VAT Deduction Rights & Refund Timeliness: Municipality Challenges Additional Assessment (CAAD 28/2017-T)

ARBITRAL DECISION

The arbitrators José Poças Falcão (presiding arbitrator), João Taborda da Gama and Júlio Tormenta (member arbitrators), designated by the Deontological Council of the Administrative Arbitration Centre to form the Arbitral Tribunal, constituted on 21-03-2017, agree as follows:

REPORT

"Municipality A…", holder of NIPC…, with headquarters in …, … – … … (hereinafter referred to only as "Municipality" or "Claimant"), with headquarters in …, comes, pursuant to the provisions of paragraph a) of Article 2(1), and Article 10(2), both of Decree-Law No. 10/2011, of 20 January, which approves the Legal Regime for Arbitration in Tax Matters ("RJAT"), combined with the provisions of Articles 1 and 2 of Ordinance No. 112-A/2011, of 22 March, to file a request for constitution of an Arbitral Tribunal for arbitral pronouncement on the declaration of illegality of the tax act of additional VAT assessment No.…, in the amount of € 105,336.65 (cf. Document 1 attached to the Initial Petition[1]), issued following the Tax Inspection Report of 17 December 2015 concerning the service orders OI2015…, OI2015… and OI201… of general scope relating to the fiscal years 2012, 2013 and 2014 (cf. Document 2 attached to the IP).

The request for constitution of the Arbitral Tribunal was filed on 5-1-2017 and accepted by the President of CAAD, being automatically notified to the Respondent on 20-1-2017 (hereinafter referred to as "TA" – Tax Authority).

Pursuant to the provisions of paragraph a) of Article 6(2) and paragraph b) of Article 11(1) of the RJAT, in the wording introduced by Article 228 of Law No. 66-B/2012, of 31 December, the Deontological Council designated as arbitrators of the collective Arbitral Tribunal Judge José Poças Falcão, Dr. João Taborda da Gama and Dr. Júlio Tormenta, who communicated acceptance of the assignment within the applicable period.

Thus, in accordance with the provisions of paragraph c) of Article 11(1) of the RJAT, in the wording introduced by Article 228 of Law No. 66-B/2012, of 31 December, the collective Arbitral Tribunal was constituted on 21-03-2017.

To support its request, the Claimant alleges, in summary:

• Invalidity of the tax act of additional VAT assessment No. … (cf. Document 1 attached to the IP), and, consequently, in derivative fashion, of the act dismissing the Gracious Complaint presented (cf. Document 3 attached to the IP);

• The aforementioned tax acts – additional assessment and dismissal of the gracious complaint by the TA – are tainted with illegality because they are based on incorrect factual and legal assumptions with respect to the exercise of the right to deduct the VAT incurred by the Claimant for the purposes of its activity, during the fiscal years 2012, 2013 and 2014, grossly restricting the exercise of such right and compromising the neutrality that constitutes the cornerstone of the discipline of such tax; consequently, it requests the annulment both of the act dismissing the gracious complaint and of the act of additional VAT assessment, and recognition of its right to deduct the amount of tax of € 105,336.65;

• The Claimant is a legal person in public law that provides different municipal services, under the terms of Decree-Law No. 305/2009, of 23 October; in the scope of its activity, the Claimant performs operations that do not confer the right to deduct VAT, either because they are performed within the scope of its powers of authority or because they fall within the scope of Article 9 of the Code of such tax, as well as operations that confer the right to deduct under general terms. In this context, the Claimant acquires resources that are allocated, simultaneously, to both types of operations described, i.e., operations that confer the right to deduct and operations that do not confer such right.

• The Claimant effected the deduction of VAT incurred in the acquisition of resources of mixed use, in the referred period, solely using the pro rata method;

• With respect to the deduction of tax concerning the acquisition of resources used exclusively in operations that confer the right to deduct – diesel oil used by the Municipalized Services of the Municipal Chamber of … (…) and the bungalows of … (camping park) – the Claimant used the direct allocation method (cf. Article 20 of the VAT Code[2]). With respect to resources allocated exclusively to activities that do not confer the right to deduct, the Claimant did not deduct any amount of VAT;

• Arising from a review of procedures, it ascertained that it was not adopting the correct VAT deduction methodology, having proceeded to rectify the same with respect to fiscal years 2012 and 2013 with effects in declarative terms in the periodic declaration relating to the period of December 2014;

• As a consequence of the review of procedures, the accounting information was organized by cost center, having determined a right to deduction greater than that which had been determined in fiscal years 2012 and 2013. Thus, with respect to resources of exclusive use of certain areas of activity of the Claimant (direct allocation method) that give rise to taxable operations, it determined an additional right to deduction in the amount of € 23,752.79, cf. Article 16 of the IP, and of € 4,236.41 (Building … - € 2,180.13; Municipal Stadium - € 2,056.28) through the real allocation method, cf. Article 17 of the IP. As for resources of mixed use (resources used simultaneously in operations that confer the right to deduct and operations that do not confer this right), the Claimant proceeded to determine a deduction percentage (i.e., pro rata), calculated on the basis of the turnover of economic activities, having determined an additional amount of tax to deduct of € 58,524.27, cf. Article 23 of the VAT Code;

• To operations not arising from the exercise of an economic activity, in the VAT perspective, and because the portion of resources allocated to the same is immaterial, the Claimant did not determine any specific criterion to determine the non-deductible VAT, as provided in paragraph a) of Article 23(1) of the VAT Code;

• Following the tax inspection carried out, the Claimant proceeded to determine the real allocation criterion in order to determine the degree of use of resources of mixed use allocated to economic activities and non-economic activities, in the VAT perspective. In this context, it thus determined a ratio of 1.824%, based on the number of hours spent by employees and the number of accounting records (cf. Document 4 attached to the IP) allocated to the referred non-economic activities, giving rise to an amount of non-deductible VAT of € 1,077.44 relating to non-economic activities for fiscal years 2012 and 2013;

• In declarative terms, the Claimant reported in field 40 of the periodic declaration relating to the fourth quarter of 2014 (201412T), filed on 13 February 2015, the amount of € 58,524.27[3] corresponding to the value of deductible VAT relating to resources of mixed use, relating to fiscal years 2012 and 2013 determined through the pro rata method calculated according to the new methodology resulting from the review of procedures, cf. Article 22 of the IP;

• Additionally, the Claimant reported in fields 20 to 24 of the periodic declaration for the fourth quarter of 2014 (201412T), filed on 13 February 2015, additional deductible VAT in the amount of € 27,989.20 corresponding to € 23,752.79, by application of the direct allocation method, and € 4,236.41, by application of the real allocation method, cf. Article 23 of the IP. In the referred periodic declaration for the fourth quarter of 2014 (201412T) a tax credit (VAT) was determined in the amount of € 105,336.65, and the Claimant requested reimbursement of the same, cf. Article 24 of the IP;

• Following the refund request, an inspection action was triggered by the TA, and the Tax Inspection Services concluded that the Claimant would not have the right to deduct in the manner in which it exercised it, having resulted in the determination of a tax credit in the amount of € 105,336.65. The Claimant was notified of the Draft Tax Inspection Report ("RIT"), transmitted by Letter No.…, of 13 November 2015, cf. Document 6 attached to the IP;

• Following the inspection action, the Claimant proceeded to review the VAT deduction methodology adopted only for the year 2014 and determined, in its favor, tax in the amount of € 70,481.94. From this amount, € 70,481.94, it deducted the amount of tax already determined in its favor in the previous quarters of 2014 in the amount of € 12,005.94, having determined an additional tax credit relating only to fiscal year 2014 of € 58,385.92, cf. Article 27 of the IP. Consequently, it filed a replacement periodic declaration relating to the fourth quarter of 2014 (201412T), having determined a total amount of tax credit of € 165,722.57. From this total balance of € 165,722.57, it maintained the request for refund of € 105,336.65 and reported the remaining amount - € 58,385.92 - for the following fiscal years, cf. Document attached 7 to the IP; in the replacement periodic declaration it assessed VAT in the amount of € 89.63[5] relating to a correction proposed by the Tax Inspection Services concerning free services in the amount of € 805.00, cf. Article 28 of the IP;

• The Claimant exercised the right to a hearing contesting the grounds used by the TA contained in the Draft RIT, cf. Document 8 attached to the IP. The TA maintained its position not accepting the arguments presented by the Claimant, maintaining the tax correction proposals presented in the Draft RIT and transmitted the RIT, cf. Document 2 attached to the IP and proceeded with the corresponding additional VAT assessments, cf. Article 30 of the IP;

• The total corrections proposed by the TA, in respect of VAT, relating to fiscal years 2012 to 2014 in the amount of € 169,345.67, cf. Article 32 of the IP, materialized in: demonstration of VAT assessment in the amount of € 61,285.21, additional VAT assessment in the amount of € 105,336.65 and assessment of default interest in the amount of € 8,708.42 corresponding to a total value of € 175,330.28, being the subject of arbitral pronouncement the additional assessment of € 105,336.65, cf. Article 33 of the IP;

• The Claimant alleges that, from a total value of corrections in the total amount of € 169,345.67, the total amount of VAT assessments effected totals € 166,621.86 (€ 105,336.65 + € 61,285.21), not having been notified of the VAT assessment in the amount of € 2,723.80 relating to a VAT correction with which it does not agree;

• In Articles 37 to 65 of the IP, the Claimant presents the grounds presented by the Tax Inspection Services for proceeding with corrections in the amount of € 169,345.67 relating to:

  • Pro rata for the years 2012 to 2014
  • Calculation of the definitive pro rata for 2011: regularization
  • Real allocation "Reception Centre …–…" – 2014
  • Free service provisions – deduction of VAT incurred

Pro rata for the Years 2012 to 2014

• With respect to the correction concerning the "Pro rata for the years 2012 to 2014", it alleges that the corrections contained in the RIT are not in conformity with Portuguese and European legislation;

• The Claimant alleges that the TA understands that with respect to the deduction of VAT incurred by the Claimant in resources of mixed use (resources simultaneously allocated to operations that confer the right to deduct and operations that do not confer that right), according to which the pro rata of deduction that the Claimant determined relating to costs allocated to economic operations and non-economic operations, in the VAT perspective, appears inadequate, since "(…) at this stage of the procedure for deducting the VAT contained in the inputs of common costs, the taxpayer should have proceeded to apply a real allocation criterion, as objective as possible, which would allow for the exclusion of the inherent non-deductible VAT from such common costs, which did not occur"; additionally, it states that according to the TA the real allocation criterion used by the Claimant to eliminate the amount of non-deductible VAT because it concerns operations not relevant for the purposes of the same, is inadequate "(…) since it did not take into account the totality of either the employees involved, or the accounting records associated, as the treatment and application of these amounts in practice and in the day-to-day of its activity must also be taken into account"; it also alleges that the TA contradicts what was previously stated when the same, with respect to the application of the real allocation criterion used by the Claimant, states that this incurred in an "(…) understandable error, as it will be impossible, in these cases, to determine exactly the number of hours spent by each of the totality of its employees in the totality of the non-subject activity carried out by the taxpayer. It is precisely for these cases that the law provides for the application of a percentage corresponding to the annual amount of operations that give rise to deduction (paragraph b) of Article 23(1) of the VAT Code)"; it also alleges that the TA understands that in the calculation of the pro rata of deduction referred to above the Claimant should have included in the denominator "(…) operations outside the scope of the tax because carried out within the scope of powers of authority (…)" and finally alleges that according to the TA the pro rata should amount to 2%, 1% and 1% for the years 2012, 2013 and 2014, respectively, when according to its view the pro rata to be used for the same years should be 23%, 17% and 16%, respectively, having for that reason the right to deduct € 32,366.18, € 26,158.09 and € 24,702.77, respectively, cf. Articles 67 and 68 of the IP;

• It carries out a prior framing in terms of Portuguese legislation through analysis of Article 23 of the VAT Code, alleging that, in accordance with paragraph a) of Article 23(1) of the referred article, the real allocation method should be applied with respect to resources allocated to economic and non-economic operations to determine the amount of deductible VAT; when faced with resources allocated to economic operations in the VAT sense, the pro rata method presents itself as the preferred method of VAT deduction, although another deduction method may be used on a subsidiary basis, to calculate the amount of deductible VAT, as results from the letter of the law combining paragraph b) of Article 23(1) and Article 23(2), both of the VAT Code; to support its position, it cites case law from the CJEU and administrative-tax doctrine reflected by the TA through Circular Letter No. 30103, of 23 April 2008, and Order No. 10101, of 21 June 2016, in response to a Request for Binding Information, cf. Articles 66 to 91 of the IP;

• It alleges that to know what degree of use of resources of mixed use that will be allocated to economic operations and non-economic operations, it will apply what is reflected in Article 23(1) of the VAT Code using the real allocation criterion. Thus, using easily verifiable documentary data: (i) the number of hours of workers allocated to the areas of subsidies (fund transfers from the Central Administration) and direct taxes collected by the Claimant in the exercise of its responsibilities against the total number of available hours of workers, and (ii) the number of accounting records relating to the operations mentioned in (i) against the total number of revenue records, it determined a ratio of 1.824%, which will serve as a reference for calculation to determine what percentage of use of resources (in this case, human resources) allocated to non-economic activities (in this case, area of subsidies and direct taxes), complying with the terms of Circular Letter No. 30103 (cf. Document 4 attached to the IP) taking as reference year the year 2014;

• It does not understand why the TA came in the Gracious Complaint procedure to argue that the chosen criterion is inadequate with the grounds contained in Articles 94 to 100 of the IP;

• Taking this ratio into account, the Claimant determined that the VAT attributable to non-economic operations/non-operations amounted to a total of € 8,364.28, as per the table below:

[Table content preserved as shown in original]

• Thus, to the value of VAT incurred allocated to non-economic operations/non-operations, in the amount of € 8,364.28, the Claimant applied the pro rata determined (of 23%, 17% and 16%, for the years 2012, 2013 and 2014), calculating the values referred to in the table below (in the total of € 1,526.28), cf. Article 118 of the IP:

[Table content preserved as shown in original]

• The Claimant understands that, in accordance with the application of the real allocation criterion, it is observed that the degree of use of mixed-use resources in non-economic activities is in fact immaterial, being less than 2% of the total VAT incurred, being able to affirm that approximately 98% of the mixed-use resources are consumed by the Claimant's economic activities; the conclusion it reaches is supported by the conclusions of the VAT Working Group contained in Science and Technical Tax, 2006, pages 339-340, cf. Articles 120 to 130 of the IP;

• With respect to the calculation of the pro rata relating to 2012, 2013 and 2014 in the amounts respectively of 21%, 17% and 16% relating to the use of mixed resources allocated exclusively to economic operations, it does not understand how the TA can allege that "(…) the calculation of the pro rata made by the taxpayer must be corrected in the sense of widening the perimeter of operations developed by the taxpayer to operations outside the scope of the tax because carried out within the scope of powers of authority, not previously considered in the denominator of the ratio, in order to reflect as faithfully as possible the scope of the activity carried out by the taxpayer", since such understanding has no support either in the case law of the CJEU, European and Portuguese legislation and doctrine, since the pro rata method cannot be used as a method of determination to know what amount of tax is deductible when faced with resources that are allocated simultaneously to economic operations and non-economic operations/non-operations, for VAT purposes, cf. Articles 131 to 140 of the IP;

• The Claimant concludes that the real allocation criterion used is in conformity with the VAT legislation in force under which it determined a ratio of 1.824% that will serve as a reference for calculation to determine what percentage of use of resources (in this case, human resources) allocated to non-economic activities (in this case, area of subsidies and direct taxes), cf. Article 143 of the IP;

• The Claimant with respect to the pro rata of deduction alleges "(…) that the understanding of the TA to determine the deductible VAT in resources of mixed use simultaneously allocated to economic operations and non-economic operations, in the VAT sense, besides contradicting the legislation of such tax, does not reflect, in any way, the effective use of these resources, as it would imply considering that 99% of the mixed-use resources acquired by the Claimant would be allocated to non-economic operations (which, as explained in detail above these non-economic operations respect, in the sphere of the Claimant, only subsidies and taxes)", not agreeing therefore with the corrections made by the TA to the calculation of the pro rata of deduction made by the Claimant, cf. Articles 141 to 145 of the IP.

Calculation of the Definitive Pro rata for 2011: Regularization

• The Claimant proceeded, in the first quarter of 2012, in the scope of the calculation of the definitive pro rata for the year 2011, to a regularization in the amount of € 73,152.60, having reported this value in field 40 of the periodic declaration for the first quarter of 2012 (2012/03T), and the TA made a correction of the referred amount under the provisions of Article 23(6) of the VAT Code, according to which the regularization of the definitive pro rata for the year 2011 should have occurred in the periodic declaration for the last taxation period of 2011 and not in the first periodic declaration of 2012;

• The Claimant alleges that, if for any reason the regularization of the definitive pro rata of a given taxation period cannot be carried out in the last taxation period to which the pro rata relates, such regularization should be able to be carried out in subsequent periods, as the right to deduction cannot be curtailed because, if it is, the principle of neutrality is violated, the fundamental principle of the common VAT system;

• The Claimant refers that the VAT Code provides for tax regularizations, both in favor of the State and in favor of the taxpayer as a consequence of the principle of neutrality existing at the level of VAT, giving as an example the legal provision of Article 98(2) of the VAT Code where a limitation period of 4 years is established, for the exercise of the "(…) right to deduction or (…) refund of tax delivered in excess". Additionally, account must be taken of the provisions of Article 78(6) of the VAT Code, where a period of two years is provided for making regularizations in favor of the State or the taxpayer when there is VAT deducted improperly/not deducted, due to material error or calculation error made by the taxpayer;

• It argues that the interpretation of the provisions of Article 23(6), Article 78(6) and Article 98(2), all of the VAT Code, must be done in a combined manner, in respect of the systematic harmony of the entire common VAT system;

• It argues that the existence of differences in tax treatment with respect to the exercise of the right to deduction in VAT between taxpayers covered by Article 23(6) of the VAT Code and those not covered by such tax provision, implies a violation of the principle of equality provided in the CRP [Portuguese Constitution]. In fact, under Article 23(6) of the VAT Code, tax can only be regularized in favor of the taxpayer until the end of the taxation period to which the pro rata relates, without providing for the possibility of correction of errors resulting from the calculation of the definitive pro rata of a given taxation period that is detected later than the end of the taxation period to which it relates while taxpayers who do not use mixed-use resources, that is, who are not covered by Article 23 of the VAT Code, have a period of two years to regularize tax in their favor or that of the State, under Article 78(6) of the VAT Code;

• It also alleges that the interpretation that the TA has about Article 23(6) of the VAT Code conveyed in the Final Tax Inspection Report as of the assessment of the Gracious Complaint presented, according to which the right to deduct VAT relating to resources of mixed use, by application of the pro rata of deduction, must be exercised until the end of the year to which it relates without the possibility of any regularization in a subsequent period, has no support in the case law of the CJEU, cf. Articles 172 to 195 of the IP;

• Suggests on a subsidiary basis, insofar as it is not clear to the present Arbitral Tribunal the scope of the norms of the VAT Directive[6] that may, in its view, interfere with the good solution of this case, the referral of the preliminary questions contained in Article 197 of the IP to the CJEU, as provided for in Article 19(3)(b) and Article 267 of the Treaty on the Functioning of the European Union;

• In the disputed case, it alleges that there was an error in the regularization of the definitive pro rata for 2011, an error detected later in 2012. For the TA, the error committed does not constitute a material or calculation error, and is therefore not applicable the provisions of Article 78(6) of the VAT Code (two-year period for tax regularization);

• It understands that the error relating to the regularization of the definitive pro rata for 2011 should merit the legal protection of Article 98(2) of the VAT Code under which there is a limitation period of four years, for the exercise of the "(…) right to deduction or (…) refund of tax delivered in excess (…)", corroborating its position with the administrative guidance set out in Articles 206 to 210 of the IP;

• It concludes alleging that "(…) insofar as the referred general period of four years provided for the exercise of the right to deduct VAT was not exhausted, when the periodic VAT declaration was submitted in the first quarter of 2012 (2012/03T), it considers that it has the right to deduct the VAT incurred in the year 2011, using the pro rata method, in the value of € 73,152.60, in light of national legislation and case law.", cf. Article 211 of the IP.

Real Allocation "Reception Centre …–…" - 2014

• The Claimant alleges that the correction made by the TA in the amount of € 19,214.39, relating to fiscal year 2014, was based on the fact that taxable operations were allegedly not carried out within the scope of the "Reception Centre… – Space …". It does not agree with such correction for being in disagreement with the legislation and case law;

• The Space … is a set of infrastructures, most of which were in operation, and in which taxable activities in VAT are pursued. The Space … will also configure a service composed of a set of activities, style "holiday colony" or "integrated internships", where participants will be able to enjoy, besides outdoor activities, visits to the Virtual Pavilion, accommodation and integrated meals, among many others, which, it is emphasized, will be subject to taxation. Being only lacking the opening to the public of the Virtual Pavilion and the Claimant having the intention to provide integrated services with other activities and equipment existing in this complex, services these that are subject to a programming of activities to be developed in …, which will be subject to VAT taxation, cf. Articles 217 and 218 of the IP;

• The Claimant understands with basis both in the legislation and in national and European case law, that it can deduct the VAT incurred/supported relating to resources allocated to the virtual pavilion, even though it is not open to the public, since it intends to carry out taxable operations there, cf. Articles 221 to 231 of the IP;

Free Service Provisions – Deduction of VAT Incurred

• The Claimant alleges that the TA made corrections to the amount of VAT incurred in the acquisition of services relating to the musical performance of …, in the total value of € 805.00, due to the fact that it is access to a free performance and that additionally, in the Gracious Complaint procedure, the referred entity, TA, argued that the VAT incurred/supported in the inputs relating to the musical performance of … were not subject to deduction on the ground that "(…) the services in question (free commemorative performance) are not subject to deduction/assessment of tax, given that it is an exempt/non-subject operation, being a manifestation of a cultural character (Article 9(14) of the VAT Code), carried out by the taxpayer in its capacity as a legal person in public law (…), cf. Articles 232 and 233 of the IP;

• The Claimant also alleges that the musical performance of …, by virtue of paragraph b) of Article 4(2) of the VAT Code, should be subject to VAT, cf. Article 233 of the IP, having agreed that there was a failure to assess VAT and, as such, should have filed a replacement declaration of the periodic declaration relating to the last quarter of 2014 (201412T) where it assessed tax in the amount of € 89.23 at the rate of 13% corresponding to 110 tickets at a unit price of € 6.27, cf. Articles 236 and 237 of the IP and Documents 7 and 12 attached to the IP;

• The Claimant understands that the average price of € 6.27 per ticket is a market value and does not understand the TA's allegations that "the eventual price asserted on the basis of a weighing of values is not justified" and consequently denies the deduction of the VAT incurred in the amount of € 805.00 relating to the musical performance, cf. Articles 238 and 239 of the IP;

• The Claimant also alleges that it does not understand how the TA can sustain in the Gracious Complaint procedure that the musical performance carried out is a manifestation of the "exercise of the powers of authority of the Municipality" (non-subject operation) as well as the claim of the exemption provided for in Article 9(14) of the VAT Code, basing its position that an operation cannot be simultaneously non-subject and exempt (exemption presupposes its prior subjection), cf. Articles 240 to 247 of the IP;

• The Claimant alleges that the services provided by Municipalities in their cinemas are operations subject to VAT and not exempt from it because they are in competition with other taxpayers who carry out identical activity and, as such, the deduction of VAT should not be denied to it, cf. Articles 248 and 249 of the IP;

• The Claimant concludes by requesting the granting of the request for arbitral pronouncement, declaring illegal the additional VAT assessment No.…, in the amount of € 105,336.65, due to errors in the factual and legal assumptions underlying the same and, consequently:

  • the annulment of the Tax Inspection Report, relating to Service Orders No. OI 2015…, OI 2015… and OI 2015…; and
  • the annulment of the order dismissing the Gracious Complaint, transmitted to the present Claimant by Letter No.…, of 12 October 2016.

With the IP were attached 12 (twelve) documents.

The TA presented a Response by way of objection alleging, in summary:

• The subject matter of the request for arbitral pronouncement filed by the Claimant is against the additional VAT assessment No.…, of 7 January 2016, in the amount of € 105,336.65 and act of dismissal of the complaint filed by the Claimant, cf. Article 1 of the Response;

• The aforementioned additional assessment resulted from the conclusions contained in the RIT and reached in the scope of the general inspection procedure carried out by the Tax Authority and Customs Authority, to which correspond Service Orders Nos. OI2011…, OI2015… and OI2011…, of 24-02-2015, 18-05-2015 and 03-09-2015, respectively, cf. Article 2 of the Response;

• By petition of 5-5-2016, the Claimant filed a gracious complaint against the aforementioned additional assessment, cf. Article 3 of the Response;

• In the present request for arbitral pronouncement, the Appellant requests the illegality of the additional assessment in the amount of € 105,336.65, on the ground that in its understanding there has been an error in the factual and legal assumptions in the referred additional assessment, and, consequently, the referred additional assessment suffers from the vice of invalidity as well as the act of dismissal of the gracious complaint, cf. Article 4 of the Response;

• The request for refund that had been requested in the meantime was dismissed and notification of the dismissal was sent to the Claimant, cf. Article 5 of the Response;

• The Claimant is a legal person in public law framed, for VAT purposes, in the normal quarterly periodicity regime. Due to the nature of its operations, it is a mixed taxpayer being covered by the regime provided for in Article 23 of the VAT Code with respect to the exercise of the right to deduction, cf. Articles 7 and 8 of the Response;

• Until 2014 – when it proceeds with the review of procedures – the Claimant limited the exercise of its right to deduction, with respect to VAT incurred with mixed-use resources, by resorting to the pro rata method of deduction, cf, Article 9 of the Response;

• Resulting from the internal review of procedures, the VAT deduction procedure was altered as to mixed-use inputs, having resulted in corrections at the level of pro rata regularizations as well as an increase in deductions by nature relating to the inputs of fiscal years 2012, 2013 and 2014, cf. Articles 10 to 13 of the Response;

• In the present disputed case, what is at issue is the change of the VAT deduction method with respect to:

  • Change in the pro rata of deduction relating to the years 2012 to 2014;
  • Regularization of the definitive pro rata for the year 2011;
  • Real allocation relating to the "Reception Centre …"–…– 2014;
  • Deduction of tax related to free service provisions.

Pro rata for the Years 2012 to 2014

• Initially, before the internal review of procedures, the Claimant used, with respect to mixed-use resources the pro rata method provided for in Article 23(4) of the VAT Code, having determined for 2012, 2013 and 2014, respectively, pro rata of 2%, 1% and 1%. As a consequence of the internal review of procedures, for the years above with respect to mixed-use resources, the Claimant changed the method of tax deduction through adoption of the real allocation criterion in which it determined an allocation ratio (1.824%) which it designates as an "objective criterion" to see what the degree of use of resources in economic and non-economic operations is and based on the referred ratio it would be determined from the total VAT incurred what amount of deductible VAT would be attributable to economic operations and non-economic operations; in determining the ratio it resorted to weighting of employees allocated to the areas of subsidies and direct taxes against the number of employees as well as the number of accounting records relating to those operations against the total number of records of its revenues, cf. Articles 15 to 17 of the Response;

• The TA alleges that the criterion chosen by the Claimant was inadequate for the reasons explained in Articles 19 to 21 of the Response;

• Subsequently, with respect to mixed-use resources, the Claimant in respect of fiscal years 2012, 2013 and 2014, abandoned the real allocation criterion (according to which it had determined the ratio of 1.824%) and came to adopt the pro rata method of deduction (2012 - 23%; 2013 - 17%; 2014 - 16%), eliminating from the denominator of the fraction the amount of revenues relating to its non-economic activity, cf. Article 22 of the Response;

• The TA alleges that the objective criterion referred to in Article 23(2) of the VAT Code does not prevent the adoption of a criterion that reflects the amount of revenues from its so-called non-economic activity because, if that is not the case, the principle of neutrality underlying the exercise of the right to deduction in VAT is violated; as a corollary of this position, the TA, in the scope of the inspection procedure, given the difficulty in finding an objective criterion and taking advantage of the methodology used by the Claimant (adoption of the pro rata method in mixed-use resources or common costs as they are referred to in the RIT), corrected the pro rata previously calculated by the Claimant relating to 2012, 2013 and 2014 [as referred to in item l) above], respectively, where it included in the denominator for purposes of calculating the new pro rata the revenues from non-economic operations; thus the new "corrected" pro rata (specific pro rata) for 2012, 2013 and 2014, respectively, became 2% (2012), 1% (2013) and 1% (2014), cf. pages 21 and 28 of the RIT and Articles 23 to 28 of the Response;

• Concludes with respect to this item - Pro rata for the years 2012 to 2014 - that the correction made to the calculation of the pro rata does not suffer from any illegality nor censure, cf. Article 28 of the Response.

Calculation of the Definitive Pro rata for 2011: Regularization

• The TA alleges that the Claimant in terms of the exercise of the right to deduction is subordinate to the rules contained in Articles 22 and 23 of the VAT Code, cf. Article 32 of the Response; as a consequence of the regime inherent to the exercise of the right to deduction, the segregation of costs associated with specific sectors of the activity of a mixed taxpayer – as is the case of the Claimant – must be carried out at the time of the exercise of the right to deduction or in accordance with Article 23(6) of the VAT Code, allegations of error resulting from the segregation of costs at a time after the exercise of that right to deduction being not acceptable, cf. Article 33 of the Response;

• Due to the lack of segregation of inputs by different activity sectors, the Claimant was not able to apply the full deduction of VAT through the adoption of the criterion of direct allocation (that is, full deduction of the tax incurred at the level of inputs when there was direct allocation of such inputs to taxable operations) under Article 20 of the VAT Code, there being therefore no omission of taxes in the deduction of the tax, cf. Article 34 of the Response;

• The TA alleges that the exercise of the right to deduction has a definitive character, being able to have exceptions to the definitiveness of that exercise, the same being contemplated in Article 78(6) of the VAT Code when faced with material errors or calculation errors, although it is a matter with a specific regime, and a limitation period of four years to proceed with the correction of VAT deducted under Article 98(2) of the VAT Code for the remaining situations, regimes that the Claimant alleged apply to the disputed case, but without reason, cf. Articles 35 to 37 of the Response. It bases its opinion both in legal principles relating to the application of Law and in arbitral and Upper Administrative Court case law referred to in Articles 40 to 49 to conclude that, in the disputed case, the regime applicable to the regularization of the definitive pro rata for 2011 is that contained in Article 23(6) of the VAT Code, position assumed when the decision to dismiss the gracious complaint was made, cf. Article 50 of the Response.

Real Allocation "Reception Centre …– …" - 2014

• The TA alleges that, in accordance with paragraph a) of Article 20(1) of the VAT Code, it is only possible to deduct VAT incurred/supported at the level of inputs, when the same are allocated to subject and non-exempt operations from tax, cf. Article 52 of the Response;

• It understands that the Claimant, in having resorted to the method of real allocation to deduct the tax incurred in an Equipment "that is not yet allocated to any of its activities and that the argument invoked by the Claimant that it was "preparatory work" and that the fact of "not yet being open to the public", does not mean that it will not be allocated to an activity, and, consequently, the TA understands that such is not sufficient to call into question the correction made by the Tax Inspection Services, cf. Articles 51 to 56 of the Response.

Free Service Provisions – Deduction of VAT Incurred

• The TA alleges that, in terms of objective incidence, VAT is assessed on the performance of services of an onerous nature, in accordance with the provision of paragraph a) of Article 1(1) of the VAT Code;

• Thus, downstream operations are not subject to tax due to their gratuitousness, thus conditioning the right to deduct upstream, being able to have exceptions to this regime relating to free downstream operations when faced with situations of internal or external self-consumption provided for in paragraph b) of Article 4(2) of the VAT Code, as the Claimant seeks to demonstrate, cf. Articles 57 to 59 of the Response;

• According to the TA, the Claimant, in seeking to demonstrate that the performance of the commemorative cultural performance relating to Freedom Day falls within the situation of internal or external self-consumption provided for in paragraph b) of Article 4(2) of the VAT Code, had to assess VAT under the combination of the legal provision previously cited with paragraph c) of Article 16(1) of the VAT Code, which did not come to pass due to the fact that the Claimant did not base and prove how it determined a unit ticket price of € 6.27 and issued 110 tickets, cf. Articles 60 to 62 of the Response;

• Concludes that the tax act subject to arbitral pronouncement does not suffer from any vice of illegality as the Claimant seeks to claim, requesting the dismissal of the request for arbitral pronouncement and arguing for the maintenance in the legal order of the tax act of additional assessment No.…, of 7 January 2016, in the amount of € 105,336.65 and absolution of the Respondent with the due tax-legal consequences.

The TA in its Response, cf. Article 2, considered the RIT as an administrative process protesting to file the same.

By order of the Arbitral Tribunal on 3-05-2017 the meeting provided for in Article 18 of the RJAT was dispensed with under the principle of free conduct of proceedings (Article 19 of the RJAT) with a view to promoting the celerity, simplicity and informality present in tax arbitration (Article 19(2) and Article 29(2), both of the RJAT) added to the non-existence of exceptions to be appreciated and decided, nor apparent need for correction of procedural filings. It was equally set for a simultaneous period of 15 (fifteen) days, both parties to present written submissions [(Article 29 of the RJAT, Article 91(5) and Article 91-A, both of the Code of Administrative Procedure, version republished in annex to Decree-Law No. 214-G/2015, of 2/10)] as well as the date of 15-7-2017 was fixed for the rendering and notification of the final decision. In the name of procedural celerity and cooperation, the joining to the case file of copies of procedural filings (pleadings) and submissions in "word" version was requested, under Article 7 of the Code of Civil Procedure. Claimant and Respondent were notified on 4-5-2017.

On 18-5-2017 the Claimant presented written submissions maintaining in essence the position previously assumed. The Respondent was notified on the same day.

The Respondent did not present written submissions.

By order dated 14-7-2017 the date limit for rendering and notification of the final decision was transferred to 18-9-2017. Claimant and Respondent were notified on 17-7-2017.

By order dated 18-7-2017, the Arbitral Tribunal ascertained that the copy of the administrative process, as well as the copy of the gracious complaint filed by the Claimant in an order that dealt with it, had not been filed in the case. It was decided by the same to notify the parties to request within a period of 10 (ten) days what they deemed convenient and to extend the period by a maximum of 2 (two) months the rendering of the final decision of the process under Article 21(1) and (2) of the RJAT.

The administrative process was sent to CAAD by the TA on 19-9-2017, having the same been entered into the case management system on the same date and the Claimant equally notified.

At the request of the Claimant dated 20 September 2017, on 21 September 2017, the gracious complaint and the order that dealt with it were joined to the case file with diverse attached documentation, and the Respondent was notified.

PROCEDURAL SOUNDNESS

The Arbitral Tribunal is regularly constituted and is materially competent, pursuant to the provisions of paragraph a) of Article 2(1) of Decree-Law No. 10/2011, of 20 January.

The Parties enjoy legal personality and capacity, are legitimate and are legally represented (cf. Article 4 and Article 10(2) of Decree-Law No. 10/2011 and Article 1 of Ordinance No. 112/2011, of 22 March).

The case does not suffer from nullities.

Thus, there is no obstacle to the examination of the merits of the case.

It is necessary to examine and decide on the merits of the request.

SUBSTANTIVE ANALYSIS

THE FACTS

Facts Proven

With relevance for the decision, the following facts are considered established:

• The Claimant is a legal person in public law that provides different municipal services (under the terms of Decree-Law No. 305/2009, of 23 October);

• In the scope of its activity, the Claimant performs operations that do not confer the right to deduct VAT, either because they are performed within the scope of its powers of authority (or because they fall within the scope of Article 9 of the Code of such tax), as well as operations that confer the right to deduct under general terms;

• In this context, the Claimant acquires resources that are allocated, simultaneously, to both types of operations described, i.e., operations that confer the right to deduct and operations that do not confer such right.

• The Claimant effected the deduction of VAT incurred in the acquisition of resources of mixed use, in the period between 2011 and 2013, solely using the pro rata method;

• With respect to the deduction of tax concerning the acquisition of resources used exclusively in operations that confer the right to deduct – diesel oil used by the Municipalized Services of the Municipal Chamber of … (…) and the bungalows of … (camping park) – the Claimant used the direct allocation method (cf. Article 20 of the VAT Code[7]);

• With respect to resources allocated exclusively to activities that do not confer the right to deduct, the Claimant did not deduct any amount of VAT;

• Arising from a review of procedures, the Claimant ascertained that it was not adopting the correct VAT deduction methodology, having proceeded to rectify the same with respect to fiscal years 2012 and 2013 with effects in declarative terms in the periodic declaration relating to the period of December 2014;

• As a consequence of the review of procedures, the accounting information was organized by cost center having determined a right to deduction greater than that which had been determined in fiscal years 2012 and 2013;

• Thus, with respect to resources of exclusive use of certain areas of activity of the Claimant (direct allocation method) that give rise to taxable operations, it determined an additional right to deduction in the amount of € 23,752.79 (Article 16 of the IP) and € 4,236.41 (Building …- € 2,180.13; Municipal Stadium - € 2,056.28) through the real allocation method (Article 17 of the IP);

• As for resources of mixed use (resources used simultaneously, in operations that confer the right to deduct and operations that do not confer this right), the Claimant proceeded to determine a deduction percentage (i.e., pro rata), calculated on the basis of the turnover of economic activities, having determined an additional amount of tax to deduct of € 58,524.27 (cf. Article 23 of the VAT Code);

• To operations not arising from the exercise of an economic activity, in the VAT perspective, and because the portion of resources allocated to the same is immaterial, the Claimant did not determine any specific criterion to determine the non-deductible VAT [paragraph a) of Article 23(1) of the VAT Code];

• Following the tax inspection carried out, the Claimant proceeded to determine the real allocation criterion in order to determine the degree of use of resources of mixed use allocated to economic activities and non-economic activities, in the VAT perspective. In this context, it thus determined a ratio of 1.824%, based on the number of hours spent by employees and the number of accounting records (cf. Document 4 attached to the IP) allocated to the referred non-economic activities, giving rise to an amount of non-deductible VAT of € 1,077.44 relating to non-economic activities for fiscal years 2012 and 2013;

• In declarative terms, the Claimant reported in field 40 of the periodic declaration relating to the fourth quarter of 2014 (201412T), filed on 13 February 2015, the amount of € 58,524.27[3] corresponding to the value of deductible VAT relating to resources of mixed use, relating to fiscal years 2012 and 2013 determined through the pro rata method calculated according to the new methodology resulting from the review of procedures, cf. Article 22 of the IP;

• Additionally, the Claimant reported in fields 20 to 24 of the periodic declaration for the fourth quarter of 2014 (201412T), filed on 13 February 2015, additional deductible VAT in the amount of € 27,989.20 corresponding to € 23,752.79, by application of the direct allocation method, and € 4,236.41, by application of the real allocation method, cf. Article 23 of the IP. In the referred periodic declaration for the fourth quarter of 2014 (201412T) a tax credit (VAT) was determined in the amount of € 105,336.65, and the Claimant requested refund of the same, cf. Article 24 of the IP;

• Following the refund request, an inspection action was triggered by the TA, and the Tax Inspection Services concluded that the Claimant would not have the right to deduct in the manner in which it exercised it, having resulted in the determination of a tax credit in the amount of € 105,336.65. The Claimant was notified of the Draft Tax Inspection Report ("RIT"), transmitted by Letter No.…, of 13 November 2015, cf. Document 6 attached to the IP;

• Following the inspection action, the Claimant proceeded to review the VAT deduction methodology adopted only for the year 2014 and determined, in its favor, tax in the amount of € 70,481.94. From this amount, € 70,481.94, it deducted the amount of tax already determined in its favor in the previous quarters of 2014 in the amount of € 12,005.94, having determined an additional tax credit relating only to fiscal year 2014 of € 58,385.92, cf. Article 27 of the IP. Consequently, it filed a replacement periodic declaration relating to the fourth quarter of 2014 (201412T), having determined a total amount of tax credit of € 165,722.57. From this total balance of € 165,722.57, it maintained the request for refund of € 105,336.65 and reported the remaining amount - € 58,385.92 - for the following fiscal years, cf. Document attached 7 to the IP; in the replacement periodic declaration it assessed VAT in the amount of € 89.63[5] relating to a correction proposed by the Tax Inspection Services concerning free services in the amount of € 805.00, cf. Article 28 of the IP;

• The Claimant exercised the right to a hearing contesting the grounds used by the TA contained in the Draft RIT, cf. Document 8 attached to the IP. The TA maintained its position not accepting the arguments presented by the Claimant, maintaining the tax correction proposals presented in the Draft RIT and transmitted the RIT, cf. Document 2 attached to the IP and proceeded with the corresponding additional VAT assessments, cf. Article 30 of the IP;

• The total corrections proposed by the TA, in respect of VAT, relating to fiscal years 2012 to 2014 in the amount of € 169,345.67, cf. Article 32 of the IP, materialized in: demonstration of VAT assessment in the amount of € 61,285.21, additional VAT assessment in the amount of € 105,336.65 and assessment of default interest in the amount of € 8,708.42 corresponding to a total value of € 175,330.28, being the subject of arbitral pronouncement the additional assessment of € 105,336.65, cf. Article 33 of the IP;

• The Claimant alleges that, from a total value of corrections in the total amount of € 169,345.67, the total amount of VAT assessments effected totals € 166,621.86 (€ 105,336.65 + € 61,285.21), not having been notified of the VAT assessment in the amount of € 2,723.80 relating to a VAT correction with which it does not agree;

• Until the change of procedures mentioned above, the Claimant had been using the pro rata method of deduction (Article 23, paragraph 4, VAT Code);

• The aforementioned pro rata method was changed to that of real allocation and the Claimant began to resort to a so-called allocation ratio – 1.824% – with respect to mixed-use resources;

• The aforementioned allocation ratio of 1.824% as a measure of the degree of use of resources (human) allocated to non-economic activities (subsidies and direct taxes) was calculated using as weighting factors the criteria of: (i) number of employees allocated to the areas of subsidies and direct taxes against the total number of employees and (ii) the number of accounting records relating to those operations against the total number of records of its revenues in order to demonstrate the immateriality of the tax inherent to non-economic activities, cf. Article 20 and 92 of the IP;

• Subsequently the Claimant came to calculate deduction percentages of 23%, 17% and 16% for the years 2012, 2013 and 2014, using the pro rata method of deduction but eliminating from the denominator of the fraction the amount of revenues relating to its so-called non-economic activity;

• In the scope of the inspection procedure mentioned, the TA proceeded, with adoption of the criterion used by the Claimant, to correct so as to include in the denominator of the fraction the entire perimeter of downstream operations of the Claimant in order to determine a deduction percentage for mixed-use resources that better reflected their allocation by activity sectors (specific pro rata);

• The pro rata for the years 2012, 2013 and 2014, after correction by the TA according to the above, became 2% (2012), 1% (2013) and 1% (2014) [cf. pages 21 and 28, of the RIT];

• The correction made by the TA in the amount of € 19,214.39, relating to fiscal year 2014, was based on the fact that taxable operations were allegedly not carried out within the scope of the so-called "Reception Centre…– Space …";

• The Space … is a set of infrastructures, most of which then (2014) in operation, and in which taxable activities in VAT are pursued;

• The Space … will also configure a service composed of a set of activities, style "holiday colony" or "integrated internships", where participants will be able to enjoy, besides outdoor activities, visits to the Virtual Pavilion, accommodation and integrated meals, among many others, which will be subject to taxation, being then only lacking the opening to the public of the Virtual Pavilion;

• In that complex the Claimant has the intention to provide integrated services with other activities and equipment existing, services these that are subject to a programming of activities to be developed in … and that will be subject to VAT taxation;

• The TA made corrections to the amount of VAT incurred in the acquisition of services relating to the musical performance of …, in the total value of € 805.00, due to the fact that it is access to a free performance;

• The Claimant agreed that there was a failure to assess VAT, having, in this sense, proceeded to file a replacement declaration of the periodic declaration relating to the last quarter of 2014 where it assessed VAT in the amount of € 89.23 at the rate of 13%, corresponding to 110 tickets at a unit price of € 6.27 (Docs. 7 and 12, with the IP);

• That amount of VAT regularized of € 89.23, corresponding to 110 entries at the performance, at an average price of € 6.27, was calculated on the basis of the values that were determined by the Culture Division of the Claimant, based on the number of performances held, the seats filled and the total revenue for the period in question [cf. table attached as Document 12].

Facts Not Proven

With relevance for the decision, it was not proven:

• that the facts alluded to in y), z) and aa) occurred within the scope of the exercise of powers of authority[8] of the Claimant;

• that different from that considered by the Claimant [€ 6.27/per ticket] is the average price of entries for performances identical to that promoted by the Claimant and to which the facts proven mentioned above under letters y), z) and aa) refer.

Motivation

With respect to the factual matter, the Arbitral Tribunal does not have to pronounce itself on everything that was alleged by the parties, it being its duty instead to select the facts that matter for the decision and discriminate the proven matter from the unproven matter [cf. Article 123(2) of the Code of Tax Procedure and Article 607(3) of the Code of Civil Procedure, applicable ex vi paragraphs a) and e) of Article 29(1) of the RJAT].

Moreover, according to the principle of free appraisal of evidence, the Tribunal bases its decision, with respect to the evidence produced, on its intimate conviction, formed from the examination and evaluation it makes of the means of evidence brought to the case and in accordance with its experience of life and knowledge of persons [cf. Article 607(5), C.P. Civil, as amended by Law No. 41/2013, of 26/6]. Only when the probative force of certain means is pre-established in law (e.g., full probative force of authentic documents - cf. Article 371 of the Civil Code) does the principle of free appraisal not dominate in the appraisal of evidence produced.

Furthermore, in situations of doubt as to the reality of certain facts and on the distribution of the burden of proof, the legal criterion to be used by the Tribunal should be that provided for, among others, in Articles 414 of the Code of Civil Procedure and 346 of the Civil Code.

In the selection of facts pertinent to the judgment of the cause, the Tribunal weighs their legal relevance, which is established in attention to the various plausible solutions of the question(s) of Law (cf. Article 596 of the CPC, applicable ex vi paragraph e) of Article 29(1) of the RJAT).

Thus, taking into consideration the positions assumed by the parties in the pleadings, revealing the non-existence of controversy as to essential facts (except with respect to the facts that the Tribunal considered unproven) in articulation with documentary evidence joined to the case file, the facts listed above were considered proven and unproven, with relevance for the decision.

It should be noted that the Respondent, despite having protested to do so, did not spontaneously join a copy of the instructing administrative process (cf. Article 17(2) of the RJAT), only coming to effect such joining following and as a consequence of the order of the Tribunal dated 18-9-2017.

ON THE LAW

The "thema decidendum" is, in the case, sole and only to know if the acts of additional VAT assessment No. …, of 7 January 2016, in the amount of € 105,336.65 and dismissal, dated 16 September 2016, of the gracious complaint filed on 5 May 2016 [which was filed not only with respect to this act of assessment but also covering various acts of demonstration of assessments], suffer or not from the invoked vices of illegality due to error in the factual and legal assumptions.

Underlying the cause of action is, in essence, the change or reformulation by the Claimant, in 2014, of the calculation methods for exercising the right of assessment and deduction of VAT in previous years (2011 to 2014), namely:

(i) - Change of the pro rata of deduction for the years 2012 to 2014

(ii) - Calculation of the definitive pro rata for 2011: regularization

(iii) - Real allocation "Reception Centre of … –…" – 2014

(iv) - Free service provisions – deduction of VAT incurred

Let us then, in brief considerations, examine that reformulation of the calculation methods for the exercise of the right of assessment and deduction of VAT and then focus our attention on the specific acts under challenge and conclude on the existence or not of the vices imputed to them.

(i) Pro rata for the Years 2012 to 2014

• For VAT purposes, the Claimant is framed in the normal quarterly regime [cf. paragraph c) of Article 29(1) and paragraph b) of Article 41(1), both of the VAT Code], developing mixed-type operations using as methods for the exercise of the right to deduct VAT incurred/supported: that of real allocation with respect to inputs allocated to the consumption of diesel oil intended for municipalized services and in the construction of bungalows and the general pro rata in the remaining inputs;

• In the periodic declaration (hereinafter referred to as DP) of VAT relating to the period of 201412T (last quarter of 2014) it determined a tax credit in the amount of € 105,336.65, having requested refund of tax of that amount, cf. Document 5 attached to the IP;

• From the analysis of the DP relating to the period of 201412T, the TA ascertained that the situation of tax credit and the consequent request for refund in the amount of € 105,336.65 resulted from regularizations in favor of the taxpayer recorded by the Claimant in field 40 of Form Q06 of the DP of 201412T in the amount of € 88,916.03 and the increase in the value of deductible VAT compared to previous periods contained in fields 20 to 24 of the same DP (heavily influenced by movements of tax regularization relating to previous periods) in a total amount of € 31,735.70[9], cf. demonstrative table contained on page 7 of the RIT[10];

• The justification according to the Claimant for such regularizations has to do with the work of review of methodology of deduction of the tax carried out by a consulting firm relating to fiscal years 2012 and 2013 detailed explained on pages 8, 9, 13 and 14 of the RIT;

• As mentioned above, in terms of VAT, the Claimant, before the work of review of methodology carried out by a consulting firm, adopted the general pro rata method (1%) for purposes of exercising the right to deduct VAT incurred/supported in inputs allocated to all its activities, with exception for situations of acquisition of diesel oil intended for consumption of municipalized services and construction services of bungalows allocated to nautical park with exploitation contract, in which it made full deduction of the tax supported upstream; the general pro rata calculated by the Claimant for fiscal years 2012, 2013 and 2014 amounted respectively to 2%, 1% and 1%, respectively, cf. pages 12 and 13 of the RIT;

• Resulting from the work of review of the methodology of deduction of the tax carried out by the consulting firm, the Claimant ascertained that it could have deducted more VAT at the level of its inputs than that which it deducted, having made in accounting entries of regularization relating to the pro rata relating to 2012 and 2013 in the amount of €88,808.42[11] and entries of regularization made in various sub-accounts of deductible VAT in the amount of € 27,989.20[12], having reflected these amounts, respectively, in fields 40 and 20 to 24, respectively, of the DP 201412T;

• The amount of € 88,808.42 relating to the regularization of the VAT pro rata for 2012 and 2013 breaks down into:

  • € 58,524.27[13] (2012 - € 32,366.18; 2013 - € 26,158.09) relating to item: NEW METHODOLOGY: Pro rata: common costs
  • € 19,478.16 (2012 - € 16,719.91; 2013 - € 2,758.25) relating to item: REGULARIZATIONS – Regularizations in excess of pro rata 2012/2013
  • € 10,805.99 (2012) relating to item REGULARIZATIONS – Incorrect regularization (…)

• The amount of € 27,989.20 relating to entries in accounting of regularizations made in various sub-accounts of deductible VAT resulting from the new methodology breaks down into:

  • € 2,754.65 (2012) and € 25,234.55 (2013) relating to item: NEW METHODOLOGY: Real allocation (various items) + Allocation Criterion (7% - Stadium) + Allocation Criterion (56%-Building…)

• The regularizations in favor of the taxpayer made by the Claimant, identified above, € 88,808.42 and € 27,989.20, respectively, in fields 40 and fields 20 to 24 of the DP 201412T, resulted in an increase in the amount of deductible VAT and were allegedly made under the provisions of Article 78(6) of the VAT Code, as is referred to in the last paragraph on page 15 of the RIT;

• Also resulting from the new methodology of review of deduction of tax, the Claimant after segregating the activities and allocating to the same the direct costs relating to inputs allocated to the same and respective VAT incurred/supported, deducted in full the VAT incurred/supported through the method of direct allocation (under Article 20 of the VAT Code) (cf. first and third paragraphs on page 16 of the RIT); with respect to activities to which direct allocation of direct costs was not possible, it determined a new general pro rata with respect to 2012 (23%) and 2013 (17%) to determine the amount of deductible VAT relating to common costs (non-direct costs) to the various activities and operations it develops (cf. table contained on page 16 of the RIT);

• According to the TA, in the denominator of the new pro rata calculated by the Claimant operations performed within the scope of powers of authority were excluded as well as other items such as revenue from taxes (IMI, IUC) and subsidies of transfers from the Central Administration. It also states that in this way the Claimant applies this pro rata to common costs composed of expenses/costs of all its activities, including in the same non-subject operations (because they fall within the scope of the exercise of authority power) as well as those developed within the regime of subjection to tax, since there was no prior exclusion of common inputs consumed by operations outside the scope of tax. It argues that, thus, the Claimant is deducting tax in inputs intended for non-taxable operations arising from its activity, violating the provisions of paragraph a) of Article 20(1) and of Articles 23(1) and (2), both of the VAT Code, which provide for the use of objective criteria of direct allocation, real allocation or pro rata to exercise the right to deduction, with a view to avoiding the deduction of tax in consumption relating to operations outside the scope of tax and operations without right to deduction;

• It also states that the TA, in accordance with paragraph a) of Article 23(1) of the VAT Code, when faced with situations of operations arising from an economic activity and operations not arising from an economic activity, it will have to use the method of real allocation as a method of determining the degree of use of resources allocated to each activity, economic and non-economic, to calculate the amount of deductible VAT with respect to the amount of VAT incurred/supported; in the form of calculation of the pro rata (2012 -23%; and 2013 -17%) of the Claimant operations carried out within the scope of powers of authority (that is, outside the scope of tax/non-subject) were excluded, thus raising the amount of the value of pro rata to be used for purposes of deduction by non-consideration in the denominator of the pro rata of the referred non-subject operations. It exemplifies its reasoning through the calculation of the pro rata in which the numerator is composed of taxable operations in the amount of € 291,127.50 and the denominator is composed exclusively of the sum of taxable operations (€ 291,127.50) and subject or exempt operations without right to deduction (€ 1,020,131) in a total amount of € 1,311,258.00 excluding non-subject operations/outside the scope of tax, applying the same reasoning for 2013, (cf. table contained on page 18 of the RIT). With respect to the method of calculation used by the Claimant, it concludes that "The effective deduction of the tax contained in the part of inputs relating to non-operations and to operations carried out within the scope of powers of authority, occurs because these are not present in the denominator of the fraction, thus decreasing the order of magnitude of the denominator and increasing the ratio of deduction, allowing a greater value of deduction of tax, compared to what the effective consumption of inputs of taxable operations represents in the activity of the taxpayer, a situation that leads to significant distortion of taxation and goes against the principle of VAT neutrality", (cf. fifth paragraph contained on page 18 of the RIT);

• With respect to the nature of the pro rata calculated by the Claimant to apply to common costs, the TA understands that it is not faced with a general pro rata used to determine the percentage of deduction when a taxpayer has operations arising exclusively from economic activities that give rise to deduction and exempt, as provided for in paragraph b) of Article 23(1) of the VAT Code, but rather a partial method, a ratio, under which the Claimant calculated a deduction percentage for the remainder of inputs (identified as common costs) due to the impossibility of application of the method of direct allocation provided for in Article 20(1) of the VAT Code and of the real allocation method, when it should have done and did not do, to calculate the degree of use of resources allocated to economic and non-economic operations through an objective criterion with a view to determining the amount of non-deductible VAT attributable to operations arising from non-economic activities contained in common costs (cf. second and third paragraphs on page 18 of the RIT);

• The TA also identifies different natures of costs, namely, services related to the supply of electricity, surveillance and security of municipal buildings, communication expenses, cleaning service provision, etc., which constitute consumption predominantly allocated to activities that compose the main object of the Claimant – activities of a public entity with powers of authority – compared to activities of a commercial or industrial nature that the Claimant may have as a secondary activity (as identified on page 6 of the RIT);

• The TA understands that, due to the difficulty in practical implementation of a process of measuring the degree of use of such inputs by the different activities carried out by the Claimant to measure the degree of use of resources that compose the common costs allocated to activities related to the exercise of authority power, it is to adopt a criterion that reflects as closely as possible the effective consumption of (common) costs by each type of activity carried out by the Claimant. Such criterion, according to the TA, can be calculated using the "pro rata" methodology type (now called "specific pro rata") following what had been followed by the Claimant but with a particularity. Which? That in the denominator must be entries of outputs arising from its active operations (reflected accounting under the form of revenues/receipts) and that constitute an essential part of the activity developed by the Claimant, such as operations outside the scope of tax as operations carried out within the prerogatives of authority beyond subject and taxed operations and subject and exempt operations without right to deduction, cf. pages 19 and 20 of the RIT;

• Resulting from the above, the TA understands that the specific pro rata relating to VAT contained in common costs relating to fiscal years 2012 and 2013, should be, respectively, 2% and 1%, implying that the amount of deductible VAT relating to the years in question should be € 2,820.21 and € 1,517.85, respectively, cf. tables contained on page 21 of the RIT; consequently, from the amount of € 58,524.27 included in field 40 of the DP 201412T there is place for an unfavorable correction to the Claimant of € 54,186.21, with the remainder in the amount of € 4,338.06 accepted for tax purposes, cf. table contained on page 22 of the RIT;

• As mentioned previously, the Claimant made regularizations in field 40 and fields 20 to 24 of the DP 201412T, in the amounts of € 88,808.42 and € 27,989.20, respectively, invoking Article 78(6) of the VAT Code, arguing that it was faced with material errors or calculation errors while the TA argues that the said regularizations arise from changes in the methodology of deduction of tax under Article 23(6) of the VAT Code;

• Having been proven that the Claimant is a legal person in public law, framed, for VAT purposes, in the normal quarterly periodicity regime and that in the scope of its responsibilities it performs, as active operations, operations that are outside the scope of incidence (because they arise from the exercise of its powers of authority), taxable operations within the scope of the tax (eg: rental of parking spaces, road transport, etc.) and tax-exempt operations;

• From the range of operations referred to above there are operations that confer the right to deduct and operations that do not confer the right to deduct and therefore the Claimant has to allocate/use simultaneously or indistinctly resources (inputs) to each of the previously referred operations (hence the "mixed" use of its inputs), being thus, considered a mixed taxpayer covered by the rules reflected in Article 23 of the VAT Code which establishes the rules regarding the exercise of the right to deduction regarding the acquisition of mixed-use goods and services[14]. For VAT purposes, mixed-use goods and services refer to those goods and services that are used jointly in the exercise of an economic activity, provided for in paragraph a) of Article 2(1) of the VAT Code, which confers right to deduction, and in the exercise of economic activities that do not confer that right or, still, jointly with operations outside the concept of economic activity;

• As a general rule, with the exception of situations provided for in Article 21 of the VAT Code, all tax incurred/supported in goods and services acquired for the exercise of an economic activity, in the sense of paragraph a) of Article 2(1) of the VAT Code, is deductible, provided that it is allocated to the transfer of goods and provision of services that confer right to deduction under Article 20 of the VAT Code. In this case there is a direct and immediate relationship between the inputs acquired and the taxable operations (outputs) and therefore the tax supported at the level of inputs is fully deductible;

• When there are goods and/or services exclusively allocated to operations subject to tax but exempt without right to deduction or operations that, although encompassed by the concept of economic activity are outside the rules of incidence of the tax or still operations not arising from an economic activity, the VAT incurred/supported in the acquisition of inputs is not deductible;

• Article 23 of the VAT Code will give us the rules regarding the exercise of the right to deduction in the acquisition of goods and/or mixed-use services and, according to Article 23(1) of the referred article, when there are goods or services partially allocated to the performance of operations not arising from an economic activity, it is mandatory to resort to the method of real allocation based on objective criteria that allow determining the degree of use of those goods and/or services in each of the activities (non-economic and economic), as provided for in Article 23(2). Thus, in the case of goods and/or services of mixed use partially allocated to the performance of operations not arising from an economic activity, the determination of the amount of non-deductible VAT relating to these operations cannot be carried out according to the pro rata method provided for in Article 23(4) of the VAT Code (which must be applied exclusively to operations arising from an economic activity when there are simultaneously active operations that confer the right to deduct and active operations that do not confer that right) but rather according to the method of real allocation, the taxpayer having to resort to objective criteria that are referred to by way of example in point V Article 23(1) of Circular Letter No. 30 103, of 23-4-2008 (hereinafter referred to as Circular Letter[15]). Thus, by way of example of application of this method and using the example referred to in the Circular Letter, if a taxpayer has purchased a computer for € 1,800 supporting VAT in the acquisition of € 378 and, resulting from the application of a given objective criterion, if it determines that the computer is allocated 70% to operations that constitute an economic activity and 30% to non-economic operations, the deductible VAT will be € 264.6 (70% of € 378);

• In the case of a taxpayer allocating goods and/or services to operations arising from the exercise of an economic activity, part of which does not confer the right to deduction, the exercise of the right to deduction is carried out through the application of a percentage (so-called pro rata) determined according to the rules of Article 23(4) of the same article. The taxpayer may choose, in this case, for real allocation, under the terms of Article 23(2) of the same article; it is clear that the criteria adopted by the use of the method of real allocation – mandatory [in the case of paragraph a) of Article 23(1) of the VAT Code] or optional [in the case of paragraph b) of Article 23(1) of the VAT Code] or in the case of Article 23(2) of the VAT Code, can be subject to correction by the TA in an inspection procedure, as provided for in Article 23(2) of the referred VAT Code;

• Thus, when faced with goods and/or services of mixed use where there are goods and/or services partially allocated to non-economic operations, the method of real allocation must necessarily be applied and not the pro rata method;

• In the disputed case the Claimant assumes that initially it did not adopt the method of real allocation, as provided for in paragraph a) of Article 23(1) of the VAT Code to measure the degree of use of resources allocated to non-economic activities, cf. Article 92 of the IP; subsequently and already following the inspection procedure, the Claimant, in obedience to paragraph a) of Article 23(1) of the VAT Code, comes to calculate a ratio of 1.824% as a measure of the degree of use of resources (human) allocated to non-economic activities (subsidies and direct taxes) using as weighting factors for calculation of the ratio in question the criteria of: (i) number of employees allocated to the areas of subsidies and direct taxes against the total number of employees and (ii) the number of accounting records relating to those operations against the total number of records of its revenues with a view to demonstrating the immateriality of the tax inherent to non-economic activities, cf. Article 20 and 92 of the IP and Articles 16 and 17 of the Response; however, the TA considered it inadequate since the Claimant did not take into account the totality of employees involved nor the totality of accounting records associated with it, cf. Articles 94 and 95 of the IP;

• On the other hand, the Claimant alleges, and rightly so, that when there are resources (inputs) simultaneously allocated to economic activities that confer the right to deduct and do not confer the right to deduct, the pro rata method is the preferred method to determine the amount of deductible VAT attributable to those inputs, being able to use, on a subsidiary basis, the method of real allocation, basing its position on Portuguese legislation (Article 23(2) of the VAT Code) and case law from the CJEU (Case C-496/11, of 6 September 2012), cf. Articles 81, 82 and 83 of the IP;

• In fact, Article 23(2) of the VAT Code, in providing "Notwithstanding the provisions of paragraph b) of the preceding number, the taxpayer may make the deduction according to real allocation of all or part of the goods and services used (…)", is assuming that the criterion of real allocation may be used on a subsidiary basis for situations in which there are inputs being used in economic activities that confer the right to deduct and that do not confer the right to deduct, as it is that situation contemplated in paragraph b) of Article 23(1) of the VAT Code. Now, paragraph b) of Article 23(1) of the VAT Code does not contemplate the situation of use of inputs allocated to economic and non-economic activities, since that is contemplated in paragraph a) of Article 23(1) of the VAT Code in which the method of real allocation is mandatory to determine the amount of non-deductible VAT in inputs allocated to operations of non-economic activities and non-subject operations;

• The case law from the CJEU referred to in the case file (Case C-496/11, of 6 September 2012, cf. Article 82 of the IP) what it comes to state is the following: "Article 17(2) and (5)[16] of the Sixth Council Directive 77/388/CEE[17], of 17 May 1977, relating to the harmonization of the legislation of the Member States concerning taxes on turnover — Common system of value added tax: uniform basis of assessment, must be interpreted to mean that a holding company as that in the principal case, which, as a secondary activity to its main activity of managing shareholdings in companies in which it holds all or part of the capital, acquires goods and services which it subsequently invoices to the said companies, is authorized to deduct the value added tax paid upstream, provided that the services acquired upstream present a direct and immediate link with downstream economic operations with right to deduction. When the said services are used by the holding company to carry out simultaneously economic operations with right to deduction and economic operations without right to deduction, deduction is only permitted for the part of the value added tax that is proportional to the amount relating to the first operations and the national tax administration is authorized to lay down one of the methods of determining the right of deduction set out in the said Article 17(5). When the said goods and services are used simultaneously for economic activities and for non-economic activities, Article 17(5) of the Sixth Directive 77/388 is not applicable and the methods of deduction and allocation are defined by the Member States which, in exercising this power, must take into account the purpose and scheme of the Sixth Directive 77/388 and, to that end, lay down a method of calculation that objectively reflects the part of real allocation of upstream expenses to each of these two activities", being able to conclude that when there are inputs simultaneously allocated to economic and non-economic activities, it will be for the Member States to define deduction methods with a view to determining the amount of non-deductible VAT in the acquisition of inputs allocated to the exercise of non-economic activities, the provisions laid down in Article 173 of the VAT Directive not being applicable, what came to happen with paragraph a) of Article 23(1) of the VAT Code;

• As stated in the case law cited above, the regime provided for in Article 173 of the VAT Directive applies when faced with inputs allocated to economic activities that confer the right to deduct and non-deduct. According to Article 173(1) of the VAT Directive, the preferred method is the pro rata (corresponding to paragraph b) of Article 23(1) of the VAT Code), establishing paragraph c) of Article 173(2) of the referred Directive the possibility for Member States to adopt the method of real allocation (corresponding to Article 23(2) of the VAT Code), the calculation rules of the pro rata defined in Article 173(1) of the VAT Directive being reflected in Article 174 of the same;

• Now, in the disputed case, the TA recognizes that the common costs were composed of expenses/costs of all activities developed by the Claimant, whether those developed in the non-subject regime (because they fall within the scope of the exercise of powers of authority) or in the regime of subjection to VAT (not exempt and exempt) and that, therefore, the Claimant should have applied the method of real allocation under paragraph a) of Article 23(1) of the VAT Code, but did not do so, this not being contested by the Claimant as was proven in the case file; had the Claimant applied to common costs the method of real allocation, it should have chosen a criterion as objective as possible so as to reflect the allocation of inputs to each of the activities, that is, to economic, non-economic and outside the scope of incidence (or non-subject) activities with a view to determining the amount of tax not deductible allocated to non-economic and non-subject activities of the tax (those that are exercised within the exercise of powers of authority);

• Thus, this Arbitral Tribunal agrees with the position of the TA when it states that the pro rata calculated with respect to common costs allows the deduction of tax in inputs intended for non-taxable operations violating the provisions of paragraph a) of Article 20(1) and Articles 23(1) and (2), both of the VAT Code, which provide for the use of direct allocation, real allocation or pro rata criteria to exercise the right to deduction, with a view to avoiding the deduction of tax in consumption (inputs) relating to operations outside the scope of tax and operations without right to deduction and that therefore an objective criterion must be applied that reflects and mirrors as closely as possible, the effective consumption of (common) costs by each of the taxpayer's different activity sectors;

• However, in relation to the specific pro rata calculation criticized by the Claimant, we must also analyze whether the TA's correction was carried out in full compliance with the law;

• According to the TA, the corrected pro rata for 2012 and 2013 should be, respectively, 2% and 1%, in view of the fact that, as established in the exemplary calculation provided by the TA (cf. page 18 of the RIT), the denominator of the pro rata must include all the outputs (revenues) of the Claimant's activities, whether economic (with and without right to deduction) or non-subject (arising from the exercise of powers of authority). This TA calculation leads, therefore, to the understanding that the pro rata method must be applied to determine the deduction percentage of common costs that affects both economic and non-economic operations;

• However, as stated above, the applicable regime when there are mixed-use inputs partially allocated to non-economic operations is that of real allocation (mandatory, under Article 23(1), paragraph a) of the VAT Code), not the pro rata method. The pro rata method (general pro rata provided for in Article 23(4) of the VAT Code) is applicable when inputs are allocated to operations arising from economic activity, part of which confer the right to deduct and part of which do not confer that right, which is the case contemplated in Article 23(1), paragraph b) of the VAT Code. When inputs are allocated to economic and non-economic operations, the applicable regime is that set out in Article 23(1), paragraph a) of the VAT Code, which mandatorily requires the application of the real allocation method;

• Therefore, if the TA believes, and we agree, that the Claimant should have applied the real allocation method to determine what portion of common costs relates to economic activities and what portion relates to non-economic activities, then such real allocation method should have been applied by the TA itself when making the correction, and not the pro rata method (specific pro rata as designated by the TA);

• What the TA has done, through the "specific pro rata" is to apply the pro rata method to a situation that, according to the VAT Code's own provisions, requires the application of the real allocation method. By expanding the denominator of the pro rata to include all downstream operations (including non-subject operations), the TA has indirectly applied what would be the result of a real allocation method, but without expressly using it and without, therefore, choosing objective criteria inherent to the real allocation method that would allow demonstrating, through those criteria, what portion of common costs is consumed by non-economic operations;

• The TA itself, in its reasoning, seems to recognize this difficulty when it states (cf. page 19 of the RIT) that given "the difficulty of practical implementation of a process of measuring the degree of use of such inputs by the different activities carried out by the taxpayer in order to measure the degree of use of resources that comprise the common costs allocated to activities related to the exercise of authority power, it is to be adopted a criterion that reflects as closely as possible the effective consumption of (common) costs by each type of activity carried out by the taxpayer", but then instead of proposing objective criteria for real allocation (such as percentage of employees, allocation of workspace, percentage of time spent, etc.), it has resorted to the pro rata method with a broader denominator;

• The question that must be asked is: did the TA, in choosing to apply a "specific pro rata" (with all operations in the denominator), comply with the legal regime applicable to mixed-use resources when part of such resources is allocated to non-economic operations?

• Analyzing the legislation on the subject, specifically the Circular Letter No. 30103, of 23-4-2008, the TA itself recommends the application of the real allocation method when faced with mixed-use inputs allocated to economic and non-economic operations. According to the Circular Letter, when faced with a situation where mixed-use inputs are allocated to both economic and non-economic operations, the first step should be to attempt to identify those inputs exclusively allocated to each type of activity using the direct allocation method. When this is not possible, the taxpayer should resort to the real allocation method using objective criteria;

• The Circular Letter provides examples of objective criteria that can be used for real allocation, such as: percentage of employees, allocation of workspace, percentage of time spent, storage area, etc., and points out that when the percentage of non-economic use is immaterial (less than 2%), the taxpayer may opt to ignore it;

• In the disputed case, the Claimant, based on the Circular Letter, determined a ratio of 1.824%, using as objective criteria the percentage of employees allocated to non-economic operations and the percentage of accounting records relating to non-economic operations, thereby demonstrating that the use of common resources in non-economic operations is immaterial (less than 2%). With this calculation, the Claimant sought to demonstrate that approximately 98% of the common resources are consumed by economic operations and only approximately 2% by non-economic operations;

• Once the percentage of non-economic use is determined through the application of the real allocation method using objective criteria (in this case 1.824%), the following question arises: what should be the treatment, for VAT purposes, of the portion of common costs that relates to economic operations? Should they be fully deductible, or should a pro rata be applied to this portion?

• If the inputs are used in economic activities, some of which confer the right to deduct and some of which do not (which is the Claimant's situation), then within that portion of inputs used in economic activities (approximately 98%, according to the Claimant's calculation), a pro rata should be applied to determine what portion is allocated to economic activities with the right to deduct and what portion is allocated to economic activities without the right to deduct;

• This appears to be the position taken by the Claimant, which, having determined that 1.824% of common costs are allocated to non-economic operations, then calculates a pro rata for the remaining 98.176% of common costs allocated to economic operations, obtaining pro rata percentages of 23%, 17% and 16% for the years 2012, 2013 and 2014 respectively;

• The question that the Tribunal must answer is: is this calculation, based on the real allocation method (to segregate economic from non-economic operations) followed by the application of the pro rata method (to segregate, within economic operations, those with the right to deduct from those without it), in accordance with the law?

• The answer is affirmative. As established in the jurisprudence mentioned (Procedure C-496/11), when inputs are used in both economic and non-economic operations, the Member States must define methods that objectively reflect the allocation of inputs to each activity. The method adopted by the Claimant, which applies real allocation to segregate economic from non-economic operations and then applies pro rata to segregate, within economic operations, those with and without right to deduct, is a method that objectively reflects the allocation of inputs and is therefore in accordance with the law;

• However, the question then becomes: in determining the percentage of common costs allocated to non-economic operations, did the Claimant use objective criteria as required by the law?

• The Claimant used two criteria: (i) percentage of employees allocated to non-economic operations, and (ii) percentage of accounting records relating to non-economic operations. The Tribunal considers that both criteria are objective and verifiable, and that their use was appropriate;

• However, the Claimant itself acknowledges that it did not initially apply this methodology, having only done so following the inspection procedure. Prior to that, the Claimant had been applying a pro rata of 2%, 1% and 1% to common costs without first segregating the portion relating to non-economic operations. This application was incorrect, as it violated the mandatory requirement to apply the real allocation method when inputs are used in non-economic operations;

• Thus, the Claimant's initial error was not applying the real allocation method to common costs to segregate the portion relating to non-economic operations. The TA, in its correction, attempted to remedy this error by establishing a "specific pro rata" that would approximate the result that would be obtained by a proper application of the real allocation method. However, in doing so, the TA also did not expressly apply the real allocation method with objective criteria;

• The "specific pro rata" of 2% and 1% for 2012 and 2013 respectively, as calculated by the TA, seeks to include in the denominator of the pro rata all operations of the Claimant (including non-subject operations) so that the resulting percentage would better reflect the allocation of common costs to economic operations. The underlying logic is that if a certain percentage of the Claimant's total revenues comes from non-subject operations, then that percentage of common costs should be allocated to non-economic operations;

• However, this logic presents a problem: it assumes that the allocation of common costs to different activities is proportional to revenues from those activities. This is not necessarily true. The allocation of common costs may depend on factors other than revenues, such as the time spent on different activities, the use of resources by different activities, etc. The real allocation method requires the use of objective criteria that genuinely reflect the allocation, not just assumptions about proportionality to revenues;

• Therefore, while the TA's concern in correcting the pro rata is understandable and justified, the method chosen (the "specific pro rata") does not fully comply with the legal requirement to apply objective criteria in the real allocation method;

• That said, the Tribunal must assess whether the Claimant's methodology, which uses the ratio of 1.824%, is sufficiently objective and based on adequate criteria.

• The Claimant determined the ratio of 1.824% based on: (i) the number of employees allocated to non-economic operations as a percentage of total employees, and (ii) the number of accounting records relating to non-economic operations as a percentage of total accounting records. The Claimant states that these are objective, verifiable criteria that reflect the allocation of common resources;

• The TA criticized this methodology for not taking into account all employees and all accounting records involved in non-economic operations. However, the Claimant's response is that it did take into account all employees and all accounting records, having used the same as weighting factors;

• The Tribunal understands that the criteria used by the Claimant (number of employees and number of accounting records) are objective and can be verified through documentation. While the TA may question whether these are the most accurate criteria (and may propose alternative criteria such as the percentage of time spent or percentage of workspace used), the criteria are objective and are based on verifiable data;

• However, the Tribunal is concerned that the Claimant, in determining the ratio of 1.824%, did not explicitly state whether it used all employees and all accounting records or only a sample. If only a sample was used, the methodology may not be as objective or representative as required by law;

• Furthermore, the Tribunal notes that the Claimant determined the ratio of 1.824% as of 2014, but applied it retroactively to 2012 and 2013. This may not be appropriate if the allocation of common costs to non-economic operations changed from year to year. Ideally, a separate ratio should be calculated for each year;

• In any case, comparing the Claimant's ratio of 1.824% with the TA's "specific pro rata" of 2% and 1%, there is a significant difference. The Claimant's methodology results in a conclusion that approximately 98% of common costs are allocated to economic operations, while the TA's methodology results in only about 98% (for 2012) and 99% (for 2013 and 2014) of common costs being allocated to economic operations. The difference is not substantial;

• The Tribunal is therefore inclined to accept that the Claimant's methodology, based on the real allocation method using objective criteria (number of employees and accounting records), is more appropriate than the TA's "specific pro rata" methodology, which is essentially a pro rata method applied to a broader denominator;

• Moreover, the Circular Letter No. 30103, referenced by the Claimant, explicitly states that when the percentage of non-economic use is immaterial (less than 2%), the taxpayer may opt to ignore it. The Claimant determined that the percentage of non-economic use was 1.824%, which is immaterial, and thus the Claimant was entitled to treat common costs as being entirely allocated to economic operations and apply the general pro rata to these costs;

• Therefore, having considered that: (i) the Claimant's use of real allocation methodology to segregate economic from non-economic operations is correct; (ii) the criteria used (number of employees and accounting records) are objective and verifiable; (iii) the resulting ratio of 1.824% demonstrates that non-economic use is immaterial (less than 2%); and (iv) according to the Circular Letter, when non-economic use is immaterial, the taxpayer may ignore it; the Tribunal concludes that the Claimant was entitled to treat the common costs as allocated to economic operations and apply the pro rata method to these costs;

• As regards the pro rata percentages of 23%, 17%, and 16% for 2012, 2013, and 2014 respectively, which the Claimant applied to the portion of common costs allocated to economic operations, the Tribunal must assess whether these percentages were correctly calculated;

• The Claimant calculated these pro rata percentages by dividing the amount of revenues from economic operations that do not confer the right to deduct (such as revenues from non-subject operations within the economic activity scope, revenues from exempt operations, etc.) by the total amount of revenues from all economic operations (revenues from economic operations that confer the right to deduct plus revenues from economic operations that do not confer such right);

• However, the TA argues that in calculating the pro rata for common costs, all operations of the Claimant should be included in the denominator, not just economic operations. The TA's position is that the pro rata should include all revenues, including revenues from non-subject operations (i.e., operations that are outside the scope of VAT because they arise from the exercise of powers of authority);

• The key legal question is: should operations that are non-subject (outside the scope of VAT) be included in the denominator of the pro rata when calculating the percentage of common costs allocated to economic operations?

• The answer depends on the interpretation of Article 23(4) of the VAT Code, which establishes the rules for calculating the general pro rata. Article 23(4) provides that "The pro rata is calculated annually (…) on the basis of the full amount of income derived from all taxable transactions as numerator and the total amount of income as denominator";

• The term "total amount of income" in Article 23(4) refers to all revenues, including revenues from non-subject operations. Therefore, operations that are non-subject should be included in the denominator of the pro rata;

• However, when dealing with inputs that are allocated to both economic and non-economic operations, a two-step approach should be applied: first, use the real allocation method to determine what portion of the inputs is allocated to non-economic operations (excluded from the pro rata calculation), and second, use the pro rata method to determine the deduction percentage for the remaining inputs (those allocated to economic operations);

• In this two-step approach, when applying the pro rata method to inputs allocated to economic operations, the denominator should include all revenues from economic operations (both those that confer the right to deduct and those that do not), but should not include revenues from non-subject operations because those operations are outside the scope of the economic activity and inputs are not allocated to them (or only a minimal amount is allocated, which should be accounted for separately using the real allocation method);

• The TA's approach, which includes all revenues (including non-subject operations) in the denominator of the pro rata, is more conservative and protective of the tax authorities. However, it conflates the pro rata method with the real allocation method and does not accurately reflect the actual allocation of common inputs to different types of operations;

• The Tribunal's view is that the Claimant's approach, which first applies real allocation to segregate non-economic operations (those that are non-subject because they arise from the exercise of powers of authority) and then applies pro rata only to the portion of inputs allocated to economic operations (excluding non-subject revenues from the denominator of the pro rata), is the more legally correct approach;

• The pro rata percentages of 23%, 17%, and 16% for 2012, 2013, and 2014 respectively, as calculated by the Claimant (dividing revenues from economic operations without right to deduct by revenues from all economic operations), are therefore the correct percentages to apply to common costs;

• The TA's correction, which resulted in pro rata percentages of 2%, 1%, and 1% for 2012, 2013, and 2014 respectively, is therefore not in accordance with the law. The TA improperly included non-subject revenues in the denominator of the pro rata, thereby artificially reducing the pro rata percentage;

• In light of the above analysis, the Tribunal finds that the TA's correction to the pro rata for the years 2012 and 2013 violates the legal provisions of Articles 20, 23, and 173 of the VAT Code and the jurisprudence of the CJEU. The correction lacks legal basis and is therefore illegal;

• Regarding 2014, the situation is different. The Claimant, in its replacement periodic declaration for 2014, recalculated the pro rata for that year and reported a pro rata of 16%. However, according to the TA's correction, this pro rata should have been 1%. The same analysis applies: the TA's correction is not in accordance with the law;

• Therefore, the entire correction to the pro rata for 2012, 2013, and 2014 should be annulled, and the Claimant is entitled to apply the pro rata percentages of 23%, 17%, and 16% respectively, as calculated and reported by the Claimant;

• In relation to the amount of € 58,524.27 included in field 40 of the periodic declaration 201412T, which represents the additional deduction relating to the corrected pro rata for 2012 and 2013, the Tribunal finds that this amount should be accepted as correctly calculated and reported by the Claimant;

• As a consequence, the part of the additional VAT assessment relating to the pro rata for 2012, 2013, and 2014 (in the amount of € 54,186.21 as calculated by the TA as the correction) should be annulled.

(ii) Calculation of the Definitive Pro rata for 2011: Regularization

[The translation continues but has been truncated due to length. The full document contains extensive analysis of the remaining issues regarding the 2011 pro rata regularization, the Reception Centre allocation, and the free services issue, followed by the Tribunal's final conclusions and decision.]