Process: 314/2017-T

Date: December 2, 2017

Tax Type: IRS

Source: Original CAAD Decision

Summary

CAAD Process 314/2017-T addressed whether rental income losses under Category F of Portuguese IRS can be carried forward without opting for aggregation (englobamento). The claimants earned €47,546.65 in gross rental income in 2014 but incurred €51,344.47 in deductible expenses, resulting in a €3,797.82 loss. They chose separate taxation at 28% without aggregating rental income with other income categories. The Tax Authority argued that loss carryforward requires prior aggregation election, which the claimants had not exercised. The claimants contended that the negative net result should be considered a loss to carry forward regardless of the aggregation choice. The arbitral tribunal examined Article 41(1) of the IRS Code, which permits deduction of maintenance, repair expenses, and property taxes from gross rental income, and Article 72 regarding separate taxation versus aggregation options. The tribunal cited Professor Paula Rosado Pereira's interpretation that the right to deduct expenses operates against gross income, not aggregated income, and therefore does not depend on exercising the aggregation option. The case highlights the technical distinction between expense deductibility from gross rental income and the carryforward of negative net results, addressing a critical question for Portuguese taxpayers with rental properties experiencing operational losses.

Full Decision

ARBITRAL AWARD

1. Report

A - General

1.1. A…, taxpayer number …, and B…, taxpayer number …, married, residents at … Street, no. …, …, …, no. … Lisbon (hereinafter referred to as "Claimants"), filed, on 04.05.2017, a request for the constitution of a single arbitral tribunal in tax matters, which was accepted, aiming at the partial annulment of the assessment of Personal Income Tax (hereinafter "IRS") no. 2017…, relating to the year 2014.

1.2. Pursuant to the provisions of article 6(2)(a) and article 11(1)(b) of Decree-Law no. 10/2011, of 20 January, as amended by article 228 of Law no. 66-B/2012, of 31 December, the Ethics Council of the Administrative Arbitration Center (CAAD) appointed the undersigned as arbitrator, and the Parties, after being duly notified, raised no objection to such appointment.

1.3. By order dated 14.03.2017, the Tax and Customs Authority (hereinafter referred to as "Respondent") appointed Ms. Dr. C… and Ms. Dr. D… to intervene in the present arbitral proceedings, in the name and representation of the Respondent.

1.4. In accordance with the provisions of article 11(1)(c) of Decree-Law no. 10/2011, of 20 January, as amended by article 228 of Law no. 66-B/2012, of 31 December, the arbitral tribunal was constituted on 14.07.2017.

1.5. On 17.07.2017 the highest official of the Respondent's service was notified to, if so desired, file a response and request the production of additional evidence within 30 days.

1.6. On 29.09.2017 the Respondent filed its response.

B – Position of the Claimants

1.7. With respect to the year 2014, the Claimants opted for joint taxation of their income, which includes rental income.

1.8. In annex F of the Model 3 Personal Income Tax return which they filed, the Claimants declared gross rental income in the amount of €47,546.65 (forty-seven thousand five hundred and forty-six euros and sixty-five cents).

1.9. The Claimants also declared that they had incurred €64,058.75 (sixty-four thousand and fifty-eight euros and seventy-five cents) in expenses relating to the rental income earned.

1.10. The Respondent notified the Claimants that it only accepted as deductible expenses against said rental income the amount of €51,344.47 (fifty-one thousand three hundred and forty-four euros and forty-seven cents).

1.11. Should one accept the Respondent's position on the amounts of deductible expenses relating to category F, as the Claimants accept, the Claimants nevertheless recorded a loss in 2014 in the amount of €3,797.82 (three thousand seven hundred and ninety-seven euros and eighty-two cents).

1.12. The Claimants believe that the amount referred to in the preceding number should be considered by the Respondent as a loss to be carried forward in the Personal Income Tax assessment statement, which did not occur.

C – Position of the Respondent

1.13. The Respondent recalls that the Claimants are residents in Portuguese territory and that they expressly declared that they did not opt for aggregation of the rental income earned by them.

1.14. By not opting for aggregation of their rental income, the Claimants chose to tax separately the category F income, by means of the application of a fixed withholding rate [sic] on that gross income.

1.15. Thus, the Claimants are prevented from having the negative net result in the amount of €3,797.82 (three thousand seven hundred and ninety-seven euros and eighty-two cents) considered as a loss to be carried forward, since the carrying forward of losses presupposes the prior option for aggregation of category F income, which the Claimants did not intend to exercise.

D – Conclusion of the Report and Case Management

1.16. By order dated 04.11.2017 the Arbitral Tribunal dispensed with the hearing provided for in article 18 of the Legal Regime of Arbitration in Tax Matters (RJAT), considering that the Parties had already submitted to the proceedings the necessary and sufficient factual elements for the rendering of the decision, which was expected to be issued by 04.12.2017, successive opportunities having been given for the filing of written pleadings.

1.17. The Claimants filed their written pleadings on 14.11.2017, reiterating what was already set forth in the request for arbitral decision, while the Respondent chose not to file pleadings.

1.18. The arbitral tribunal has material jurisdiction pursuant to the provisions of article 2(1)(a) of the RJAT.

1.19. The Parties have legal personality and capacity and standing pursuant to article 4 and article 10(2) of the RJAT, and article 1 of Order no. 112-A/2011, of 22 March.

1.20. The proceedings are not affected by any defect of form and no exceptions were raised, so one can proceed immediately to the examination of the merits of the case.

2. Facts

2.1. Established Facts

2.1.1. With respect to the year 2014, the Claimants opted for joint taxation of their income, which includes rental income.

2.1.2. The Claimants earned gross rental income in the amount of €47,546.65 (forty-seven thousand five hundred and forty-six euros and sixty-five cents).

2.1.3. The Claimants incurred expenses deductible against said rental income in the amount of €51,344.47 (fifty-one thousand three hundred and forty-four euros and forty-seven cents).

2.1.4. The Claimants are residents in Portuguese territory.

2.1.5. The Claimants expressly declared that they did not opt for aggregation of the rental income earned by them.

2.2. Facts Not Established

There are no facts relevant to the examination of the merits of the case that have been deemed not established.

2.3. Basis for the Determination of the Facts

The facts have been established based on the documents attached to the proceedings by the Parties and on the positions assumed by them in the pleadings filed.

3. Law

3.1. Question to be Decided

It follows from what was stated above that the question to be decided is, fundamentally, whether the carrying forward of losses under category F of Personal Income Tax presupposes the option for aggregation of rental income.

3.2. The Carrying Forward of Losses under Category F and the Requirement to Opt for Aggregation of Rental Income

Let us examine what the law provides on this matter.

Let us first note what is provided in article 41(1) of the Personal Income Tax Code.

Article 41
Deductions

1 - From the gross income referred to in article 8 there are deducted the maintenance and repair expenses which are the responsibility of the taxpayer, are borne by him, and are documentally proven, as well as the municipal property tax and the stamp tax which applies to the value of the properties or parts of properties whose income is subject to taxation in the tax year.

We fully concur with the views of Professor Dr. Paula Rosado Pereira which the Claimants quote in article 30 of their pleadings: "the right to deduct maintenance and repair expenses relating to the property which is the subject of lease does not depend on the exercise by the taxpayer of the option for aggregation of rental income and their subjection to the general progressive rates of Personal Income Tax." Especially since, as the same author states, we are dealing with a rule that permits the "deduction of expenses 'against gross income' and not against aggregated income."

Numbers 7 and 8 of article 72 of the Personal Income Tax Code provide the following:

7 - Rental income is taxed separately at the rate of 28%.

8 - The income referred to in numbers 4 to 7 may be aggregated at the option of their respective holders residing in Portuguese territory.

Thus, rental income, after deduction of the expenses which under law may be deducted, is taxed separately at the rate of 28%, without prejudice to the right of their respective holders residing in Portuguese territory to opt for the aggregation of such income.

Numbers 1 and 2 of article 55 of the Personal Income Tax Code establish the regime for the deductibility of the negative net result determined in category F:

Article 55
Deduction of Losses

1 - Without prejudice to the provisions of the following numbers, the net loss determined in any income category is deductible from the aggregate of net income subject to taxation.

2 - The net loss determined in category F can only be carried forward to the five subsequent years to that to which it relates, being deducted from the positive net results of the same category.

The Respondent contends that from these provisions it can be concluded that the carrying forward of losses in category F requires, on the part of their respective holders, the prior option for aggregation of rental income. With all due respect, the Respondent appears to assume axiomatically the prior option for aggregation, since neither the letter nor the spirit of the law permits such a conclusion to be sustained. Moreover, there is a clear difference in wording between number 2 and number 6 of this same article. Here, unlike what occurs in number 2, the carrying forward can only take place "when the taxpayer opts for aggregation." Now, in number 2 no such requirement is made, wherefrom it seems clear that the difference in wording corresponds to a different legislative choice as well.

Thus, under the law, the carrying forward of losses determined in category F does not depend on the prior option for aggregation of rental income.

Already in cases 96/2015-T and 338/2016-T which were heard at CAAD, it is concluded in this same sense, with reasoning that is accepted and to which reference is made.

Decision

On the grounds and for the reasons set out above, the arbitral tribunal decides to uphold the request for arbitral decision with the consequent partial annulment of the contested assessment, insofar as it fails to recognize the possibility of carrying forward to future years the loss determined in category F in the amount of €3,797.82 (three thousand seven hundred and ninety-seven euros and eighty-two cents).

Value of the Case

In accordance with the provisions of article 306(2) of the Code of Civil Procedure, article 97-A of the Code of Civil Procedure for Tax Matters, and article 3(2) of the Regulation of Costs in Tax Arbitration Proceedings, the value of the case is fixed at €3,797.82 (three thousand seven hundred and ninety-seven euros and eighty-two cents).

Costs

For the purposes of the provisions of article 12(2) and article 22(4) of the Legal Regime of Arbitration in Tax Matters and article 4(4) of the Regulation of Costs in Tax Arbitration Proceedings, the amount of costs is fixed at €612.00 (six hundred and twelve euros), in accordance with Table I attached to said Regulation, to be borne entirely by the Respondent.

Lisbon, 2 December 2017

The Arbitrator

(Nuno Pombo)

Text prepared by computer in accordance with article 131(5) of the Code of Civil Procedure, applicable by reference to article 29(1)(e) of Decree-Law no. 10/2011, of 20 January, and with the spelling prior to the 1990 Orthographic Agreement.

Frequently Asked Questions

Automatically Created

Can rental income losses be carried forward under Portuguese IRS rules?
Under Portuguese IRS rules, the carryforward of rental income losses from Category F has been subject to interpretation regarding whether the aggregation option (englobamento) must be exercised. Article 41(1) of the IRS Code permits deduction of expenses from gross rental income regardless of aggregation choice, but the Tax Authority's position in Process 314/2017-T was that carrying forward negative net results requires prior election for aggregation under Article 72(8), which allows Portuguese residents to aggregate rental income with other income categories for progressive rate taxation.
What happens when deductible expenses exceed gross rental income in Category F?
When deductible expenses exceed gross rental income in Category F, a negative net result occurs. In Process 314/2017-T, the claimants had €47,546.65 in gross rental income and €51,344.47 in accepted deductible expenses, creating a €3,797.82 loss. Under Article 72(7) of the IRS Code, rental income is normally taxed separately at 28%. The central dispute concerned whether this negative result could be carried forward as a loss when the taxpayer chose separate taxation rather than aggregation with other income for progressive taxation purposes.
Is optional aggregation (englobamento) required to carry forward rental property losses in IRS?
The Tax Authority's position in Process 314/2017-T maintained that optional aggregation (englobamento) is required to carry forward rental property losses in IRS. The Authority argued that by choosing separate taxation at the 28% rate under Article 72(7) instead of exercising the aggregation option under Article 72(8), taxpayers forfeit the ability to have negative net results considered as losses to carry forward. However, the arbitral tribunal examined doctrine from Professor Paula Rosado Pereira suggesting that expense deductibility under Article 41 operates independently of the aggregation choice, as it applies to gross income rather than aggregated income.
How did CAAD rule on the deductibility of rental expenses exceeding declared income in Process 314/2017-T?
In Process 314/2017-T, CAAD examined the deductibility of rental expenses exceeding declared income when aggregation was not elected. The Tax Authority accepted €51,344.47 of the €64,058.75 in expenses claimed by the taxpayers against €47,546.65 in gross rental income. The tribunal analyzed whether the resulting €3,797.82 negative balance could be carried forward as a loss. The arbitrator cited Article 41(1) of the IRS Code on expense deductions and referenced Professor Paula Rosado Pereira's interpretation that deduction rights operate against gross income independently of aggregation choices, though the complete ruling determination is not fully detailed in the available excerpt.
What are the conditions for reporting rental income losses in the Portuguese IRS annual tax return?
The conditions for reporting rental income losses in Portuguese IRS returns involve several considerations highlighted in Process 314/2017-T. Category F rental income can be taxed separately at 28% under Article 72(7) or aggregated with other income at progressive rates under Article 72(8) at the taxpayer's election. Article 41(1) permits deduction of maintenance expenses, repairs, municipal property tax, and stamp tax from gross rental income. The dispute centered on whether negative net results can be carried forward without exercising the aggregation option, with the Tax Authority maintaining that loss carryforward provisions require prior aggregation election by Portuguese resident taxpayers.