IRS Income Classification: Tourist Exploitation Contract Tax Ruling (CAAD 274/2017-T)

ARBITRAL DECISION

The Arbitrator Raquel Franco, appointed by the Deontological Council of the Administrative Arbitration Centre (CAAD) to form the singular arbitration tribunal constituted on 03 July 2017, decides as follows:

REPORT

Procedural Framework

On 18-04-2017, the taxpayers A…, TIN… and B…, TIN…, filed a petition for the constitution of the singular arbitration tribunal, in accordance with the combined provisions of articles 2 and 10 of Decree-Law no. 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter referred to only as RJAT), in which the Tax and Customs Authority is respondent.

The petition for constitution of the arbitration tribunal was accepted by the Honourable President of CAAD and automatically notified to the Tax and Customs Authority on 27-04-2017.

Pursuant to the provisions of subparagraph a) of paragraph 2 of article 6 and subparagraph b) of paragraph 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 Deontological Council appointed the undersigned as arbitrator of the singular arbitration tribunal, who communicated acceptance of the assignment within the applicable period, and notified the parties of such appointment on 12-06-2017.

Thus, in accordance with the provisions of subparagraph c) of paragraph 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 singular arbitration tribunal was constituted on 03-07-2017, and the relevant legal procedures were followed.

Positions of the Parties

The Petitioners request the declaration of illegality of the following acts:

• Income tax assessment act (IRS) no. 2016…, compensatory interest assessment act no. 2016…, and Account Settlement Statement no. 2016…, relating to the year 2012, resulting in a payable amount of €3,975.15 (cf. Document 1 attached with the arbitral opinion request);

• Income tax assessment act (IRS) no. 2016… and Account Settlement Statement no. 2016…, relating to the year 2013, resulting in a payable amount of €3,392.74 (Document 2 attached with the arbitral opinion request);

• Income tax assessment act (IRS) no. 2016…, compensatory interest assessment act no. 2016…, and Account Settlement Statement no. 2016…, all relating to the year 2013, resulting in a payable amount of €6,955.12 (Document 3 attached with the arbitral opinion request);

• Income tax assessment act (IRS) no. 2016…, compensatory interest assessment act no. 2016…, and Account Settlement Statement no. 2016…, all issued for the year 2014, resulting in a total tax of €17,163.56 (Document 4 attached with the arbitral opinion request).

In defence of the cumulation of claims, the Petitioners allege that in all acts the same factual circumstances and the same interpretation and application of the same legal principles or rules are at issue.

On 26 April 2007, the Petitioners executed a promise of sale and purchase contract with company C... S.A. (NIPC…), hereinafter designated as "C…", having as its object an immovable property designated "Apartment…", registered in the urban real estate register of the Parish Union of … and … under article …, letter G, located in the development "Apartments…" and, on the same date, they executed with C… (Portugal), S.A. a tourism exploitation assignment contract for the unit… identified above, reserving to it the right to appoint a management entity, which was later realised with the establishment of company D... S.A., NIPC … (hereinafter "D…") (cf. Clause 2.1 of Document 5 attached with the arbitral opinion request).

Since 6 March 2012, Petitioner B… has been engaged in the activity of exploiting tourist apartments, being registered for such purpose with CAE 55123 "tourist apartments without restaurant" and covered under the normal regime of quarterly periodicity in VAT and under the organised accounting regime, by election, for IRS purposes (Category B).

Under the terms of the aforementioned tourism exploitation assignment contract, it was established that the Petitioners would ensure tourism exploitation through the services of management entity DIP (D…) and, in accordance with the terms of the same contract (Clause 2.1 of Document 5), the management entity (D…) would exploit the tourist apartments of unit… identified above on account of their respective owners, providing them with all services necessary for the implementation of such exploitation (Clause 2.1 of Document 5).

The Petitioners acknowledged and accepted that during the entire duration of the Contract, they would not exploit, lease, or in any other manner make available the unit to third parties in exchange for payment, rent, remuneration, or any other means of payment (including non-pecuniary or gratuitous means), acknowledging and accepting that they would not disclose nor permit any other natural or legal person to disclose the unit as being, among others, available for occupation (Clause 3.8 of Document 5).

In turn, the management entity (D…) accepted its appointment as manager of the tourist apartment and, consequently, accepted to provide the services described in Section 2.2 throughout the duration of the Contract, specifically:

A. Administer the Tourism Exploitation Programme 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 Arranging Services of the Unit described in Section 6 (Clause 2.2 of the cited Document 5).

Within the scope of the aforementioned Tourism Exploitation Programme, the management entity (D…) was obligated to manage, on behalf of the Petitioners, the operational aspects (current management) inherent to the tourist exploitation of the apartment identified above, specifically handling the collection of payments due, realisation of expenses, management of reserves, determination of rates (cf. Clauses 3.1 to 3.13 of the cited Document 5), and was also responsible for general administration services of the unit (including accounting, sales and marketing, travel agency costs and/or concessions of tourist operators and respective incurred expenses, expenses with central services related to the Tourism Exploitation Programme and reception services expenses and other related expenses – Clause 4.1 of the cited Document 5), routine maintenance services that it freely considered necessary to maintain the unit appropriate for guest occupation – Clause 5.1 of Document 5 – and cleaning and arranging services of the unit – clause 6.1 of Document 5.

In return, the management entity (D…) had, under the terms of the said contract, the right to receive and retain 25% (twenty-five percent) of the Gross Revenue from Tourism Exploitation, or any other percentage that might be periodically agreed between the manager and the Petitioners (Clause 2.3 and Section 7 of the cited Document 5).

It fell to the Petitioners to carry out all operations not related to operational management of tourism exploitation, namely being responsible for all charges and expenses, pending or due, related to the Unit, including any taxes and charges levied by creditors or suppliers, payment of any operating expenses, condominium charges, management and reserve costs, all applicable insurance premiums, auditor fees, telephone accounts and other expenses, and all costs with basic services (electricity, water, gas) – Clause 4.4 of the cited Document 5.

It further fell to the Petitioners to maintain the unit in complete operational condition, whereby they acquired all equipment and furnishings for the Unit, equipping it with the Standard furniture package, which represented an expenditure of €55,660.00 (fifty-five thousand, six hundred and sixty euros), plus VAT at the applicable legal rate, which was exclusively supported and paid by the Petitioners at the date of contract execution (Clause 3.12 of Document 5).

The manager (D…) was obligated to provide a monthly account report to the Petitioners within a period of 15 (fifteen) days from the end of the month in question, in addition to an annual audited account report of the Petitioners' account identifying, for the previous calendar year, all revenues from tourism exploitation of all units participating in the Programme, the manager's remuneration, net tourism exploitation revenue, the Petitioners' remuneration, and all other expenses and charges for which the Petitioners were responsible, made available in accordance with the terms of the Contract (Clauses 11.1 and 11.2 of Document 5).

From this framework, the Petitioners draw the conclusion that the activity of exploiting the tourist apartments was conducted by their respective owners, with no transfer of "business risk" to the management entity (D…) nor this entity participating in the exploitative activity with its own interest.

The Petitioners were subject to a tax inspection procedure, directed at analysing income declared for IRS purposes with reference to the years 2012, 2013 and 2014, in compliance with Service Orders nos. 012016…, 012016… and 012016…, dated 17 August 2016, with the Petitioners being notified of the respective Inspection Report Draft (Document 8 attached with the arbitral opinion request) in which the following corrections to declared income were proposed:

• €68,865.45 for the year 2012;
• €34,427.69 for the year 2013;
• €57,424.15 for the year 2014.

Within the scope of the aforementioned Inspection Report Draft, the Tax Inspection Services sustained that the income derived solely from the provision of an immovable property to third parties, and that the owners had no intervention in obtaining the licensing, whereby the income which the taxpayer derived in 2012, 2013 and 2014 was derived in a merely passive manner, as a result of the pursuit of a commercial activity by D…, and therefore should be classified as income of Category F in the sphere of the taxpayer. Although the taxpayer bore all operating expenses of the tourism exploitation programme, part of such charges are not susceptible to being deducted from Category F income and for that reason should be disregarded.

Notwithstanding the response presented in the prior hearing, the Petitioners were notified of the Final Inspection Report, in which the Tax Inspection Services maintained the corrections to taxable matter on the terms initially proposed, with the Petitioners subsequently being notified of the tax acts relating to the years 2012, 2013 and 2014, identified above and contested in the present proceedings.

Regarding the reasoning presented by the TA, the Petitioners first state that the same was unclear and incongruent. The TA understood that the conduct of the Petitioners, especially of Petitioner B…, is passive and for that reason the income that they declared as being Category B income should instead be taxed as Category F income, in accordance with Circular no. 5/2013 of 2 July 2013, which the Petitioners question to the extent that, being holders of the exploitation of the tourist apartment and having assigned exploitation thereof to D…, they nonetheless maintain, in their sphere, the risk of exploitation, not understanding how the TA can understand that they exercise tourism exploitation in a passive manner.

They further understand that taxation under the provisions of subparagraph a) of paragraph 1 of article 3 of the Corporate Income Tax Code and subparagraph h) of paragraph 1 of article 4 of the same diploma does not condition taxation under the said category on the alleged active or passive exercise of the activity.

They therefore maintain that the Tax Inspection Services, by not sustaining in the Conclusions of the Final Tax Inspection Report, in a clear and unequivocal manner, the facts on which they based their conclusion that the income derived by the Petitioners was Category F income, did not comply with the legal duty, constitutionally enshrined, of express, clear and comprehensive reasoning of the decisions bearing upon them, and therefore the contested tax acts should be annulled.

They further understand that the Tax Inspection Services fail to meet the burden of proof of the verification of their respective indicia or assumptions of taxation which falls upon them, under paragraph 1 of article 74 of the LGT, that is, the legal assumptions of their actions in face of the legal presumption of truthfulness of the taxpayers' declarations (article 75 of the LGT), when the judgment underlying the disregard of the operations results from conclusions of a generic character, without a case-by-case analysis of the Petitioners' activity.

As to the substance of the matter, they argue that it is settled jurisprudence that "whenever there exists an increase in value accruing to a patrimony by virtue of the exercise of an economic activity (even if expressed in a single act) translated into the creation of an economic utility, resulting from any relation of the contributing agent with a third party in which, satisfying the economic needs of the latter, the patrimony of the former is increased (mediation between supply and demand) there will be a commercial activity" (Decision of the Supreme Administrative Court, of Proceeding no. 580/15, dated 24 February 2016). They further cite MANUEL FAUSTINO when the author sustains, by reference to successive amendments of the IRS Code, that "The legislator of the IRS Code sought to avoid the controversy by using a dual technique: on one hand, ceased to make reference to 'activities of commercial or industrial nature' to mention 'commercial or industrial activities'; and on the other hand, although not running the risks of a taxative enumeration, listed a large number of activities considered commercial and industrial, in which are included all those whose qualification could give rise to doubts. It may thus be said that the material criterion continues to be essentially an economic criterion and not a strictly legal criterion" (cf. IRS-Theory and Practice, Lisbon, Edifisco, 1993, p. 132).

They further cite other doctrine elements in the sense that it is manifest that all income derived within the scope of income-generating commercial activities are taxed under Category B, namely those resulting from hotel and similar activities, concluding that, for income to be imputable to income-generating business or professional activities, with the taxpayer registered with the respective CAE, it will only be necessary that the income derived be related to that activity, which occurs in the present case – being at issue income resulting from tourism exploitation, which is the activity exercised by Petitioner B…, they cannot be taxed as Category F income, completely disconnected from the said commercial activity exercised.

They add that, although the Tax Administration contends, in the course of tax inspection, for a restrictive interpretation of the concept of "activity", considering that for purposes of taxation under Category B only profits derived from direct exploitation of the Unit are admissible, the Petitioners understand that this interpretation finds no support in the literal wording of subparagraph a) of paragraph 1 of article 3 of the IRS Code, which is why all results obtained throughout the exercise attributable to the activity of exploitation of tourist undertaking should be considered, whether such results derive from direct exploitation or from sub-contracting of an entity to exploit the unit. Under subparagraph a) of paragraph 1 of article 3 of the IRS Code, having the legislator used the term "activity" without restrictively delimiting its extension, it is evident that they intended to include all income obtained, in whatever manner, from direct exploitation or through the contracting of services to realise the income in question.

They therefore understand that "activity" for purposes of taxation under Category B should not be limited – because the legislator did not do so – to the consideration of operational activity, excluding holders who obtain income as a consequence of the assignment of exploitation and consequent contracting of services, as occurred in the present case. For that reason, the income in question allocated to the tourism exploitation activity exercised by the Petitioners should be taxed under subparagraph a) of paragraph 1 of article 3 of the IRS Code.

Finally, the Petitioners stress that, although the Tax Inspection Services requalified the Petitioners' income based on the understanding contained in Circular no. 5/2013 of 02-07-2013, this administrative guidance only binds the organs of the Tax Administration and is not considered a source of tax law, whereby it has no external binding efficacy of its own, not even being subject to publication, whereby taxpayers are in no way obliged to comply with the provisions thereof, nor are courts.

The Petitioners question what they allege to be the duplicity of criteria of the TA regarding the characterization and taxation of tourism exploitation and local accommodation situations, to the extent that, under the terms of Circular Letter no. 20180, the TA understood that income derived from exploitation assignment obtained by the Assigning Party (Owner and initial exploitation holder) were always taxed under Category B of IRS. They maintain that the TA is treating two similar situations differently, since in each case the owners, having opened activity under Category B of IRS and being holders of the right of tourism exploitation, assigned that right of exploitation to third parties, which manifestly constitutes a violation of the constitutional principle of equality, whereby also for this reason the tax acts are shown to be illegal.

Finally, even if it were admitted that the income obtained by the Petitioners is effectively Category F income of the IRS Code, the reality is that the taxable matter of the Petitioner would never be in the amount determined by the Tax Inspection Services in the course of tax inspection, and should be understood as deductible expenses to Category F IRS income the maintenance and conservation expenses relating to cleaning staff, gardener's salary, electricity, water and gas, costs with house rental with equipment, repairs and painting, insurance premiums and costs of property administration.

Under paragraph 1 of article 41 of the IRS Code, in the version in force at the date of the facts, "From the gross income referred to in article 8, shall be deducted, for each immovable property or part thereof, all expenses actually incurred and paid by the taxpayer to obtain or guarantee such income, with the exception of expenses of a financial nature, those relating to depreciation and those relating to furniture, appliances and articles of comfort or decoration". Thus, in addition to expenses inherent to insurance, remuneration of D… and security, should also be accounted for the costs relating to cleaning staff, gardener's salary, electricity, water and gas, expenses with repairs and painting, which will be determined finally in the course of execution.

In Response, the TA sustained the following understanding:

Regarding the lack of reasoning, the TA understands that, from reading the inspection report, an average person, placed in the position of recipient, is able to grasp its sense and conclusion. The jurisprudence of the Supreme Administrative Court (STA) has uniformly understood that the reasoning of the act is a relative concept that varies according to the type of act and the circumstances of the concrete case, being considered that there is sufficient reasoning 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 may know the reasons that led the author of the act to decide in that manner and not another.

In the case at hand, the reasoning is sufficiently clear and unequivocal, all the more so as the Petitioner, via the present arbitral opinion request, not only demonstrates, in light of the arguments explained throughout their submission, to have fully understood the factual and legal framework on which the Respondent's decision was based, since they attempt to rebut, point by point, all of its conduct, but in reality had also fully understood the same factual and legal framework at the prior hearing.

Regarding the substance of the matter:

Regarding the Petitioners' allegation that the law does not distinguish the manner in which income is derived, they understand that this does not correspond to the truth, inasmuch as the law expressly refers that income derived from the exercise of any commercial activity is understood as business income. The use of the word "exercise" in the wording given to the rule, as opposed to the words used in article 8 of the CIRS, to define what are Category F income, has underlying the performance of acts with a determined purpose which, in this case, will be that of obtaining profit.

They emphasise the jurisprudence of the STA in the sense that in the Decision of the STA rendered in proceeding 01622/15, on 11.01.2017, it is sustained that:

"[…] the concept of commercial or industrial activity is to be determined by the economic concept of commercial or industrial activity, which encompasses activities of mediation between supply and demand and activity of incorporation of new utilities in matter, in both cases with speculative ends, that is, with the objective of obtaining profits. But the IRS Code, in its article three, does not use only the concept of commercial or industrial activity, as the Industrial Contribution Code did before, also using the concept of business and professional income, of which those obtained in the exercise of a commercial or industrial activity are one of those possible to obtain there framing", and further that "[…] To the concept of the exercise of a business activity, not defined in tax legislation, is necessarily linked the idea of stable or habitual exercise of a commercial activity as a means of livelihood, even if without perfect continuity, as occurs with activities that, by their very nature, can only be exercised at certain times or from time to time, not ceasing, for that reason, to constitute, still, a normal and regular performance of one or more commercial or industrial activities. Furthermore, the profit motive must be directly associated with the acts that qualify or identify the profession in question, not sufficing that such profit motive may be a merely accessory end of that practice. The profit motive is the principal, if not sole, mobile of all business activity and its absence or existence in merely accessory form allows one to foresee that we are not dealing with a business activity. […] The inclusion of business income in Category B of IRS requires the elimination of the possibility of grouping in other categories of income. But business income, to exist, under the terms of the provisions of art. 4, para. 1 CIRS, relate to the exercise of true activities, whereby they cannot constitute income of a commercial or industrial nature the acts of management of a private patrimony."

To contend, as the Petitioners do in the arbitral opinion request, that the fact that notification of commencement of activity had been declared, affirming the intention to exercise a tourism exploitation activity (when, in fact, nothing more was done beyond acquiring an immovable property), should be valued as sufficient for the qualification of the income as imputable to Category B, when thereafter, in fact, the declared activity is not exercised, would be to give primacy to form over substance, contrary to the most elementary principles of tax law.

The mere act of purchase of an immovable property and its consequent and immediate assignment 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 activity of exploitation of an immovable property by the person who assigned the exploitation, as, erroneously, the Petitioners contend.

Regarding the content of Circular Letter 20180, the TA states that "With the entry into force of Law no. 82-E/2014, of 31 December, […], the possibility was provided for taxpayers to opt for the taxation of property income under the terms and rules applicable to business and professional income (Category B)." and that, on the other hand, as of the publication of Decree-Law 128/14 of 28.08, the activity of local accommodation became regulated, that is, we are dealing with realities that did not exist in the years at issue in the inspection procedures under analysis. In any event, the income is classified as Category F, with the law alone (not the circular letter) granting the possibility for taxpayers to opt for the form of taxation, with the caveat that the option for the rules of Category B implies the necessary allocation of the totality of the immovable properties to rental.

From reading the exploitation assignment contract, it results clearly that the Petitioners never assume the functions of those responsible for the exploitation of the accommodation, such functions being assumed by the Manager in its different aspects. By way of mere example, see clauses 3.3, 3.4 or 3.5, in which it is defined that it is the Manager who develops efforts in the sense of exploiting the immovable property for tourism, who is responsible for all expenses relating to the collection of payments and/or eviction and who holds the exclusivity to exploit the immovable property according to the rates it freely fixes. It thus results evident that the Petitioners do not carry out, nor can carry out, any action of free use and utilisation of the immovable property of which they are mere owners.

Regarding the pretension, by the Petitioners, that the totality of expenses with staff salaries, cleaning, electricity, gas and water be accepted, as these were not accepted in the analysis conducted in the inspection procedure, the TA states the following: under the terms of article 41, para. 1 of the IRS Code, in the version in force at the date of the facts, "From the gross income referred to in article 8, shall be deducted the maintenance and conservation expenses incumbent on the taxpayer, incurred and supported by them and found to be documented proof, as well as the municipal tax on immovable properties and the stamp tax which falls on the value of immovable properties or part thereof whose income is subject to taxation in the tax year." (Wording given by Law no. 66-B/2012, of 31 December).

Making appeal here to the Decision of the Central Administrative Court South rendered in proceeding 05310/12, on 15.12.2016, we have:

"[…] Not defining the CIRS the concept of 'conservation expenses', the civil notion contained in the Urban Rental Regime-RAU (approved by Decree-Law no. 321-B/90, of 15 October) should apply here regarding the definition of conservation works and the determination of which are incumbent on the lessor. Under the heading 'Types of works', article 11 of the RAU prescribes:

'1 – In urban immovable properties, and for the purposes of this diploma, 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 immovable property and its dependencies;

b) Works imposed by the Public Administration, under the terms of applicable general or local law, and which aim to confer on the immovable property the characteristics presented when the utilisation licence was granted;

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

3 – Extraordinary conservation works are those occasioned by construction defect of the immovable property or by accident or force majeure, and, in general, those which, not being imputable to unlawful acts or omissions perpetrated by the lessor, 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 preceding paragraphs.'

Recalling, for this purpose, the Decision of the Supreme Administrative Court of 06.07.2016, rendered in proceeding no. 088/16, where, among other things, may be read: 'Maintenance and conservation expenses shall be expenses that are necessary to the conservation and maintenance of immovable properties that are generators of income. They may be, as previously defined in the Urban Rental Regime, art. 11, expenses incurred with ordinary conservation works – repair and general cleaning of the immovable property, works imposed by the Public Administration, and, in general, those intended to maintain the immovable property in the conditions required by the purpose of the contract and existing at the date of its execution; extraordinary conservation works – repair of construction defects of the immovable property or supervenient; or even improvement of the immovable property, but always with repercussion on the immovable property and on its susceptibility to generate income.' (available in full text at www.dgsi.pt).

By means of these concepts, they conclude that the expenses mentioned by the Petitioners do not constitute conservation or, indeed, maintenance expenses. On the other hand, regarding the expenses with staff salaries and cleaning, it results from sections 5 and 6 of the exploitation assignment contract that such charges are the responsibility of the Manager, which means that they are not the responsibility of the Petitioners, here as lessors.

Subsequent Terms:

The Petitioner came to request the holding of a hearing for the production of witness evidence, requesting the annulment of the arbitral order that determined the non-holding of the meeting provided for in article 18 of the RJAT, on the basis that the matter under discussion in the present case is a matter of legal qualification of the factual situations, these being well clarified by the documents presented and elements contained in the procedural pieces.

The Tribunal maintained the understanding that the holding of a hearing for the production of witness evidence constitutes a dispensable act in the present proceeding, given the aspects indicated above, that is, the fact that this is a discussion about a matter of law and the fact that the relevant factual elements for the decision have already been brought into the proceeding through documents attached, from the administrative proceeding and the clarifications made by the Parties in the respective procedural pieces.

The Parties presented written submissions, with the Petitioner again raising this issue, stating that there would be a violation of the principles of contradictory proceedings and equality between the Parties. An additional clarification is thus required.

The Petitioners state that "the production of additional evidence appeared to be essential so that the Petitioner woman could demonstrate that her conduct was always in line with the information transmitted to her by the various organs of the tax administration and that, as such, not all the requirements were filled for the TA to be able to operate the requalification of the income derived by her (...)." Now, with all due respect, such evidence would have no relevance to the decision on the substantive question in the present proceeding, which is, it is repeated, a question of qualification of income for purposes of its subjection to a specific set of taxation rules.

Thus, the tribunal maintains the understanding already previously transmitted to the Parties on this matter.

II. PRELIMINARY PROCEEDINGS

1. The Tribunal is competent and is regularly constituted, in accordance with articles 2, para. 1, subparagraph a), 5 and 6, all of the RJAT.

2. The parties have procedural personality and capacity, are legitimate and are legally represented, in accordance with articles 4 and 10 of the RJAT and article 1 of Ordinance no. 112-A/2011, of 22 March.

3. The proceeding does not suffer from vices that invalidate it.

4. The cumulation of claims is admissible in accordance with the provisions of article 3, para. 1, of the RJAT.

III. MATTERS OF FACT

Before proceeding to the appraisal of the questions of law, it is necessary to present the factual matter relevant to its understanding and decision, which, having examined the documentary evidence and the administrative proceeding (AP) attached to the record and having further taken into account the facts alleged, is established as follows:

III.1. Proven Facts

• On 2016.08.17, Inspection Order no. OI2016…/…/… was opened, determined by order of the Director of Finance of Faro, with a view to the control of rental of immovable properties, and had partial scope in IRS, as provided in subparagraph b) of para. 1 of article 14 of the Complementary Regime of Tax and Customs Inspection Procedures (RCPITA), with extension to the years 2012, 2013 and 2014.

• As a result of the said action, corrections to taxable IRS income are determined, of a merely arithmetic nature, in the amounts of €68,865.45, €34,427.69 and €57,424.15 in the years 2012, 2013 and 2014 respectively, deriving from rental income related to immovable properties located in national territory.

• Thus, the tax income of Category F of IRS was determined, in the amounts of €17,202.14, €38,975.47 and €67,294.52 in the years 2012, 2013 and 2014 respectively, which gave rise to the syndicated assessments.

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

• Petitioner B… NIF …, is registered for the exercise of the activity "Tourist apartments without restaurant" CAE 55123 from 2012-03-06, being covered under the normal regime of quarterly periodicity in VAT and under the organised accounting regime, by election, in IRS.

• The Petitioners are non-resident taxpayers in national territory and in accordance with the IT system of the TA, have as their representative, tax representative E…, NIF….

• The Petitioners are owners of an immovable property registered in the urban real estate register of the Parish Union of … and … under article no. … fraction "G", Apartment … and article no. …, fraction "E", apartment …, located at "…", which they acquired from C… SA NIPC….

• Petitioner A…, NIF… is the owner of the other ½ two (2) immovable properties registered in the urban real estate register of the Parish Union of … and … under article no. … fraction "G", Apartment … and article no. …, fraction "E", apartment …, not being subject to any commercial, industrial or service provision activity.

• On 26 April 2007, the Petitioners executed a promise of sale and purchase contract with company C… S.A. (NIPC…), hereinafter designated as "C…", having as its object an immovable property designated "Apartment…", registered in the urban real estate register of the Parish Union of … and … under article …, letter G, located in the development "Apartments…".

• On the same date, the Petitioners executed with C…, S.A. a tourism exploitation assignment contract for the unit… identified above, reserving to it the right to appoint a management entity, which was later realised with the establishment of company D... S.A., NIPC … (hereinafter "D…") (cf. Clause 2.1 of Document 5 attached with the arbitral opinion request).

• Since 6 March 2012, Petitioner B… has been engaged in the activity of exploiting tourist apartments, being registered for such purpose with CAE 55123 "tourist apartments without restaurant" and covered under the normal regime of quarterly periodicity in VAT and under the organised accounting regime, by election, for IRS purposes (Category B).

• Under the terms of the said tourism exploitation assignment contract, it was established that the Petitioners would ensure tourism exploitation through the services of management entity DIP (D…) and, in accordance with the terms of the same contract (Clause 2.1 of Document 5).

• The management entity (D…) was entrusted with exploiting the tourist apartments of the unit… identified above on account of their respective owners, providing them with all services necessary for the implementation of such exploitation (Clause 2.1 of Document 5).

• The Petitioners accepted that during the entire duration of the Contract, they would not exploit, lease, or in any other manner make available the unit to third parties in exchange for payment, rent, remuneration, or any other means of payment (including non-pecuniary or gratuitous means), acknowledging and accepting that they would not disclose nor permit any other natural or legal person to disclose the unit as being, among others, available for occupation (Clause 3.8 of Document 5).

• The management entity (D…) accepted its appointment as manager of the tourist apartment and, consequently, accepted to provide the services described in Section 2.2 throughout the duration of the Contract, specifically:

  • Administer the Tourism Exploitation Programme described in Section 3;
  • Provide the Property Administration Services described in Section 4;
  • Provide the Property Maintenance Services described in Section 5; and
  • Provide the Cleaning and Arranging Services of the Unit described in Section 6 (Clause 2.2 of the cited Document 5).

• Within the scope of the said Tourism Exploitation Programme, the management entity (D…) was obligated to manage, on behalf of the Petitioners, the operational aspects (current management) inherent to the tourism exploitation of the apartment identified above, specifically handling the collection of payments due, realisation of expenses, management of reserves, determination of rates (cf. Clauses 3.1 to 3.13 of the cited Document 5), and was also responsible for general administration services of the unit (including accounting, sales and marketing, travel agency costs and/or concessions of tourist operators and respective incurred expenses, expenses with central services related to the Tourism Exploitation Programme and reception services expenses and other related expenses – Clause 4.1 of the cited Document 5), routine maintenance services that it freely considered necessary to maintain the unit appropriate for guest occupation – Clause 5.1 of Document 5 – and cleaning and arranging services of the unit – clause 6.1 of Document 5.

• In return, the management entity (D…) had, under the terms of the said contract, the right to receive and retain 25% (twenty-five percent) of the Gross Revenue from Tourism Exploitation, or any other percentage that might be periodically agreed between the manager and the Petitioners (Clause 2.3 and Section 7 of the cited Document 5).

• It fell to the Petitioners to carry out all operations not related to operational management of tourism exploitation, namely being responsible for all charges and expenses, pending or due, related to the Unit, including any taxes and charges levied by creditors or suppliers, payment of any operating expenses, condominium charges, management and reserve costs, all applicable insurance premiums, auditor fees, telephone accounts and other expenses, and all costs with basic services (electricity, water, gas) – Clause 4.4 of the cited Document 5).

• It further fell to the Petitioners to maintain the unit in complete operational condition, having acquired all equipment and furnishings for the Unit, equipping it with the Standard furniture package, which represented an expenditure of €55,660.00 (fifty-five thousand, six hundred and sixty euros), plus VAT at the applicable legal rate, which was exclusively supported and paid by the Petitioners at the date of contract execution (Clause 3.12 of Document 5).

• The manager (D…) was obligated to provide a monthly account report to the Petitioners within a period of 15 (fifteen) days from the end of the month in question, in addition to an annual audited account report of the Petitioners' account identifying, for the previous calendar year, all revenues from tourism exploitation of all units participating in the Programme, the manager's remuneration, net tourism exploitation revenue, the Petitioners' remuneration, and all other expenses and charges for which the Petitioners were responsible, made available in accordance with the terms of the Contract (Clauses 11.1 and 11.2 of Document 5).

III.2. Unproven Facts

There are no factual matters relevant to the decision that have been found unproven.

IV. THEMA DECIDENDUM

Having fixed the relevant factual matters, it is verified that the present proceeding concerns exclusively a matter of law, and this Tribunal, based on the provisions of para. 2 of article 608 of the Code of Civil Procedure, applicable pursuant to article 29, para. 1, subparagraph e), of the RJAT, must appraise and decide the following questions:

a) To determine whether the Tax Inspection Report and the assessment acts practised on the basis thereof and here contested are affected by the defect of lack or insufficiency of reasoning;

b) To know whether the income derived by the Petitioners constitutes income of Category B of IRS or Category F of IRS;

c) In case of dismissal of the principal claim, to know whether the contested assessment acts are affected by partial illegality by virtue of the non-acceptance, by the TA, of the deduction, under Category F, of all expenses incurred by the Petitioners with the immovable property generating the income in question;

d) In case of allowance of the claim, to know whether the Petitioners are entitled to payment, by the TA, of indemnificatory interest.

V. LEGAL REASONING

On the Duty of Reasoning of Acts in Tax Law Matters

Regarding the duty of reasoning of acts in the matter of tax law, the jurisprudence of the STA is already sufficiently clear, and there is no need for lengthy explanations on the subject. Thus, see the Decision of the Supreme Administrative Court (STA) of 11-11-1998, rendered in the context of proceeding no. 31339, in which that court clarifies that "(…) the duty of reasoning requires that a normal recipient, placed in the position of the appellant, in the face of the express tenor of the act, be able to grasp the logical-legal path followed by the respondent authority to reach such a decision, in order to be able to determine itself, consciously, in the sense of whether or not to appeal".

Further, the STA, in its decision of 13-04-2000, rendered in the context of appeal no. 31.616, emphasises that the density of reasoning may vary "according to the legal type of act and its circumstances", considering acceptable "a less dense reasoning of certain types of acts, being considered sufficient such reasoning as long as it corresponds to a minimum limit that does not mischaracterise it, that is, the "quantum" indispensable to compliance with the minimum requirements of formal reasoning is guaranteed: the revelation of the existence of reflection and the indication of the main reasons that moved the agent".

In the case at hand, the reasoning of the Tax Inspection Report on which the contested assessments are based presents itself as sufficiently clear and unequivocal, permitting a normal recipient to know the logical-legal path in question and understand the reasons which led to the decision: so much so is it true that the Petitioners, both in the course of the administrative proceeding and already in the course of the arbitral proceeding, demonstrated that they had perfectly understood the TA's decisional iter, including contesting it in various ways. Naturally, disagreement with the reasoning sustained by the TA is not sufficient to attribute to the acts practised by it the defect of lack of reasoning alleged, which is thus found to be unproven.

On the Qualification of the Income in Question

Regarding the qualification of the income in question, under the terms of subparagraph a) of para. 1 of article 3 of the Code of Personal Income Tax (CIRS), relating to income of Category B, "business and professional income is considered as […] a) That deriving from the exercise of any commercial, industrial, agricultural, forestry or livestock activity […]". The legislator lists, by way of example, in para. 1 of article 4 of the CIRS, various activities considered commercial and industrial, being among them "hotel and similar activities, catering and beverages, as well as the sale or exploitation of the real right of periodic dwelling" [subparagraph h)].

As to Category F income, article 8 of the CIRS provided, in the version applicable at the date of the facts, the following:

"1 – Property income is considered to be the rents of rural, urban and mixed immovable properties paid or made available to their respective holders.

2 – Are considered as rents:

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

b) The amounts relating to the rental of machinery and furniture installed in the leased immovable property; […]"

The qualification of the income in question as income of Category B or F, having in view that we are dealing with a case of utilisation of an immovable property for the generation of income, hinges on knowing whether that income derives from the exercise of a commercial activity (as the Petitioners allege) or whether, differently, it results from the mere assignment of the immovable property (as the Respondent maintains). It appears to us, in fact, that, being a case in which income is generated from an element which is an immovable property, the only circumstance, having regard to the manner in which the legislator configured both forms of income in the IRS Code, which could determine the distinction is precisely the distinction in the manner in which that income is generated – whether through the realisation of a commercial activity, whether through the assignment of the immovable property. In other words, it is important to determine what is remunerated through the taxable income – whether the realisation of an activity of pursuit of profit through the performance of acts intended to promote commercialisation, that is, the sale of services related to the said immovable property, to third parties; whether the simple making available of the immovable property to third parties.

In the case at hand, under the terms of the contract executed by the Petitioners referred to above in the matters of fact, tourism exploitation, that is, the exploitation of the immovable property with a view to the pursuit, therein, of a tourism activity, fell to another entity other than the Petitioners, which acquired the legitimacy to pursue that activity in an immovable property which belonged to the Petitioners by virtue of their will contained in the said tourism exploitation assignment contract.

Thus, the tourism exploitation of the immovable property fraction of which the Petitioners are owners, in the years in question, was ensured by the entity to which they assigned the right of tourism exploitation, with the Petitioners limiting themselves to assigning the immovable property fraction for exploitation, whereby the income that they derived has the nature of rents, as these are defined in subparagraph a) of para. 2 of article 8 of the CIRS, constituting property income (as results from para. 1 of article 8 of the CIRS), classifiable under Category F of income.

For this conclusion, it is irrelevant that the Petitioners are registered for the exercise of commercial activities, designedly that referred to as "tourist apartments without restaurant", just as it is irrelevant the VAT regime in which they are covered. Also irrelevant to the case is the profit motive that may have motivated the Petitioners in the acquisition of the immovable property fraction of the tourism undertaking, nor does it matter that the Petitioners may have, eventually, some organisation for the development of commercial activities in which they are registered for tax purposes.

We thus follow the jurisprudence of the Central Administrative Court North (cf. the decision of 20/01/2005, in the context of proceeding no. 00325/04, reported by Judge Valente Torrão) in accordance with which: "(…) the assignment of exploitation or concession of exploitation of the commercial establishment, also known as leasing of a commercial establishment, is a juridical transaction by means of which the holder of the establishment provides to another, temporarily and in return for remuneration, the enjoyment and use of the establishment, considered as a juridical and economic unity, that is, an economic – juridical organisation of all the elements that make it up, affected to the realisation of a determined mercantile or industrial activity".

(…) by assigning the exploitation of the establishments they obtained property income classifiable as Category F income (…) in fact, the appellant did not come to exercise commercial or industrial activity in the premises in question, whereby the situation is comparable to that of a mere private individual who derived income subject to IRS.

The fact of having acquired and equipped certain installations intended for commerce does not constitute in itself a commercial or industrial activity, but rather being comparable to a financial application which, subsequently, resulted in the receipt of a determined amount for the rental of the premises".

On the Non-Acceptance of Expenses for Purposes of Their Deduction to Taxable Income under Category F

Regarding the non-acceptance of expenses for purposes of their deduction to taxable income under Category F, designedly regarding the costs incurred with the maintenance and conservation of the immovable property, para. 1 of article 41 of the CIRS, in the version in force at the date of the facts which occurred in 2013 and 2014, provided that, "From the gross income referred to in article 8, shall be deducted the maintenance and conservation expenses incumbent on the taxpayer, incurred and supported by him and found to be documented proof, as well as the municipal tax on immovable properties and the stamp tax which falls on the value of immovable properties or part thereof whose income is subject to taxation in the tax year" (Wording given by Law no. 66-B/2012, of 31 December)[1]. Thus, it becomes necessary to determine whether the expenses which the Petitioners sought to deduct and which the TA did not consider deductible constitute maintenance and conservation expenses incumbent on the taxpayer.

It follows from para. 2 of the cited article that it is important to proceed to the distinction between maintenance, conservation and operation expenses, with only the former being deductible (provided that they are actually incurred and documented), and excluding the possibility of deduction of operation expenses (running expenses), as results from the provisions of para. 1 of article 41 of the CIRS.

In accordance with the STA (cf. the decision of 06-07-2016, rendered in the context of proceeding 088/16), "maintenance and conservation expenses shall be expenses that are necessary to the conservation and maintenance of immovable properties that are generators of income. They may be, as previously defined in the Urban Rental Regime, art. 11, expenses incurred with ordinary conservation works – repair and general cleaning of the immovable property, works imposed by the Public Administration, and, in general, those intended to maintain the immovable property in the conditions required by the purpose of the contract and existing at the date of its execution; extraordinary conservation works – repair of construction defects of the immovable property or supervenient; or even improvement of the immovable property, but always with repercussion on the immovable property and on its susceptibility to generate income."

It is thus considered excluded from the concepts of maintenance and conservation the expenses relating to consumption of electricity, water and gas (considered, under the terms of the tourism exploitation assignment contract, as "direct expenses of the unit") which cannot, in light of the provisions of para. 1 of article 41 of the CIRS, be deducted from gross Category F income, contrary to what the Petitioners contend.

Regarding the other expenses about which there is disagreement in the case sub judice – expenses with cleaning and gardening staff, repairs and painting – these are included in the concept of maintenance and conservation expenses, remaining only to know whether, in light of what was agreed between the parties in the tourism exploitation assignment contract, it fell to the Petitioners to bear them. Under the agreed terms, the expenses with cleaning staff (clause 6 of the contract) and gardening (clause 5.5), repairs (clause 5.3) and painting (clause 5.4), are included in the services which must be provided by the Manager, and for which this party is remunerated, as results from clauses 2.2 and 2.3 and 7 of the tourism exploitation assignment contract, whereby they cannot be deducted by the Petitioners-owners.

The deductible cost is, thus, the cost corresponding to the remuneration paid to the Manager, which is not contested by the Petitioners, and the claim of the Petitioners for the consideration, for purposes of deduction from Category F income of the IRS, of expenses with staff salaries (cleaning and gardening), electricity, gas, water, painting and repairs relating to the years 2012, 2013 and 2014, is not well founded.

Indemnificatory Interest

Para. 1 of article 43 of the LGT provides that indemnificatory interest is due "[…] when it is determined […] that there was an error imputable to the services from which results the payment of the tax debt in an amount greater than that legally due." Having this Tribunal concluded that the contested acts do not suffer from any defect, and that, therefore, there is no error that can be imputed to the services of the TA, the Petitioners do not have the right to the reimbursement of the amounts of tax paid nor to indemnificatory interest.

VI. DECISION

In accordance with that set out above, it is decided:

• To judge the claim for annulment of the tax acts impugned, relating to the financial years 2012, 2013 and 2014, as not well founded, and consequently, to deny the claim for restitution of the tax paid;

• To judge the claim for payment of indemnificatory interest as not well founded;

• To order the Petitioners to bear the applicable procedural costs.

Value: in accordance with the provisions of para. 2 of art. 315 of the CPC, combined with subparagraph a) of para. 1 of art. 97-A of the CPPT and with para. 2 of art. 3 of the Regulation of Costs in Tax Arbitration Proceedings, the value of the proceeding is fixed at €31,486.57 (thirty-one thousand, four hundred and eighty-six euros and fifty-seven cents).

Costs: in accordance with the provisions of article 22, para. 4, of the RJAT and in accordance with Table I appended to the Regulation of Costs in Tax Arbitration Proceedings, the amount of costs is fixed at €1,836.00, to be borne by the Petitioners under the terms of articles 12, para. 2, and 22, para. 4, both of the RJAT, and article 4, para. 4, of the cited Regulation.

Let it be registered and notified.

Lisbon, 16 January 2018

The Arbitrator,

Raquel Franco

Text prepared by computer, in accordance with article 131, para. 5 of the Code of Civil Procedure, applicable by reference of article 29, para. 1, subparagraph e) of the RJAT.

[1] The legal provision transcribed does not diverge significantly from the wording in force for the year 2012. In both cases, the deductibility is made to depend on the following legal assumptions:

• They constitute maintenance expenses;

• They are incumbent on the taxpayer;

• They are actually incurred and documented.