Capital Gains Tax (IRS) on Article 51 CIRS – CAAD Arbitral Decision 300/2014-T

ARBITRAL DECISION

I – REPORT

A – PARTIES

A…, and B…, holders of the Tax Identification Numbers … and …, married, holders of ID card nos …, issued on 03/12/2004 by the SIC of Lisbon and no …, issued on 01/08/2002 by the SIC of Lisbon, hereinafter designated as Claimant or taxable entity.

TAX AND CUSTOMS AUTHORITY (which succeeded the General Directorate of Taxes, by means of Decree-Law no. 118/2011, of 15 December) hereinafter designated as Respondent or AT.

The request for constitution of the arbitral tribunal was accepted by the President of CAAD, and the Arbitral Tribunal was regularly constituted on 31-03-2014, to appreciate and decide the object of the present proceeding, and automatically notified to the Tax and Customs Authority on 31-03-2014, as shown in the respective minutes.

The Claimant did not proceed to appoint an arbitrator, whereby under the provisions of section 1 of Article 6 and section 1(b) of Article 11 of Decree-Law no. 10/2011 of 20 January, with the wording introduced by Article 228 of Law no. 66-B/2012 of 31 December, the Ethics Council designated Dr. Paulo Ferreira Alves, the appointment having been accepted in the terms legally provided.

On 20-05-2014 the parties were duly notified of such appointment, having not expressed the will to refuse the appointment of arbitrators, in accordance with Article 11, section 1, sections (a) and (b) of the RJAT and Articles 6 and 7 of the Code of Ethics.

In accordance with the provisions of section 1(c) of Article 11 of Decree-Law no. 10/2011 of 20 January, with the wording introduced by Article 228 of Law no. 66-B/2012 of 31 December, the single arbitral tribunal is regularly constituted on 04-06-2014.

The arbitral tribunal is regularly constituted. It is materially competent, in accordance with Articles 2, section 1(a), and 30, section 1, of Decree-Law no. 10/2011 of 20 January.

On 03-09-2014, the meeting provided for in Article 18 of the RJAT was held, in which the representatives of the claimant and the respondent were given the opportunity to speak.

The parties have legal personality and capacity, are legitimate and are legally represented (Articles 4 and 10, section 2, of the same statute and Article 1 of Regulation no. 112-A/2011 of 22 March).

The proceedings do not suffer from defects that would invalidate them.

B – REQUEST

1. The now Claimant seeks a declaration of illegality of the tax assessment act and reconciliation statement in respect of Personal Income Tax no. …, which set a total tax to be paid of €38,492.66 (thirty-eight thousand four hundred ninety-two euros and sixty-six cents).

C – CAUSE OF ACTION

1. To support its request for arbitral pronouncement, the Claimant alleged, with a view to declaring illegal the tax assessment act and reconciliation statement in respect of Personal Income Tax no. …, in summary, the following:

2. The claimant acquired the urban property registered in the land register of the parish of … under article …, on 14 October 2005, for the price of €227,280.00, alleging that in view of the state of deterioration, the claimant had to proceed with its recovery.

3. The claimant maintains that to proceed with the recovery of the property, it contracted the following loans: a loan in the amount of €227,280.00, a loan in the amount of €425,000.00 and a final loan in the amount of €50,000.00, totaling €702,280.00.

4. The claimant justifies that such loans were fundamental to make the property habitable.

5. After completion of the recovery works, the claimant alienated the aforementioned property in 2009 for the value of €835,000.00.

6. The claimant maintains that it had financial expenses totaling €219,970.09, corresponding to interest supported with the loans contracted with banks for the performance of the property recovery works, and that such expenses should be tax-deductible, since they are intrinsically linked to the alienated property, just as the contracted loans.

7. The claimant alleges that such expenses should have been accounted for, whereby the corrections made by AT in determining the taxable income of Personal Income Tax in the amount of €122,809.89 which corresponded to a tax to be paid of €38,492.66, is manifestly illegal.

8. The claimant supports its position by arguing that the gain in capital gains resulting from the onerous alienation of a real right over an immovable property is constituted by the difference between the realization value and the acquisition value.

9. Moreover, the respondent states that pursuant to Article 43 of the Personal Income Tax Code, the value of income qualified as capital gains that is determined is that corresponding to the balance between the capital gains and losses realized in the same year, being that in 2009 they were the only ones and thus is determined in accordance with section 2 of the same article, that is, that corresponding to 50% of the balance determined in that year 2009.

10. The claimant also invokes in its substantiation that it complies with the requirements of Article 51 of the Personal Income Tax Code, an article that covers the financial expenses inherent to bank loans entered into for the performance of improvement works, arguing that they meet the necessary requirements, respectively, that the expenses with the appreciation of the property are duly proven with fiscally relevant documents, that they are undertaken in the last 5 years, and that they are demonstrably related to the improvement works of the property in question.

11. Whereby the rule does not restrict any expenses incurred with the appreciation of the goods, demonstrably undertaken in the last 5 years, material or physical appreciations, encompassing also effectively supported expenses that economically appreciate them.

12. The interest supported with the loans contracted with Banks for recovery of the property is and always will be a deductible expense for the purposes of Article 51, section (a) of the Personal Income Tax Code.

13. The claimant, in the case at hand, further alleges that of the financial expenses supported by the transferor, are absolutely indispensable to the appreciation of the property, given the financial insufficiency for its recovery, in view of its state of deterioration, and duly proven, also, its direct relationship between the loans obtained and their application in the appreciation of the property, not being able to fail to show that the requirements of the rule are met.

14. As for the question of necessary and effectively practiced expenses, inherent to acquisition and alienation, in the situations provided for in section (a) of section 1 of Article 10, the respondent refers that the expenses of acquisition of the property in question fall within this scope the Municipal Tax on Onerous Transfers of Immovable Property and the notarial and land registry charges, because "without them (expenses) the operation could not be carried out".

15. As for the property alienation expenses, the commissions for sale duly paid to the broker, as well as advertising expenses, if duly proven, are considered as eligible expenses.

16. The claimant maintains that to the total value of the expenses, loans plus interest, must be added to the acquisition value of the reconstructed property, since they directly reflect in the increase in the realization value, as they enabled the complainants to dispose of the property in better negotiating conditions.

17. In the understanding of the claimant, everything that may contribute to the economic appreciation of a property must necessarily be considered as an "appreciation expense", under pain of committing a grave injustice, by taxing a nonexistent contributory capacity: the contributory capacity without being burdened with the value of the interest paid, for not being considered expenses by the Tax Administration.

18. The claimant thus sustains the annulability of the acts of the tax assessment act and reconciliation statement in respect of Personal Income Tax for violation of law.

D – RESPONSE FROM THE RESPONDENT

1. The Respondent, duly notified for such purpose, submitted timely its response in which, in abbreviated summary, alleged the following:

2. The question at hand in the present proceedings is whether the expense with the payment of interest by resorting to third-party capital is a necessary expense either for acquisition or for alienation, or even for the appreciation of an immovable property, it being necessary to qualify the nature and characteristics of the expenses in question, and whether it is covered by Article 51 of the Personal Income Tax Code.

3. The position of the respondent is that the expenses in question are not covered by Article 51 of the Personal Income Tax Code, substantiating its position on the following grounds.

4. Any of the economic operations in the case at hand, be it acquisition, appreciation or alienation, can occur in the absence of payment of interest by reason of recourse to third-party capital, and the greater the investment made by recourse, or not, to credit, the greater the probability of obtaining capital gains of higher value.

5. However, the expense with bank interest is not a necessary expense inherent to alienation or acquisition whereby it has no place in the provisions of the cited legal rule.

6. Since bank interest, contracted for the performance of works, does not appreciate the property, neither directly nor indirectly, bank interest does not have the virtue of per se appreciating an immovable property, and its relevance is only instrumental for the performance of another type of legally provided expense.

7. Moreover, it states that its occurrence depends on the motivation of the economic agent to assume certain risks through the carrying out of an investment, which implies negotiation with third-party entities, the value at which it will acquire and the necessary resources that will allow it to make certain investments, that is, the occurrence of interest will or will not arise, depending on the motivation and economic capacity of the economic agent.

8. In its substantiation, the respondent maintains that there is a recognized margin of indeterminacy in filling in the concept of expenses of the rule of Article 51, it is not certain to affirm, as the Claimants do, that the rule does not expressly exclude financial expenses for the performance of indispensable works.

9. Nevertheless, in the case at hand, it might even be admitted, although this does not appear to be proven, that the financial expenses supported by the transferors, here Claimants, contributed to the appreciation of the property. But from this one cannot draw as a logical inference that the interest rate paid to the bank for the borrowed capital is automatically considered as a necessary and inherent expense to alienation.

10. In the understanding of the respondent, expenses are necessary or not, depending on whether one understands that only with its accomplishment can the legal transaction be concluded, whereby one cannot confuse two realities as different as capital and interest.

11. As for the expenses with interest and amortization of the loans contracted, they do not have a framework in the concept of property appreciation, for whether or not they exist, the value of the property is the same.

12. That is, even if they can be proven, not only the direct relationship between the loans obtained and their application in the appreciation of the property, one cannot consider that the financial expenses supported by the transferor, in light of the bank loans to which he resorted to make works on the property, fall within the concept of absolutely indispensable to the appreciation of the property.

13. Thus, one cannot accept that the expenses incurred for the recovery of the property, in light of its state of deterioration, were absolutely indispensable, in the perspective that it would be impossible to sell the property without incurring such expenses and such financial expenses.

14. Thus, AT by not accepting such costs in determining the capital gains subject to tax, in light of the provisions of the aforementioned section (a) of Article 51 of the Personal Income Tax Code, did so because such expenses do not fall within the concept of expenses of the aforementioned rule, for not being able to be considered expenses inseparable from the sale operation.

15. The respondent concludes in the sense that the act in crisis does not suffer from any illegality whereby it is challenged as unfounded, the present request for arbitral pronouncement should be judged to have failed due to lack of proof, and consequently absolved the Respondent entity from all requests, with the disputed assessments remaining in the legal order, as they constitute a correct application of the law to the facts.

E – FACTUAL FOUNDATION

1. Before proceeding to the appreciation of these matters, it is necessary to present the factual matter relevant for its respective understanding and decision, which was carried out based on documentary evidence, taking into account the facts alleged.

2. As a matter of relevant fact, this tribunal establishes the following facts:

3. The claimant acquired on 14 October 2005, by deed of sale carried out at the Notarial Office of the notary …, for the price of €227,280.00, the urban property registered in the land register of the parish of… under article….

4. The claimant contracted three loans, one in the amount of €425,000.00, another in the amount of €227,280.00 and yet another of €50,000.00.

5. The Claimant alienated the property described above in 2009 for the value of €835,000.00.

6. The claimant presented the following costs, respectively, administrative costs (including the acquisition value) in the amount of €428,702.21, construction costs in the amount of €163,876.82, financial costs in the amount of €163,876.82 and insurance costs in the amount of €56,093.27.

7. On 13 April 2012, the Tax Inspection opened service order no. …, which is considered fully produced.

8. The service order no. … resulted in the following changes in the determination of the fiscal capital gain: from the documents presented by the taxable entity in the amount of €420,228.54, AT understood that some expenses do not meet the conditions to be accepted as expenses and deductions under Article 51 of the Personal Income Tax Code, corresponding to the value of €235,848.32.

9. From the total value of expenses not accepted by AT, it results that €219,970.09 correspond to financial expenses and insurance.

10. The claimant's income was altered from €63,918.77 to €151,961.89 in order to include the fiscal capital gain in the value of €122,809.89, with other corrections being made that are not contested and not relevant for the case at hand.

11. On 4 May 2012, the Tax Inspection notified the complainants to proceed with the replacement of the Personal Income Tax form 3 for 2009, and to deliver together with the same a form called Annex G, which the claimant complied with.

12. The claimant was notified of the inspection action, and notified of the contents of the draft report of the arithmetic corrections made, and of the right to exercise the right to be heard.

13. The claimant exercised its Right to be Heard, in accordance with the provisions and for the purposes of Article 60 of the General Tax Law (LGT) and Article 60 of the Supplementary Regime of Tax Inspection (RCPIT), and presented the corresponding procedural guarantee.

14. The respondent notified the claimant of the Final Report prepared by the Tax Administration which substantiated the making of corrections to the taxable income of Personal Income Tax in the amount of €122,809.89.

15. The claimant was subsequently notified of the additional assessment act and reconciliation statement no. … in the amount of €38,492.66.

16. The Claimant proceeded to pay the tax in the amount of €38,492.66.

F – UNPROVEN FACTS

1. Of the facts with interest for the decision of the case, contained in the claim, all subjects of concrete analysis, those that are not contained in the factuality described above were not proven.

G – QUESTIONS TO BE DECIDED

1. Given the positions of the parties assumed in the arguments presented, the central question to be decided is the following, which it is therefore necessary to appreciate and decide:

a) The alleged by the Claimant, declaration of illegality of the tax assessment act and reconciliation statement in respect of Personal Income Tax no. ….

H – LEGAL MATTERS

1. Given the positions of the parties assumed in the pleadings presented, the central question to be decided by this arbitral tribunal consists of appreciating the legality of the Personal Income Tax assessment act.

2. The question that must be appreciated, according to the positions of the parties, consists of determining whether the financial expenses corresponding to interest and insurance supported with the loans contracted by the claimant for the acquisition and renovation of the property are covered by the concepts of "expenses with the appreciation of goods" and "necessary and effectively practiced expenses, inherent to acquisition and alienation" prescribed in section (a) of Article 51 of the Personal Income Tax Code.

3. It is relevant for the substantiation of the present decision to take into account that capital gains are patrimonial increments, as defined in Articles 9 and 10 of the Personal Income Tax Code, being included in category G income.

4. Capital gains constitute, in the present case, the gains obtained that result from the onerous alienation of real rights over immovable property, as provided for in Article 10, section 1(a).

5. Although capital gains constitute patrimonial increases not arising from productive activity, it is unavoidable that the "gain obtained" (Article 10, section 1 of the Personal Income Tax Code) can result from the assumption of a whole series of expenses/charges/costs, without which it would not exist, or would not assume the quantitative expression that such charges enable. [1]

6. In those circumstances, in which this quantitative expression of the "gain" has underlying the accomplishment of expenses that contribute necessarily and decisively to its manifestation, it will be necessary to take them into account insofar as only by attributing them relevance will one achieve the real contributory capacity of the subject, taxing it accordingly by the "net" gain, not being able to fail to establish a relationship of mutual causal interference between expenses that are the condition of the existence of the capital gain, or of its quantitative dimension, and the gains that without them would not exist, at least in the value that those provide. [2]

7. It should be considered "necessary and inherent" expense, for the purposes of the provision of Article 51, section (b) of the Personal Income Tax Code, all expense that assumes itself as a conditio sine qua non - inseparable, therefore - of the concretely obtained income, because translated into a necessary expense for the very existence of income subject to tax in the quantitative expression which it increases and not only those expenses that are formally inseparable from the transaction, without which it could not be formally carried out.

8. A different interpretation would result in the material unconstitutionality of the referred rule due to violation of the principle of contributory capacity in the requirement of taxation of net income, for the interpretative criterion applied by the tribunal a quo allows and admits that the charges/expenses/costs concretely supported that translate into the appreciation of the alienated property and as such constitute concretely the condition of the quantitative expression of the alienation not be valued[3]

9. The legislator aims to tax gains that reflect themselves in the increase of the patrimony of the taxable entity, in harmony with constitutional principles, in particular the principle of contributory capacity.

10. Article 104, section 1 of the Constitution of the Portuguese Republic expressly provides for the taxation of personal income, as the primary indicator of the taxable entity's contributory capacity, in order to obtain a fair distribution of tax burdens, it being necessary to calculate the net or taxable income.

11. The principle of contributory capacity implies, for the personal income tax, the so-called principle of net income, according to which only the amount of net income constitutes (true) income for the payment of taxes, that is, for each category of income are deducted the specific expenses for its obtaining. This means that, in principle, all expenses necessary for the production or obtaining of certain income, as a negative expression of contributory capacity that they are, must be excluded from that income.[4]

12. A principle that imposes an adaptation of the tax to the economic possibilities of the taxable entity.

13. Furthermore, Article 4, section 1 of the General Tax Law states, "taxes are based essentially on contributory capacity, revealed, in accordance with the law, through income or its use and property," and Article 6, section 1(b) of the same statute, "the patrimonial situation, including the legitimate charges, of the family unit."

14. Effectively, in accordance with the referred constitutional principle, in the present case, there must be a correspondence between capital gains or patrimonial increments and the taxable entity's contributory capacity, for which purpose must be taken into account for its calculation the charges and expenses necessary to obtain a patrimonial increase.

15. On this subject, Article 10, section 4(a) of the Personal Income Tax Code states:

"4 - The gain subject to Personal Income Tax is constituted by
a) The difference between the realization value and the acquisition value, net of the portion qualified as income from capital, where applicable, in the cases provided for in sections (a), (b) and (c) of section 1;"

1. A rule that does not contemplate the incurred and supported expenses, and is thus supplemented by Article 51 of the Personal Income Tax Code, which establishes the following limits:

"For the determination of capital gains subject to tax, the acquisition value increases by:

a) The expenses with the appreciation of goods, demonstrably undertaken in the last five years, and the necessary and effectively practiced expenses, inherent to acquisition and alienation, in the situations provided for in section (a) of section 1 of Article 10;

b) The necessary and effectively practiced expenses, inherent to alienation, in the situations provided for in sections (b) and (c) of section 1 of Article 10" (emphasis ours)

1. It results that the expressions "expenses with the appreciation of goods" and "necessary and effectively practiced expenses" contain some margin of indeterminacy, whereby it is incumbent upon this tribunal to determine whether the expenses and/or charges under consideration effectively fall within these concepts.

2. On the expression necessary expenses, effectively practiced and inherent to alienation, it is important to note the position assumed by the SAT in judgment 0585/09, on the same expression but in section (b) of section 1 of Article 51, which pronounced itself in the following sense:

"It should be considered 'necessary and inherent' expense, for the purposes of the provision of Article 51, section (b) of the Personal Income Tax Code, all expense that assumes itself as a conditio sine qua non - inseparable, therefore - of the concretely obtained income, because translated into a necessary expense for the very existence of income subject to tax in the quantitative expression which it increases and not only those expenses that are formally inseparable from the transaction, without which it could not be formally carried out.

1. A different interpretation would result in the material unconstitutionality of the referred rule due to violation of the principle of contributory capacity in the requirement of taxation of net income, for the interpretative criterion applied by the tribunal a quo allows and admits that the charges/expenses/costs concretely supported that translate into the appreciation of the alienated property and as such constitute concretely the condition of the quantitative expression of the alienation not be valued."

2. The legal regime of Personal Income Tax establishes that the gain subject to Personal Income Tax is constituted by the capital gain resulting from the sale of immovable property equal to the difference between the realization value and the acquisition value (Article 10, section 4(a)), deducted from necessary and effectively practiced expenses inherent to acquisition and alienation (Article 51).

3. In the interpretation of the concepts of Article 51, it is fundamental to take into account the constitutional and legal principles on which it is based, in particular the principle already mentioned of equality and contributory capacity, which fundamentally aim to tax the net income of the taxable entity and its family unit.

4. By not considering that the financial expenses of a loan, a common instrument in the acquisition of immovable property, as part of the calculation of the net income of the taxable entity, even if the concept of Article 51 is not precise, one would be violating the principles on which Personal Income Tax is based and in concrete, in the case at hand the category H - Patrimonial Increments, because in fact there must be a nexus of causality between the patrimonial increment and the taxation of actual income.

5. Because in fact the actual income of the taxable entity supported the financial expenses it had to obtain the income.

6. Only after deduction of the actual charges that the taxable entity had with the acquisition and alienation of the property can one in fact respect the principle of contributory capacity and tax its actual income, because the reality is that the taxable entity only had that patrimonial increment, and the financial charges were paid to the lender and taxed in the legal sphere of the latter.

7. To the acquisition value, certain charges and expenses must be added, considered as necessary for obtaining the capital gain.

8. In these terms, the value of the taxable capital gain results from the difference between the gain from the alienation of the property (realization value of the right relating to the property) and the acquisition value (corresponding to the net value of the costs or expenses necessary for the realization of alienation).

9. We have, thus, to determine whether the charges supported by the claimant are intrinsically connected with the acquisition and/or alienation of the property, and demonstrate whether without the charges the claimant would have obtained the capital gain, that is, would the respondent have obtained the referred capital gain without having incurred the supported charges or expenses, in accordance with the principle of contributory capacity.

10. The claimant resorted to financing from banking entities for the purchase and renovation of the property, in which it was proven that the loans contracted were intended for the acquisition and remodeling of the property, whereby they are intrinsically connected with the property, thus related to its acquisition and subsequent alienation.

11. There are two crucial moments, that of acquisition and that of alienation, for the calculation of the capital gain, in the first moment - that of acquisition which corresponds to €227,280.00 - and the second moment, that of alienation which corresponds to €835,000.00. The claimant in order to obtain the sale or alienation in the value of €835,000.00, had to incur investments with the property, including here the financial charges.

12. It is verified that the claimant resorted to loans for two purposes, one for the acquisition of the property and another for the renovation of the acquired property.

13. Equally, it is verified that the value of the property increased with the alienation, motivated by the renovation works, whereby such expenses with the appreciation of the property were necessary for the increase in the value of the property, thus existing a direct relationship between the renovation expenses and the alienation value, also being verified that, without the expenses, the alienation value would necessarily be lower.

14. It is concluded that there is a nexus of causality between the loan obtained for the acquisition of the property and the capital gain obtained with the alienation.

15. There is, similarly, a nexus of causality between the two loans obtained for renovation and the renovation expenses presented and accepted, and there is a nexus of causality between such expenses and the increase in the alienation value of the property.

16. It is true that income can be created without resort to loans, however it is equally true that without the loan the claimant would not have created the income, situations that are not distinguished in the regime in question.

17. Just as the respondent refers in its substantiation, the claimant could in fact have acquired the said property and carried out the recovery works without resorting to loans, if it had the necessary capital, it being a free choice of the taxable entity, whereby the legislator does not distinguish, nor can AT the respondent impose a different regime for the two situations, or impose such choice on the taxable entity.

18. What is sought is the net or actual income, whereby it is necessary to consider the loan in its entirety, that is, the value of the renovation expenses plus the financial charges it incurred to be able to undertake such renovation expenses, because this is what represents the actual income of the taxable entity.

19. The financial charges with the loans contracted for the renovation of the property, these are intrinsically linked with the expenses presented by the claimant, expenses which there is no doubt constitute "expenses with the appreciation of goods", and are not contested by the parties.

20. The actual cost of the taxable entity is not restricted only to expenses with appreciation, such as the invoices that the claimant presented, but is comprehensive to the cost that the taxable entity had in reality to be able to undertake such appreciation, a cost that was proven with documents and whose veracity and limits were not contested.

21. It is concluded that the claimant, regardless of whether or not it had the need to resort to bank credit to acquire and renovate the property, it is verified that the loan contracted for acquisition of the property is intrinsically linked to the acquisition of the property, and thus necessary to acquire it and, effectively, if it is necessary, so are the expenses inherent to the loan, in particular the interest.

22. Moreover, since the taxable entity did not have its own capital to acquire a property or to carry out recovery works, it would necessarily have to resort to banking, which further demonstrates the indispensable nature of the referred loan, since without it it could not acquire or alienate a property, nor obtain the income.

23. From the outset there is no doubt that it must be accepted as necessary expense in the calculation of the capital gain, falling under section (a) of section 1 of Article 51 of the Personal Income Tax Code, in accordance with the principle of equality and contributory capacity.

24. Proven that the loans are directly connected with the appreciation charges, it must be accepted that section (a) of section 1 of Article 51 of the Personal Income Tax Code encompasses in the case at hand the financial charges, since it has been demonstrated that there is a nexus of causality thereof with the appreciation charges.

25. As for the loans for the recovery of the property, there is a nexus of causality between the loans obtained and the expenses supported and presented by the taxable entity in the referred recovery, equally such loans were accepted as expense in the calculation of the capital gain.

26. The concept, given its indeterminacy, in its broader sense can be understood as encompassing all expenses and charges that the taxable entity incurred in order to obtain such income.

27. The most recent understanding by jurisprudence and AT has been to accept as expenses within the scope of Article 51, the Municipal Tax on Transfers, the notarial and land registry charges, because without them the operation could not be carried out, as well as the amounts paid to the real estate broker with the concrete transaction that gave rise to the taxable capital gain.

28. The tax administration, on Article 51, section 1(a), pronounced itself through binding information 12/2008, regarding real estate brokerage expenses, logical interpretation that can be applied in the present case.[5]

29. Both from the binding information and from the conclusions of AT, it results that three fundamental types of considerations are necessary to be accepted as an expense: (i) the income to be taxed as capital gain should, whenever possible, be net income, (ii) economic double taxation should be avoided; and (iii) potential tax fraud schemes must be guarded against.

30. These considerations that are met in the case sub judice, let us see.

31. As for the first consideration (i) the income to be taxed as capital gain should, whenever possible, be net income.

32. From the outset the net income earned by the taxable entity for the acquisition of the property corresponds effectively to the loan and expenses inherent thereto, and as already stated, without the payment of interest and insurance, the taxable entity could not have acquired the loan and consequently could not have acquired nor alienated the referred property, and created the income and the capital gain.

33. Inseparably in the calculation of the claimant's actual income it is essential to take into account all the charges it supported to obtain it, consequently the loan obligations supported fall within this.

34. As for the second consideration, (ii) economic double taxation should be avoided, in the case at hand, since by not considering the financing expenses for the calculation of capital gains, the taxable entity is being taxed on income it does not possess, and that income in the form of interest and insurance that is being taxed in the legal sphere of the lender.[6]

35. With respect to the last consideration, (iii) potential tax fraud schemes must be guarded against, as to this consideration. It is stated that AT at no time contested the veracity of the loans and that the referred loans were not used for the acquisition and for the renovation works of the property, and it is further stated that the loans were obtained from a duly authorized banking entity, the issue of tax fraud not being raised by the parties from the outset, and thus this requirement is met.

36. For the case at hand, the present tribunal sees no impediment to applying the argumentative logic that AT used regarding the necessary requirements for real estate brokerage expenses to be admitted in the calculation of capital gains.

37. It is further stated that brokerage expenses are not mandatory, and from the outset constitute a free choice of the taxable entity for the acquisition or alienation of immovable property, and are covered according to AT's binding information by Article 51, section 1(a). The same is said regarding the financial charges with the loans, constituting a free choice of the taxable entity, but intrinsically linked to the acquisition and alienation of the property, and to the obtaining of income.

38. In these terms it is verified that the financial expenses that the taxable entity had to support to obtain financing for the acquisition, appreciation and alienation of the property in question are guarded against in the three considerations that the tax administration understands.

39. Equally it is said that the financial expenses are duly documented.

40. For all that has been stated, there is a nexus of causality between the taxable capital gain and the charges/expenses incurred with the appreciation of goods, relating to the loans obtained and their inherent financial expenses, whereby it is concluded that the same are covered by Article 51, section 1(a), and should thus be accepted as charges and expenses in the calculation of the capital gain.

41. It would not be possible to obtain the taxable gain if the taxable entity had not incurred the financial charges under discussion.

42. Thus, the present tribunal concludes by declaring illegal the assessments sub judice, for they suffer from the defect of violation of Article 51, section 1(a), for error regarding the legal prerequisites, which justifies the declaration of its illegality and annulment (Article 135 of the Code of Administrative Procedure).

A – COMPENSATORY INTEREST

1. The claimant further petitions for the payment of compensatory interest.

2. In view of the foregoing, the assessment of Personal Income Tax, in the part covered by the annulment, which will be decreed, result from errors of fact and law attributable exclusively to the tax administration, insofar as the Claimant fulfilled its duty of declaration, and such errors were committed by it and it could not fail to be aware of different understandings.

3. In truth, being demonstrated that the claimant paid the contested tax in a part superior to that which is owed, by virtue of the provisions of Article 61 of the Code of Administrative Court Procedure and Article 43 of the General Tax Law, the Claimant has the right to compensatory interest owed, such interest to be counted from the date of payment of the undue tax (annulled), until the date of issuance of the respective credit note, counting the period for such payment from the beginning of the period for the voluntary execution of the present decision (Article 61, sections 2 to 5, of the Code of Administrative Court Procedure), all at the rate determined in accordance with the provision of section 4 of Article 43 of the General Tax Law until complete reimbursement.

4. The claimant's request is granted.

I - DECISION

Therefore, in view of all the foregoing, the present Arbitral Tribunal decides:

I. To judge as well-founded the request for declaration of illegality of the tax assessment acts in the field, for error regarding the legal prerequisites, which justifies the declaration of its illegality and annulment.

II. To condemn the Respondent to restore to the claimant the amount indevidly assessed and paid, increased by the payment of accrued compensatory interest, relating to the period from 18 December 2013 to be calculated on the amount of €38,492.66, as well as in the payment of accruing compensatory interest to be counted from the latter date, all in accordance with sections 2 to 5 of Article 61 of the Code of Administrative Court Procedure and at the rate determined in accordance with the provision of section 4 of Article 43 of the General Tax Law until complete reimbursement.

III. The value of the case is fixed at €38,492.66, the value of the assessment, taking into account the economic value of the case measured by the value of the disputed assessments, and accordingly the costs are fixed, in the respective amount of €1,836.00 (one thousand eight hundred and thirty-six euros), to be borne by the respondent in accordance with Article 12, section 2 of the Tax Arbitration Regime, Article 4 of the Code of Administrative Court Procedure and Table I appended thereto. – section 10 of Article 35, and sections 1, 4 and 5 of Article 43 of the General Tax Law, Articles 5, section 1(a) of the Code of Administrative Court Procedure, 97-A, section 1(a) of the Code of Administrative Court Procedure and 559 of the Code of Civil Procedure).

Let it be notified.

Lisbon, 2 October 2014.

The Arbitrator

Paulo Renato Ferreira Alves

[1] As per the judgment of the SAT in case 0585/09 of 18/12/2009.

[2] As per the judgment of the SAT in case 0585/09 of 18/12/2009.

[3] As per the judgment of the SAT in case 0585/09 of 18/12/2009.

[4] On this matter, José Casalta Nabais, The Fundamental Duty to Pay Taxes, pp. 520 and 521.

[5] The binding information, case 12/2008, stated the following: "In accordance with Article 51, section (a) of the Personal Income Tax Code, for the determination of capital gains subject to tax, to the acquisition value are added the expenses with the appreciation of goods, demonstrably undertaken in the last 5 years, and the necessary and effectively practiced expenses, inherent to the acquisition and alienation of real rights over immovable property

The expression 'necessary expenses' contained in section (a) of Article 51 contains some margin of indeterminacy, whereby it is incumbent upon the Tax Directorate General to fill it in, for which it must resort to at least three fundamental types of considerations: (i) the income to be taxed as capital gain should, whenever possible, be net income, (ii) economic double taxation should be avoided; and (iii) potential tax fraud schemes must be guarded against.

In light of these considerations, expenses inseparable from the property sale operation that the transferor demonstrably supported to undertake it should, in principle, be taken into account in the determination of capital gains.

Thus, once all the necessary requirements are met to demonstrably show the connection of the amount paid to the real estate broker with the concrete transaction that gave rise to the taxable capital gain and being duly documented the intervention of the respective broker in accordance with the applicable legal terms, the brokerage commission may be considered a 'necessary expense' for purposes of section (a) of Article 51 of the Personal Income Tax Code. In light of these considerations, expenses inseparable from the property sale operation that the transferor demonstrably supported to undertake it should, in principle, be taken into account in the determination of capital gains."

[6] The SAT assumed an identical position in the judgment which stated "(...) the fact that the income to be taxed as capital gain should be, in principle, net income, corresponding to the actually acquired contributory capacity, and on the other hand, economic double taxation should be avoided (since the compensation received by the tenant will be subject to Personal Income Tax) and equally, an interpretation favoring tax fraud should be avoided (...)"