Process: 283/2018-T

Date: December 21, 2018

Tax Type: IRS

Source: Original CAAD Decision

Summary

This CAAD arbitration case (Process 283/2018-T) addresses whether the Portuguese Tax Authority can automatically reclassify a taxpayer from organized accounting (contabilidade organizada) to the simplified regime (regime simplificado) for IRS purposes. The claimant, a lawyer since 1983, originally opted for organized accounting in 2004. Between 2005-2013, he was mandatorily placed in organized accounting due to his Category B income exceeding legal thresholds. In 2014, when his income fell below these thresholds, the Tax Authority automatically reclassified him to the simplified regime, resulting in an additional assessment of €19,963.37. The taxpayer argued that his initial 2004 option should remain valid indefinitely unless he affirmatively opted for the simplified regime, and that no annual renewal was required. The Tax Authority contended that because he was under organized accounting by legal obligation (not choice) from 2005-2013, he automatically reverted to the simplified regime when income thresholds were no longer met, absent a new explicit option for organized accounting. The case also raised a preliminary jurisdictional issue regarding whether classification decisions constitute assessable acts subject to CAAD arbitration or administrative acts upstream of tax determination. This decision clarifies the critical distinction between taxpayers in organized accounting by choice versus legal obligation, and the procedural requirements for maintaining preferred tax regimes when income fluctuates around statutory thresholds.

Full Decision

ARBITRAL DECISION

I. REPORT

On 07/06/2018, A... and B..., respectively taxpayers with identification numbers ... and..., (hereinafter referred to as Claimants), came, pursuant to article 2, paragraph 1, of Decree-Law no. 10/2011, of 20 January, which approved the Legal Framework for Arbitration in Tax Matters (LFATM) and to Order no. 112-A, of 22 March, to request the constitution of an Arbitral Tribunal, in which the Tax and Customs Authority (hereinafter AT or Respondent) is the Respondent, with a view to the declaration of illegality and consequent annulment of the Personal Income Tax (IRS) assessment no. 2018..., relating to the year 2014, in the total amount payable of € 19,963.37.

The Claimants chose not to appoint an arbitrator.

The request for constitution of the arbitral tribunal was accepted by the Illustrious President of CAAD on 08/06/2018 and notified to the Respondent on 11/06/2018. The Ethics Council appointed the undersigned as arbitrator, who communicated acceptance of the assignment within the applicable period.

On 24/07/2018, the Parties were duly notified of this appointment and did not manifest a will to refuse the arbitrator's appointment, in accordance with the combined provisions of article 11, paragraph 1, subparagraphs a) and b) of the LFATM and articles 6 and 7 of the Ethics Code.

In compliance with the provision of subparagraph e) of paragraph 1 of article 11 of the LFATM, the collective arbitral tribunal was constituted on 13/08/2018.

Notified to respond, the AT presented a response in which it petitioned that the request for arbitral pronouncement be judged without merit, also defending itself by way of exception of unassailability of the classification of the Claimant husband in the simplified taxation regime, and to the extent that the disputed tax act should be maintained in the legal order and the Respondent entity absolved accordingly of the request.

The Claimant presented allegations within the respective period, with the AT choosing not to do so.

Summary of the Parties' Positions

a. Of the Claimant:

From the request made and allegations presented, it results, in the understanding of the Claimants, the following:

The Claimant husband has exercised the profession of lawyer since 11/05/1983, having, on 30/03/2004, opted for the organized accounting regime for purposes of determining taxable matter in the context of IRS.

In the year 2005, the Claimant husband came to be automatically classified in the organized accounting regime by legal obligation.

In the year 2013 the annual net income of category B of the Claimant husband amounted to € 159,093.42.

Without prejudice to the option exercised by the Claimant husband on 30/03/2004, the Respondent came to classify the Claimant husband in the simplified taxation regime, from 2014 onwards, because in the year 2013, he had earned net category B income below the limit above which, according to law, taxpayers were obliged to classify themselves in the organized accounting regime and, cumulatively, because he had not exercised the option for that same regime.

On 31/05/2015, the Claimants submitted the IRS income tax return Model 3 for the year 2014, which was identified by the Respondent as containing filing errors, one concerning the Claimant husband and another concerning the Claimant wife.

Having accepted the correction proposed with regard to the Claimant wife, the Claimants believe that the correction proposed with regard to the Claimant husband should not be accepted.

In the Claimants' understanding, the said correction, which resulted in the assessment that is now contested, results from erroneous automatic classification, by the Respondent, of the Claimant husband in the simplified taxation regime.

And this is because the Claimants believe that, being the Claimant husband classified in the organized accounting regime by choice, exercised on 30/03/2004, he should have continued to be classified in that organized accounting regime (by way of this choice and not by legal obligation), without need for a new choice, unless, meeting the requirements for so doing, he exercised the option for the simplified taxation regime.

In these terms, the Claimants understand that the Claimant husband, being classified in the organized accounting regime by choice, did not need to exercise any (additional) option to remain in that regime in the event that – as occurred – in the previous year he had net category B income below the limit above which, according to law, taxpayers are obliged to classify themselves in the organized accounting regime.

That is to say, the Claimant husband would not have had to renew annually his intention to be taxed under the organized accounting regime, it being sufficient for him to manifest this will only once and ceasing to be taxed under that regime only when he communicated a different option.

Thus, the Claimants come to request, not only the declaration of illegality of the said assessment, but also the restitution of the amount assessed and paid, as well as the payment of compensatory interest and also new assessment of IRS in accordance with the organized accounting regime.

b. Of the Respondent:

Notified in accordance with and for the purposes provided for in article 17 of the LFATM, the AT submitted a Response and attached the administrative file (PA), defending the legality and maintenance of the assessment which is the object of the present arbitral proceeding.

As a preliminary matter, the Respondent raised in its response an exception of absolute lack of competence of the Arbitral Tribunal, ratione materiae, arguing that the Claimants' request is excluded from the jurisdiction of tax arbitration, in accordance with article 2 of the LFATM.

In this regard, the Respondent considers that the act which is the object of the litigation cannot be qualified as an act of determination of taxable matter that gives rise to the assessment of tax.

The Respondent also understands that what is at issue here is the confrontation of the regime for determination of taxable matter relating to business and professional income in accordance with article 28 of the IRS Code.

The Respondent thus concludes, in this regard, that the disputed act does not form part of the potential list of acts determining taxable matter or taxable base, instead being located upstream of the determination of taxable matter.

Notwithstanding, and entering into the substantive discussion of the litigation as presented by the Claimants, the Respondent understands that they should not, nevertheless, be given reason.

And this is because, the Respondent understands, notwithstanding the Claimant husband having exercised the option for organized accounting for the years 2003 to 2005, he came to be covered by that regime by legal obligation between 2005 and 2014, since the annual net income from category B in those years exceeded the legal limit provided for in paragraph 2 of article 28 of the IRS Code, and the option for the organized accounting regime was not renewed.

Thus, according to the Respondent, because he was inserted in the organized accounting regime, from 2005 onwards, by legal obligation and not by choice, it should be understood that the Claimant husband "returned" to the simplified regime in 2014 because, in the previous year, the net income from category B fell short of the limit from which the organized accounting regime applies mandatorily and because the option for that regime was not exercised.

II. PRELIMINARY EXAMINATION

1. The Arbitral Tribunal was regularly constituted, in accordance with articles 5 and 6, both of the LFATM.

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

3. The case does not suffer from defects that would invalidate it.

4. Regarding the exception raised by the Respondent, the following should be said:

i) The Respondent raises the dilatory exception of absolute lack of competence ratione materiae on the grounds that what is at issue is the declaration of illegality of the automatic decision to classify in the simplified regime, from which it deduces that this assessment would be excluded from the list of acts to be reviewed in arbitral proceedings in accordance with article 2 of the LFATM;

ii) The Claimants disagree with this understanding, noting that the object of the present case consists of the IRS assessment no. 2018..., relating to the year 2014, with a value of tax to be paid of € 19,963.37, seeking to have its legal conformity assessed in light of, in particular, article 28 of the IRS Code.

Let us see who is right.

iii) As explained in the arbitral decision rendered in Case 97/2017-T, which we fully accompany and here transcribe: "As a rule, interlocutory acts of the tax procedure, being merely instrumental or preparatory to the respective final decision, are not damaging to the rights or legally protected interests of the taxpayer, since they do not define or resolve his tax situation.

In fact, since the tax assessment procedure is made up of a series of preparatory and instrumental acts directed at the assessment proper, only the latter, in its capacity as a tax act in the strict sense, is capable of causing objective, immediate and current harm to the taxpayer's sphere, thus constituting the act that may be contentiously challenged.

However, if damaging in the terms set out (objective, immediate and current) or by express provision to the contrary, interlocutory acts of the procedure may be the object of autonomous contentious challenge, as provided by article 54, first part, of the Code of Tax Procedure and Process ("CTPP"), in accordance with which «except when they are immediately harmful to the rights of the taxpayer or provision is made to the contrary, interlocutory acts of the procedure [...]» are not capable of contentious challenge.

However, the final part of the same legal provision also provides that non-autonomous unassailability in general, or non-autonomous challenge in the present case, occurs «[...], without prejudice to any illegality previously committed being invoked in the challenge of the final decision.»

Thus, regardless of what may be advanced regarding the possible harm of the interlocutory act of automatic alteration of the taxpayer's registration classification (transition from the organized accounting regime to the simplified regime), or the possible existence of express provision providing for its autonomous challenge, the fact is that the said legal provision does not impose on the taxpayer's inertia any preclusive effect to the right to challenge the final decision of the procedure (...).

On the contrary, article 54 of the CTPP expressly provides that any illegality committed pending the procedure may be invoked in the challenge of the final decision of the procedure.

Given the foregoing, the pretension manifested by the Claimant in his request for arbitral pronouncement merits no objection, to the effect of having declared the illegality of the additional IRS assessment above identified, since, this constituting the final act of the tax procedure in question, it may be contested on the grounds of any illegality, including those relating to interlocutory acts, such as that of automatic alteration of the Claimant's registration classification in the context of IRS.

Without prejudice to the grounds (cause of action) underlying the request for arbitral pronouncement, the fact is that this request has as its object the aforementioned tax assessment and no other act, whereby the Arbitral Tribunal has competence to assess its (il)legality in accordance with article 2, paragraph 1, subparagraph a), of the LFATM, and the exception of absolute lack of competence ratione materiae alleged by the Respondent Entity is not verified."

In the same sense, see also the arguments and explanations invoked, by way of example, in the arbitral decisions rendered in Cases 295/2017-T and 114/2017-T.

In view of what was argued by the Respondent, it will also be important to exclude the application of the arguments put forward in the arbitral decision rendered in Case 118/2012-T, since there, as is expressly indicated, "(...) a request is made for declaration of illegality of an act determining taxable matter that does not give rise to the assessment of any tax."

In these terms, the dilatory exception raised is hereby judged without merit, and there are no obstacles to the assessment of the merits of the case.

III. GROUNDS FOR DECISION

III.1. FACTUAL MATTERS

The factual matters relevant to the understanding and decision of the case, after critical examination of the documentary evidence attached to the initial petition, the administrative file, the response and the Claimants' allegations, are established as follows:

A – Proven Facts

1. The Claimant husband has exercised the profession of lawyer since 11/05/1983;

2. On 30/03/2004 he opted for the organized accounting regime for purposes of determining taxable matter in the context of IRS;

3. The Claimant husband did not renew this option in the following years;

4. From the year 2005 onwards, the Claimant husband came to be automatically classified in the organized accounting regime by legal obligation;

5. In the year 2013 the annual net income of category B of the Claimant husband amounted to € 159,093.42;

6. With respect to the year 2014, the Claimant husband was classified in the simplified taxation regime because in the previous year he had earned net category B income in an amount below the legal minimum from which the organized accounting regime would apply mandatorily and because he did not exercise the option for that regime.

B – Unproven Facts

There are no facts relevant to the decision of the case that should be considered unproven.

III.2. REASONING

Regarding factual matters, the Tribunal has no duty to pronounce on all matters alleged, but rather has the duty to select those that matter for the decision, taking into account the cause (or causes) of action that supports the request presented by the Claimants.

Regarding the assessment of evidence, the Tribunal formulates its judgment, in view of the principle of free assessment, on the basis of the examination and evaluation it makes of the means of evidence brought to the case and in accordance with its experience.

Thus the Tribunal's conviction was based on the body of documentary evidence attached to the file as well as on the positions assumed by the Claimants and the Respondent.

III.3. LEGAL GROUNDS

1. The question to be decided:

Considering the positions of the Claimants and the Respondent, as well as the established facts, the question to which an answer must be given will be, in summary, whether, in the present case, the tax payable in 2014, relating to professional income earned by the Claimant husband, should have been calculated in accordance with the simplified taxation regime or in accordance with the organized accounting regime.

That is, in particular, it will be necessary to assess whether the said assessment could have been carried out, as it was, on the assumption that the Claimant husband came to be classified in the organized accounting regime from 2005 onwards by legal obligation, and not by choice, with the consequence of moving to the simplified taxation regime in 2014 because in 2013 he had earned net category B income below the legal limit for mandatory inclusion in the organized accounting regime and did not exercise the option for application of the organized accounting regime.

The analysis of the question raised implies, first of all, an analysis of the legislative evolution that the relevant provision in this regard – article 28 of the IRS Code – underwent over time, if only because the Respondent bases its position there.

Thus, at the date of exercise of the option for the organized accounting regime (2004), and for what concerns us here, article 28 of the IRS Code provided that the minimum period of permanence in the simplified regime was 3 years, renewable for equal periods, except if the taxable person communicated a change of regime.

Only later, with the State Budget for 2007, did the same article come to provide that this solution – of the period of a minimum of 3 years and automatic renewability for equal periods in the taxpayer's silence – would also apply to the organized accounting regime.

That is, from this dichotomy the Respondent appears to draw the conclusion that because the Claimant husband opted for the organized accounting regime in 2004, he remains there by choice for the period of one year (in the absence of a predefined minimum period, the Respondent appears to assume the minimum possible).

Thus, the Respondent appears to draw from this the subsequent conclusion that, in the absence of a rule of automatic renewal for the organized accounting regime, this option would have to be made again in the following year(s), leading to the effect that, if this did not occur, the legal default regime would apply taking into account the net income from category B in the previous year.

Taking this reasoning to its extreme, the Respondent understands that, not having the Claimant husband exercised the option again for the organized accounting regime in 2005, he came to be subject to the legal regime applicable in the absence of choice, that is, to come to be classified in the organized accounting regime, no longer by choice, but by legal obligation, having regard to the income earned.

Thus, in the Respondent's understanding, with the legal requirement for classification in the organized accounting regime ceasing to exist, and in the absence of choice to maintain that regime, the Claimant husband should "return" to the simplified regime in 2014.

It is thus important to assess the Respondent's line of reasoning, starting, as is required, from the beginning.

In fact, following the Respondent's cognitive path, it is easy to detect that the resolution of the present dispute lies in the question of whether the Claimant husband had to, in 2005 (and in the following years, at least until 2007), once again request his classification in the organized accounting regime.

In fact, from the letter of the law it did not result, in an express manner (as it now does), that the option for the organized accounting regime, once exercised, would remain until indication by the taxable person to the contrary.

However, does this mean that the law imposed, at the date of the facts, an automatic and annual lapse of the option for the organized accounting regime?

In referring, in paragraph 5 of article 28 of the IRS Code, (only) to the simplified taxation regime, was the law imposing that the option for the organized accounting regime be renewed on an annual basis?

It does not seem so.

At the date of the facts, paragraph 2 of article 28 of the IRS Code stated that taxable persons were covered by the simplified regime if (i) in the previous year they had not exceeded the objectively fixed limits and (ii) if they had not opted for the organized accounting regime.

Further, paragraph 4 of the same article stated that the option (for the organized accounting regime) should be made (i) in the declaration of commencement of activity or (ii) by means of a declaration of changes.

That is, it is clear from the combination of the legal regimes at the time that the simplified regime, if applicable, presupposed that there had been no option for the organized accounting regime and that this option would be effected through a declaration of changes. That is, a change of regime (from simplified to organized accounting).

Having the option for the organized accounting regime already been validly exercised in the previous year, and even though at the time there was no obligation of permanence in the regime for 3 years with express renewability, what sense would it make to require the submission of a declaration of changes to maintain the regime from the previous year?

Certainly the anachronism of the question leads to the answer that is required.

In fact, it would make little sense for the taxable person, having opted for the organized accounting regime, to be required to submit a declaration of changes to maintain that same regime.

Thus, neither did the letter of the law impose such a requirement, nor should the legal basis used by the Respondent have the effect which it advocates.

With the (imperfect) regime then in force, what was intended was, in fact, to avoid fluctuations between the simplified regime and organized accounting, as a matter of administrative stability and efficiency.

To impose a declarative, confirmatory and annual burden, for submission to a legal regime – that of organized accounting – which is recognizedly that which best accords with the basic principles of the tax itself would certainly be incomprehensible, particularly as no technical or tax policy question could be seen to justify it.

In fact, in the case discussed here, the Claimant husband was not covered by the organized accounting regime by legal obligation. Rather, he was covered because he opted for this regime.

Nowhere did the legal regime in force at the time impose annual confirmation of this option (if anything appearing to suggest that such obligation would only exist for a change of regime).

As such, and especially having regard to subsequent legislative changes which came to provide for automatic renewability also of the option for the organized accounting regime, it should be concluded that the Claimant husband should, also in the year 2014, and notwithstanding having earned net category B income in an amount below the legal threshold for mandatory application of the organized accounting regime, have been taxed in accordance with the organized accounting regime because he exercised this option already in 2004, without ever having changed it.

IV. DECISION

On the basis of the factual and legal grounds set out above and, in accordance with article 2 of the LFATM, the Arbitral Tribunal decides:

I) To judge fully favorably the request for arbitral pronouncement and, in consequence, to annul the Personal Income Tax assessment no. 2018..., relating to the year 2014, with a value of tax to be paid of € 19,963.37;

II) To condemn the Respondent to restitution of the amount of the tax annulled;

III) To condemn the Respondent to the payment of compensatory interest in favor of the Claimant, in accordance with articles 43 and 100, both of the General Tax Law; and

IV) To condemn the Respondent to payment of all costs, given the complete success of the request.

CASE VALUE: In accordance with the provision of article 306, paragraphs 1 and 2, of the Code of Civil Procedure, article 97-A, paragraph 1, subparagraph a), of the Code of Tax Procedure and Process, and article 3, paragraph 2, of the Regulation of Costs in Tax Arbitration Proceedings, the case value is fixed at € 19,963.37 (nineteen thousand, nine hundred and sixty-three euros and thirty-seven cents).

COSTS: Calculated in accordance with article 4 of the Regulation of Costs in Tax Arbitration Proceedings and Table I attached thereto, in the amount of € 1,224.00 (one thousand two hundred and twenty-four euros).

Lisbon, 21 December 2018

José Calejo Guerra

Text prepared by computer, in accordance with paragraph 5 of article 131 of the Code of Civil Procedure, applicable by reference of subparagraph e) of paragraph 1 of article 29 of Decree-Law 10/2011, of 20 January.

The drafting of this decision is governed by the orthographic agreement of 1990.

Frequently Asked Questions

Automatically Created

What happens when a taxpayer previously opted for organized accounting but is reclassified to the simplified regime by the Portuguese Tax Authority?
When a taxpayer previously opted for organized accounting but subsequently qualifies for organized accounting by legal obligation due to exceeding income thresholds, the Tax Authority may reclassify them to the simplified regime if their income later falls below the mandatory threshold and they have not exercised a new explicit option for organized accounting. The key distinction is between classification by choice versus legal obligation. If a taxpayer is under organized accounting solely due to mandatory income thresholds (not an active option), they may automatically revert to the simplified regime when those conditions no longer apply. However, this reclassification is subject to challenge at CAAD if taxpayers believe their original option should persist.
Can the Portuguese Tax Authority automatically switch a taxpayer from organized accounting to the simplified IRS regime based on income thresholds?
Yes, the Portuguese Tax Authority can automatically switch a taxpayer from organized accounting to the simplified IRS regime based on income thresholds, but the legality depends on whether the taxpayer was in organized accounting by choice or legal obligation. According to Article 28 of the IRS Code, when a taxpayer's Category B income falls below the mandatory threshold for organized accounting and they have not exercised an explicit option to remain in that regime, the Tax Authority may reclassify them to the simplified regime. This automatic reclassification is particularly applicable when the taxpayer was previously under organized accounting due to legal obligation (exceeding income limits) rather than voluntary election. Taxpayers who wish to remain in organized accounting despite lower income must formally exercise that option.
What are the income limits that determine whether a taxpayer must use the simplified regime or organized accounting for IRS Category B income in Portugal?
Under Portuguese IRS law, specifically Article 28(2) of the IRS Code, taxpayers earning Category B income (business and professional income) are mandatorily required to use organized accounting when their annual net income exceeds specific thresholds established by law. While the decision excerpt does not specify the exact euro amounts for 2013-2014, it indicates that the claimant's 2013 income of €159,093.42 exceeded the mandatory threshold, requiring organized accounting. When income falls below this threshold, taxpayers may use the simplified regime unless they opt for organized accounting. The thresholds are periodically updated and determine whether classification in organized accounting is mandatory (by legal obligation) or voluntary (by taxpayer option). Taxpayers near these thresholds should monitor their income levels and formally communicate regime preferences to avoid unwanted automatic reclassification.
How can taxpayers challenge an IRS tax assessment resulting from incorrect classification under the simplified taxation regime at CAAD?
Taxpayers can challenge IRS assessments resulting from incorrect classification under the simplified regime versus organized accounting by filing a request for arbitration at CAAD (Centro de Arbitragem Administrativa) under the Legal Framework for Arbitration in Tax Matters (Decree-Law 10/2011). The challenge must be filed within the legal deadline, clearly identifying the contested assessment and articulating why the Tax Authority's classification was erroneous. In this case, the taxpayers argued that their original 2004 option for organized accounting should have remained valid without requiring annual renewal. The challenge should address both substantive issues (whether classification was legally correct) and may involve preliminary jurisdictional questions about whether classification decisions constitute assessable acts subject to arbitration. Taxpayers should provide documentation of any prior regime elections and income records demonstrating why their classification should differ from the Tax Authority's determination.
What is the legal basis for contesting the impugnability of a taxpayer's classification under the simplified regime versus organized accounting in Portuguese tax arbitration?
The legal basis for contesting the impugnability of taxpayer classification under the simplified regime versus organized accounting in Portuguese tax arbitration involves two key issues: jurisdictional competence and substantive tax law. Jurisdictionally, Article 2 of the LFATM (Legal Framework for Arbitration in Tax Matters) defines which acts are subject to arbitration. The Tax Authority may argue that classification decisions are administrative acts upstream of actual tax determination, falling outside arbitration jurisdiction. Substantively, the contest centers on interpreting Article 28 of the IRS Code, which governs when taxpayers are in organized accounting by legal obligation versus voluntary choice. The critical legal question is whether an initial option for organized accounting persists indefinitely or whether taxpayers must renew this option when circumstances change (such as income falling below mandatory thresholds). This involves analyzing whether classification constitutes an assessable act determining taxable matter or a preliminary administrative determination.