Process: 252/2017-T

Date: November 20, 2017

Tax Type: IVA

Source: Original CAAD Decision

Summary

CAAD Process 252/2017-T addresses whether a Portuguese municipality can exercise VAT deduction rights in tax periods subsequent to invoice receipt and accounting, specifically when correcting errors in the application of deduction methods. The municipality challenged additional VAT assessments totaling €38,168.59 for tax years 2013-2015, arguing it had unduly restricted its deduction rights by applying only the real allocation method to direct water distribution expenses. In 2016, the municipality discovered it could have deducted VAT on common resources (mixed-use assets subject to pro rata method) and resources fully dedicated to taxable operations. The municipality filed substitute declarations invoking the 4-year limitation period under Article 98(2) of the VAT Code, arguing this was an error of law correctible through retroactive changes in deduction methods, supported by CJEU and CAAD jurisprudence. The Tax Authority rejected this position, contending that Article 22(2) of the VAT Code mandates exercising deduction rights in the period following invoice receipt, with exceptions only for invoice rectifications or material/calculation errors within two years under Article 78. The Respondent emphasized that the municipality freely chose its deduction method for 2013-2015 and cannot retroactively alter this choice outside the Article 78 framework. Central to the dispute is whether taxpayers can correct legal errors in deduction method selection beyond the standard exercise period, the interaction between Articles 22, 23, 78, and 98 of the VAT Code, and whether the principle of fiscal neutrality permits late deductions when no material or calculation errors exist. The case has significant implications for public entities managing mixed taxable and non-taxable activities under Portuguese VAT law.

Full Decision

ARBITRAL DECISION

Dr. Filipa Barros, Arbitrator (sole arbitrator), appointed by the Deontological Council of the Administrative Arbitration Centre ("CAAD") to form the Sole Arbitral Tribunal, constituted on 27 June 2017, hereby decides as follows:

I. STATEMENT OF FACTS

Municipality A..., a legal entity under public law no...., with registered office at ..., ...-..., ..., hereinafter "Claimant", hereby, pursuant to the provisions of Article 2, No. 1, paragraph a), and Articles 10 et seq. of Decree-Law No. 10/2011, of 20 January, hereinafter referred to as "RJAT"[1], requests the constitution of the Arbitral Tribunal to rule on the illegality and consequent annulment of additional VAT assessments issued in 2017, relating to the tax years 2013 to 2015, totalling the amount of € 38,168.59, hereinafter identified:

  • Additional assessment note no...;
  • Additional assessment note no...; and
  • Additional assessment note no....

To support its request, the Claimant argues, in summary, that the additional VAT assessments now challenged are based on the alleged impossibility of taxpayers deducting tax in a period subsequent to the receipt and accounting of invoices, based on the interpretation that the Tax Authority advocates of the provisions of No. 2 of Article 22 of the VAT Code.

The Claimant cannot accept the corrections proposed for the tax years 2013 to 2015, as it considers itself entitled to deduct the tax in dispute.

It states that the Municipality carries out a set of operations not falling within the exercise of its powers of authority, and therefore subject to VAT, under the general terms of the Code for this tax.

During the years 2013, 2014 and 2015, the Municipality only deducted the tax incurred, based on the application of the real allocation method, in the acquisition of certain resources directly related to the distribution of water to residents, an activity which is subject to VAT.

Therefore, in 2016, during a procedures review, the Claimant found that it had unduly restricted the exercise of the right to deduct the VAT incurred, and thus bore tax that, in accordance with the rules of the VAT Code, would be recoverable. Specifically, it found that it had incurred excessive VAT in the acquisition of common resources (resources used simultaneously in both taxed and non-taxed activities, whose VAT would be recoverable by the pro-rata method or based on objective criteria) as well as certain resources wholly dedicated to the realisation of taxed operations (whose VAT would be wholly recoverable).

To this end, the Claimant incurred an error of qualification of the operations carried out (error of law), and in the year 2016 proceeded to correct the calculation of deductible VAT, submitting replacement returns, within the legal period prescribed for this purpose, based on the provisions of Articles 22 and 98 of the VAT Code.

Supported by the jurisprudence of the CJEU and the CAAD, the Claimant submits that taxpayers have the legitimacy and the right to carry out retroactive changes in methods of deduction, correcting errors of law, with Article 78 of the VAT Code not being applicable, but rather the discipline contained in No. 2 of Article 98 of the same Code, which expressly states it applies "without prejudice to special provisions" which, in this case, it is concluded do not exist.

It further argues that Article 23 of the VAT Code provides that taxpayers may choose the method according to which they wish to effect the deduction of VAT incurred; however, contrary to the Tax Authority's thesis, the article in question does not state that the taxpayer cannot review that choice, as this would imply the impossibility of filing a replacement return to correct errors of law committed, which would violate the principle of fiscal neutrality.

The Claimant concludes by stating that taxpayers can exercise the right to deduct in any period subsequent to the receipt (and respective accounting) of invoices, naturally having to do so within the period provided for in No. 2 of Article 98 of the VAT Code, that is, within a period of 4 years.

On 26 April 2017, the request for constitution of the Arbitral Tribunal was accepted by His Excellency the President of the CAAD and was immediately notified to the Respondent in accordance with legal procedures.

The Claimant did not appoint an Arbitrator.

Therefore, in accordance with the provisions of No. 1 of Article 6 and paragraph b) of No. 1 of Article 11 of the RJAT, by decision of His Excellency the President of the Deontological Council, duly communicated to the parties within the legally prescribed periods, the undersigned was appointed arbitrator of the Sole Arbitral Tribunal, and communicated to the Deontological Council and to the Administrative Arbitration Centre the acceptance of the appointment within the period stipulated in Article 4 of the Deontological Code of the Administrative Arbitration Centre.

In accordance with the provisions of paragraph c), No. 1, of Article 11 of Decree-Law No. 10/2011, of 20 January, as amended by Article 228 of Law No. 66-B/2012, of 31 December, the Sole Arbitral Tribunal was constituted on 27 June 2017, followed by the relevant legal procedures.

The Respondent, duly notified for this purpose, filed its reply in which it argues for the rejection of the request for arbitral ruling.

To that end, it submits, in summary, that the Claimant freely chose the real allocation method of deduction in the years 2013, 2014 and 2015, and only in 2016 decides to file periodic returns which contradict the choice previously made by it, inevitably causing perplexity with its conduct.

Thus, it follows from the combined reading of the norms contained in Articles 22 and 78 of the VAT Code that there is a temporal limitation on the exercise of the right to deduction, which must be exercised in the return for the period following the one in which the receipt of invoices occurred, being exceptionally admitted the deduction at a later time, namely in the case of invoice rectification or for the correction of material or calculation errors, but always within a limit of two years.

The Respondent found that the Claimant's request is not supported by Articles 22 and 23 of the VAT Code, nor by Article 78 No. 6 of the same Code, as one is not dealing with the correction of material or calculation errors of registration, moreover, as both Claimant and Respondent agree.

Consequently, and making reference to the Opinion of the Tax Studies Centre No. 41/2013 of 04/10/2013, it argues that the right to deduction must be exercised in the period of receipt of invoices, as follows from No. 2 of Article 22 of the VAT Code and the choice (or by the same reasoning, the change of choice) of a calculation method must be made in accordance with the provisions of No. 6 of Article 23 of the VAT Code, that is, in the return for the last period of the year in question. After that moment, the law only permits changes in situations provided for in Article 78 of the VAT Code, being consensual that the situation in dispute does not fit within this legal provision.

The Respondent concludes by the impossibility of applying the 4-year period for the exercise of the choice between deduction methods, arguing for the rejection of the alleged defects in the administrative action.

On 25 September 2017, given that in this case none of the purposes legally entrusted to it were present, and with no objection from the parties, pursuant to the provisions of Articles 16 paragraph c), 19 and 29 No. 2 of the RJAT, as well as the principles of procedural economy and prohibition of useless acts, the holding of the meeting referred to in Article 18 of the RJAT was dispensed with.

Written submissions were presented by the Claimant, followed by submissions by the Respondent.

In the submissions presented, the parties reiterated in essence the positions defended in their respective pleadings.

II. CASE MANAGEMENT

The Arbitral Tribunal is materially competent and is regularly constituted, in accordance with Articles 2 No. 1, paragraph a), 5 and 6 No. 1, of the RJAT.

The parties have legal personality and capacity, show themselves to be legitimate and are regularly represented (see Articles 4 and 10, No. 2 of the RJAT and Article 1 of Regulation No. 112-A/2011 of 22 March).

The case is not affected by nullities.

III. REASONING

1. Facts Established as Proven

The facts were established as proven based on the documents attached in the course of the administrative proceedings, in the request for arbitral ruling, and in the reply presented by the Tax Authority, in accordance with the following indication.

  • The Claimant is a legal entity under public local law, whose activity consists in the pursuit of its municipal attributions in the most diverse areas;

  • The Claimant is classified, for VAT purposes, under the normal regime with quarterly periodicity;

  • In the pursuit of its attributions, the Claimant carries out a vast set of operations falling within the scope of its powers of authority (e.g. setting traffic signs, subdivision of works), which are excluded from VAT liability, by virtue of the Claimant not acting in the capacity of a VAT taxable person, pursuant to the provisions of No. 2 of Article 2 of the VAT Code.

  • Simultaneously, the Claimant carries out a set of operations, whether transfers of goods or provision of services, not falling within the scope of its powers of authority, and therefore subject to VAT in accordance with the general terms of the Code for this tax;

  • In the exercise of its attributions, the Claimant carries out both operations taxed under VAT (e.g. distribution of water to residents) and operations exempt from this tax;

  • During the years 2013, 2014 and 2015, the Claimant only deducted the tax incurred, based on the application of the real allocation method, in the acquisition of certain resources directly related to the distribution of water to residents;

  • In 2016, during a procedures review, the Claimant found that it had unduly restricted the exercise of the right to deduct the VAT incurred, and thus bore tax that, in accordance with the rules of the VAT Code, would be recoverable in the following respects:

    a) VAT incurred in the acquisition of common resources (i.e. resources used simultaneously in both taxed and non-taxed activities);

    b) In certain resources wholly dedicated to the realisation of taxed operations;

  • For the purposes of deducting the VAT incurred in the two respects mentioned in paragraphs a) and b) of point 7, the Claimant submitted, on 12 February 2016, two replacement returns relating to the 4th quarter of 2013 and the 4th quarter of 2014, determining a VAT credit of € 8,235.15 and € 14,968.87;

  • For the purposes of deducting the VAT incurred in the two respects mentioned in paragraphs a) and b) of point 7, on 23 May 2016, the Claimant submitted a replacement return relating to the 4th quarter of 2015, determining a VAT credit of € 20,367.02;

  • For the purposes of the deduction referred to in the previous points, the Claimant took into account the time limit of 4 (four) years for VAT recovery provided for in No. 2 of Article 98 of the VAT Code;

  • Following a refund request made in the periodic return for the period 201606T, the Claimant was subject to an internal inspection procedure covering the years 2013 to 2015, for the purpose of verifying the legitimacy of the VAT credits contained in the refund request;

  • The inspection procedures were opened with service orders no. OI2016..., OI2016... and OI2016..., carried out by the Tax Inspection services of the Finance Department of ...;

  • Following the inspection procedures, the Claimant was notified, through letters no.... and ... of 10 November 2016, of Draft Corrections to the Tax Inspection Reports for the years 2013, 2014 and 2015;

  • The Claimant exercised its right to be heard, and the Tax Authority partially cancelled the proposed corrections;

  • On 30 December 2016, the Claimant was notified through letters no.... and ..., of the final Tax Inspection Reports where arithmetic corrections were made in the amount of € 8,235.15, € 12,318.72 and € 17,609.72 for the years 2013, 2014, and 2015, respectively;

  • In accordance with the TIRs, whose content is deemed to be fully reproduced, the amounts reflected in the periodic returns and recorded in the accounts of the Claimant adequately translated the amounts assessed and deducted by it, except for the amounts declared in the replacement periodic returns for the periods 1312T, 1412T and 1512T;

  • It is stated specifically in the reasoning of the TIR that "the deduction of tax presupposes the accounting entry of the supporting document, which in accordance with Article 48 No. 1 of the VAT Code must be made, at the latest, by the deadline for submission of the periodic return (within the period) if we pay attention to Article 22 No. 2 of the VAT Code, the deduction must be effected in the period or the period following that in which the receipt of the document that gave rise to it occurred and always based on the accounting entries. It is not possible to retroactively change the calculation method of the initial deduction right, nor to correct calculations of the final deduction, as provided for in Article 23 of the VAT Code, No. 6, which is transcribed below: "6 – The deduction percentage referred to in paragraph b) of No. 1, calculated provisionally on the basis of the amount of operations carried out in the previous year, as well as the deduction made in accordance with No. 2, calculated provisionally on the basis of the objective criteria initially used for the application of the real allocation method, are corrected in accordance with the definitive values relating to the year to which they relate, giving rise to the corresponding regularisation of the deductions made, which must be included in the return for the last period of the year to which it relates.

Also, and even if Article 23 No. 6 of the VAT Code permitted it, corrections to deductions made after that moment would only be acceptable if they had the character of regularisations and were covered by Article 78 of the VAT Code. (...)

And the TIR continues by transcribing Circular Letter No. 30082/2005, of 17 November:

"In that sense, the mechanisms provided for in Article 71 (currently Article 78) cannot be used in other situations, namely:

  • Change of the VAT deduction method in mixed taxable persons;

  • Pro-rata calculation;

  • VAT regularisations on real estate and other fixed assets or relating to the use of real estate for purposes other than those for which they are intended.

These situations should be regularised under Articles 23, 24, 24A and 25 of the VAT Code as applicable. Similarly, the mechanisms provided for in Article 71 (currently 78) do not apply in cases of exercise of the right to deduct tax mentioned in documents not yet recorded, which must be carried out in accordance with Article 22, provided it is within the period provided for in No. 2 of Article 91, all of the VAT Code". (...)

It follows from the foregoing that there is no legal support to allow a retroactive change in the calculation method of the initial deduction right relating to goods and services of mixed use, based on Article 71 Nos. 6 and 7 of the VAT Code, as worded in 2004, since this choice, as demonstrated previously, can only be made for each acquisition of goods or services at the moment the right to deduction arises under the conditions provided for in No. 1 of Article 20, No. 1 of Article 22 and in Article 23 of the VAT Code.

It should also be noted that within the current legal framework it is also unequivocal that it is not possible to retroactively change the calculation method of the initial deduction right relating to goods and services of common use in exempt and taxed activities, nor to correct calculations of the deduction percentage finally determined in a given year based on Article 78 of the VAT Code, since such corrections do not fall within the provisions contained therein."

  • Subsequently, the Claimant was notified of additional VAT assessments no.... and ..., in the total amount of € 38,163.59, relating respectively to the periods 1312T, 1412T and 1512T;

  • On 7 April 2017, the Claimant filed the request for constitution of the Arbitral Tribunal that gave rise to the present proceedings (cf. electronic request to the CAAD).

2. Facts Not Proven

No facts with relevance to the assessment of the matter were found that were not proved.

3. Motivation

With regard to matters of fact, the Tribunal does not have to rule on everything alleged by the parties; rather, its duty is to select the facts that matter for the decision and distinguish the proven matter from the unproven (cf. Article 123, No. 2, of the Tax Procedure Code and Article 607, No. 3 of the Code of Civil Procedure, applicable by virtue of Article 29, No. 1, paragraphs a) and e), of the RJAT).

In this way, the facts relevant to the judgment of the case are chosen and outlined based on their legal relevance, which is determined in view of the various plausible solutions of the legal question(s) (cf. former Article 511, No. 1, of the Code of Civil Procedure, corresponding to current Article 596, applicable by virtue of Article 29, No. 1, paragraph e), of the RJAT).

Thus, taking into account the positions assumed by the parties, in light of Article 110 No. 7 of the Tax Procedure Code, the documentary evidence, the statements of the Claimant that were not questioned by the Tax Authority and the proceedings file attached to the case, the facts listed above were considered proved, with relevance for the decision.

4. Legal Matters

4.1 The Question to be Assessed

The Claimant, as referred to, is a legal entity under public law that in the pursuit of its attributions carries out a vast set of operations falling within its powers of authority, which are excluded from VAT liability, by virtue of not acting in the capacity of a VAT taxable person, pursuant to No. 2 of Article 2 of the VAT Code.

However, in parallel, the Claimant carries out a set of operations whether transfers of goods or provision of services, outside the use of "ius imperii", that is, powers of authority, which are subject to VAT under the general terms, from which it follows that some of these operations are taxed under VAT, while others are exempt from this tax.

During the years 2013, 2014 and 2015, the Claimant used only the real allocation method in the acquisition of certain resources directly related to the wholly taxed activity. Having found that it had unduly restricted its right to deduct VAT during the said period, particularly with regard to the acquisition of common resources - whose VAT could be recoverable by the pro-rata method or based on objective criteria - as well as in certain resources wholly dedicated to the realisation of taxed operations – whose VAT could be wholly recoverable - the Claimant made supplementary tax deductions, on the understanding that this was permitted under the VAT Code.

However, the Tax Authority, in accordance with the reasoning set out in the TIR, understood, in summary, that the situation in question does not constitute the correction of material or calculation errors, provided for in Article 78 No. 6 of the VAT Code, but rather a retroactive change in the method of deduction without any legal basis. Indeed, in the view of the Tax Authority, taxable persons do not enjoy full freedom in determining the timing of the exercise of their right to deduct, since No. 2 of Article 98 of the VAT Code, invoked by the Claimant, merely establishes the limit until which the right to deduct can be exercised, not allowing the taxable person the freedom to determine the timing of the exercise of that right.

In 2016, the Claimant understood that it was entitled to deduct the VAT incurred in its taxed activity, as well as the VAT incurred in the acquisition of common resources, simultaneously using the pro-rata methods and real allocation (and not only the real allocation applicable to resources directly related to the distribution of water to residents), whereby, on 12 February 2016, it submitted two replacement returns relating to the 4th quarter of 2013 and the 4th quarter of 2014, and on 23 May 2016, it submitted a replacement return relating to the 4th quarter of 2015.

Thus, the Tax Authority understood that the four-year period established in No. 2 of Article 98 of the VAT Code does not apply to the situation in question, since this norm regulates the period during which taxable persons may, at most, exercise the right to deduct, and should take into account the special periods provided for in Article 22 of the same code, and the choice "or by the same reasoning, the change of choice) of a calculation method must be made in accordance with the provisions of Article 23 of the VAT Code". The Tax Authority argues that the period in No. 2 of Article 98 of the VAT Code only applies in cases of accounting entries beyond the periods laid down in Article 22 of the VAT Code, but within the four-year period from the birth of the right to deduct, and that, in the case of the proceedings, "the taxable person wishes to deduct more tax than that which it previously self-assessed based on the same accounting entries, by means of the use of a different allocation criterion", which cannot proceed.

Finally, the Tax Authority invokes in support of its thesis the Decision of the Supreme Administrative Court of 18-05-2011, rendered in proceedings No. 0966/10 of 18 May 2011 and the Decision rendered by the CJEU in the case Ecotrade SpA (Decision of 8 May 2008, joined cases C-95/07 and C-96/07).

In these terms, the question to be assessed consists in determining whether the position assumed by the Claimant is correct, which maintains the possibility of being able, during a period of 4 years, to exercise the right to deduct based on the provisions of Articles 22 No. 2 and 23 of the VAT Code, having regard to what is laid down in No. 2 of Article 98 of the same legal provision.

4.2 Jurisprudence on the Case at Issue

To support its position on the functioning of the limitation periods for the exercise of the right to deduct tax incurred by taxable persons, the Tax Authority invoked the jurisprudence contained in the Decision of the Supreme Administrative Court rendered in proceedings No. 0966/10 of 18 May 2011, as well as the jurisprudence of the CJEU rendered in the case Ecotrade SpA.

With regard to the jurisprudence contained in the Decision of the Supreme Administrative Court in proceedings No. 0966/10, it is important to first note that although the Decision is from 2011, the VAT regime in force in 2003 was applied therein, as expressly stated therein.

Now, the regime in force in 2003 was substantially different from that which followed on 01-01-2004, with regard to the possibility of exercising the right to deduct, in view of the amendment introduced by Law No. 107-B/2003, of 31 December, to Article 22, No. 2, of the VAT Code.

In fact, in the wording in force until this legislative amendment, Article 22, No. 2, of the VAT Code provided that "Without prejudice to the possibility of correction provided for in Article 71, the deduction shall be made in the return for the period in which the receipt of invoices, equivalent documents or proof of payment of VAT which forms part of import returns occurred" (wording of Decree-Law No. 166/94, of 9 June).

In light of this wording, there was no legal support to assert that, outside of cases provided for in special norms, a VAT taxable person could exercise the right to deduct in returns for subsequent periods, as was understood in the decision of the Supreme Administrative Court of 18 May 2011, rendered in proceedings No. 0966/10, which applied the legislation in force in 2003.

In the wording given to that No. 2 of Article 22 by Law No. 107-B/2003, of 31 December), the following was established: "Without prejudice to the provisions of Article 71, the deduction shall be made in the return for the period or a period following that in which the receipt of invoices, equivalent documents or proof of payment of VAT which forms part of import returns occurred".

The enormous difference lies in the possibility of deducting VAT not only in the return for the period of receipt of documents, but also in a return for a subsequent period, without any restriction.

Indeed, assuming that the legislator knew how to express its intent in appropriate terms, as must be presumed by virtue of No. 3 of Article 9 of the Civil Code, the use of the expression "of a subsequent period", without the definite article, and not "of the subsequent period" reveals that it is not even required that the VAT be deducted in the return for the immediately following period after receipt of documents, being permitted in the return for any subsequent period, without prejudice, naturally, to the special and general limits, in particular those contained in Articles 78 and 98, No. 2 of the VAT Code.[2]

Consequently, taxable persons are not obliged to deduct VAT incurred in the tax return for the period in which they receive the invoice and record it in accounting, as the Tax Authority argues, nor in the immediately subsequent period. Article 22, No. 2, of the VAT Code enshrines a permission to deduct in a subsequent period, which must be articulated with the general limitation period provided for in No. 2 of Article 98 of the VAT Code, without prejudice to the application of special periods to certain situations, which do not occur in the case at hand.

With regard to the jurisprudence rendered in the Decision of the CJEU in Ecotrade SpA, also invoked by the Tax Authority to support its thesis, it is important to note that the Court expressly pronounces itself in favour of the stipulation of limitation periods for the exercise of the right to deduct, and these must, in turn, comply with parameters required by the principles of equivalence and effectiveness in order to be considered valid in the light of Community law, in the sense that they should be compatible with the principle of neutrality.

Thus, it is stated in the mentioned Ecotrade Decision that a limitation period of two years does not, in principle, prevent a sufficiently diligent taxpayer from benefiting from the possibility of deducting tax borne upstream.

However, the Court ultimately considers incompatible with Community law the refusal, by the Italian authorities, of the exercise of the right to deduct VAT by Ecotrade beyond that period. Indeed, the case did not concern the conduct of a not diligent taxpayer, who had failed to claim VAT deduction in good time through inattentiveness and negligence, but rather a taxable person that, by virtue of accounting lapses, had incurred errors in the preparation of the corresponding tax returns and thus had failed to exercise its rights under VAT.

According to the CJEU, the tax administration used the mechanism of limitation of the right to deduct as a way of punishing the taxpayer for non-compliance with accounting and reporting obligations, and such a situation appears excessive and contrary to the principles governing this tax, and therefore has no basis in the Directive (in this case, the Sixth Directive). In this regard, the Court clearly states in paragraph 67 that "(....) a practice of rectification and recovery, such as that in the main proceedings, which punishes the violation of obligations of accounting and reporting by the taxable person by a refusal of the right to deduct clearly exceeds what is necessary to achieve the objective of ensuring proper compliance with those obligations, within the meaning of Article 22, No. 7, of the Sixth Directive, since Community law does not prevent the Member States, in order to punish non-compliance with the said obligations, from applying, where appropriate, a fine or a financial penalty proportionate to the gravity of the infringement." And it adds "The said practice also exceeds what is necessary to guarantee proper recovery of VAT and to prevent fraud, within the meaning of Article 22, No. 8, of the Sixth Directive, since it can even lead to loss of the right to deduct if rectification of the return by the Tax Administration occurs only after the term of the limitation period available to the taxable person to effect deduction has expired (see, by analogy, Gabalfrisa judgment and others, already cited, Nos. 53 and 54)."

Consequently, and contrary to what the Tax Authority states in its reply, the CJEU considered incompatible with Community law the refusal of the right to deduct in these circumstances, being required in light of the principle of fiscal neutrality that the deduction of VAT incurred be granted even if the taxable person has neglected certain formal requirements.

Among us, the Supreme Administrative Court has recognised in a recent decision in proceedings No. 01427/14, dated 28 June 2017, in which it was stipulated that the applicable period for claiming VAT paid in excess, in a situation that could fall within the so-called error of law, is of 4 years, in accordance with the provisions of Article 98, No. 2 of the VAT Code.

In the perspective of the Supreme Administrative Court, explained in the said decision, everything depends on whether, in the concrete case at hand, the disputed question concerns material or calculation errors or rather errors of law.

In the first case, according to established jurisprudence, the two-year period provided for in No. 6 of Article 78 of the VAT Code applies, whereas, in the second case, the period to be considered is the general four-year period, in accordance with what is laid down in No. 2 of Article 98 of the aforementioned VAT Code.[3]

4.3 The Applicable Legal Regime

Article 98, No. 2, of the VAT Code establishes that "without prejudice to special provisions, the right to deduct or refund tax paid in excess can only be exercised until the expiry of four years after the birth of the right to deduct or payment in excess of tax, respectively".

In the case at hand, both Claimant and Respondent agree that it is not a situation that could be classified under Article 78, No. 6, of the VAT Code, which provides for a special period of two years for regularisation of "correction of material or calculation errors", including in periodic returns, in the following terms: "the correction of material or calculation errors in the registration referred to in Articles 44 to 51 and 65, in the returns mentioned in Article 41 and in the guides or returns mentioned in paragraphs b) and c) of No. 1 of Article 67 is optional when it results in tax in favour of the taxable person, but can only be carried out within a period of two years, which, in the case of the exercise of the right to deduct, is counted from the birth of the respective right in accordance with No. 1 of Article 22, being mandatory when it results in tax in favour of the State".

Article 95-A, No. 2, of the Tax Procedure Code provides a concept of "material or manifest errors" indicating that it includes, "in particular those resulting from anomalous operation of the tax administration's computer systems, as well as unequivocal situations of calculation error, writing error, inaccuracy or slip".

The association of calculation error with material error made in this No. 6 of Article 78 of the VAT Code, similarly to what happens in other norms (such as Article 249 of the Civil Code, Article 667 of the Code of Civil Procedure of 1961 and Article 614 of the Code of Civil Procedure of 2013) reveals that the calculation errors referred to will be of this type, namely arithmetic errors in the operations of calculating the amount to deduct.

Thus, there will be a material error in the completion of the amount of deductible VAT in a return when one intended to write a certain amount and, through carelessness or slip, ended up writing a different amount, or when the error in completion of the return results from an earlier error of the same type that exists in the accounting or in some document that serves as the basis for the exercise of the right to deduct.

There will be a calculation error when the arithmetic operations to determine the amount of deductible VAT were carried out incorrectly, in the return itself or in any of the documents on which it is based.

The error as to the application of certain legal regimes constitutes neither material error nor calculation error, so it is manifest that the regime of the said No. 6 of Article 78 of the VAT Code cannot be applied to it. In particular, the error attributable to the Claimant in the case at hand arises from a procedures review resulting from the need to review the legal classification applicable, under VAT, to a set of very diverse costs arising from the various business sectors in which it operates.

This is, therefore, an error of law, that is, an error of classification regarding the existence of the right to deduct VAT incurred in the acquisition of common resources (by application of pro-rata), as well as in the acquisition of goods and services directly allocated to taxed operations.

Thus, as the regime of the said Article 78, No. 6, is not applicable, nor is there any regime that provides for a special time limit for the exercise of the right to deduct on the basis of an error of law, the general regime on this matter contained in Article 98, No. 2, of the VAT Code will apply, which, as is said in the decision of the Supreme Administrative Court of 18-5-2011, rendered in proceedings No. 966/10 (at this point with full actuality), sets a maximum limit of four years that cannot be exceeded in any case.

It is therefore concluded that the assessments whose declaration of illegality is requested are affected by an error in the legal presuppositions, by reason of misinterpretation of Article 98, No. 2, of the VAT Code, combined with Articles 22, No. 2, and 78, No. 6, of the same Code, a defect that justifies its annulment [Article 135 of the Administrative Procedure Code, applicable by virtue of the provision in Article 2 paragraph c), of the General Tax Law].

5. Compensatory Interest

The Claimant further petitioned for condemnation of the Respondent to pay compensatory interest, accrued and accruing until the date of reimbursement of the amounts of tax unduly assessed, considering that, in the concrete case, unduly assessed VAT occurred, as a result of an error attributable to the services.

In accordance with Article 43 of the General Tax Law and Article 61 of the Tax Procedure Code "Compensatory interest is due when it is determined, in a gracious claim or judicial challenge, that there was error attributable to the services of which resulted payment of the tax debt in an amount higher than legally due".

Error attributable to the administration is understood to be error not attributable to the taxpayer and based on erroneous presuppositions of fact and law, which are not the responsibility of the taxpayer. Thus, "the right to compensatory interest covers only one of the causes of responsibility of the Tax Administration, acting as such: that originated by payment of unduly paid taxes, which is attributable to it (...) the right to compensatory interest in favour of the taxpayer comes, as a general rule, from a duty of indemnification of the Tax Administration resulting from the forced unproductiveness of the amounts disbursed by the taxpayer."(cf. António Lima Guerreiro, General Tax Law Annotated, Rei dos Livros Publishers, p. 204 and 205).

In the case at hand, it is demonstrated that the Claimant unduly bore a tax obligation by virtue of the assessments that are the subject of the present proceedings, seeing thwarted by the Tax Authority the refund request that it had made. To this extent, the Claimant is entitled to reimbursement of the tax unduly paid, by virtue of Articles 24, No. 1, paragraph b), of the RJAT and 100 of the General Tax Law, as this is essential to "restore the situation that would have existed if the tax act that is the subject of the arbitral decision had not been executed", which should be determined in execution of final judgments.

Thus, the illegality of the assessments is attributable to the Tax Authority, which rejected of its own initiative the refund request.

In normal circumstances the Claimant should be reimbursed, in accordance with Article 22 of the VAT Code, which did not happen due to the responsibility of the Tax Authority, and therefore the Claimant is entitled to compensatory interest, calculated on the amount that it unduly paid, at the rate of legal interest provided for in Article 559 of the Civil Code and, currently, in Regulation No. 291/2003, of 8 April (Articles 43, No. 4, and 35, No. 10, of the General Tax Law).

IV. DECISION

For these reasons, this Arbitral Tribunal hereby decides to judge the arbitral request filed by the Claimant as having merit and, consequently:

  • Annul the assessment acts that are the subject of the present proceedings, in the total amount of € 38,168.59;

  • In consequence, order the reimbursement of this amount whose assessment was unduly made;

  • Condemn the Tax Authority and Customs Authority to pay to the Claimant compensatory interest, in accordance with Articles 24, No. 5, of the RJAT, 43, No. 1, of the General Tax Law and 61 of the Tax Procedure Code;

  • Condemn the Tax Authority and Customs Authority to pay the costs of the proceedings.

V. VALUE OF THE PROCEEDINGS

The value of the proceedings is fixed at € 38,168.59, in accordance with Article 97-A, No. 1, a), of the Tax Procedure and Process Code, applicable by virtue of paragraphs a) and b) of No. 1 of Article 29 of the RJAT and No. 2 of Article 3 of the Regulations on Costs in Tax Arbitration Proceedings.

VI. COSTS

The arbitration fee is fixed at € 1,836.00, in accordance with Table I of the Regulations on Costs in Tax Arbitration Proceedings, payable by the Tax Authority and Customs Authority, since the request was entirely successful, in accordance with Articles 12, No. 2, and 22, No. 4, both of the RJAT, and Article 4, No. 4, of the said Regulations.

Let notification be made.

Lisbon, 20 November 2017

The Arbitrator

(Filipa Barros)

[1] Acronym for Legal Regime of Tax Arbitration.

[2] See, in this sense, decision of the CAAD in proceedings No. 502/2014-T.

[3] See also the decision of the Central Administrative Court of the South of 22 January 2015 rendered in proceedings No. 05273/12.

Frequently Asked Questions

Automatically Created

What is the time limit for exercising the right to deduct VAT under Portuguese tax law?
Under Portuguese VAT law, the right to deduct VAT must generally be exercised in the return for the period immediately following the receipt and accounting of invoices, as established in Article 22(2) of the VAT Code. However, Article 78 allows late deduction in exceptional circumstances—specifically for invoice rectifications or corrections of material or calculation errors—within a two-year limit. The Tax Authority argues this is the exclusive temporal framework. Conversely, taxpayers may invoke Article 98(2) of the VAT Code, which establishes a general four-year limitation period for correcting tax returns 'without prejudice to special provisions.' The central legal question is whether errors in choosing or applying VAT deduction methods (errors of law) fall under the restrictive two-year Article 78 regime or the broader four-year Article 98 framework. CAAD jurisprudence and CJEU principles of fiscal neutrality increasingly support the latter interpretation, allowing taxpayers to exercise deduction rights within four years when correcting legal qualification errors, not merely material or calculation mistakes.
Can a municipality recover VAT deductions omitted in prior tax periods through substitute declarations?
Yes, under certain conditions. In Process 252/2017-T, the municipality filed substitute declarations in 2016 to recover VAT deductions omitted in 2013-2015, arguing it had committed an error of law by incorrectly restricting its deduction rights to the real allocation method. The municipality's position rests on Article 98(2) of the VAT Code, which permits corrections within four years, and on the principle that taxpayers can retroactively change deduction methods when correcting legal errors—distinct from material or calculation errors. The Tax Authority opposes this, arguing Article 22(2) requires contemporaneous deduction and Article 23(6) limits method changes to the year-end return, with post-period modifications restricted to Article 78 scenarios (rectifications, material/calculation errors) within two years. The municipality cited CJEU jurisprudence emphasizing fiscal neutrality and CAAD precedents supporting retroactive method corrections. Success depends on characterizing the omission as a correctible error of law rather than an impermissible late election, and on whether courts prioritize the strict temporal rules of Articles 22 and 78 or the broader correction framework of Article 98.
What happens when the Portuguese Tax Authority denies late VAT deductions based on Article 22(2) of the VAT Code?
When the Portuguese Tax Authority denies late VAT deductions based on Article 22(2) of the VAT Code, it issues additional tax assessments for the amounts claimed, as occurred in Process 252/2017-T (€38,168.59 for 2013-2015). Taxpayers can challenge these assessments through CAAD arbitration under Decree-Law 10/2011 (RJAT). The Tax Authority's denial rests on the interpretation that Article 22(2) mandates exercising deduction rights in the return for the period following invoice receipt, with limited exceptions. The Authority argues that changing deduction methods or belatedly claiming omitted deductions falls outside Article 78's narrow exceptions (invoice rectifications, material/calculation errors within two years). Taxpayers challenging such denials must demonstrate either: (1) their situation qualifies under Article 78 exceptions; (2) Article 98(2)'s four-year correction period applies to legal errors in deduction method selection; or (3) the denial violates EU principles of fiscal neutrality and proportionality. The arbitral tribunal evaluates whether the temporal restrictions in Articles 22 and 78 constitute 'special provisions' that override Article 98's general correction framework, considering CJEU jurisprudence on the fundamental nature of deduction rights in the VAT system.
How does the pro rata method and real allocation method affect VAT recovery for mixed-use resources by public entities?
The pro rata method and real allocation method significantly impact VAT recovery for public entities performing both taxable and non-taxable activities. Under Article 23 of the Portuguese VAT Code, taxpayers can choose between these methods. The real allocation method allows full deduction of VAT on resources exclusively used for taxable operations, no deduction on resources for exempt/non-taxable activities, and pro rata deduction on common (mixed-use) resources based on the proportion of taxable turnover. The pro rata method applies a single percentage to all VAT incurred, calculated as taxable operations divided by total operations. In Process 252/2017-T, the municipality initially applied only real allocation to direct water distribution expenses, failing to deduct VAT on common resources that should have received pro rata treatment and on certain resources wholly dedicated to taxable operations that warranted full deduction. This resulted in €38,168.59 in unrecovered VAT. The choice of method affects cash flow and compliance complexity: real allocation provides more accurate recovery but requires detailed tracking, while pro rata is simpler but may over- or under-recover VAT. The dispute centers on whether municipalities can retroactively correct method application errors beyond the initial election period.
What is the CAAD arbitral procedure for challenging additional VAT assessments issued by the Portuguese Tax Authority?
The CAAD (Centro de Arbitragem Administrativa) arbitral procedure for challenging additional VAT assessments follows Decree-Law 10/2011 (RJAT). In Process 252/2017-T, the procedure involved: (1) The municipality filed a request for arbitral tribunal constitution under Article 2(1)(a) and Articles 10+ of RJAT, identifying the contested assessments and legal grounds; (2) The CAAD President accepted the request on April 26, 2017, and notified the Tax Authority; (3) As the claimant didn't appoint an arbitrator, the Deontological Council appointed a sole arbitrator under Articles 6(1) and 11(1)(b) of RJAT; (4) The tribunal was constituted on June 27, 2017; (5) The Tax Authority filed its reply defending the assessments; (6) The tribunal dispensed with the oral hearing under Articles 16(c), 19, and 29(2) of RJAT, applying principles of procedural economy when no hearing purposes were present and parties didn't object; (7) Both parties submitted written final arguments reiterating their positions. The procedure provides an alternative to judicial courts for tax disputes, offering specialized expertise, faster resolution, and binding decisions. Taxpayers must file within the statutory deadline, typically within 90 days of notification of the contested act, and the tribunal issues a reasoned decision applying Portuguese tax law and EU VAT Directive principles.