Process: 330/2017-T

Date: November 2, 2017

Tax Type: IRS

Source: Original CAAD Decision

Summary

CAAD Decision 330/2017-T addresses whether improvement works on a newly acquired property can be included in the reinvestment value for IRS capital gains exclusion purposes under Article 10(5) of the Portuguese Personal Income Tax Code (CIRS). The claimants sold their primary residence for €570,000 in July 2014 and purchased a new property for €285,000 in August 2014, subsequently performing improvement works costing €69,547.34. They sought to exclude capital gains by claiming total reinvestment of €354,547.34. The Tax Authority reduced the accepted reinvestment value to €285,000, disallowing the improvement costs. The claimants argued that Article 10(5) uses the disjunctive 'or' when listing qualifying reinvestment activities (acquisition OR construction, expansion, improvement), indicating these are alternative rather than cumulative requirements. Therefore, reinvestment in both acquisition and improvement of the same property for own and permanent housing should qualify. The Tax Authority contended that the provision does not permit simultaneously counting both the acquisition price and improvement works on the same property as reinvestment. This arbitral proceeding challenges the ex officio correction that reduced the reinvestment value, arguing the law permits cumulative application when both activities serve the same purpose of establishing own and permanent housing. The case illustrates critical interpretation issues regarding the scope of capital gains rollover relief in Portuguese tax law, specifically whether taxpayers can aggregate acquisition costs and subsequent improvement expenditures when calculating qualifying reinvestment amounts under the CIRS reinvestment exemption regime.

Full Decision

ARBITRAL DECISION

REPORT

A… and B…, taxpayers numbers … and no. …, respectively, resident at Rua…, …, …, …– Cascais, hereinafter referred to as Claimants, filed on 19/05/2017 a request for establishment of an arbitral tribunal and arbitral pronouncement, in which they request the annulment of the decision of tacit dismissal of the administrative petition filed and, consequently, part of the assessment of Personal Income Tax (IRS) no. 2016 … for the year 2014.

The Honourable President of the Deontological Board of the Administrative Arbitration Centre (CAAD) appointed on 11/07/2017 Francisco Nicolau Domingos as arbitrator.

On 26/07/2017 the arbitral tribunal was constituted.

In compliance with the provision of art. 17, nos. 1 and 2 of Decree-Law no. 10/2011, of 20 January (RJAT), the Respondent was notified on 26/07/2017 to, should they wish, file a response, request the production of additional evidence and send the administrative file (PA).

On 29/09/2017 the Respondent filed a response, in which it argues for the complete rejection of the request for arbitral pronouncement.

The tribunal on 06/10/2017, in the absence of evidence to be produced, the non-existence of matters of exception to be decided before the merits are considered and the unnecessary nature of inviting the parties to correct their procedural documents, decided to dispense with the holding of the meeting referred to in art. 18, no. 1 of RJAT, based on the principle of autonomy of the arbitral tribunal in conducting the proceedings and in determining the rules to be observed with a view to obtaining, within a reasonable timeframe, a decision on the merits of the claims formulated, see art. 16, para. c) of RJAT, granted 8 days for the parties, should they wish, to file final written submissions and set a deadline for issuing the arbitral decision.

The parties filed their final written submissions on 16/10/2017 and 23/10/2017, respectively, maintaining their initial positions.

POSITIONS OF THE PARTIES

The Claimants begin by alleging that the Tax Authority of Cascais … proceeded with the ex officio correction of their Personal Income Tax declaration for the year 2014 as follows: i) reduction from € 85,561.00 to € 81,426.00 of the value of necessary and effectively paid expenses, on the grounds that charges for taxes and notarial fees will only be considered upon alienation of the property; ii) reduction from € 176,179.03 to € 94,187.56 of the value of the loans to be deducted from the realized value, on the grounds that only the outstanding loan value relating to the loan for the purpose of "acquisition" should be relevant and iii) reduction from € 393,820.97 to € 285,000.00 of the value of the relevant reinvestment, on the grounds that for such purpose the amount invested in the performance of works on the acquired property is not relevant.

The Claimants challenge exclusively in these proceedings the correction iii), that is, the reduction of the reinvestment value arising from the disregard of amounts spent on the performance of improvement works on the property.

In their view, the use of the alternative conjunction "or" instead of "and" in art. 10, no. 5, para. a) of the Personal Income Tax Code (CIRS), at the date of the taxable event, means that we are not faced with cumulative requirements. That is, reinvestment also occurs when the acquisition of the property and the performance of works on it are carried out for allocation to own and permanent housing. It is the acquisition of a property latu sensu, with a view to its recovery, for allocation to own and permanent housing.

In summary, if the Claimants decided to proceed with the reinvestment of the realized value of the sale of their own and permanent housing in a property to allocate it to the same purpose, based on the improvement works they consider essential for the reinvestment, it is devoid of any legal foundation to consider that both situations, when isolated, are covered by the exclusion rule, but that when they occur cumulatively such is no longer the case.

The Claimants further petition that the Respondent be ordered to proceed with the refund of the part of the tax unduly paid and the payment of compensation interest.

The Respondent argues that the contested tax act should be maintained in the legal order.

To that end it defends itself by way of objection, arguing that the application of the negative delimitation of the taxable base set out in art. 10, no. 5 of CIRS requires the fulfillment of two requirements: i) within a period of 36 months from the date of realization, the sale value deducted from the amortization of any loan contracted for acquisition of the alienated property be reinvested in the acquisition of another property or in the construction, expansion or improvement of a property, exclusively with the same purpose (own and permanent housing) and ii) the realized value, deducted from the amortization of any loan contracted for the acquisition of the property be used in payment of the acquisition referred to in the previous item (property for housing or land for construction, located in Portuguese territory or in the territory of another Member State of the European Union or of the European Economic Area, provided that, in the latter case, there is an exchange of information on tax matters), whenever carried out in the 24 months prior.

It observes that, while it is true that the Claimants had their tax domicile in the alienated property and allocated the acquired property to own and permanent housing, on the other hand, art. 10, no. 5 of CIRS does not allow simultaneously the acquisition of the property and improvement works on the same property intended for own and permanent housing.

Finally it argues that the petition for condemnation to payment of compensation interest should not proceed, since the Tax and Customs Authority (AT) applied the law as it is constitutionally bound to do as an executive body, and therefore one cannot speak of "error attributable to the services" and, thus, the petition should be rejected.

Accordingly, these are the matters that the tribunal must decide:

Whether the contested tax act should be annulled due to error in the legal assumptions;

Whether the Respondent should be ordered to refund the tax unduly paid and to pay compensation interest.

SCREENING

The case does not suffer from nullities, the arbitral tribunal is regularly constituted and is materially competent to know and decide on the claim, and the conditions for issuing the final decision are thus verified.

4. FACTS

4.1. Facts deemed proven

4.1.1. The Claimants acquired on 30/11/2001, for € 139,663.41, a property located at Rua…, nos. … and …, Cascais, registered in the urban property register of the said parish under article ....

4.1.2. The property was intended for own and permanent housing of the Claimants.

4.1.3. The property described in 4.1.1. was sold by the Claimants on 18/07/2014, for € 570,000.00.

4.1.4. In order to realize the said sale, the Claimants incurred payment of a banking intermediation commission in the amount of € 81,426.00.

4.1.5. With the proceeds of the alienation, the Claimants proceeded, in particular, to amortize a bank loan in the amount of € 94,187.56, contracted for the acquisition of the alienated property.

4.1.6. On 18/08/2014 the Claimants acquired, for € 285,000.00, the property located at Rua…, …, …, …, …, registered in the property register of the Union of Parishes of … and … under article ….

4.1.7. The property was intended for own and permanent housing.

4.1.8. On the date of execution of the public deed of purchase and sale, the property described in 4.1.6. had a certificate of occupancy.

4.1.9. On the property described in the preceding item, the Claimants carried out improvement works, in the amount of € 69,547.34.

4.1.10. When completing the annex to the Personal Income Tax declaration for the year 2014, the Claimants indicated the intention to reinvest the amount of € 393,820.97.

4.1.11. This value can be broken down as follows: i) € 354,659.46, corresponding to the value reinvested in the acquisition of a new property for own and permanent housing and the value of works performed on it; ii) € 85,561.00, relating to real estate intermediation commissions and notarial fees and iii) € 176,179.03, in respect of the loan value at the date of alienation of the asset.

4.1.12. The Claimants were notified on 29/06/2016 of the following discrepancy in the income declaration for Personal Income Tax for the year 2014 - "Verification of the values of loans or reinvestment values declared".

4.1.13. The AT proceeded, in particular, to correct the relevant reinvestment value to € 285,000.00, on the grounds that: "…for the purposes of non-taxation of the inherent capital gain realized, as provided in no. 5 of art. 10 of the Personal Income Tax Code, the hypotheses mentioned there are not cumulative".

4.1.14. The AT proceeded to assess additional Personal Income Tax for the year 2014 (2016…), in the amount of € 20,725.10, in which € 813.90 is included, as compensation interest.

4.1.15. The Claimants filed an administrative petition against such assessment on 23/11/2016.

4.1.16. The request for arbitral pronouncement was filed on 19/05/2017.

4.1.17. The Claimants were not notified of a decision on the administrative petition until 19/05/2017.

4.2. Facts deemed not proven

There are no other facts with relevance to the arbitral decision that have not been deemed proven.

4.3. Grounds for the facts deemed proven

The facts deemed proven have their origin in the documents used for each of the alleged facts.

5. LAW

The subject matter to be decided in these proceedings is to determine whether it is possible to combine the reinvestment in the acquisition of a property with the performance of improvement works on it.

It is thus necessary to examine the applicable regulatory framework. Article 10, no. 5 of CIRS (at the date of the taxable event) provided that: "Excluded from taxation are the gains arising from the onerous transfer of properties intended for own and permanent housing of the taxpayer or of their family group, under the following conditions: a) If, within a period of 36 months from the date of realization, the value of realization, deducted from the amortization of any loan contracted for the acquisition of the property, be reinvested in the acquisition of the ownership of another property, of land for the construction of a property, or in the construction, expansion or improvement of another property exclusively with the same purpose situated in Portuguese territory or in the territory of another Member State of the European Union or of the European Economic Area, provided that, in the latter case, there is an exchange of information on tax matters; b) If the value of realization, deducted from the amortization of any loan contracted for the acquisition of the property, be used in payment of the acquisition referred to in the preceding paragraph provided that carried out in the 24 months prior; c) For the purposes of the provision in paragraph a), the taxpayer shall manifest the intention to proceed with the reinvestment, even if partial, by mentioning, in the income declaration concerning the year of alienation, the value which they intend to reinvest".

Thus, the regulation excludes from taxation the gains arising from the transfer of properties intended for own and permanent housing of the taxpayer and of the family group, provided that they proceed, within the timeframe described above, to reinvest the realized value, deducted from the amortization of any loan contracted for the acquisition of the property.

The acquisition of the property referred to by the legislator shall be intended for own and permanent housing and may be carried out through the acquisition of a property for housing already built, the acquisition of an urban property classified as "land for construction" and through improvement or expansion of a property, insofar as in this way the taxpayer incorporates into their assets a new urban property with the purpose described above.

In this regard, the doctrine sustains[1]: "Reinvestment may be made in the direct acquisition of housing or land for the construction of a property, or also in the construction, expansion or improvement of another property; in the last two cases – acquisition of land for construction and construction, expansion or improvement of another property – the law establishes (in paragraphs b) and c) of no. 6) tight temporal conditions for the allocation of the property to own and permanent housing. Otherwise, the construction or improvement could be postponed and the statutory purpose frustrated (…)".

The teleology underlying the regulation will be found in not placing a tax burden on the right to housing[2]. That is, this rule of exclusion from the taxable base is intended to promote the ownership of a property intended for permanent housing.

Reverting such interpretation to the concrete case, if the foundation of the exclusion from taxation consists in the neutrality of the realization of the fundamental right to housing and if the Claimants acquired a property for own and permanent housing already registered in the register as urban and with a certificate of occupancy, their claim cannot succeed.

And it should not be invoked to the contrary that: "…the capital gain arising from the transfer of a property that constitutes own and permanent housing of the taxpayer may be excluded from taxation, provided that the value of realization, i.e. the proceeds of the sale, be reinvested in the acquisition (latu sensu, as will be seen below) of new own and permanent housing.", arbitral decision issued in the course of case no. 60/2012-T, of 31/07/12 and in which Dr. JAIME CARVALHO ESTEVES served as arbitrator, invoked by the Claimants in their request for arbitral pronouncement. That is, in the Claimants' view, it would be possible to combine the acquisition of a property for own and permanent housing with the performance of improvement works on it.

It happens that in such proceedings, as results from the facts deemed proven, the Claimants acquired a property that required recovery works to make it habitable, they alleged and proved that they performed works on such property for that purpose. That is, both operations are necessary for the realization of the right to housing.

Now, in the concrete case such is not so, that is, if the Claimants acquired a property intended for housing and still performed works on it, the right to housing of the Claimants is in no way placed under a tax burden, therefore, their application for annulment must, it is repeated, fail.

In fact, the expenses in question constitute, instead, charges with the enhancement of assets, that is, works that result in the appreciation of the property and, as such, may be used within the framework of determining the acquisition value, under the conditions described in art. 51 of CIRS. Therefore, if the tribunal were now to consider them, nothing would prevent that if the property were alienated within the period set in such regulation, its amount would contribute to the determination of the acquisition value.

In summary, the Claimants' claim fails entirely.

The matters of the right to refund and condemnation to payment of compensation interest are decided with prejudice to decision on the merits.

6. DECISION

Accordingly and with the grounds described above, it is decided to judge the request for arbitral pronouncement totally unfounded, with all the legal consequences thereof.

7. VALUE OF THE CASE

The value of the case is fixed at € 7,253.81, under the terms of art. 97-A of the Tax Procedure and Process Code (CPPT), applicable by virtue of the provision in art. 29, no. 1, para. a) of RJAT and of art. 3, no. 2 of the Regulation of Costs in Tax Arbitration Proceedings (RCPAT), insofar as the Claimants sought the partial annulment of the Personal Income Tax assessment act.

8. COSTS

Costs to be borne entirely by the Claimants, in the amount of € 612, see art. 22, no. 4 of RJAT and Table I attached to RCPAT.

Notify.

Lisbon, 2 November 2017

The Arbitrator,

(Francisco Nicolau Domingos)

[1] JOSÉ GUILHERME XAVIER DE BASTO, IRS: Real Incidence and Determination of Net Income, Coimbra Editor, 2007, p. 413.

[2] ANDRÉ SALGADO DE MATOS, Personal Income Tax Code (IRS): Annotated, Higher Management Institute, 1999, p. 168.

Frequently Asked Questions

Automatically Created

What qualifies as reinvestment for IRS capital gains exclusion under Article 10(5) of the Portuguese CIRS?
Under Article 10(5) of the Portuguese CIRS, capital gains from selling one's primary residence can be excluded from taxation if the sale proceeds are reinvested within 36 months in: (1) acquiring another property for own and permanent housing, or (2) construction, expansion, or improvement works on a property for the same purpose. The reinvestment amount equals the sale price minus any loan amortization for the sold property. Only the portion actually reinvested qualifies for the exclusion. The property must be located in Portugal or another EU/EEA member state with tax information exchange agreements.
Can renovation and improvement costs on a newly acquired property count toward the reinvestment value for IRS purposes?
This is the central dispute in Decision 330/2017-T. The claimants argued that improvement and renovation costs (€69,547.34) on their newly acquired property should be added to the acquisition price (€285,000) when calculating total reinvestment value. The Tax Authority rejected this, accepting only the acquisition cost. The claimants contended that Article 10(5) CIRS uses 'or' disjunctively, meaning acquisition and improvement are alternative qualifying activities that can be combined when both serve own and permanent housing. The Tax Authority argued the law does not permit simultaneously counting acquisition and improvements on the same property.
How does the CAAD arbitral tribunal handle disputes over capital gains reinvestment deductions in IRS?
CAAD arbitral tribunals provide an alternative dispute resolution mechanism for IRS capital gains reinvestment disputes. The process involves: (1) taxpayer filing an arbitration request challenging the tax assessment or tacit dismissal of administrative appeals; (2) appointment of an arbitrator by the CAAD President; (3) notification of the Tax Authority to file a response and submit the administrative file; (4) optional evidence production and hearings; (5) written submissions from both parties; and (6) issuance of a binding arbitral decision. The tribunal reviews whether the Tax Authority correctly applied Article 10(5) CIRS provisions regarding qualifying reinvestment amounts and required formalities.
What corrections can the Portuguese tax authority make to IRS declarations regarding property reinvestment values?
The Portuguese Tax Authority can make ex officio corrections to IRS declarations regarding property reinvestment under Article 10(5) CIRS. In this case, the Tax Authority made three corrections: (1) reducing deductible expenses by excluding certain taxes and notarial fees (€85,561 to €81,426); (2) reducing deductible loan amounts to only loans for acquisition purposes (€176,179.03 to €94,187.56); and (3) reducing qualifying reinvestment value by excluding improvement works performed on the acquired property (€393,820.97 to €285,000). These corrections aim to ensure taxpayers comply with the specific requirements and limitations established in the CIRS reinvestment exemption regime.
What is the procedure for challenging an IRS capital gains assessment through CAAD arbitration in Portugal?
The procedure for challenging IRS capital gains assessments through CAAD arbitration involves: (1) filing a prior administrative appeal (reclamação graciosa) with the Tax Authority; (2) if dismissed or tacitly rejected after the legal deadline, filing an arbitration request with CAAD within the statutory time limit; (3) the request must identify the contested act, legal grounds, and relief sought; (4) upon tribunal constitution, the Tax Authority is notified to respond and provide the administrative file; (5) parties may request evidence production and file written submissions; (6) the tribunal issues a binding decision that can annul unlawful tax assessments and order refunds plus compensatory interest if applicable.