accordance with clause 3.11: "THE MANAGER SHALL be responsible for payment of the Tourism Exploitation Program Operation expenses in its own name and for account of the FIRST PARTY, during the duration of this Contract. The Tourism Exploitation Program Operation expenses are considered to include, for the purposes of this Contract, the expenses (but not limited to) for: (i) Property Administration Services (Section 4); (ii) Property Maintenance Services (Section 5); (iii) Cleaning and Tidying Services (Section 6); (iv) Equipment Expenses (included in Section 4.3); and (v) Insurance Premiums." (see pages 8 and 9 of the contract);

F.13) The Manager shall provide the services receiving as consideration the remuneration described in Section 7 of the Contract (see clause 2.3, page 3 of the contract);

F.14) Under clause 7, for the administration of the Tourism Exploitation Program with respect to the Unit, the Manager shall be entitled to receive and retain 25% of Gross Tourism Exploitation Revenue (see page 16 of the contract);

F.15) The Claimants, under clause 3.8, are bound to: "(...) during the entire duration of this Contract, not exploit, rent or in any other way make available the Unit to any third party in exchange for payment, rent, remuneration or any other means of payment (including non-monetary character or free of charge), while acknowledging and accepting THE FIRST PARTY not to disclose nor permit any other natural or legal person to disclose the Unit as being, among others, available for occupation." (see page 4 of the contract);

F.16) According to clause 9, each owner shall be entitled to receive, as remuneration, a proportional share, corresponding to the amount calculated on the basis of: "(I) Number of units participating in the Tourism Exploitation Program; and (ii) Number of days on which the Unit was available for use within the Tourism Exploitation Program, (that is, period that are not occupied by the FIRST PARTY. Subtracted from the value corresponding to the costs and expenses incurred by the MANAGER, in its name and for account of the FIRST PARTY (to which the name "Net Tourism Exploitation Revenue" is given)." (see pages 16 and 17 of the contract);

F.17) Under clause 9.2, the Manager "(...) shall deliver to each owner, within a maximum of 15 days from the end of each month, an extract/statement on the Net Tourism Exploitation Revenue relating to the previous month." (see page 17 of the contract);

F.18) Under clause 11, the Manager provides to the Claimants a Monthly Report and an Annual Report. It being the responsibility of the Manager to freely appoint the auditor to audit the annual financial report (see page 18 of the contract);

F.19) According to clause 3.12, the Claimants agree to "(...) furnish and equip the Unit with the standard package of furniture, arrangements and equipment selected by G... and by the MANAGER" (see page 9 of the contract).

  • The title constitutive of the "..." was deposited in the General Directorate of Tourism on 08-02-2008 (as per Document no. 5 attached to the request for arbitral decision);

  • The Municipal Council of..., on 07-07-2008, granted to G..., S.A., the license for tourism-related use relating to the development called "Apartments..." (as per Document no. 6 attached to the request for arbitral decision);

  • The Claimants were subject to a tax inspection procedure, through the Tax Inspection Services of the Tax Department of Faro, concerning the PIT of the years 2012 (Service Order no. OI 2016..., of 18-08-2016), 2013 (Service Order no. OI2016..., of 18-08-2016) and 2014 (Service Order no. OI2016..., of 18-08-2016) (as per Administrative File pages 7 to 12);

  • The draft Tax Inspection Report was notified to the Claimants, in accordance with article 60 of the GTL and article 60 of the Regulations for Tax Inspection Procedures, through the letter no. ... from the Tax Inspection Services of the Tax Department of Faro, of 11-10-2016 (as per Document no. 7 attached to the request for arbitral decision);

  • The Claimants presented, on 25-10-2016, in accordance with article 60, no. 7, of the GTL, their request for prior hearing (as per Document no. 8 attached to the request for arbitral decision);

  • The Claimants were notified of the Tax Inspection Report, through the letter no. ... from the Tax Inspection Services of the Tax Department of Faro, of 16-11-2016 (as per Document no. 9 attached to the request for arbitral decision);

  • The Tax Inspection Report, identified in the previous paragraph, proposed corrections to the taxable income of the Claimants of € 31,168.83 for the year 2012, € 18,061.36 for the year 2013 and € 5,984.63 for the year 2014, resulting from the classification of the rents received, relating to the granting of use of the property owned by the Claimants, in category F, in accordance with paragraph a) of no. 2 of article 8 of the PIT Code (as per Administrative File pages 86 to 104);

  • As a consequence of the Inspection Report, referred to in the previous paragraph, the Claimants were notified of the following tax acts: (i) Act of assessment of PIT no. 2016..., relating to the year 2012, from which resulted a total assessment of € 3,975.15; (ii) Act of assessment of PIT no. 2016..., the act of assessment of compensatory interest no. 2016..., and the Statement of Account Adjustment no. 2016... all relating to the year 2013, from which resulted an amount to be paid of € 10,225.00; (iii) Act of assessment of PIT no. 2016..., the act of assessment of compensatory interest no. 2016..., and the Statement of Account Adjustment no. 2016..., all relating to the year 2014, from which resulted an amount to be paid of € 2,874.57 (as per Documents nos. 1, 2 and 3 attached to the request for arbitral decision);

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

18.3. Substantiation of the Factual Matter

As to the facts given as proven, the Arbitral Tribunal's conviction was based on the free assessment of the documentary evidence filed with the record, whose authenticity was not called into question, as well as on the analysis of the administrative file submitted by the Respondent and the testimony of witnesses C... and D..., who appeared to be impartial in their testimony and to have knowledge of the facts they reported.

III.2. Matter of Law

  1. The issue at stake in the present arbitral proceedings consists of determining whether the income earned by the Claimants, resulting from the contract for tourism-related exploitation which they concluded, is classifiable as income of category B of the PIT, in accordance with paragraph a) of no. 1 of article 3 of the PIT Code, or whether, instead, it should be qualified as income of category F of the PIT, in accordance with the provisions of paragraph a) of no. 2 of article 8 of the same statute.

Previously, it is important to analyze the Claimants' allegation concerning the violation of the duty to substantiate the additional assessments made by the Tax and Customs Authority, due to the defect of lack of substantiation of the Tax Inspection Report.

Finally, in the event of the main claim being dismissed, it is necessary to analyze whether the contested assessment acts suffer from partial illegality due to the Tax and Customs Authority not having taken into account, for purposes of deduction under Category F, all the expenses incurred by the Claimants with the property generating the income in question.

  1. The first issue that must be assessed concerns the alleged lack of substantiation of the Tax Inspection Report, identified in paragraph L) of no. 18.1 above, which forms the basis of the motivation of the tax acts subject to the present request for arbitral decision.

20.1. In the legal framework of this issue, it is important to consider the provisions of article 268, no. 3, of the Constitution of the Portuguese Republic (CPR) and article 77, no. 1 of the GTL.

Article 268, no. 3, of the CPR establishes that "administrative acts are subject to notification to the interested parties, in the manner provided by law, and lack express and accessible substantiation when they affect rights or legally protected interests."

Article 77, no. 1 of the GTL provides that "(...) the decision of the proceeding is always substantiated through a brief exposition of the factual and legal reasons that motivated it, and the substantiation may consist of a mere declaration of agreement with the grounds of previous opinions, information or proposals, including those that are part of the tax inspection report."

20.2. The jurisprudence of the Supreme Administrative Court has held that "(...) the duty to substantiate requires that a normal recipient, placed in the position of the appellant, given the express content of the act, may understand the logical-legal path taken by the respondent authority to reach such decision, so as to be able to determine, consciously, in the direction of challenging or not challenging it." (see, Decision of the Supreme Administrative Court, of 11-11-1998, case no. 31339).

20.3. The Tax Inspection Report, above identified, in section III "Description of facts and grounds for corrections that are merely arithmetic to the taxable matter," exposes with clarity the position of the Tax and Customs Authority which led to the determination of corrections to the taxable income of the Claimants, even referring to the provisions of Circular no. 5/2013, of 02-07-2013, and binding information nos. 477 and 1369 requested by G... S.A. (see page 91 of the Administrative File). From the reading of the said Tax Inspection Report, it is perfectly evident the legal framework used, allowing a normal recipient to "understand the logical-legal path" of the Respondent in the decision taken. Consequently, nothing prevents the Claimants from knowing and understanding the reasons invoked by the Tax and Customs Authority. Indeed, the Claimants, both in the exercise of the right to be heard with respect to the Draft Tax Inspection Report (see paragraph K) of no. 18.1 above) and in the very request for arbitral decision (see article 34 of the request for arbitral decision), demonstrate having fully understood the factual and legal reasons exposed by the Respondent in the Tax Inspection Report. The Claimants may obviously not agree with the reasons invoked by the Tax and Customs Authority, but that is not a question of lack of substantiation.

20.4. Based on the foregoing, we conclude that there is no defect of lack of substantiation of the Tax Inspection Report, which gave rise to the additional assessment acts contested by the Claimants in the present request for arbitral decision.

  1. We shall now analyze the issue of qualification of the income earned by the Claimants, resulting from the contract for the transfer of tourism-related exploitation which they concluded. It is important to determine whether said income is classifiable in category B (Business and Professional Income) of the PIT, or whether, instead, it should be qualified as income of category F (Real Estate Income) of the PIT.

21.1. It is evident from the title constitutive of the development (see paragraph G) of no. 18.1 above) that this is subject to the legal regime for the installation and operation of tourism-related developments.

The legal regime for the installation and operation of tourism-related developments (hereinafter "LRIOD") in force on 08-02-2008, the date of deposit of the said title constitutive of the development, was set forth in Decree-Law no. 167/97, of 4 July, amended by Decree-Law no. 305/99, of 6 August, by Decree-Law no. 55/2002, of 11 March, and by Decree-Law no. 217/2006, of 31 October.

The LRIOD, in article 1, no. 1, defined tourism-related developments as "establishments intended to provide temporary accommodation services, restaurant or tourism animation services, having, for their operation, an adequate set of structures, equipment and complementary services."

Article 44, no. 1, of the LRIOD established that "The exploitation of each tourism-related development must be the responsibility of a single entity." And no. 2 of the same article provided that "The exploitation unit of the development is not preventive of the ownership of the various real property fractions that compose it belonging to more than one person."

21.2. Decree-Law no. 39/2008, of 7 March, approved a new LRIOD, and maintained the legal consecration of the rule of unity of exploitation, contained in article 44, no. 1, and reinforces it in article 45 by establishing the following:

"1 - Without prejudice to the provisions of article 49, the accommodation units are permanently in a regime of tourism-related exploitation, with the exploring entity assuming the continued exploitation of all of them, even if occupied by their respective owners.

2 - The exploring entity must ensure that the accommodation units remain at all times furnished and equipped in full conditions to be leased for accommodation to tourists and that the mandatory services of the category assigned to the tourism-related development are provided in them.

3 - When the ownership and the tourism-related exploitation do not belong to the same entity or when the development is in a regime of plural ownership, the exploring entity must obtain from all owners a legal title that enables it to exploit all the accommodation units.

4 - The title referred to in the previous number must provide for the terms of the tourism-related exploitation of the accommodation units, the participation of the owners in the results of the exploitation of the accommodation unit, as well as the conditions of its use by the respective owner.

5 - The owners of the accommodation units, when occupying the same, enjoy the mandatory services of the category of the development, which are covered by the periodic provision provided for in article 56.

6 - The accommodation units provided for in no. 3 cannot be exploited directly by their owners, nor can they be the subject of contracts that compromise the tourism-related use of the same, in particular, rental contracts or constitution of rights of use and habitation."

As was stated in the Arbitral Decision issued in case no. 275/2017-T:

"53. The legislator here clearly distinguished between the ownership of the various real property fractions that make up the development, which can be plural, and the exploitation of this, which 'must be the responsibility of a single entity'.

  1. In other words, the legislator admits plural ownership, but imposes the unity of exploitation.

  2. From this stems the indispensability of the conclusion of contracts for the transfer of tourism-related exploitation between the owners of the real property fractions and the entity responsible for the tourism-related exploitation.

  3. The conclusion of such contracts results from the necessity of compliance with the law, and not from the will of the contracting parties – it is not, therefore, a question of a management option on the part of the owner of the fraction, but rather a necessary condition for the acquisition of the real property fraction."

21.3. The tourism-related exploitation of the property of which the Claimants are owners was ensured by the managing company, in accordance with the rule of unity of exploitation enshrined in article 44, no. 1, of the LRIOD.

From the contract for the transfer of tourism-related exploitation described above (see paragraphs F.2) to F.13) of no. 18.1 above) it appears that it is the responsibility of the managing company to ensure the tourism-related exploitation of the real property fraction of which the Claimants are owners. Indeed, the Claimants, as owners, during the term of the contract for the transfer of tourism-related exploitation, are prevented from exploiting, renting or in any other way making available the property to third parties (see paragraph F.15) of no. 18.1 above).

In accordance with paragraph a) of no. 1 of article 3 of the PIT Code, business and professional income (category B) is considered "a) That derived from the exercise of any commercial, industrial, agricultural, silvicultural or livestock activity."

The legislator indicates, in paragraph h) of no. 1 of article 4 of the PIT Code, "hotel and similar activities, catering and beverages, as well as the sale or exploitation of the real right of periodic housing," in the list of various activities considered commercial and industrial.

However, the commercial activity consisting of the tourism-related exploitation of the property is not developed by the Claimants, but by the managing company. In such a context, the income earned by the Claimants does not result from the tourism-related exploitation of the real property fraction of which they are owners, but rather from the transfer of said property for exploitation by another entity (the so-called managing company or manager, under the contract for the transfer of tourism-related exploitation).

As is stated in the Arbitral Decision in case no. 275/2017-T: "69. What is decisive is that, by legal mandate, the tourism-related exploitation of the real property fraction of which the Claimants are owners cannot be ensured by them, and therefore the income earned by them, (...) cannot, logically, be attributed to such activity."

21.4. The registration of the Claimant in the CAE, as well as the VAT regime in which it is framed, is not determinative for the solution of the present case. The present proceedings do not aim to determine whether the Claimant is or is not exercising the commercial activity in which it is registered. What is sought to be determined is whether the income earned, resulting from the exercise of the tourism-related exploitation activity, can be attributed to the Claimant as title of commercial income (category B of PIT).

21.5. Article 8 of the PIT Code, relating to income of category F, establishes the following:

"1 - Real estate income is considered to be the rents of rustic, urban and mixed properties paid or made available to their respective holders.

2 - Rents are considered to be:

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

Thus, the income earned by the Claimants results from the transfer of the property, and therefore is of the nature of real estate income and is covered by the provisions of the article cited above.

21.7. In this sense, at least, the decisions of the CAAD have already ruled in cases nos. 211/2017-T, 235/2017-T and 275/2017-T.

  1. It is now necessary to analyze the Claimants' claim, presented as a subsidiary matter, that the deduction of all costs incurred in the years 2012, 2013 and 2014 with maintenance and upkeep expenses relating to personnel salaries, cleaning, electricity, water and gas (see article 122 of the request for arbitral decision) be accepted.

22.1. In accordance with no. 2 of article 13 of the PIT Code, taxpayers for PIT purposes are "(...) natural persons residing in Portuguese territory and those who, not residing there, earn income there."

The PIT is levied on "the annual value of income from the following categories, even when arising from unlawful acts, after the corresponding deductions and abatements are made." (see article 1, no. 1, of the PIT Code).

The amounts received by the Claimants as title of rents are considered real estate income – category F (see article 8 of the PIT Code).

The expenses that may be deducted from real estate income are provided for in article 41 of the PIT Code.

Article 41 of the PIT Code, in the wording in force in 2012, provided that "from the gross income referred to in article 8, deductions are made for maintenance and upkeep expenses that fall to the taxpayer, supported by it and documented, as well as the property tax and stamp duty tax that falls on the value of the properties (...) whose income has been included."

The wording in force in 2013 and 2014 provided that "from the gross income referred to in article 8, deductions are made for maintenance and upkeep expenses that fall to the taxpayer, supported by it and documented, as well as the property tax and stamp duty tax that falls on the value of the properties (...) whose income is subject to taxation in the tax year."

Given the provisions of article 41 of the PIT Code, the legal prerequisites for considering expenses and charges incurred depend on: i) Maintenance and upkeep expenses that fall to the taxpayer; ii) Expenses actually incurred and documented; iii) Property tax falling on the value of the leased property, whose income is subject to taxation in the tax year, that is, paid in the year of the income to be taxed in PIT.

22.2. The rule for deductibility of costs in category F is associated with maintenance and upkeep costs necessary for obtaining taxable real estate income, but which the legislator never typified. Indeed, "(...) the PIT Code does not define what is understood by 'maintenance and upkeep expenses,' and therefore the interpretation of that concept should be made having as reference article 11 of the GTL. Taking into account the civil law notion contained in the Urban Rental Regime (URR), because it is the statute that defined the rules of urban rental and defined which works fell to the landlord, even though there is no terminological correspondence between 'maintenance and upkeep expenses,' provided for in article 41 of the PIT Code, and the URR, which distinguishes between 'ordinary conservation works,' 'extraordinary conservation works' and 'improvement works,' article 11 provided that:

1 - In urban properties, and for the purposes of this statute, ordinary conservation works, extraordinary conservation works and improvement works may take place.

2 - Ordinary conservation works are:

a) The repair and general cleaning of the property and its dependencies; b) The works ordered by the Public Administration, in accordance with the applicable general or local law, and which aim to give the property the characteristics presented when the license was granted;

c) In general, the works intended to maintain the property in the conditions required by the purpose of the contract and existing at the date of its conclusion.

3 - Extraordinary conservation works are those occasioned by construction defects of the property or by accident or force majeure, and, in general, those which, not being attributable to unlawful actions or omissions perpetrated by the landlord, exceed, in the year in which they become necessary, two-thirds of the net income of that same year.

4 - Improvement works are all those not covered in the two previous numbers."

See, in this regard, the Decision of the Supreme Administrative Court of 06.07.2016, issued in case no. 088/16, where, among other things, one can read: "Maintenance and upkeep expenses will be expenses that are necessary for the conservation and upkeep of the properties that generate income. They may be, as previously defined in the Urban Rental Regime, article 11, expenses made with ordinary conservation works - repair and general cleaning of the property, works ordered by the Public Administration, and, in general, those intended to maintain the property in the conditions required by the purpose of the contract and existing at the date of its conclusion; extraordinary conservation works – repair of construction defects of the property or supervening ones; or even improvement of the property, but always with an effect on the property and on its ability to generate income."

Thus, maintenance and upkeep expenses will be expenses that are necessary for the conservation and upkeep of the properties generating income. They may be expenses made with ordinary conservation works, repair and general cleaning of the property, works ordered by the Public Administration, and, in general, all those intended to maintain the property in the conditions required by the purpose of the contract and existing at the date of its conclusion; extraordinary conservation works, repair of construction defects of the property or supervening ones, or even improvement of the property, but always with an effect on the same and on its ability to generate income. Being that only ordinary conservation works are the responsibility of the landlord. On the other hand, extraordinary conservation works and improvement works are only the responsibility of the landlord when their execution is ordered by the competent municipal council or when there is written agreement of the parties to their execution, with specification of the works to be carried out."[1]

In view of the foregoing, expenses relating to consumption of electricity, water and gas do not integrate the concepts of "maintenance and upkeep" and consequently cannot be deducted from the gross income of category F, in accordance with the provisions of no. 1 of article 41 of the PIT Code.

22.3. With respect to the other expenses invoked by the Claimants, they integrate themselves into the concept of maintenance and upkeep expenses, but, under the terms of the contract for the transfer of tourism-related exploitation, these expenses are the responsibility of the managing company (see paragraph F.15) of no. 18.1 above and Section 6 and clauses 5.3, 5.4 and 5.5 of the contract for the transfer of tourism-related exploitation which is attached, as document no. 4, to the request for arbitral decision).

Therefore, the payments relating to this type of expense are made by the managing company. It can be stated that these expenses are incurred indirectly by the Claimants through the remuneration they pay to the managing company (see paragraph F.15) of no. 18.1 above). The deductible cost for the Claimants is that corresponding to the remuneration paid to the managing company, which is not contested by the Claimants.

22.4. In conclusion, the Claimants' request to consider, for purposes of deduction from the income of category F of the PIT, expenses with personnel salaries, cleaning, electricity, gas and water in the years 2012, 2013 and 2014 is dismissed.

IV - Decision

In view of the foregoing, the Arbitral Tribunal decides to judge the request for arbitral decision as unfounded and, as a consequence, absolves the Respondent from the claim, with the respective legal consequences.

V - Value of the Case

Given the provisions of articles 32 of the Code of Administrative Procedure, 306, no. 2, of the Code of Civil Procedure and 97-A of the CTPP, applicable by virtue of the provisions of article 29, no. 1, paragraphs a) and b), of the LRTA, and article 3, no. 2, of the Regulations of Costs in Tax Arbitration Proceedings, the value of the case is set at € 17,074.72 (seventeen thousand, seventy-four euros and seventy-two cents).

VI - Costs

Costs charged to the Claimant, in the amount of € 1,224.00 (one thousand two hundred and twenty-four euros), in accordance with Table I of the Regulations of Costs in Tax Arbitration Proceedings, in compliance with the provisions of articles 12, no. 2, and 22, no. 4, both of the LRTA, as well as the provisions of article 4, no. 4, of the Regulations of Costs in Tax Arbitration Proceedings.

Notify accordingly.

Lisbon, Administrative Arbitration Center, 22 February 2018

The Arbiter

Olívio Mota Amador

[1] Cf., Arbitral Decision issued in case no. 264/2017-T.

Frequently Asked Questions

Automatically Created

How are income payments from tourist exploitation assignment contracts classified for IRS purposes in Portugal?
Income from tourist exploitation assignment contracts can be classified as either Category B (business and professional income) or Category F (property income) depending on the nature of the activity. If the income derives from active business operations in tourism with proper CAE registration and commercial characteristics, it may qualify as Category B. However, the Tax Authority may classify it as Category F if it considers the income primarily derived from property exploitation rather than business activity.
Can taxpayers challenge IRS tax assessments related to tourism income through CAAD tax arbitration?
Yes, taxpayers can challenge IRS assessments related to tourism income through CAAD (Centro de Arbitragem Administrativa) tax arbitration. Process 240/2017-T demonstrates this right under Article 2(1)(a) and Article 10 of the RJAT. Taxpayers can request annulment of IRS assessment acts, compensatory interest assessments, and account adjustments through this alternative dispute resolution mechanism.
What legal framework governs the tax arbitration process under Decreto-Lei 10/2011 (RJAT)?
The Legal Regime of Tax Arbitration (RJAT) is governed by Decree-Law 10/2011 of 20 January, as amended by Article 228 of Law 66-B/2012 of 31 December, and Ordinance 112-A/2011 of 22 March. The framework establishes CAAD competence, arbitrator appointment procedures by the Ethics Council, procedural timelines, evidence rules, and the tribunal's powers to annul tax acts. Article 19 and 29(2) emphasize procedural speed, simplification and informality.
What were the grounds for annulling the IRS assessments for 2012, 2013, and 2014 in CAAD Process 240/2017-T?
The grounds for challenging the IRS assessments included: (1) the Tax Authority's failure to meet its burden of proof under Article 74 GTL to demonstrate reasonable indications justifying Category F classification; (2) improper reliance on administrative circulars rather than legal analysis; (3) violation of the legal presumption of truthfulness of taxpayer declarations under Article 75 GTL; and (4) misapplication of the principle of preponderance of Category B income when derived from registered business activities.
How does the Portuguese Tax Authority (AT) treat rental income from tourism property exploitation agreements?
The Portuguese Tax Authority may treat rental income from tourism property exploitation agreements as Category F income (property income) when it considers the income primarily derived from property rights rather than business operations. However, if taxpayers are registered with appropriate CAE codes and actively engaged in tourism business activities, they may argue for Category B classification. The AT must demonstrate reasonable indications supporting its classification and cannot rely solely on administrative circulars without substantive legal justification.