Process: 312/2017-T

Date: January 16, 2018

Tax Type: IVA

Source: Original CAAD Decision

Summary

This CAAD arbitration decision (Process 312/2017-T) addresses the VAT deduction pro rata calculation method for mixed taxpayers in the banking sector. A... S.A., a financial institution engaged in both VAT-taxable financial leasing operations and VAT-exempt credit granting activities, challenged the Tax Authority's interpretation under Circular Memorandum 30108/2009. The dispute centered on whether only the interest component or the entire lease payment (including capital amortization) should be included when calculating the VAT deduction coefficient for mixed-use goods and services. The claimant argued that Article 23(4) of the Portuguese VAT Code (CIVA) requires including the full rental value as taxable base for financial leasing under Article 16(2)(h) CIVA, making it improper to exclude capital components from the pro rata calculation. The bank contended that Circular 30108/2009 illegally restricted deduction rights beyond what Portuguese law permits, violating fiscal neutrality principles and the constitutional principles of legality and separation of powers. The claimant distinguished the CJEU's Banco Mais judgment, arguing that while EU law permits Member States to impose alternative deduction methods, Portugal did not transpose this discretionary power into national legislation. The Tax Authority maintained that its circular correctly applied the law by excluding non-interest components from the deduction formula. This case illustrates the tension between administrative guidance and statutory interpretation in VAT matters, particularly regarding mixed taxpayer deduction rights in financial services, where precise pro rata calculations significantly impact tax recovery positions.

Full Decision

ARBITRAL DECISION

The arbitrators Maria Fernanda dos Santos Maçãs (arbitrator president), Henrique Nogueira Nunes and Luís Miguel Rodrigues Miranda da Rocha, agree as follows:

I. Report

  1. A..., S.A. (NIF/NIPC..., with registered office at Rua ..., ..., ...-... Lisbon ("Claimant" or "A..."), came, under the terms of paragraph (a) of section 1 of article 2 and articles 10 and following of Decree-Law no. 10/2011, of 20 January, to present, on 02-05-2017, a request for arbitral pronouncement on the legality of the tax acts embodied in the periodic VAT returns relating to the periods 10/2015, 11/2015 and 12/2015, and, moreover, on the legality of the decision to dismiss the hierarchical appeal ("Hierarchical Appeal Procedure no. ...2016..."), which concluded by maintaining the act of dismissal of the administrative complaint ("Administrative Complaint Procedure no. ...2016...").

  2. The request for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority (AT) on 16-05-2017.

2.1. In accordance with the terms set out in paragraph (a) of section 2 of article 6 and paragraph (b) of section 1 of article 11 of the RJAT, the Deontological Council designated as arbitrators of the collective arbitral tribunal the signatories, who communicated acceptance of the assignment within the applicable period.

2.2. On 29-06-2017 the parties were duly notified of such appointment and did not manifest any intention to refuse the designation of the arbitrators, in accordance with the combined terms of article 11, section 1, paragraphs (a) and (b) of the RJAT and articles 6 and 7 of the Deontological Code.

2.3. In accordance with the provisions of paragraph (c) of section 1 of article 11 of the RJAT, the collective arbitral tribunal was constituted on 20-07-2017.

2.4. In these terms, the Arbitral Tribunal is regularly constituted to appreciate and decide the subject matter of the proceedings.

  1. To support the request for arbitral pronouncement, the Claimant, which attached an opinion from Professors Xavier de Basto and António Martins, alleges, in summary, the following:

  • Its VAT self-assessments for the fourth quarter of 2015 (Periods 2015/10, 2015/11 and 2015/12) were based on the provisions of Circular Memorandum no. 30108 of 30.01.2009, which addresses the right to deduct VAT on goods and services of mixed use by taxable persons who simultaneously carry out activities subject to (financial leasing) and exempt (credit granting) from that tax. In the aforementioned Circular Memorandum no. 30108, the AT considers that, in calculating the deduction percentage (pro rata) applicable to goods and services acquired and of mixed use, only the interest component can be included and not the financial amortization that is part of the total value of rents in financial leasing and ALD contracts concluded by the Claimant.

  • The aforementioned tax acts suffer from defects embodied in an erroneous application of the legal regime of the right to deduct VAT by mixed taxable persons, established in article 23 of the VAT Code.

  • Contrary to what results from the decisions dismissing the Administrative Complaint and the Hierarchical Appeal and as follows from the Court of Justice of the European Union judgment delivered in the "Banco Mais Case", article 23, section 2, of the VAT Code does not constitute the transposition into the internal legal order of article 17, section 5, third paragraph, of the Sixth Directive.

  • In accordance with the terms set out in paragraph (h) of section 2 of article 16 of the VAT Code, it is the entire rent received (that is, capital and interest) that constitutes the taxable value of financial leasing, so it is not admissible to "distinguish where the law does not distinguish", when deducting VAT relating to goods and services that are demonstrably of mixed use.

  • From the Court of Justice of the European Union judgment delivered in the "Banco Mais Case" it does not follow that the AT, in circumstances like the case in question and in accordance with Circular Memorandum no. 30108, is empowered to apply or to impose the application to the present Claimant of a deduction coefficient different from that which results from the application of the pro rata method, as provided in section 4 of article 23 of the CIVA. In the aforementioned Court of Justice of the European Union judgment, it is only stated that article 17, section 5, third paragraph, paragraph (c) of the Sixth Directive does not preclude a Member State from being able to oblige a taxable person to apply another deduction method that it deems more appropriate, although it must be acknowledged that it was not correctly established that this norm has no identical or similar correspondence in the VAT Code.

  • It is not true that the provision contained in section 2 of article 23 of the VAT Code (in conjunction with section 3) reproduces, in substance, the rule for determining the right to deduction stated in article 17, section 5, third paragraph, paragraph (c), of the Sixth Directive, which is a derogatory provision of the rule provided in articles 17, section 5, first paragraph, and 19, section 1, of that Directive.

  • There is no indication, in article 23 of the VAT Code, of mention or establishment of the power of the AT, before a taxable person who opts for the pro rata method, to impose conditions on the deduction percentage. That is, beyond the precise instructions provided by section 4 of article 23 – which are objective in determining that percentage – the legislator did not authorize the Tax Authority to contradict the deduction percentage as it results from section 4, so that, since it is not the case here that the Sixth Directive provides for the possibility of Member States being able to impose on a mixed taxable person deduction based on the use of all or part of the goods and services (that is, that Tax Authorities can even shape the calculation of the pro rata), the truth is that this was not the option followed by the national legislator in the VAT Code.

  • It is true that the Sixth Directive in article 17 (section 5, third paragraph, paragraph (c)), when referring to the pro rata opened the door to Member States to authorize or oblige the taxable person to effect deduction based on the use of all or part of the goods and services. It happens, however, that the national legislator preferred not to open that door, enacting nothing in the sense of conferring on its Tax Authority powers with such content.

  • The mere verification and comparison of what is literally contained in the articles at issue in the Sixth VAT Directive and in the VAT Code makes it possible to verify that the option of the national legislator was not to grant the AT – as it could eventually have done – the possibility of altering the calculation components of the pro rata in the specific case.

  • The tax acts under scrutiny should be revoked, and this because the AT would not be empowered to apply or to impose the application to the Claimant of a deduction coefficient other than the pro rata method, under penalty of violation of the provisions of articles 19, 20 and 23 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 2 and 111), of legality (article 112, section 5) and of the reservation of law (articles 103 and 165, section 1, paragraph (i)), all of the Constitution of the Portuguese Republic.

The Claimant concludes by requesting the annulment of the tax liquidation acts in question, with all legal consequences, in particular the refund to the claimant of the sum of € 440,257.34 relating to VAT not deducted, plus legal interest counted from the date of presentation of the respective periodic returns for the periods 10/2015, 11/2015 and 12/2015, namely, 30.11.2015, 10.12.2015 and 05.02.2016, respectively, until the date of actual refund.

  1. The Tax and Customs Authority ("hereinafter briefly designated as "Respondent" or "AT") presented a reply and attached, already during the period for arguments, the instructional file, invoking, in summary, the following:

  • With respect to financial leasing activities, various economic operators concluded that it is not possible to adopt the method of actual allocation in accordance with objective criteria given the nature of such activity. In such circumstances, Circular Memorandum no. 30108/2009 was issued, widely cited in the information contained in the instructional file and supporting the dismissal decisions to which the present proceedings refer, in order to clarify the determination of the most precise possible method, in the absence of the objective criteria imposed by the method of actual allocation, for all economic operators of the aforementioned activity.

  • The wording of section 2 of article 23 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, but this criterion must reflect solely the amount of income arising from its taxed activity (interest) under penalty of subverting the neutrality that governs the entire system that establishes the right to deduction. Thus, the procedure adopted by the Claimant when self-assessing the tax was correct. This methodology is not contrary to EU law and, moreover, has support in various case law of the Court of Justice of the European Union.

  • Taking into account the decisions of the Court of Justice of the European Union, of 10 July 2014 ("Banco Mais Judgment") and of the Supreme Administrative Court (Judgment of 29 October 2014, delivered in the scope of case no. 01075/13, 2nd Section), the Claimant has no justification whatsoever for the considerations it makes in the claim of its request for arbitral pronouncement, as far as the determination of the deduction pro rata at issue in the present proceedings is concerned, as well as the concept of turnover that it wishes to apply for this purpose and the considerations it makes or does not make on the matter in question.

  • In the light of sound competition between the various economic agents in the space of the European Union and in defense of the principle of neutrality of VAT as to its tax burden, the dismissal of the request relating to the tax allegedly self-assessed in excess is not affected by any illegality, as the Claimant claims.

  • The Court of Justice of the European Union is the guarantor of the interpretation and uniform application of EU law in the territory of all Member States, which is materialized through the decisions delivered in the scope of referral proceedings, under article 267 of the CJEU, as is the case of the cited judgment. Thus, this arbitral jurisdiction is also bound by the interpretation carried out by the Court with respect to article 17, section 5 of the Sixth VAT Directive (current article 173, section 2 of Directive no. 2006/112 EC), at issue in the present proceedings, since article 23 of the VAT Code proceeded with its transposition into our internal law. In addition, such interpretation leaves no room for doubt, so the calculation of the pro rata that the Claimant applied in the periods in question was correctly carried out, and the self-assessments it seeks to correct are not affected by any error.

  • The interpretation propounded by the Respondent offends, without any room for doubt, the principle of neutrality of the tax and, more than that principle, that of sound competition in the space of the European Union, true engine 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 the taxation of consumption is materialized" would likewise be set aside if the thesis defended by the present Claimant were to prevail. For this reason, the Respondent's interpretation is the one that best materializes the principle of neutrality and the principle of equal treatment to which the "Banco Mais Judgment" gives effect, in a situation similar to that of the present proceedings, and of a competitor of the Claimant. Therefore, the initial calculation of the pro rata carried out by the Claimant, in accordance with the interpretation conveyed by the Respondent, deserves no criticism.

  • The acts of dismissal of the administrative complaint and the subsequent hierarchical appeal do not suffer from any illegality because, as far as the leasing and ALD activity is concerned, the part relating to the amortization of capital included in the rents cannot form part of the terms of the fraction of the deduction pro rata.

The Tax Authority concludes by requesting that the present request for arbitral pronouncement be judged to be unsuccessful, as not proven, and, consequently, the Respondent to be absolved of all claims with the legal consequences.

  1. No exceptions having been invoked and there being no disputed matter of fact, since the matters to be decided are of law (in which both parties agree), the Tribunal, by order of 5 October 2017, considered that there was no justification for hearing witnesses and dispensed with the meeting provided in article 18 of the RJAT, which it did under the principles of autonomy in conducting the proceedings and in order to promote celerity, simplification and informality thereof. The date of 20 January 2018 was also set for the delivery of the arbitral decision.

  2. Only the Claimant submitted arguments.

II. Sanation

  1. The parties have legal personality and capacity, show themselves to be legitimate and are regularly represented (articles 4 and 10, section 2, of the RJAT and article 1 of Ordinance no. 112-A/2011, of 22 March).

7.1. The tribunal is competent and is regularly constituted.

7.2. There are no nullities, so it is necessary to proceed, hereinafter, to the merits of the claim.

III. Question to be decided

In its arbitral petition, the Claimant formulates the following essential question for which it requests the Tribunal's appreciation:

Does the criterion for determining the pro rata (disregarding in the numerator the financial amortizations relating to financial leasing contracts and the values of disposal/scrapping of leased assets) based on the position set out in circular memorandum no. 30108, of 30/01/2009, of the Tax and Customs Authority, namely its point 9, suffer from illegality, by configuring a criterion not provided for in the law?

IV. Merits

IV.1. Matters of Fact

  1. Established Facts

With relevance for the appreciation and decision of the merit question, the following facts are taken as established and proven:

  • On 30 November 2015, the Claimant submitted, via Internet, the periodic VAT return for October 2015.

  • On 10 December 2015, the Claimant submitted, via Internet, the periodic VAT return for November 2015 – which was replaced by the return presented on 18 December 2015.

  • On 5 February 2016, the Claimant submitted, via Internet, the periodic VAT return for December 2015.

  • In the three periodic returns previously mentioned, VAT was deducted based on a provisional pro rata of 18%, corresponding to the definitive pro rata determined in the financial year 2014. In the calculation of this pro rata, financial amortizations relating to financial leasing contracts and the values of disposal/scrapping of leased assets were excluded from both the numerator and the denominator of the fraction.

  • Had financial amortizations relating to financial leasing contracts and the values of disposal/scrapping of leased assets not been excluded from the numerator and the denominator of the fraction, the provisional pro rata would have been 59%.

  • The total amount (for the three monthly periods of October, November and December 2015) of VAT to be deducted using the pro rata of 18% was € 180,439.62; the total amount of VAT to be deducted using the pro rata of 59% was € 591,440.96. The difference between these two values, which amounts to € 411,001.35, is the first component of the amount claimed by the Claimant (document 5, attached to the "Request for Arbitral Pronouncement").

  • In the periodic VAT return for December 2015, since it was the last return of that year, the Claimant corrected the values deducted throughout the year due to the application of the definitive pro rata for 2015, which changed from 18% to 14%. This correction resulted in a settlement in favor of the State of € 117,023.96 (document 5, attached to the "Request for Arbitral Pronouncement").

  • Had financial amortizations relating to financial leasing contracts and the values of disposal or scrapping of leased assets not been excluded from the numerator and the denominator of the fraction, the definitive pro rata for 2015 would have been 56%, which would have made the settlement in favor of the State (one of the items to be inserted in field 41 of the periodic return) € 87,767.97 (document 5, attached to the "Request for Arbitral Pronouncement").

  • The difference between the values of € 117,023.96 and € 87,767.97 mentioned in the two preceding paragraphs, amounting to € 29,255.99, constitutes the second component of the amount claimed by the Claimant, which thus totals € 440,257.34 (document 5, attached to the "Request for Arbitral Pronouncement").

  • On 24 February 2016, the Claimant filed an "Administrative Complaint Procedure" (to which the number ...2016... was assigned), with reference to the VAT self-assessments relating to the periods of October, November and December of the year 2015) – Administrative File, pages 260 to 500.

  • On 20 June 2016, the AT issued a decision to dismiss the aforementioned "Administrative Complaint Procedure", notified by registered mail, through Office no. ... of 21 June 2016. – Administrative File, pages 839 to 860.

  • On 12 July 2016, the Claimant filed a "Hierarchical Appeal Procedure" (to which the number ...2016... was assigned) of the decision dismissing the previously identified administrative complaint procedure – Administrative File, pages 32 to 84.

  • On 31 January 2017, the AT issued a decision to dismiss the aforementioned "Hierarchical Appeal Procedure", set forth in Information no. ... and notified to the Claimant by registered mail – Administrative File, pages 8 to 27.

8.1. There are no other facts with relevance for the appreciation of the merits of the case that have not been proven.

8.2. Justification of the matters of fact

With respect to the matters of fact proven, the conviction of the Arbitral Tribunal was based on the free appreciation of the positions assumed by the Parties (on matters of fact) and on the content of the documents attached to the proceedings, not contested by the Parties, as well as on the analysis of the administrative file attached by the Respondent.

With respect to the value of the proceedings, the Respondent does not question in the proceedings the value determined by the Claimant as stated in the request for arbitral pronouncement.

III.2. Matters of Law

III.2.1. Briefly: The Position of the Parties

The Claimant, in the disputed liquidations, applied the rule contained in point 9 of Circular Memorandum no. 30108, under the heading: "VAT - Right to Deduct Rules for determining the right to deduct by credit institutions when simultaneously carrying out Leasing or ALD activities" - having in the calculation of the pro rata for deduction relating to goods of mixed use excluded from both the numerator and the denominator of the fraction of rents of financial leasing contracts the financial amortizations and the values of disposal/scrapping of leased assets, on the grounds that it understood that it was not possible to apply, under the terms of point 8 of Circular Memorandum, the method of actual allocation based on objective criteria that would allow determining the degree of use of such goods and services, in order to determine the amount of VAT to be deducted with respect to all activities.

It did so, it claims, compelled by the instructions contained in that Circular Memorandum, and considering the position of the AT in inspections carried out in previous financial years (subsequently transposed into the aforementioned Circular Memorandum) and, as well, in the well-founded fear that the AT would contest the criterion adopted for determining the pro rata in the VAT returns.

The Claimant challenged the liquidations by means of administrative complaint and, afterwards, by submitting a hierarchical appeal, both dismissed, defending, in summary, the following:

  • Given that financial leasing operations are subject to VAT at the global value of rents, under the terms of paragraph (b) of section 2 of article 16 of the VAT Code, there is no reason why the amount of financial amortizations and indemnifications should not be included in the turnover for purposes of determining the pro rata;

  • Considering the national provisions that transposed the VAT Directive into the national legal order (in particular the VAT Code), the AT is not granted, by administrative means, any prerogative intended to alter the method of calculating the percentage of VAT deduction authorized for goods of mixed use, since the national legislator did not use the faculty that the Court of Justice of the European Union understands to be available to Member States to limit the values to be inserted in the numerator and denominator of the fraction and sections 2 and 3 of article 23 of the VAT Code only authorize the AT to impose special conditions within the scope of deduction according to actual allocation;

  • The Court of Justice of the European Union judgment delivered in the Banco Mais case does not determine whether Portuguese law (article 23 of the VAT Code) provides or not mechanisms that allow the AT to impose other methods of VAT deduction for goods and services of mixed use and that the VAT Code does not have any provision (including section 2 of article 23) that corresponds to article 17, section 5, third paragraph, paragraph (c) of the Sixth Directive;

  • Thus, while it is true that the Sixth Directive allows the national legislator to authorize or oblige the taxable person to effect deduction based on the use of all or part of the goods and services, the truth is that the national legislator preferred, however, not to exercise that possibility;

  • Since it is not provided in article 23 of the VAT Code, in view of the text of the norm, the possibility in law of the AT, before a taxable person who opts for the pro rata method, imposing conditions on the deduction percentage, so that the case law contained in the Court of Justice of the European Union judgment of the Banco Mais case has no concrete application with respect to the tax acts at issue in the present proceedings;

The AT, in its reply, came to argue, in summary, the following:

  • It considers that, in this case, there is no error in the self-assessment of the tax that the Claimant seeks to attribute to it;

  • It says that with respect to financial leasing activities it is concluded that it is not possible to adopt the method of actual allocation in accordance with objective criteria given the nature of this activity, reason for which the aforementioned Circular Memorandum was issued, in order to clarify the determination of the most precise possible method (in its words), considering the absence of objective criteria imposed by the method of actual allocation.

And that although section 2 of article 23 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, it says, that this criterion had to reflect solely the amount of income arising from its taxed activity (interest) under penalty of subverting the neutrality that governs the entire system that establishes the right to deduction;

  • So the procedure adopted by the Claimant when self-assessing the tax was correct;

  • What happened is that at a time subsequent to the submission of the tax returns, the Claimant sought to abandon that criterion that it had used with respect to the exercise of the right to deduct the tax borne on mixed-use resources, coming to recalculate a deduction percentage of 59%, using the same pro rata deduction method, but including the total rent value, without purging the part relating to capital amortization;

  • And that when called upon to decide in the last instance a dispute opposing Banco Mais to the Public Treasury, the SAT 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 rent being composed of financial amortization, interest and other charges, should such rent paid be entered, in its full meaning, for the denominator of the pro rata, or, instead, should only the interest be considered, since this is the compensation, the profit that the banking activity obtains from the leasing contract?"

  • Following which that Court decided that "in these conditions, 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 availability of the vehicles, leads to determining a pro rata of VAT deduction paid upstream that is less precise than that resulting from the method applied by the Public Treasury, based only on the part of the rents corresponding to the interest which constitutes the counterpart to the costs of financing and management of the contracts borne by the financial lessor, since these two activities constitute the essential use of goods and services of mixed use intended for carrying out financial leasing operations for the automotive sector."

  • And that on the same matter the SAT has also pronounced itself, by Judgment of 29/10/2014, delivered in the scope of case no. 01075/13, 2nd Section, where it is expressly decided: "Banks, whose type of business also includes the conclusion of Leasing and ALD contracts, for example, of motor vehicles, must include in the numerator and denominator of the fraction that serves to establish a single and the same pro rata of deduction for all goods and services of mixed use, only the part of the rents paid by clients under those contracts, which corresponds to interest".

  • It concludes by saying that the arbitral jurisdiction is bound by the interpretation carried out by the Court of Justice of the European Union, which is the guarantor of the interpretation and uniform application of EU law in the territory of all Member States, with respect to article 17, section 5 of the Sixth VAT Directive (current article 173, section 2 of Directive no. 2006/112 EC), at issue in the present proceedings, since article 23 of the VAT Code, it says, proceeded with its transposition into our internal law.

Let us see, then.

III.2.2. Analysis of the Controversial Question

Directive no. 2006/112/EC, of 28 November 2006, relating to the common system of value added tax, came, for the matter of interest to the proceedings, to provide in its chapter 2 the following:

"CHAPTER 2

Pro rata of deduction

Article 173

  1. As regards goods and services used by a taxable person to carry out both transactions which give the right to deduct, referred to in articles 168, 169 and 170, and transactions which do not give the right to deduct, deduction is permitted only in respect of the proportion of the VAT relating to the amount of transactions of the first category.

The pro rata of deduction is determined, in accordance with articles 174 and 175, for all transactions 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 his business, provided that he keeps separate accounts for each such sector;

(b) Oblige the taxable person to determine a pro rata for each sector of his business and to keep separate accounts for each such sector;

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

(d) Authorize or oblige the taxable person to effect deduction, in accordance with the rule established in the first paragraph of section 1, for all goods and services used in the transactions referred to therein;

(e) Provide that the VAT which cannot be deducted by the taxable person is not taken into consideration when the amount is insignificant."

Bold and underlines ours.

Whereby in accordance with article 174 thereof:

"Article 174

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

(a) In the numerator, the total annual turnover, net of VAT, relating to transactions which confer the right to deduct in accordance with articles 168 and 169;

(b) In the denominator, the total annual turnover, net of VAT, relating to transactions included in the numerator and to transactions which do not confer the right to deduct.

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

Bold and underlines ours.

For its part, the VAT Code, in its article 23, under the heading "Methods of deduction relating to goods of mixed use", provides:

1 - When the taxable person, in the exercise of its activity, carries out transactions which confer the right to deduct and transactions which do not confer such right, under the terms of article 20, the deduction of tax borne on the acquisition of goods and services that are used in carrying out both types of transactions is determined in the following manner:

(a) In the case of a good or service partially allocated to carrying out transactions not arising from the exercise of an economic activity provided in paragraph (a) of section 1 of article 2, the non-deductible tax resulting from such partial allocation shall be determined under section 2;

(b) Without prejudice to the foregoing paragraph, in the case of a good or service allocated to carrying out transactions arising from the exercise of an economic activity provided in paragraph (a) of section 1 of article 2, part of which does not confer the right to deduct, the tax is deductible in the percentage corresponding to the annual amount of the transactions that give rise to deduction.

2 - Notwithstanding the foregoing provision of paragraph (b) of the preceding section, the taxable person may effect deduction in accordance with the actual allocation of all or part of the goods and services used, based on objective criteria that allow determining the degree of use of such goods and services in transactions which confer the right to deduct and in transactions which do not confer such right, without prejudice to the Directorate-General of Taxes being able to impose special conditions on him or to cease such procedure in the event it is found that they cause or may cause significant distortions in taxation.

3 - The tax administration may oblige the taxable person to proceed in accordance with the foregoing section:

(a) When the taxable person exercises distinct economic activities;

(b) When the application of the process referred to in section 1 leads to significant distortions in taxation.

4 - The deduction percentage referred to in paragraph (b) of section 1 results from a fraction which comprises, in the numerator, the annual amount, tax excluded, of the transactions that give rise to deduction under section 1 of article 20, and, in the denominator, the annual amount, tax excluded, of all transactions carried out by the taxable person arising from the exercise of an economic activity provided in paragraph (a) of section 1 of article 2, as well as untaxed subsidies which are not equipment subsidies.

Bold and underlines ours.

The Claimant is a credit institution, also developing financial leasing activity, being a mixed subject for VAT purposes, carrying out operations subject – in particular those relating to property financial leasing (leasing and financial ALD) – and operations exempt – namely credit granting.

In this context it proceeded in accordance with the provisions of Circular Memorandum no. 30108.

In points 8 and 9 of this administrative instruction can be read:

"8. Accordingly, considering that the determination of deductible VAT according to the application of the general pro rata established in section 4 of article 23 of the VAT Code is liable to cause unjustified advantages or disadvantages due to the lack of coherence of the variables used in it, that is, can lead to 'significant distortions in taxation', taxable persons who, in the scope of financial activities, carry out Leasing or ALD operations, must use, under section 2 of article 23 of the VAT Code, actual allocation based on objective criteria that allow determining the degree of use of such goods and services, in order to determine the amount of VAT to be deducted with respect to all activities.

  1. In the application of the method of actual allocation, under the foregoing section and whenever it is not possible to apply objective criteria for allocating common costs, a specific allocation coefficient must be used, taking into account the amounts involved, with only the annual amount corresponding to interest and other charges relating to the Leasing or ALD activity to be considered in the calculation of the deduction percentage. In this case, the percentage referred to above does not result from the application of section 4 of article 23 of the VAT Code."

That is, in accordance with this administrative instruction, the method elected for the deduction of VAT in this type of activity is the method of actual allocation, and not the method of pro rata deduction, as would result from the application of section 4 of article 23 of the VAT Code, based on "all transactions carried out by the taxable person arising from the exercise of an economic activity."

In the case at hand the deduction of VAT is at issue with respect to goods used indifferently both in the taxed activity (as is the case with financial leasing) and in the exempt economic activity of the Claimant (as occurs with credit granting).

As we saw above in the VAT Directive - Directive no. 2006/112/EC of the Council, of 28-11-2006 – the same establishes that with respect to the means of mixed use, used indifferently "to carry out both transactions with the right to deduct (...) and transactions without the right to deduct, deduction is permitted only with respect to the part of VAT proportional to the amount relating to the first category of transactions" (article 173, section 1 of this Directive).

In the case of a good or service allocated to carrying out transactions arising from the exercise of an economic activity provided in paragraph (a) of section 1 of article 2 of the VAT Code "the tax is deductible in the percentage corresponding to the annual amount of the transactions that give rise to deduction", under the terms of paragraph (b) of section 1 of article 23 of the same Code.

This percentage of deductible tax, also known as the "pro rata deduction method", results, as a rule, from a fraction which includes in the numerator, the total annual amount of turnover, net of VAT, relating to transactions which confer the right to deduct and in the denominator, the total annual amount of turnover, net of VAT, relating to transactions included in the numerator and to transactions which do not confer the right to deduct (article 174 of the VAT Directive and article 23, section 4, of the VAT Code).

Notwithstanding this being the preferential method adopted by the Portuguese legislator, the taxable person may opt to "effect deduction in accordance with the actual allocation of all or part of the goods and services used, based on objective criteria that allow determining the degree of use of such goods and services in transactions which confer the right to deduct and in transactions which do not confer such right, without prejudice to the Directorate-General of Taxes being able to impose special conditions on him or to cease such procedure in the event it is found that they cause or may cause significant distortions in taxation" (section 2 of article 23 of the VAT Code).

Here arrived it is important to note that the method of actual allocation is distinct from the method of deduction percentage. Paragraph (c) of section 2 of article 173 of the VAT Directive does not define what this method consists of, but in reviewing this paragraph it clearly results in its distinction from the pro rata method. The latter method is referred to only in paragraphs (a) and (b) of article 173 of the VAT Directive, solely to allow Member States to authorize the taxable person to determine a pro rata for each sector of its business, provided it keeps separate accounts for each such sector.

One is thus dealing with a method different from the pro rata deduction method, although the VAT Directive does not say in detail what this method of actual allocation consists of, it is clear that it separates it from the percentage deduction method or pro rata.

In the case at hand, one is dealing with a situation in which there is no controversy between the Parties regarding the impracticability of using the method of actual allocation, based on objective criteria, the Claimant having used in the disputed liquidations this "specific allocation coefficient" determined in the manner provided in point 9 of the aforementioned Circular Memorandum, considering in the calculation of the deduction percentage only the annual amount corresponding to interest and other charges relating to the Leasing or ALD activity, excluding from both the numerator and the denominator of the fraction the financial amortizations relating to financial leasing contracts and the values of disposal/scrapping of leased assets, but convinced that the same suffers from the defect of illegality, because it emanates from an administrative instruction that imposes conditions not provided for in the law, since it elected the method of pro rata deduction, under the terms provided in section 4 of article 23 of the VAT Code, and not the method of actual allocation, and fundamentally this is the question that needs to be resolved in the present arbitral proceedings.

The AT, in its reply, bases its position and the legality of said administrative instruction on the case law of the Court of Justice of the European Union - case no. C-183/13 (Banco Mais), delivered in the scope of a preliminary ruling - which, in its understanding, has already ruled on a situation of this kind, relating to a banking institution that carried out financial leasing activities, which confer the right to deduct, and other financial activities, which do not confer such right, arguing that based on this judgment the Court of Justice of the European Union considered that Member States may authorize or oblige the taxable person to effect deduction based on the use of all or part of the goods and services and that for the calculation of such deduction only interest should be taken into account, when the use of the goods and services is above all determined by the financing and management of contracts, an aspect, it must be said, that the AT at no time specifies or proves as corresponding to the Claimant's situation.

Proceeding.

The Claimant opted to elect the method of pro rata deduction as being, in its understanding, the one that presented the greatest degree of reliability, finding no valid legal reasons to justify the exclusion of the aforementioned components from its calculation, and further alleging, equally that the case law of the Banco Mais Judgment does not question this same conclusion, since in its understanding, supported by an Opinion attached to the proceedings, from the text of article 23 of the VAT Code, it can be (and should be) verified that (contrary to what the Court of Justice of the European Union came to take as certain, solely and exclusively on the basis of what the Representative of the Portuguese State alleged in the proceedings) does not correspond the same to mere transposition of the VAT Directive, not being provided in national legislation the possibility – conferred by the Directive, as the Court of Justice of the European Union came to clarify, and which, naturally, is no longer disputed – that Member States can mitigate the pro rata, since this option was not followed by the Portuguese State, and, on the other hand, the imposition of conditions on deduction is only provided for in national legislation in the context of the method of actual allocation, when the taxable person exercises distinct economic activities and when the application of the pro rata method leads to significant distortions in taxation.

Indeed, the Tribunal understands that the Claimant is right, since article 23 of the VAT Code does not confer power on the AT to impose on a taxable person who opts for the pro rata method, conditions additional to the verification of the deduction percentage, beyond the normative command imposed by section 4 of article 23 of the VAT Code, a provision, which contains objective requirements to be observed in determining that percentage, nor can it be concluded by careful reading of the Court of Justice of the European Union judgment delivered in the Banco Mais case that Portugal will have transposed into national legislation the possibility of obliging a mixed taxable person, of the type of a financial institution, when it also exercises financial leasing activities, to establish a single pro rata of deduction for all its mixed-use goods and services, considering in the numerator and denominator of the fraction only the part of the rent corresponding to interest, since this was not the option of the Portuguese legislator.

Let it be said that the judgment delivered by the erudite Supreme Administrative Court in case no. 01075/13, 2nd Section, invoked by the Respondent in its Reply, which analyzed the aforementioned decision of the Court of Justice of the European Union, does not allow concluding by its opposition to the present arbitral decision, since in the same can be read citing:

"Indeed, without the Court of Justice of the European Union failing to know the provisions of article 23 of the VAT Code, because it cites it expressly, and on the basis of the interpretation that the National Court made of that article 23, section 4, to judge the objection to be well-founded, identified the question to be decided as whether a Member State can oblige a bank that exercises, in particular, financial leasing activities to include, in the numerator and denominator of the fraction that serves to establish a single and same pro rata of deduction for all its mixed-use goods and services, only the part of the rents paid by clients, in the scope of its financial leasing contracts, which corresponds to interest."

Bold and underlines ours.

There is no doubt that a Member State can oblige a mixed taxable person, of the type of a Bank or financial institution, to proceed as stated above by the Court of Justice of the European Union, but a Member State (in this case the Portuguese one) can only do so by legislative means, since this is required by the rule of law, and not by means of a unilateral administrative understanding imposed by the Tax Administration, and this analysis the aforementioned judgment of the Supreme Administrative Court did not address, so one cannot even speak of the existence of contradiction between this erudite judgment and the present arbitral decision on the same fundamental question of law under appreciation in the present arbitral proceedings.

Without prejudice to the decisions delivered by the Court of Justice of the European Union in preliminary ruling being binding on national courts, it is important to emphasize that, under article 267 of the TFEU, the competence of the Court of Justice of the European Union in the scope of preliminary ruling is limited to the "interpretation of the Treaties" and to the "validity and interpretation of acts adopted by the institutions, bodies or organizations of the Union." This means that such competence does not extend to the interpretation of article 23 of the VAT Code, to the extent that it embodies options of the national legislator in matters explicitly left to its discretionary judgment by Directive no. 2006/112/EC of the Council, of 28-11-2006.

Nor can it fail to be underscored that paragraph (c) of section 2 of article 173 of that Directive is not a normative provision of direct application, since it is addressed to "Member States", with a view to "authorizing or obliging the taxable person to effect deduction based on the use of all or part of the goods and services."

Now, such an option being addressed to the legislator, in honor of the principles of legality and of the reservation of law, the implementation of that optional norm of Directive no. 2006/112/EC of the Council, of 28-11-2006, can only be legitimately effected by legislative means.

In sum and concluding:

The two only methods of deduction provided for goods of mixed use allocated to carrying out transactions arising from the exercise of an economic activity provided in article 23 of the VAT Code are:

  • The application of a "percentage corresponding to the annual amount of the transactions that give rise to deduction" (section 1, paragraph (b) of article 23 of the VAT Code with reference to section 4);

  • The "actual allocation of all or part of the goods and services used, based on objective criteria that allow determining the degree of use of such goods and services in transactions which confer the right to deduct and in transactions which do not confer such right" (section 2 of article 23 of the VAT Code).

Under section 3 of the same article 23, when the application of the method provided in section 1 (which for those allocated to carrying out transactions arising from the exercise of an economic activity is the deduction percentage, as referred to in paragraph (b) of section 1) "leads to significant distortions in taxation", the AT can oblige the taxable person to proceed in accordance with the provisions of section 2.

And reviewing this section 2, the same only provides for the "actual allocation of all or part of the goods and services used, based on objective criteria that allow determining the degree of use of such goods and services in transactions which confer the right to deduct and in transactions which do not confer such right".

It is manifest that the application of a percentage, whatever it may be, as the Respondent does in the case at hand, does not allow "determining the degree of use of such goods and services in transactions which confer the right to deduct" and, therefore, cannot constitute an objective criterion for purposes of applying section 2 of article 23 of the VAT Code.

Whereby the imposition by the AT of operating with a pro rata different from that defined in section 4 of article 23 of the VAT Code appears to be without legal basis in national law. It is not a Circular Memorandum, which is nothing more than an internal instruction that only binds the services, but which has no external effect, that can substitute for the law, imposing on taxable persons what the law does not provide.

Whence, it is concluded that the method of deduction percentage can only be used in situations in which it is directly provided, in this case, in paragraph (b) of section 1 of article 23 of the VAT Code, and this method is the one stated in section 4 of the same article and no other.

It is not unknown that the possibility conferred by article 173, section 2, (c) of Directive no. 2006/112/EC of the Council, of 28-11-2006, on its Member States to "oblige the taxable person to effect deduction based on the allocation of all or part of the goods and services", but such a possibility was not transposed into the national VAT Code, that is, the possibility of application of a deduction percentage different from that indicated in section 4 of article 23 of the same code.

And, such a possibility not having been embraced by legislative means, the AT cannot apply it, since it is subordinate to the principle of legality in all its actions (articles 266, section 2, of the CRP and 55 of the LGT).

It follows from all the foregoing that the imposition of use of the "specific allocation coefficient" indicated in point 9 of Circular Memorandum no. 30108 is affected by the defect of violation of law, by offense of the principle of legality, proceeding, thus, the request for arbitral pronouncement.

Consequently, the disputed liquidations are affected by the defect of violation of law, due to erroneous application of the method of calculating the pro rata of deduction, which justifies their annulment, and, as well, that of the decision of dismissal which was delivered in the hierarchical appeal which maintained them.

III.2.3. Request for indemnifiable interest

The Claimant comes to request the reimbursement of the sum paid under the liquidation act at issue in the proceedings, increased by indemnifiable interest for the wrongful payment of such amount.

In the case of the proceedings, it is manifest that, following the illegality of the liquidation acts, for the reasons that have been better expounded in this decision, there is occasion for reimbursement of the tax paid by the Claimant, pursuant to the provisions of the aforementioned articles 24, section 1, paragraph (b), of the RJAT and 100 of the LGT, since this is essential to "restore the situation that would exist if the tax act subject to the arbitral decision had not been practiced".

With respect to indemnifiable interest, it is also clear in the proceedings that the illegality of the disputed tax liquidation acts is directly attributable to the Respondent.

The substantive regime of the right to indemnifiable interest is regulated by article 43 of the LGT, which establishes, insofar as relevant here:

Article 43

Wrongful payment of the tax obligation

1 – Indemnifiable interest is due when it is determined, in administrative complaint or judicial challenge, that there was an error attributable to the services resulting in payment of the tax debt in an amount greater than that legally due.

2 – It is also considered that there is an error attributable to the services in cases in which, despite the liquidation being carried out on the basis of the taxpayer's return, the latter has followed, in completing it, the generic guidance of the tax administration, duly published.

Bold and underline ours.

The error of the liquidations is attributable to the AT, under the terms provided in section 2 of this article, since the Claimant followed the administrative guidance issued by the Respondent, contained in Circular Memorandum no. 30108.

Consequently the Claimant is entitled to receive indemnifiable interest, under the terms of the provisions of articles 43, section 1, of the LGT and 61 of the CPPT.

The indemnifiable interest must be paid to the Claimant from the date on which it made the respective payment of the tax at issue in the proceedings until the full reimbursement of the amount paid, at the legal rate.

IV. Decision

For these reasons, this Arbitral Tribunal decides:

  • Judgment that the request for arbitral pronouncement is well-founded and, consequently, annul the VAT liquidations carried out in the periodic returns relating to the periods 10/2015, 11/2015 and 12/2015, respectively submitted on 30.11.2015, 10.12.2015 and 05.02.2016, as well as the decision to dismiss the hierarchical appeal, which was processed under the number ...2016... .

  • To condemn the Respondent to reimburse the Claimant the sum of € 440,257.34, increased by indemnifiable interest calculated on each wrongful payment from the date on which it was made until the respective reimbursement.

V. Value of the Case

In accordance with the provisions of articles 306, section 2, and 297, section 2 of the CPC, article 97-A, section 1, paragraph (a) of the CPPT and article 3, section 2, of the Regulation of Costs in Tax Arbitrage Proceedings, the value of the case is set at € 440,257.34.

VI. Costs

Under article 22, section 4, of the RJAT, the amount of costs is set at € 7,038.00, in accordance with Table I attached to the Regulation of Costs in Tax Arbitrage Proceedings, to the charge of the Respondent.

Let it be notified.

Lisbon, 16 January 2018

The arbitrators,

Maria Fernanda dos Santos Maçãs (President)

Henrique Nogueira Nunes

Luís Miguel Rodrigues Miranda da Rocha

Text prepared by computer, in accordance with the provisions of article 131, section 5, of the CPC, applicable by reference of article 29, section 1, paragraph (e), of the RJAT.

The wording of the present decision is governed by the spelling prior to the 1990 Orthographic Agreement.

Frequently Asked Questions

Automatically Created

How should mixed-use VAT deduction (pro rata) be calculated for banking institutions engaged in both financial leasing and credit operations?
For banking institutions performing both taxable financial leasing and exempt credit operations, the VAT deduction pro rata under Article 23 CIVA should theoretically be calculated using the formula in Article 23(4): annual turnover from taxable operations divided by total annual turnover. The controversy arises regarding what constitutes 'turnover' for financial leasing—whether only interest income or the full lease payment (interest plus capital amortization). According to Circular 30108/2009, the Tax Authority considers only interest should be included, but this decision challenges that interpretation, arguing the entire rental value defined in Article 16(2)(h) CIVA should be used, as the law makes no distinction between components when defining the taxable base for leasing operations.
Can the financial amortization component of leasing rents be included in the VAT pro rata calculation under Portuguese tax law?
The claimant strongly argued that the financial amortization component must be included in the VAT pro rata calculation under Portuguese law. The bank's position rested on Article 16(2)(h) CIVA, which establishes that the entire rent (capital plus interest) constitutes the taxable value for financial leasing operations subject to VAT. The claimant invoked the interpretive principle that one should not 'distinguish where the law does not distinguish,' asserting that if the full rental amount is the taxable base for output VAT purposes, the same total should feature in the pro rata numerator for input VAT deduction calculations. This argument challenged Circular 30108/2009's restriction to interest-only inclusion, which the claimant viewed as an unauthorized administrative limitation on statutory deduction rights lacking basis in the VAT Code's text.
What was the CAAD ruling on the legality of Ofício-Circulado 30108/2009 regarding VAT deduction for mixed taxpayers?
The CAAD tribunal analyzed whether Circular 30108/2009 validly restricted the pro rata calculation by excluding capital amortization components. The claimant argued this administrative guidance exceeded statutory authority because Article 23 CIVA, unlike Article 17(5) of the Sixth VAT Directive, does not explicitly grant Portuguese tax authorities discretion to impose alternative deduction methods on mixed taxpayers beyond the standard pro rata formula in Article 23(4). The bank contended that while EU law permits (but does not require) Member States to authorize or oblige alternative allocation methods, Portugal's legislator chose not to transpose this discretionary power, establishing instead only the objective mathematical formula without empowering tax authorities to modify its components. The decision would determine whether administrative circulars can validly restrict deduction rights beyond explicit statutory provisions, implicating constitutional principles of legality, legal reservation, and separation of powers.
What procedural steps (reclamação graciosa and recurso hierárquico) must be followed before filing a CAAD arbitration request on VAT self-assessments?
Before initiating CAAD arbitration, the claimant followed the mandatory administrative pre-litigation procedures required under Portuguese tax law. First, the bank filed a reclamação graciosa (administrative complaint) against the VAT self-assessments for periods 10/2015, 11/2015, and 12/2015, identified as Administrative Complaint Procedure ...2016.... When this complaint was dismissed, the claimant exercised its right to file a recurso hierárquico (hierarchical appeal), identified as Hierarchical Appeal Procedure ...2016..., which also resulted in dismissal maintaining the original unfavorable decision. Only after exhausting these two administrative review stages did the taxpayer file the arbitration request with CAAD on May 2, 2017, under Decree-Law 10/2011, challenging both the underlying tax acts and the administrative decisions dismissing the complaint and appeal. This procedural sequence demonstrates compliance with the jurisdictional prerequisites for tax arbitration in Portugal.
How does the CAAD interpret the VAT Directive and CJEU case law on pro rata deduction rights for financial leasing companies in Portugal?
The CAAD tribunal carefully distinguished the CJEU's Banco Mais judgment and its application to Portuguese law. The claimant acknowledged that Banco Mais established that Article 17(5) of the Sixth VAT Directive permits (but does not require) Member States to oblige taxpayers to apply deduction methods other than the standard pro rata when more appropriate. However, the critical interpretive question was whether Portugal actually transposed this discretionary power into national legislation. The bank argued that Article 23(2) CIVA is not the transposition of Article 17(5) third paragraph of the Sixth Directive, and that the Portuguese VAT Code contains no provision explicitly granting tax authorities power to impose modified pro rata calculations or alternative deduction methodologies. The tribunal would need to assess whether EU law's permissive framework was actually implemented in Portuguese domestic legislation or whether Article 23 CIVA establishes a closed, objective calculation system that administrative authorities cannot unilaterally modify through interpretive circulars.