CAAD 311/2017-T: VAT Pro Rata Calculation for Mixed Taxable Persons in Leasing and Financial ALD

ARBITRATION DECISION

The Arbitrators José Poças Falcão (President), José Nunes Barata and Maria Isabel Guerreiro, appointed by the Ethics Council of the Administrative Arbitration Center (CAAD) to form this Collective Arbitration Tribunal, agree on the following

ARBITRATION DECISION

I. REPORT

1. A…, SA (hereinafter referred to as "Claimant"), legal entity no. …, with registered office at Rua …, no.… to …, Lisbon, …-…, submitted a request for arbitral pronouncement and constitution of an arbitration tribunal on 2 May 2017, pursuant to the provisions of article 4º and no. 2 of article 10º of Decree-Law no. 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter referred to as "RJAT"), in which the Tax and Customs Authority (hereinafter referred to as "Respondent" or "AT") is the respondent.

2. In the aforementioned request for arbitral pronouncement, the Claimant requests that the Arbitration Tribunal declare:

(i) the annulment of the tax acts embodied in the periodic VAT declarations relating to the periods 07/2015, 08/2015 and 09/2015, submitted on 17.08.2015, 10.09.2015 and 10.11.2015, respectively;

(ii) the refund to the Claimant of the sum of 254,064.47 euros relating to non-deducted VAT;

(iii) the recognition of the right to legal interest calculated from the date of submission of the respective periodic declarations relating to the periods 07/2015, 08/2015 and 09/2015, namely, 17.08.2015, 10.09.2015 and 10.11.2015, respectively, until the date of actual refund.

1. The request for constitution of the Arbitration Tribunal was accepted by the President of CAAD and notified to the Respondent on 3 May 2017.

2. The Claimant did not appoint an arbitrator, and therefore, pursuant to the provisions of article 6º, no. 2, paragraph a) of the RJAT, the undersigned were appointed as arbitrators by the President of the Ethics Council of CAAD, with the appointments having been accepted within the legally prescribed timeframes.

3. On 20 July 2017, the arbitration tribunal was constituted.

4. Notified for this purpose on 28 June 2017, the Respondent submitted its Reply on 3 October 2017 and forwarded a copy of the administrative file.

5. On 8 October 2017, the arbitration hearing provided for in article 18º of the RJAT was dispensed with, and the Claimant and Respondent were invited to present written arguments, with 15/12/2017 being fixed as the deadline for delivery and notification of the final arbitration decision.

6. On 30 October 2017 and 10 November 2017, the Claimant and Respondent respectively submitted their written arguments, reaffirming, in substance, the positions already assumed in the petition and reply.

7. The Claimant supports its claim, in summary, as follows:

— On 17 August 2015, the Claimant submitted, via Internet, the periodic VAT declaration relating to July 2015 – which was subsequently replaced by the declaration submitted on 08 September 2015;

— On 10 September 2015, the Claimant submitted, via Internet, the periodic VAT declaration relating to August 2015 – which was subsequently replaced by the declaration submitted on 12 October 2015;

— On 10 November 2015, the Claimant submitted, via Internet, the periodic VAT declaration relating to September 2015;

— Given that the Claimant was and is, for VAT purposes, a mixed taxable person (carrying out operations that grant the right to deduction and operations that do not grant such right), it deducted, in the periodic declarations relating to the periods of July, August and September 2015, the VAT on the basis of the calculation of the provisional pro rata, corresponding to the final pro rata for the 2014 fiscal year;

— In determining the pro rata, the Claimant should have considered, both in the numerator and in the denominator, in particular: (i) the financial depreciation relating to financial leasing contracts and (ii) the values of disposal/write-off by destruction of leased assets;

— However, in those same declarations (as occurred in the remaining periods of previous fiscal years), the Claimant, in determining the pro rata calculation, excluded from the numerator and denominator of the fraction the financial depreciation relating to financial leasing contracts and the values of disposal/write-off by destruction of leased assets;

— Thus reducing its pro rata from 59% [final value for 2014 (and provisional for 2015), according to the criterion followed by the Claimant] to 18% [final value for 2014 (and provisional for 2015)], adopting the criterion imposed by the Tax and Customs Authority, [hereinafter abbreviated as "AT"], the Claimant saw the amount to be deducted decrease from € 365,604.98 to € 111,540.50;

— The Claimant proceeded in the manner described above – i.e., altered[1] the criterion for determining the pro rata (ceasing to disregard from the numerator and denominator the financial depreciation relating to financial leasing contracts and the values of disposal/write-off by destruction of leased assets) – by virtue of the position set forth in Circular Letter no. 30108, of 30.01.2009, endorsed by the Director General of AT and followed by the Inspection Services in inspections of the Claimant in previous fiscal years;

— In the said Circular Letter no. 30108, the AT established, in particular, the following: "In the application of the real allocation method, as per the preceding paragraph and whenever objective criteria for allocation of common costs cannot be applied, a specific allocation coefficient must be used, taking into account the values involved, and in calculating the deduction percentage, only the annual amount corresponding to interest and other charges relating to Leasing or ALD activity should be considered";

— For which reason, taking into account the position of AT in inspections carried out on the Claimant in previous fiscal years (subsequently transposed into the said circular letter) and, moreover, the well-founded fear that AT would, once again, contest the criterion adopted for determining the pro rata in the VAT declarations, the Claimant decided to correct the amounts deducted in the monthly periodic VAT declarations relating to the periods 2015/07, 2015/08 and 2015/09;

— Thus avoiding, from the outset, for mere reasons of caution, that on the amount that would be corrected by AT legal interest would accrue and corresponding misdemeanor proceedings would be initiated;

— Nevertheless, the foregoing notwithstanding, the Claimant sought, through the "Voluntary Reclamation Procedure no. …2015…" and the "Hierarchical Appeal Procedure no. …2016…", to contest the said VAT self-assessment acts, since the same were based on the said general guidance of AT - relating to the rules for determining the right to deduction for credit institutions when simultaneously carrying out Leasing or ALD activities - which in its view is manifestly contrary to law;

— It being certain that in the aforementioned procedures it is widely recognized that all data and factual elements should be considered as proven tending to demonstrate that in the periodic declarations relating to the periods from July to September 2015, there would have resulted an overpayment of value added tax ("VAT") in the amount of € 254,064.47;

— Thus, there is no doubt that what is at issue in the present case is solely and exclusively the procedure adopted by the Claimant in the application of the pro rata deduction method for tax borne on goods and services of mixed use (i.e., used in operations that grant the right to deduction and operations that do not grant such right), that is, to ascertain whether items (i) the financial depreciation relating to financial leasing contracts and (ii) the values of disposal/write-off by destruction of leased assets should be considered in the numerator and denominator of the pro rata calculation fraction;

— It is evident and patent, therefore, that AT did not contest nor refute the calculation schedules demonstrating the deduction percentage determined in accordance with Circular Letter no. 30108 (18%) and, moreover, the deduction percentage determined in accordance with the Claimant's perspective on the legal framework in force (59%) when reviewing the procedures it had adopted;

— For which reason, all the grounds contained in the petition of the "Hierarchical Appeal Procedure no. …2016…" and the "Voluntary Reclamation Procedure no. …2015…" are hereby fully reproduced, from which it follows that the Claimant, in following the general guidelines and by virtue of the criterion defined by AT (insofar as its right to deduction was restricted), ascertained a lower deduction percentage (18% against 59%), which constituted an over-adjustment in the total amount of € 254,064.47;

— As is widely recognized by AT, the Claimant's present claim "…is based on an assessment of illegality with respect to the administrative instructions advocated in the Circular Letter, regarding the imposition that, in the activity of financial leasing, in calculating the deduction percentage of tax borne on mixed assets, the financial depreciation component of rents should be disregarded" (cf. § 43 of document no. 1);

— According to AT, "The VAT deduction scheme for mixed taxable persons was clarified in 2008, in particular with regard to the scope and characterization of the real allocation method, which may consist of a deduction percentage based on criteria other than turnover" (cf. § 57 of document no. 4);

— AT thus considers that "…it is and was (as of the date of the facts) legally authorized to, within the scope of the real allocation method, consider a specific deduction percentage (specific pro rata) that, in its calculation, includes only the annual amount corresponding to interest and other charges relating to leasing or ALD activity, and not the capital component of rents and the disposal/compensation for write-off by destruction of leased assets, this imposition being justified by the existence of significant distortion of taxation [if general methods were used, in particular the general pro rata provided for in paragraph b) of no. 1 and no. 4 of article 23º of the VAT Code]" (cf. § 59 of document no. 4);

— Furthermore, and in line with AT's position, "…the inclusion in the deduction ratio of the component relating to capital repayment (financial depreciation/indemnification), as an integral part of the rent, would cause an unjustified increase in the percentage of final deduction, given that it would be significantly and positively influenced through a mere repayment of a financing, the underlying asset of which has already been subject to liquidation (by the supplier) and deduction (by the lessor) of VAT at the time of acquisition" (cf. § 69 of document no. 4);

— Therefore, according to AT, the Claimant's claim "…would generate increased deductions, with respect to the acquisition of all goods and services of mixed use, as a result of the use of an exaggerated coefficient relative to the reality of taxable operations…[because] the lessor's main activity does not consist in the purchase and sale of goods, not obtaining profits in that way, but solely in the granting of credit to third parties for the acquisition of those goods, even though it takes the place of the recipients of the goods in the acquisition, reserving for itself the right of ownership" (cf. §§ 70 and 71 of document no. 4);

— For AT, the guidance contained in the aforementioned Circular Letter was confirmed by the Court of Justice of the European Union ("CJEU") itself, in a judgment delivered on 10 July 2014 in Case C-183/13 ("Banco Mais Case"), which concluded in the following terms: "in these circumstances, the calculation of the right to deduction in application of the method based on turnover, which takes into account the amounts relating to the part of the rents that clients pay and which serve to compensate for the provision of the vehicles, leads to determining a pro rata of VAT deduction paid upstream less accurate than that resulting from the method applied by the Tax Authority, based solely on the part of the rents corresponding to the interest that constitutes the counterpart of the financing and management costs of the contracts borne by the financial lessor, since these two activities constitute the essential use of the goods and services of mixed use intended for the realization of financial leasing operations for the automotive sector" (cf. §§ 73 to 75 of document no. 4);

— AT thus states that "…the calculation of the right to deduction in accordance with the administrative instructions conveyed in Circular Letter no. 30108/2009 is that which most closely approximates the principle of tax neutrality, being in compliance with the provisions of article 23º of the VAT Code and the VAT Directive. Therefore, intending to proceed with deduction in a different manner, the rectification of the self-assessments made is not legitimate (cf. § 77 of document no. 4);

— Following the provisions of the VAT Directive, article 19º of the VAT Code enshrines the aforementioned principle of deduction of tax borne upstream, that is, the deductibility of tax due or paid by the taxable person in the acquisition of goods or provision of services intended for the realization of taxable operations;

— However, the national legislator, and in order to seek to prevent distortions in taxation – and still following what is provided in the VAT Directive – imposed limits on the right to deduction;

— In those terms, and as provided for in no. 1 of article 20º of the VAT Code, there is only a right to deduct tax if the same has been borne by the taxable person for the realization, downstream, of operations subject to VAT, that is, the right to deduction of tax borne upstream, will only be permitted if the acquisitions of goods or services are made with a view to the realization of taxable operations;

— In other words: should the goods or services acquired be related to operations not subject to or exempt from VAT, then the right to deduction is "barred", except in cases of complete exemptions – such as exports – and cases of waivers of exemption where deduction is allowed;

— Moreover, where we are dealing with a mixed taxable person (that is, where a taxable person, in addition to taxable operations that grant the right to deduction, simultaneously carries out operations not subject to tax or exempt from tax, which do not grant the right to deduction), as is the case with the Claimant, the right to deduction is partial (partial deduction);

— The legislator provided for two solutions to modulate the right of deduction in cases where the activity of the taxable person encompasses operations that grant the right to deduction and those that do not grant such right, which are set out in article 23º of the VAT Code, corresponding to no. 1 of article 174º of the VAT Directive:

— the rule of real allocation, according to which, on the one hand, the taxable person is granted the right to fully deduct the VAT borne in the acquisition of goods and services exclusively intended for taxable activities (that is, conferring the right to deduction), on the other hand, the taxable person is prevented from deducting the VAT borne in the acquisition of goods and services exclusively intended for non-taxable or exempt activities without the right to deduction;

— and the pro rata rule (or deduction percentage), according to which deduction is limited to the fraction corresponding to the percentage value of taxable operations in all operations carried out by the mixed taxable person.

— Notwithstanding, until the amendment to article 23º of the VAT Code introduced by the State Budget Law for 2008 (Law no. 67-A/2007, of 31 December), the wording thereof seems to suggest a generic use of the pro rata method to mixed taxable persons, the fact is that article 173º of the VAT Directive, particularly its no. 1, indisputably confers a residual/subsidiary character on that method;

— Indeed, since the pro rata method is a method of "fiction", based on a fraction that is nothing more than a mere estimate, and the real allocation method is that which best adapts to the factual situation (only allowing the deduction of VAT in the part of the activity that grants the right to deduction – taxable or exempt operations with the right to deduction), it is clear that, having regard to the principle of neutrality intended to be ensured through the right to deduction and that the pro rata method may significantly distort taxation, the real allocation method should prevail over the pro rata method;

— It is only through the application of the real allocation method that full recovery of tax borne on costs assigned to the operations in question is permitted;

— Presenting a residual/subsidiary character, the pro rata method should only be applied to common costs (costs assigned indiscriminately to several activities, taxable operations and exempt operations);

— But the confirmation of the prevalence of the real allocation method follows from the aforementioned State Budget Law for 2008 (Law no. 67-A/2007, of 31 December), and this amendment had precisely the purpose of adapting national legislation to what is recommended at the community level, in particular to the understanding of the CJEU regarding the prevalence of the real allocation method;

— There is no doubt, therefore, that real allocation presents itself as the elected method to modulate the right of mixed taxable persons, the pro rata method being the residual method, especially intended for deduction in expenses indiscriminately assigned to taxed operations and non-taxed operations;

— Indeed, on this matter, article 163º of the VAT Directive provides as follows:

"With regard to goods and services used by a taxable person to carry out both operations with the right to deduction, provided for in articles 168º, 169º and 170º, and operations without the right to deduction, deduction is only permitted with respect to the part of VAT proportional to the amount relating to the first category of operations.

The pro rata of deduction is determined, in accordance with articles 174º and 175º, for the entirety of operations carried out by the taxable person".

— In turn, no. 1 of the aforementioned article 174º provides that:

"The pro rata of deduction results from a fraction that includes the following amounts:

— in the numerator, the total amount of annual turnover, net of VAT, relating to operations that grant the right to deduction in accordance with articles 168º and 169º;

— in the denominator, the total amount of annual turnover, net of VAT, relating to operations included in the numerator and to operations that do not grant such right to deduction"

— This latter provision was transposed to our legal system by no. 4 of article 23º of the VAT Code, which provides that:

"The deduction percentage referred to in paragraph b) of no. 1 results from a fraction that comprises, in the numerator, the annual amount, tax excluded, of operations that give rise to deduction in accordance with no. 1 of article 20º, and in the denominator, the annual amount, tax excluded, of all operations carried out by the taxable person arising from the exercise of an economic activity provided for in paragraph a) of no. 1 of article 2º, as well as non-taxed subsidies that are not equipment subsidies".

— In that measure, it thus results that when the application of the real allocation method is not possible, the deduction of common costs must necessarily be made according to the pro rata method, being calculated through the following formula: in the numerator (dividend) the total amount of annual turnover/transfers of goods and provision of services relating to operations that grant the right to deduction should be taken into account; and in the denominator (divisor), the same value of the numerator plus operations that do not grant the right to deduction (exempt or outside the scope of tax operations) should be included.

— The larger the denominator (i.e., the larger the exempt operations), the smaller the percentage and, consequently, the smaller the deduction;

— According to what has been mentioned above, AT considers that there is no basis for tax adjustment in favor of the Claimant for the reason that in the self-assessments relating to the periods in question, it correctly determined the VAT deduction percentage, and this is because it did not include in the numerator and denominator of the fraction the capital depreciation component in the rents of movable financial leasing contracts (and equally the value of disposal/write-off of leased assets) but only the interest component;

— This is not, however, the position of the Claimant, which has been corroborated by a legal opinion of January 2012 jointly authored by Dr. JOSÉ GUILHERME XAVIER DE BASTO and Professor Dr. ANTÓNIO MARTINS (Opinion attached to the voluntary reclamation, reproduced as document 6);

— In fact, the position defended by AT is incomprehensible and untenable, these authors considering that "(...) it is clear that it is on the totality of the rent, without distinction between interest and capital, that VAT should be charged, because the taxable value of tax in financial leasing operations is, according to paragraph h) of no. 2 of article 16º of the VAT Code, "the amount of the rent received or receivable from the lessee"; and it is equally clear that the numerator of the fraction expressing the deduction percentage is made up of "the annual amount", tax excluded, of operations giving rise to deduction", namely the value of operations that were taxed, and that its denominator is the "annual amount, tax excluded, of all operations carried out by the taxable person…", which obviously includes the former."

— Concluding thus that the "(…) solution proposed by the tax administration, of taxing the entire rent, as ordered by paragraph h) of no. 2 of article 16º, based on the taxable value, and of excluding, for purposes of determining the deduction percentage, from the numerator and denominator of the fraction the part of the rent corresponding to financial depreciation, has no direct support in legal texts."

— Therefore, as there is no way to contest the subjection of the operation to VAT, there will be no basis for the amount of financial depreciation and indemnifications not to be included in turnover for purposes of determining the pro rata;

— The aforementioned professors further add that such "(…) would result in contradiction between the calculation algorithm of the deduction percentage and the basic principle that guides this calculation, which is that of partial deduction in proportion to the amount of operations that grant the right to deduction."

— In any case, and as also embraced in the aforementioned opinion (in the wake of other authors, as we shall see further on), it is more than clear that in light of the national provisions that transposed the VAT Directive into the national legal system (in particular the VAT Code), AT is not attributed any prerogatives intended for the alteration of the method of calculating the VAT deduction percentage authorized for goods of mixed use, that is, with respect to "(...) common costs that could not be attributed by objective criteria to the two groups of operations, taxable and exempt, of the taxable person";

— Indeed, despite the margin granted by the VAT Directive to Member States in the context of deduction of goods and services of mixed use, the fact is that, according to national legislation (in particular the VAT Code), the possibility is not provided for AT to be able to alter the pro rata component;

— Thus, as is justly sustained in a very recent Supplementary Opinion prepared by J. GUILHERME XAVIER DE BASTO and ANTÓNIO MARTINS (which constitutes an update of the 2012 Opinion, following subsequent developments that occurred with the "Banco Mais" case and the decision that the CJEU issued on it), what really happens is that "(…) the national legislator did not make use of the faculty that the CJEU understands to be available to member states to limit the values to be inserted in the numerator and denominator of the fraction. The taxation distortions that the national legislator foresaw could exist in the modulation of the right to deduction are, in our law, resolved through the imposition on the taxable person of the real allocation method [no. 3, paragraph b) of article 23º of the VAT Code], or, when they result from the taxable person having opted for this method, the imposition to abandon it (final part of no. 2 of the same article). It is also true that the law consents that, in the case of opting for the real allocation method, the administration may impose on the taxable person "special conditions", which the law does not define, but which do not consist in alteration to the pro rata of deduction" (Opinion attached, reproduced as document 7);

— AT alleges that the inclusion of the financial depreciation component of rents of financial leasing contracts in the fraction for determining the pro rata causes "significant taxation distortions", based on the doctrine set forth in the aforementioned Circular Letter no. 30108, from which it follows that "In the application of the real allocation method (…) and whenever objective criteria for allocation of common costs cannot be applied, a specific allocation coefficient must be used, taking into account the values involved, and the deduction percentage calculation should only consider the annual amount corresponding to interest and other charges relating to Leasing or ALD activity";

— The truth, however, is that AT alleges that "significant taxation distortions" are found in the context of the application of the pro rata method and not in the framework of the imposition of the real allocation method, although nos. 2 and 3 of article 23º of the VAT Code only empower AT to impose special conditions or to cause that procedure to cease for the taxable person that carries out operations that grant the right to deduction and operations that do not grant such right within the scope of deduction according to real allocation;

— Indeed, despite the fact that AT does not impose on the taxable person the use of the real allocation method, it argues that the "significant taxation distortions" allegedly verified should be corrected through the exclusion of the financial depreciation comprised in the rents of financial leasing contracts both from the numerator and from the denominator of the fraction for determining the deduction percentage resulting from the application of no. 4 of article 23º of the VAT Code;

— However, AT does not invoke, as would be incumbent upon it, the reason why the recourse to the pro rata method as a way of measuring the deduction percentage of goods and services indiscriminately used in the realization of operations that grant the right to deduction and operations that do not grant such right is susceptible to causing "significant taxation distortions".

— And, more precisely, because it is that taxable persons who both carry out activities subject to VAT (such as Leasing and Financial ALD) and exempt activities (such as consumer credit), find themselves obliged to adopt a method of deduction of VAT from goods and services that are used in the realization of both types of operations that does not result from any specific legal or regulatory mandate to prevent "significant taxation distortions";

— If it were thus, moreover, the legislator would have already provided for the obligation for taxable persons that carry out financial leasing activities to deduct the inputs of mixed use according to real allocation;

— The truth is that the determination to exclude the capital of rents of financial leasing contracts from determining the deduction percentage constitutes the modeling of another method of VAT deduction, which clearly goes beyond the scope of the powers attributed to AT in this specific domain;

— In the present circumstances, it does not appear to us legitimate that AT presume that the use of the pro rata method in the terms provided for in no. 4 of article 23º of the VAT Code causes "significant taxation distortions", without any additional investigation effort, and it is instead required that it justify the reason why the Claimant should observe another deduction method;

— Indeed, AT merely reproduces the understanding set forth in the aforementioned Circular Letter no. 30108, without demonstrating that there is "(…) lack of coherence in the variables used therein, susceptible of causing unjustified advantages or disadvantages (…)";

— Terms in which, from the point of view of established law (iure constituto) – that is, under the applicable legal provisions – it is important to conclude the illegality of the VAT tax acts subject to this Request for Arbitral Pronouncement, insofar as it is manifestly unfounded the assertion that the application of the pro rata method intended by the Claimant in determining the degree of use of goods and services used in mixed operations in accordance with the terms of no. 4 of article 23º of the VAT Code leads to "significant taxation distortions";

— This same conclusion has even been adopted in a Judgment, not yet final, of the Lisbon Tax Court, delivered in the proceedings of Case no. 927/11.4BELRS (Organizational Unit 1) on 19.09.2012, in which it was determined that "… the understanding that only the annual amount corresponding to interest and other charges relating to financial leasing should be considered in calculating the deduction percentage has no minimum correspondence in the letter of the law";

— As already mentioned, in the rejection decisions of the Voluntary Reclamation and Hierarchical Appeal procedures that preceded this Request for Arbitral Pronouncement, the jurisprudence of the CJEU in the "Banco Mais Case" was invoked and cited, although, as we have already had the opportunity to foreshadow, the same must be subject to careful analysis and consideration;

— The CJEU considered that the Sixth VAT Directive does not prevent Member States from applying, in a particular operation, a method or criterion different from the method based on turnover, provided that such method ensures a more precise determination of the pro rata of deduction than that resulting from the other method;

— Once the CJEU's Judgment in the Banco Mais Case is examined, it becomes apparent – with due respect – that the same rests on a manifest and clamorous misunderstanding, as it assumes, without actually ascertaining, whether Portuguese law (more precisely the provisions of article 23º of the VAT Code) provides or not mechanisms that allow AT to impose other methods of VAT deduction for goods and services of mixed use;

— Indeed, in § 19 of the CJEU's Judgment, the following is stated: "Consequently, it is important to consider, as confirmed by the Portuguese Government at the hearing, that article 23º, no. 2, of the VAT Code constitutes the transposition, into the internal law of the Member State in question, of article 17º, no. 5, third paragraph, paragraph c) of the Sixth Directive";

— As JOSÉ MARIA MONTENEGRO states, "…at this basic point, I would even say critical point – that we distance ourselves from the CJEU Judgment of 10 July 2014. For it is not true that the provision contained in no. 2 of article 23º of the VAT Code (combined with no. 3) reproduces, in substance, the rule for determining the right to deduction set out in article 17º, no. 5, third paragraph, paragraph c) of the Sixth Directive, which is a derogating provision of the rule provided for in articles 17º, no. 5, first paragraph, and 19º, no. 1, of that Directive. And we will have even greater difficulty in following the assertion that article 23º, no. 2, of the VAT Code constitutes the transposition, into the internal law of the Member State in question, of article 17º, no. 5, third paragraph, paragraph c) of the Sixth Directive" (Annotation to the aforementioned jurisprudence, reproduced as document 8);

— In that sense, and according to the CJEU, the calculation of the right to deduction in the application of the turnover-based method leads to determining a less precise pro rata of deduction than that resulting from the method applied by AT, based solely on the part of rents corresponding to interest which constitutes the counterpart of the financing and management costs of contracts borne by the financial lessor, given that these two activities will constitute the essential use of goods and services of mixed use intended for the realization of financial leasing operations for the automotive sector;

— Thus, the CJEU concluded that "…article 17º, no. 5, third paragraph, paragraph e) of the Sixth Directive…must be interpreted in the sense that it does not prevent a Member State, in circumstances such as those of the main proceedings, from obliging a bank that carries out, in particular, financial leasing activities, to include, in the numerator and denominator of the fraction which serves to establish a single and same pro rata of deduction for all goods and services of mixed use, only the part of the rents paid by clients, within the scope of their financial leasing contracts, which corresponds to interest, when the use of those goods and services is essentially determined by the financing and management of those contracts, which is a matter for the referring court to verify";

— However, it is important to establish the meaning and scope of the CJEU's interpretive decision in order to adapt its application to the matter at hand, following three lines of reasoning:

— First, it is important to note that the CJEU's Judgment does not directly answer the preliminary question formulated in the "Banco Mais Case", which was based on the question of whether the rent corresponding to financial depreciation should be considered in the denominator of the pro rata, or instead, whether only interest should be considered, as only this constitutes the remuneration or profit of an entity that carries out financial leasing activities (subject to tax) and other activities associated with credit provision (exempt);

— Hence, when the question is rephrased, the answer to the preliminary question is intended to focus precisely on "…whether the provisions of the common VAT system regarding the right to deduction, in particular those contained in the third paragraph of no. 5 of article 17º of the Sixth Directive, permit a Member State to establish that banks that also carry out financial leasing operations, ascertain the right to deduction relating to goods and services of mixed use taking into account, as regards the aforementioned operations, the part corresponding to the remuneration of capital (interest) invested in the acquisition of the goods given in lease, as well as any commissions and related charges";

— As results from the facts alleged and not contested by AT in the context of the Voluntary Reclamation and Hierarchical Appeal procedures, financial leasing does not constitute merely an ancillary activity of a financial institution such as the Claimant;

— From which it follows that for the case at bar it would be essential to consider that in accordance with the provisions of paragraph h) of no. 2 of article 16º of the VAT Code it is the entire rent received, that is, capital and interest, which constitutes the taxable value of financial leasing operations, with that legal provision making no distinction between interest and capital when referring to the taxable value in financial leasing operations, taxing the entirety of the rent received;

— It would therefore not be admissible in any way, as advocated by AT in Circular Letter no. 30108 (which, let us not forget, provides the basis for the tax acts at issue in the present arbitration instance), "to distinguish where the law does not distinguish";

— It is indisputable, both for the doctrine and for the jurisprudence, that an administrative instruction cannot be regarded as law!

— Second, it should be recalled that the CJEU's Judgment should not even have undertaken to ascertain whether, effectively, Portuguese law (more precisely the provisions of article 23º of the VAT Code) provides mechanisms that allow AT to impose other methods of VAT deduction for goods and services of mixed use, and much less in the reckless manner in which it undertook that assessment;

— Indeed, the CJEU ended up confining its pronouncement to the question of whether article 17º, no. 5, third paragraph, paragraph c) of the Sixth Directive does not prevent a Member State from being able to obligate a taxable person to apply another deduction method that is deemed more suitable;

— However, the aforementioned provision has no correspondence in the VAT Code, which determines that AT is not authorized to oblige taxable persons to apply a VAT deduction method for goods and services of mixed use different from the pro rata method as provided for in article 23º of the VAT Code;

— It is not extraordinary that the supposed special criterion which grants Member States the third paragraph of no. 5 of article 17º is not expressly reflected in Portuguese internal VAT legislation, but rather in "…administrative instructions issued by the Portuguese Tax Administration, contained in circular letter 30108, of 30 January, of the Office of the Sub-Director General of VAT Management…", whose nos. 6 to 9 allegedly clarify that "…in order to determine the extent of the right to deduction of VAT related to common costs of credit institutions that also carry out financial leasing operations, it does not correspond to the general pro rata method based on turnover of each category of operations, which is provided for in no. 4 of article 23º of the VAT Code";

— It being certain that such assertion is contrary to what is justly referred to in the "Banco Mais Case", as inadvertently (and, worse, without foundation) the CJEU considered that the Portuguese Government confirmed at the hearing that article 23º, no. 2, of the VAT Code constitutes the transposition, into internal law, of article 17º, no. 5, third paragraph, paragraph c) of the Sixth Directive;

— The preliminary reference should only invoke the interpretation and application of community rules, and not, obviously, the interpretation and application of internal law rules, so it is wholly illegitimate that AT has come to assume or presume that the doctrine contained in the CJEU's Judgment has concrete application with respect to the tax acts under challenge;

— Third, it should be noted that the CJEU's Judgment sustains that the judgment of suitability for the application of another method of VAT deduction for goods and services of mixed use is dependent on the verification of the requirement consisting in the question of whether the use of those goods and services is essentially determined by the financing and management of financial leasing contracts;

— It is not possible to perceive the meaning and scope that the CJEU intends to give to this statement, given the circumstance that in Portuguese legislation there is no provision for the possibility of modeling the calculation of the pro rata, since the requirement is not contained in any legal or regulatory rule, nor even in Circular Letter no. 30108 which was at the basis of the tax acts at issue;

— Therefore, beyond constituting a requirement that has no legal place (in particular, in the VAT Code), such requirement could never be subject to allegation and proof by the taxable person, but rather by AT (since it is this which, in case of "significant taxation distortion", could impose the alteration – and not its modeling – of the method to the taxpayer);

— It was not incumbent upon the CJEU to ascertain whether, effectively, Portuguese law (more precisely the provisions of article 23º of the VAT Code) provides mechanisms that allow AT to impose other methods of VAT deduction for goods and services of mixed use;

— In fact, the preliminary reference should only invoke the interpretation and application of community rules, and not, obviously, the interpretation and application of internal law rules, so it would be wholly illegitimate that the sentence to be delivered in the present proceedings come to assume or presume that the doctrine contained in the CJEU's Judgment has concrete application in the present proceedings;

— The aforementioned provision of the community directive has no correspondence in the VAT Code, which determines that AT is not authorized to oblige taxable persons to apply a VAT deduction method for goods and services of mixed use different from the pro rata method as provided for in article 23º of the VAT Code;

— Therefore, the Claimant considers that it will now be incumbent upon this Arbitration Tribunal to ascertain whether effectively article 23º, no. 2 of the VAT Code constitutes (or does not constitute) a mere transposition of article 17º, no. 5, third paragraph, paragraph c) of the Sixth Directive;

— Article 17º, no. 5, third paragraph, paragraph c) of the Sixth Directive provides that "…a Member State may provide for a deduction regime that takes into account the special allocation of all or part of the goods and services in question."

— However, article 23º, no. 2 of the VAT Code only provides that, if the taxable person adopts the real allocation method for deduction of goods and services of mixed use, the Directorate-General of Taxes (that is, AT) has the possibility of causing that procedure to cease in the event that it verifies that the application of that method causes or may cause significant taxation distortions;

— From the confrontation of the aforementioned rules it results that it is absolutely false that the normative of the Sixth Directive, subject to assessment in the CJEU's interpretive judgment [article 17º, no. 5, third paragraph, paragraph c)], corresponds to article 23º, no. 2 of the VAT Code;

— The Claimant thus considers that the CJEU bases its Judgment on a totally wrong premise: that article 23º, no. 2 of the VAT Code constitutes the mere transposition into internal law of article 17º, no. 5, paragraph c) of the Sixth Directive!

— Article 23º, no. 2 of the VAT Code does not constitute the mere transposition into internal law of article 17º, no. 5, paragraph c) of the Sixth Directive;

— The aforementioned understanding does not conflict with the decision delivered by the CJEU, according to which article 17º, no. 5, third paragraph, paragraph c) of the Sixth Directive does not prevent a Member State from being able to oblige a bank to apply another deduction method that is deemed more suitable, although it was not taken into account that this rule has no identical or similar correspondence in the VAT Code;

— Having regard to the CJEU's understanding endorsed in the "Banco Mais Case", for AT to effectively be able to model the components of the pro rata fraction, in order to exclude the depreciation part from the calculation, it would be necessary that equal legitimacy be conferred upon it by article 23º of the VAT Code – which, as we have seen, is not the case;

— Concluding, we have that in the present case the prerequisites or cumulative conditions fixed by the CJEU in this jurisprudential direction are not, in a manifest way, verified, insofar as:

— First: article 23º, no. 2 of the VAT Code does not constitute the mere transposition, into Portuguese internal law, of article 17º, no. 5, third paragraph, paragraph c) of the Sixth Directive;

— Second: the prerogatives that article 23º, no. 2 of the VAT Code attributes to AT for imposing special conditions are restricted to the real allocation method and are reduced to the control of such objective criteria to be used to measure the intensity of inputs that cannot be directly attributed to two groups of operations, taxable and exempt;

— Third: AT has never identified or quantified the existence of supposed significant taxation distortions;

— Fourth: what is at issue is the modeling of the right to deduct certain goods and services (the so-called common costs) which cannot be subject to either direct allocation or allocation by real allocation, that is, it is not possible to ascertain the exact measure of apportionment in which the use of goods and services is determined by the financing and management of financial leasing contracts;

— Fifth: the consideration received by the lessor comprises not only the interest that corresponds to the remuneration of the service provided by a taxable person that carries out financial leasing activities, but also other charges and especially the financial depreciation that appears to correspond to the price paid by this party for the acquisition of the motor vehicle, and this composition of the consideration is in accordance with the provisions of article 16º, no. 2, paragraph h) of the VAT Code, which determines that the taxable value of operations arising from a financial leasing contract is the amount of the rent received or receivable from the lessee;

— Concluding, the Claimant considers that the tax acts under scrutiny should be revoked, and this because AT would not be authorized to apply or impose the application to the Claimant of a deduction coefficient different from the pro rata method, under penalty of violation of the provisions of articles 19º, 20º and 23º of the VAT Code and of the principles that characterize VAT (the principle of fiscal neutrality, the principle of equal treatment between taxable persons, the principle of legal certainty and the principle of protection of legitimate confidence of taxable persons), as well as of the constitutional principles of separation of powers (articles 2º and 111º), legality (article 112º, no. 5) and reservation of law (articles 103º and 165º, no. 1, paragraph i), all of the Constitution of the Portuguese Republic.

REPLY OF AT

1. The Respondent replied arguing for the dismissal of the request for arbitral pronouncement and alleging, in summary, that:

— The request for arbitral pronouncement sub judice has as its immediate object the decisions of rejection, of 31.01.2017, of the hierarchical appeal presented by the Claimant against the rejection of the voluntary reclamation request no. …2015…, of 18.02.2016, relating to VAT self-assessments, concerning the periods of July, August and September of the year 2015;

— In fact, the Claimant, in relation to those periods of tax, exercised its right to deduction based on the provisional pro rata of 18%, corresponding to the final pro rata it had calculated in relation to the year 2014;

— It understands, however, the Claimant, that it self-assessed tax in excess in the said periodic declarations since in a review of internal procedures it came to ascertain a pro rata of 59% and in that circumstance delivered tax in excess, in a total of € 254,064.47;

— Effectively, within the scope of the present proceedings, what is discussed and what is intended to be ascertained is whether or not there was an error in the self-assessment of tax, relating to the tax periods of July, August and September 2015, due to the fact that in calculating its deduction pro rata, the amount of financial depreciation relating to financial leasing contracts and the value of disposal or write-off by destruction of leased assets were disregarded;

— The Claimant is a credit institution covered by the General Regime for Credit Institutions and Financial Companies approved by Decree-Law no. 298/92, of 31 December;

— Within the scope of its activity it carries out operations to which no. 27 of article 9º of the VAT Code applies, namely financing and credit granting operations;

— Such operations constitute simple or incomplete exemptions which, as such, do not allow the right to deduct tax borne upstream;

— Besides this, the Claimant carries out financial leasing operations, through financial leasing contracts, namely movable financial leasing "Leasing and Financial Long-Term Rental", operations subject to and not exempt from which grant the right to deduction in accordance with paragraph a) of no. 1 of article 20º of the VAT Code;

— It is thus found that the Claimant falls within the category of a taxable person covered by the normal monthly periodicity regime and having the nature of a mixed taxable person for purposes of exercising its right to deduction;

— Moreover, as it is a mixed taxable person, the Claimant, with respect to acquisitions of goods and services of mixed use – used indiscriminately in the various operations it carries out – for purposes of exercising the right to deduction adopted the pro rata deduction method in accordance with paragraph b) of no. 1 and no. 4 of article 23º of the VAT Code;

— Thus, taking into account the characterization of the financial leasing contract through which there is no transfer of ownership, but rather the cession of the use of a good, the Claimant as lessor is obligated "to provide a service translated in the availability of the good in question, receiving in return, a consideration, without prejudice, to the possibility of providing for the option to purchase at the end of the contract, in favor of the lessee, for a residual value fixed by agreement of the parties";

— In this circumstance, financial leasing is characterized as a provision of services subject to tax in accordance with no. 1 of article 4º of the VAT Code;

— In the case of leasing operations, the consideration is realized in the rents collected by the Claimant, as the leasing entity;

— The rent is composed of a part corresponding to interest and another to financial depreciation or capital, as these leasing operations (leasing and ALD) reflect a form of credit;

— By so being, this activity conducted by the Claimant is nothing more than "in substance, (which) the granting of financing, whose remuneration consideration is essentially constituted by interest and other charges included in the rents";

— In fact, within the scope of the financial leasing contracts the Claimant enters into, it deducts the tax it bore in the acquisition of the said goods, in accordance with the real allocation method, and delivers the said goods to the lessee receiving in return rents, which include the amortization of capital, interest and possibly other expenses;

— The full deduction carried out by the Claimant with respect to the acquisition of the said leased assets occurs by direct allocation by the fact that the said goods are intended for an activity taxed with the right to deduction in accordance with article 20º of the VAT Code;

— However, this does not occur with respect to the acquisition of goods and services of mixed use, the so-called goods and services of a promiscuous nature that are intended indiscriminately for the various activities of the Claimant – subject and not exempt and exempt without the right to deduction;

— With respect to the said goods, deduction is effected taking into account the general rule established in paragraph b) of no. 1 of article 23º and calculated in accordance with no. 4 of the same legal provision or the real allocation method in accordance with objective criteria;

— Moreover, with respect to financial leasing activities, the various economic operators concluded that it was not possible to adopt the real allocation method in accordance with objective criteria in view of the nature of the said activity;

— In that circumstance, a Circular Letter no. …/2009 was issued, extensively cited in the information contained in the instructing file and which supports the rejection decisions to which the present proceedings relate, in order to clarify the ascertainment of a method as precise as possible, in the absence of the objective criteria imposed by the real allocation method, for all economic operators of the said activity;

— It being certain that the wording of no. 2 of article 23º of the VAT Code does not prevent the objective criterion from being determined in accordance with the deduction percentage assigned to all resources of the Claimant, it is no less certain that this criterion had to reflect only the amount of the profits arising from its taxed activity (the interest) under penalty of subverting the neutrality that presides over the entire system that enshrines the right to deduction;

— Thus, the procedure adopted by the Claimant when making the self-assessments of tax was the correct one;

— Contrary to what the Claimant seeks to assert, this methodology is not contrary to community law and, furthermore, has support in diverse jurisprudence of the CJEU;

— Now, what is found is that at a later time the Claimant sought to abandon that criterion which it used in relation to exercising the right to deduction of tax borne on resources of mixed use, coming to recalculate a deduction percentage of 59%, using the same pro rata deduction method but including the total value of the rent, without excluding the part relating to capital depreciation;

— Moreover, the Claimant invokes many principles relating to the uniform application of community law – the principle of neutrality, non-distortion of competition, etc. – in order finally to comprehensively state that there is a violation of community law in the case of calculating the pro rata of deduction which it calculated and seeks to recalculate;

— Now, it is precisely in light of the aforementioned principles that the additional assessments, at issue in the present proceedings, are shown to be perfectly legal, causing to fall any type of argumentation in the opposite sense and which seeks to safeguard the claim that the Claimant seeks to advance;

— In fact, in the midst of so much evocation of principles inherent to the taxation of consumption, as well as the express invocation of certain community jurisprudence, it causes us some strangeness that the Claimant should come to say that the Judgment of the Court of Justice of the EU, of 10 July 2014, does not properly relate to the matter of the proceedings;

— It is important, therefore, to summarize and cite what is referred to and decided in that Judgment.

The following is referred to in the said Judgment:

"Banco Mais is a banking institution that carries out financial leasing activities in the automotive sector and other financial activities.

It follows from the case file that the Court of Justice has that, in carrying out its activities, Banco Mais carries out operations that grant the right to deduction and operations that do not grant such right.

With respect to goods and services of mixed use, Banco Mais calculated its pro rata of deduction based on a fraction that comprises, in the numerator, the remuneration received with respect to financial operations that granted the right to deduction, to which was added the turnover generated by financial leasing operations that granted the right to deduction, and, in the denominator, the remuneration received with respect to all financial operations, to which was added the turnover generated by all financial leasing operations. In practice, this method led Banco Mais to consider that 39% of the VAT due or paid on those goods and services was deductible".

— And further on it says:

"In that decision the Tax Authority did not call into question the possibility of Banco Mais calculating its pro rata of deduction, with respect to credit operations different from financial leasing, by reference, in substance, to the part of remuneration relating to operations that grant the right to deduction. On the other hand, it considered, with respect to financial leasing operations, that the fact that it had used as a criterion the part of turnover generated by operations that granted the right to deduction, without excluding from that turnover the part of the rents received that compensated the cost of acquisition of the vehicles, had had the effect of distorting the calculation of the pro rata of deduction".

— Called upon to decide in final instance the said dispute, the Supreme Administrative Court submitted to the Court of Justice of the European Union the following preliminary question:

"In a financial leasing contract, in which the client pays the rent, this being composed of financial depreciation, interest and other charges, should this rent paid enter, in its full sense, into the denominator of the pro rata, or instead should only interest be considered, since this is the remuneration, the profit that banking activity obtains from the leasing contract?"

— It being that further on that Court states:

"Now, in these circumstances, the calculation of the right to deduction in the application of the method based on turnover, which takes into account the amounts relating to the part of the rents that clients pay and which serve to compensate for the provision of the vehicles, leads to determining a pro rata of VAT deduction paid upstream less accurate than that resulting from the method applied by the Tax Authority, based solely on the part of the rents corresponding to interest which constitutes the counterpart of the financing and management costs of contracts borne by the financial lessor, since these two activities constitute the essential use of goods and services of mixed use intended for the realization of financial leasing operations for the automotive sector".

— Thus, recalling once again that the common VAT system should ensure perfect neutrality with respect to the tax burden of all economic activities, the Court of Justice of the European Union came to consider that article 17º, no. 5, third paragraph, paragraph c) of the Sixth Directive: "must be interpreted in the sense that it does not prevent a Member State, in circumstances such as those of the main proceedings, from obliging a bank that carries out, in particular, financial leasing activities, to include, in the numerator and denominator of the fraction which serves to establish a single and same pro rata of deduction for all of its goods and services of mixed use, only the part of the rents paid by clients, within the scope of their financial leasing contracts, which corresponds to interest, when the use of those goods and services is essentially determined by the financing and management of those contracts, which is a matter for the referring court to verify.";

— Moreover, on this matter, the Supreme Administrative Court also ruled, by Judgment of 29 October 2014, issued within the scope of Case no. 01075/13, 2nd Section, where it was expressly decided: "Banks, whose business model also includes the conclusion of Leasing and ALD contracts, for example of motor vehicles, should include in the numerator and denominator of the fraction which serves to establish a single and same pro rata of deduction for all goods and services of mixed use, only the part of the rents paid by clients within the scope of those contracts, which corresponds to interest";

— By so being, the Claimant has not the least reason in respect to the considerations it makes in the petition of its arbitration claim, with respect to the determination of the pro rata of deduction, at issue in the present proceedings, as well as to the concept of turnover which, for this purpose, it seeks to apply and to the considerations which it makes or does not make on the matter in question;

— In fact, in light of fair competition among the various economic agents in the space of the European Union and in defense of the principle of VAT neutrality as to its tax burden, the rejection of the claim with respect to the tax supposedly self-assessed in excess is not vitiated by any illegality as the Claimant seeks to assert;

— On the other hand, it is important to note that, vis-à-vis the Treaties, the Court of Justice of the European Union is the guarantor of the interpretation and uniform application of European Union law in the territory of all Member States, which is realized through decisions delivered in the context of preliminary reference proceedings, pursuant to article 267º of the TFEU, as is the case with the aforementioned Judgment;

— Thus, this arbitration court is also bound by the interpretation made by the Court with respect to article 17º, no. 5 of the Sixth VAT Directive (current article 173º, no. 2 of Directive no. 2006/112 CE), at issue in the present proceedings, since article 23º of the VAT Code proceeded to its transposition into our internal law;

— Moreover, that interpretation leaves no room whatsoever for doubt, so the calculation of the pro rata which the Claimant applied in the periods in question was correctly calculated, with the self-assessments which it seeks to correct not suffering from any type of error;

— To proceed with an interpretation as advocated by the Claimant would, without any room for doubt, violate the so-acclaimed principle of tax neutrality and more than that the principle of fair competition in the space of the European Union, the true driver of all indirect harmonization and the consequent obligation to introduce VAT by all Member States;

— Furthermore, the principle of neutrality through which "the equality of enterprises before taxation of consumption" is realized would likewise be disregarded to sustain the thesis defended by the Claimant;

— By so being, the Claimant's interpretation, curiously, is the one that best materializes the principle of neutrality and the principle of equal treatment which the Banco Mais Judgment embodies, in a situation similar to that of the present proceedings, and of a competitor of the Claimant;

— Therefore, the calculation of the pro rata initially calculated by the Claimant, in accordance with the interpretation conveyed by the Respondent, does not merit any censure;

— In that sense, the acts of rejection of the voluntary reclamation and the subsequent hierarchical appeal do not suffer from any illegality in that, with respect to the leasing and ALD activity, the part relating to capital depreciation included in the rents cannot be part of the terms of the fraction of the pro rata deduction;

— The present request for arbitral pronouncement should be judged unsubstantiated, as unproven, and, consequently, the Respondent absolved of all claims with the legal consequences thereupon.

II - PRELIMINARY ISSUE

1. The Tribunal is competent and is regularly constituted, in accordance with articles 2º, no. 1, paragraph a), 5º and 6º, all of the RJAT.

2. The parties have legal standing and capacity, are properly parties and are represented, in accordance with articles 4º and 10º of the RJAT and 1º of Ordinance no. 112-A/2011, of 22 March.

3. There are no nullities or preliminary matters that affect the entire proceeding, so it is now necessary to address the merits of the claim.

III - LEGAL REASONING

Object of the Arbitral Pronouncement

1. The request for arbitral pronouncement sub judice has as its immediate object the decisions of rejection, of 31.01.2017, of the hierarchical appeal presented by the Claimant against the rejection of the voluntary reclamation request no. …2015…, of 18.02.2016, relating to VAT self-assessments, concerning the periods of July, August and September of the year 2015.

The following questions are posed to the Tribunal:

— Whether the procedure adopted in the application of the pro rata method of deduction of tax borne on goods and services of mixed use (i.e., used in operations that grant the right to deduction and operations that do not grant such right), items (i) the financial depreciation relating to financial leasing contracts and (ii) the values of disposal/write-off by destruction of leased assets should be considered in the numerator and denominator of the pro rata calculation fraction;

— Whether the VAT self-assessment acts that used the "specific allocation coefficient" referred to in point 9 of Circular Letter no. 30.108, of 30.01.2009, of AT" and embodied in the periodic VAT declarations, concerning the periods July/2015, August/2015 and September/2015, are vitiated by illegality.

Factual Matters

1. With respect to the factual matters, it is important to note, first of all, that the Tribunal need not pronounce on everything that has been alleged by the parties, rather it is its duty to select the facts that matter for the decision and to distinguish the proven facts from those not proven (cf. article 123º, no. 2, of the Code of Tax Procedure and article 607º, nos. 3 and 4, of the Code of Civil Procedure, applicable ex vi article 29º, no. 1, paragraphs a) and e), of the RJAT). In this way, the facts relevant for the judgment of the case are chosen and selected in function of their legal relevance, which is established with regard to the various plausible solutions of the question(s) of Law.

The Facts Proven

In this parameter, having regard in particular to the positions assumed by the parties, the documentary evidence produced by both parties and the copy of the administrative file attached to the proceedings, the following facts are considered proven with relevance for the decision:

15.1 The Claimant is a credit institution covered by the General Regime for Credit Institutions and Financial Companies (approved by Decree-Law no. 298/92, of 31 December and successive amendments) and carries out, among others, leasing (financial leasing) and ALD (long-term rental) activities;

15.2 For VAT purposes, the Claimant is (thus) a mixed taxable person (carries out operations that grant the right to deduction and operations that do not grant the right to deduction);

15.3 On 17 August 2015, the Claimant submitted, via Internet, the periodic VAT declaration relating to the month of July 2015 – which was subsequently replaced by the declaration submitted on 08 September 2015;

15.4 On 10 September 2015, the Claimant submitted, via Internet, the periodic VAT declaration relating to the month of August 2015 – which was subsequently replaced by the declaration submitted on 12 October 2015;

15.5 On 10 November 2015, the Claimant submitted, via Internet, the periodic VAT declaration relating to the month of September 2015;

15.6 The Claimant deducted in the periodic declarations relating to the periods of July, August and September 2015, the VAT on the basis of the calculation of the provisional pro rata, corresponding to the final pro rata for the fiscal year 2014;

15.7 As a consequence of the declarations presented on 8.9.2015, 12.10.2015 and 10.11.2015, the initial pro rata, calculated in the above terms, of 59% was reduced to 18%;

15.8 These declarations were presented by the Claimant as a consequence of what was established by AT in circular letter no. 30108, of 30-1-2009, issued by the then Director General of Taxes;

15.9 The Claimant claimed, through the "Voluntary Reclamation Procedure no. …2015…" and the "Hierarchical Appeal Procedure no. …2016…", contesting the respective VAT self-assessment acts;

15.10 The Claimant understands that in determining the pro rata should have been considered (as it had done in the initial and replaced declarations), both in the numerator and in the denominator, in particular: (i) the financial depreciation relating to financial leasing contracts and (ii) the values of disposal/write-off by destruction of leased assets;

15.11 Both the Voluntary Reclamation and the Hierarchical Appeal were judged unsubstantiated by decisions of 18.02.2016 and 31.01.2017 with the grounds contained in the copy of the administrative file attached to the proceedings by AT.

16. Facts Not Proven

There are no other relevant facts, proven or not proven.

17. Grounds for Determination

The tribunal based its determination of the aforementioned factual framework on the examination of the documents, which were not contested, attached to the proceedings and on the absence of controversy between the parties as to factual matters.

18. No unproven facts of interest for the decision of the case exist, considering the possible legal solutions.

III - LEGAL REASONING (continued)

THE LAW

1. The acts subject to challenge are the acts of rejection of the Voluntary Reclamation no. …2015… and the Hierarchical Appeal no. …2016… arising from the declarations presented on 8/9/2015, 12/10/2015 and 10/11/2015 (cf. facts proven, 15.3, 15.4 and 15.5).

The Claimant imputes to those acts, if we understand the initial petition correctly, the vice of illegality due to lack of factual and legal prerequisites.

At the heart of the question are the divergent understandings of the parties regarding the deduction of VAT for goods and services of mixed use (article 23º of the VAT Code), in the case where the taxable person is a credit institution that, in addition to operations that form part of its specific object, also carries out leasing and ALD operations.

That is, more concretely: having considered the methods or forms of calculating VAT deduction when the taxable person carries out operations that grant the right to deduction and other operations that do not grant such right, if the VAT assessment in which the pro rata calculation excluded from the numerator and denominator of the fraction the financial depreciation relating to leasing contracts and the values of disposal/write-off by destruction of leased assets is vitiated or not by vices of illegality due to lack of factual and legal prerequisites, all in execution of the rules for determining the right to deduction for credit institutions when they simultaneously carry out Leasing or ALD activities, rules which were established in circular letter no. 30108, of 30-1-2009, issued by the Director General of Taxes.

Let us see, for better expository clarity, the most relevant legal provisions to assess and resolve the question, as well as the content of the circular letter to which reference was made above:

From the VAT Code:

Article 23º

Methods of Deduction Relating to Goods of Mixed Use

1 - When a taxable person, in the exercise of its activity, carries out operations that grant the right to deduction and operations that do not grant such right, in accordance with article 20º, the deduction of tax borne in the acquisition of goods and services that are used in the realization of both types of operations is determined as follows:

a) Where it is a good or service partially assigned to the realization of operations not arising from the exercise of an economic activity provided for in paragraph a) of no. 1 of article 2º, the non-deductible tax as a result of that partial assignment is determined in accordance with no. 2;

b) Without prejudice to the provision of the preceding paragraph, where it is a good or service assigned to the realization of operations arising from the exercise of an economic activity provided for in paragraph a) of no. 1 of article 2º, part of which does not grant the right to deduction, tax is deductible in the percentage corresponding to the annual amount of operations that give rise to deduction.

2 - Notwithstanding the provision of paragraph b) of the preceding number, a taxable person may carry out deduction in accordance with the real allocation of all or part of the goods and services used, based on objective criteria that make it possible to determine the degree of use of those goods and services in operations that grant the right to deduction and in operations that do not grant such right, without prejudice to the Directorate-General of Taxes being able to impose special conditions on it or to cause that procedure to cease in case it is verified that they cause or may cause significant taxation distortions.

3 - The tax administration may oblige the taxable person to proceed in accordance with the provision of the preceding number: a) When the taxable person carries out distinct economic activities; b) When the application of the process referred to in no. 1 leads to significant taxation distortions.

4 - The deduction percentage referred to in paragraph b) of no. 1 results from a fraction that comprises, in the numerator, the annual amount, tax excluded, of operations that give rise to deduction in accordance with no. 1 of article 20º, and in the denominator, the annual amount, tax excluded, of all operations carried out by the taxable person arising from the exercise of an economic activity provided for in paragraph a) of no. 1 of article 2º, as well as non-taxed subsidies that are not equipment subsidies.

5 - In the calculation referred to in the preceding number, however, the transfers of goods from the fixed assets that have been used in the activity of the company nor real property operations or financial operations that have an ancillary character in relation to the activity carried out by the taxable person are not, however, included.

6 - The deduction percentage referred to in paragraph b) of no. 1, calculated provisionally on the basis of the amount of operations carried out in the previous year, as well as the deduction made in accordance with no. 2, calculated provisionally on the basis of the objective criteria initially used for application of the real allocation method, are corrected according to the final values relating to the year to which they relate, giving rise to the corresponding regularization of the deductions made, which must be stated in the declaration of the last period of the year to which it relates.

7 - Taxable persons who begin the activity or alter it substantially may practice tax deduction based on a provisional estimated percentage, to be entered in the declarations referred to in articles 31º and 32º.

8 - For determining the deduction percentage, the quotient of the fraction is rounded up to the hundredth immediately above.

9 - For purposes of the provision of this article, the Minister of Finance, with respect to certain activities, may consider as non-existent the operations that give rise to deduction or those that do not confer such right, whenever the same constitute an insignificant part of the total turnover and the procedure provided for in nos. 2 and 3 does not appear viable.

From the VAT Directive

Articles 173º, 174º and 175º of Directive no. 2006/112/CE, of the Council, of 28.11.2006, establish as follows (highlighting what is of interest in this case, through underlining):

Pro rata of Deduction

Article 173º

1. With regard to goods and services used by a taxable person to carry out both operations with the right to deduction, referred to in articles 168º, 169º and 170º, and operations without the right to deduction, deduction is only permitted with respect to the part of VAT proportional to the amount relating to the first category of operations.

The pro rata of deduction is determined, in accordance with articles 174º and 175º, for all operations carried out by the taxable person.

1. Member States may take the following measures:

a) Authorize the taxable person to determine a pro rata for each sector of its activity, if it has separate accounts for each of those sectors;

b) Oblige the taxable person to determine a pro rata for each sector of its activity and to maintain separate accounts for each of those sectors;

c) Authorize or oblige the taxable person to carry out deduction based on the allocation of all or part of the goods and services;

d) Authorize or oblige the taxable person to carry out deduction, in accordance with the rule established in the first paragraph of no. 1, with respect to all goods and services used in the operations referred to therein;

e) Establish that VAT that cannot be deducted by the taxable person shall not be taken into account, when its amount is insignificant.

Article 174º

1. The pro rata of deduction results from a fraction that includes the following amounts:

a) In the numerator, the total amount of annual turnover, net of VAT, relating to operations that grant the right to deduction in accordance with articles 168º and 169º;

b) In the denominator, the total amount of annual turnover, net of VAT, relating to operations included in the numerator and to operations that do not grant the right to deduction.

Member States may include in the denominator the amount of subsidies that are not those directly linked to the price of deliveries of goods or provisions of services referred to in article 73º.

1. By way of derogation from the provision of no. 1, in calculating the pro rata of deduction, the following amounts are not taken into account:

a) The amount of turnover relating to deliveries of capital goods used by the taxable person in its enterprise;

b) The amount of turnover relating to ancillary real property and financial operations;

c) The amount of turnover relating to operations referred to in paragraphs b) to g) of no. 1 of article 135º, if they are ancillary operations.

1. When they make use of the faculty provided for in article 191º of not requiring regularization in relation to capital goods, Member States may include the proceeds of the disposal of those goods in the calculation of the pro rata of deduction.

Article 175º

1. The pro rata of deduction is determined annually, fixed as a percentage and rounded up to the immediately higher whole unit.

2. The pro rata applicable provisionally to a given year is calculated on the basis of operations of the previous year. In the absence of such reference, or where this is not significant, the pro rata is estimated provisionally, under the supervision of the administration, by the taxable person, in accordance with its forecasts.

However, Member States may continue to apply their regulations in force on 1 January 1979 or, with respect to Member States that acceded to the Community after that date, on the date of their respective accession.

1. The fixing of the final pro rata, which is determined for each year during the following year, entails the regularization of deductions made on the basis of the pro rata applied provisionally.

Circular Letter of AT no. 30108, of 30-1-2009

This administrative instruction establishes the following (highlighting what is of interest in this case, through underlining):

Subject: VAT - Right to Deduction. Rules for Determining the Right to Deduction for Credit Institutions When They Simultaneously Carry Out Leasing or ALD Activities.

For knowledge of the Services and other interested parties, and with a view to disseminating the correct interpretation to be given to article 23º of the VAT Code with respect to its application by credit institutions that exercise, among others, the Leasing or ALD activity, it is communicated that, by my dispatch of 2009.01.30, made in information no. 106, of 19 January 2009, of the Office of the Sub-Director General of the area of VAT Management, the following was determined:

1. Circular Letter no. 30103, of 2008.04.23, of the Office of the Sub-Director General of the area of VAT Management, proceeded to disseminate generic instructions to uniformize the interpretation to be given to the amendments introduced to article 23º of the VAT Code (CIVA), to ensure the correct framework of the various activities in light of the new provisions, to establish the procedures to be followed in determining the deduction of tax and, furthermore, to clarify the criteria to be used, when recourse is made to real allocation in determining the amount of tax to be deducted and whenever goods and services of mixed use are involved.

2. In accordance with the aforementioned instructions and following the rules of article 23º of the VAT Code, to ascertain the deductible tax contained in goods and/or services of mixed use, the method of percentage or pro rata is applied in a supplementary manner, except where operations not arising from an economic activity are involved, in which case real allocation is mandatory. In other cases, real allocation is optional, but the Tax Administration may impose this allocation method when the application of the pro rata leads to significant taxation distortions (no. 3 of article 23º).

3. In the case of use of real allocation, mandatory or optional, and in accordance with no. 2 of article 23º, the taxable person, in order to determine the degree of allocation or use of goods and services for the realization of operations that grant the right to deduction or operations that do not grant such right, must

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