Process: 339/2018-T

Date: March 25, 2019

Tax Type: IVA

Source: Original CAAD Decision

Summary

This CAAD arbitration decision (339/2018-T) addresses the critical issue of VAT deduction methodology for mixed taxpayers engaged in financial leasing operations in Portugal. The claimant, a credit institution conducting both taxable financial leasing and VAT-exempt credit operations, challenged the Tax Authority's restriction of pro rata VAT deduction calculations. The dispute centers on whether only the interest component of leasing rents should be included in the pro rata formula, or whether the entire rent (including capital amortization) must be considered. The Tax Authority relied on Circular Notice 30108/2009 and the CJEU Banco Mais judgment to exclude capital amortizations from the numerator and denominator of the pro rata fraction. The claimant argued this interpretation violated Article 23 of the VAT Code, which provides objective criteria for pro rata calculation, and that the taxable value of financial leasing under Article 16(2)(h) includes the entire rent received. The case raises fundamental questions about the limits of administrative interpretation, the correct transposition of EU Directive provisions into Portuguese law, and whether the Tax Authority can impose deduction restrictions beyond statutory provisions. The dispute also implicates constitutional principles including legality, separation of powers, parliamentary reservation on tax matters, and fiscal neutrality. The outcome determines whether mixed taxpayers can rely on statutory pro rata rules or must accept administrative modifications based on EU case law interpretation.

Full Decision

ARBITRATION DECISION

I – Report

  1. A..., S.A., with collective taxpayer identification number ..., with registered office at Rua ..., ...-... Lisbon, hereby requests the establishment of an arbitral tribunal, pursuant to Articles 2, no. 1, subparagraph a), and 10 of Decree-Law no. 10/2011, of 20 January, to assess the legality of the tax acts embodied in the periodic VAT declarations relating to the periods of April, May and June 2015, and likewise the decision dismissing the administrative appeal against them, further requesting condemnation to pay compensatory interest.

The request is grounded in the following terms.

In the periodic VAT declarations relating to the months of April, May and June 2015, the Claimant, in its capacity as a mixed taxpayer that simultaneously carries out activities subject (financial leasing) and exempt (credit extension) from tax, deducted VAT based on the pro rata calculation, in compliance with the position contained in Circular Notice no. 30108, of 30 January 2009, which considers that in calculating the percentage of pro rata deduction only the interest component and not the financial amortizations relating to financial leasing contracts may be included.

The tax acts in question suffer from incorrect application of the law, in particular the legal regime of the right to VAT deduction of mixed taxpayers, established in Article 23 of the VAT Code.

First, pursuant to subparagraph h) of no. 2 of Article 16 of the VAT Code, the taxable value of financial leasing is constituted by the entire rent received (principal and interest), with no reason to distinguish when VAT deduction is permissible in relation to goods and services of mixed use.

Furthermore, the judgment of the CJEU handed down in the Banco Mais case, which is invoked by the Tax Authority in the decision dismissing the hierarchical appeal, only permits the conclusion that Article 17, no. 5, third paragraph, subparagraph c) of the Sixth Directive does not preclude a Member State from obliging a taxpayer to apply another deduction method that is deemed more appropriate, but it cannot be affirmed that this Community provision is transposed into domestic law by Article 23, no. 2, of the VAT Code.

And this provision of domestic law contains no reference that would permit the Tax Authority to impose conditions on the deduction percentage relating to a taxpayer that opts for the pro rata method, beyond the objective instructions provided by no. 4 of Article 23 for determining that percentage.

Whereas the Sixth Directive opens the possibility for Member States to require a mixed taxpayer to effect deduction on the basis of the use of all or part of the goods and services, this was not, however, the option followed by the national legislature in the VAT Code.

In these terms, the VAT self-assessed acts, as well as the decision dismissing the administrative appeal, in being based on the possibility of altering the components of the pro rata calculation violate the provisions of Articles 19, 20 and 23 of the VAT Code and the principles of fiscal neutrality, equal treatment among taxpayers, legal certainty and protection of legitimate expectations, as well as the principles of separation of powers (Articles 2 and 111 of the Constitution), legality (Article 112, no. 5) and parliamentary reservation (Articles 103 and 165, no. 1, subparagraph i)).

The Tax Authority, in its response, states that the Claimant is a credit institution covered by the General Regime of Credit Institutions and Financial Companies, which carries out financing operations and credit extension, which are VAT-exempt, and financial leasing operations, which are subject and not exempt from tax and confer the right to VAT deduction, thus characterizing itself as a mixed taxpayer that has opted for the pro rata method for purposes of the right to deduction, pursuant to Article 23, nos. 1, subparagraph b), and 4, of the VAT Code.

Financial leasing constitutes a service provision subject to tax whose consideration is realized in the rents received by the lessor entity, which are composed of interest and financial amortization or principal. And in relation to these mixed-use services, the deduction criterion in light of the provision of no. 2 of Article 23 of the VAT Code can only reflect the amount of income derived from its taxed activity (interest) under penalty of subverting the principle of tax neutrality.

The VAT self-assessments accordingly followed the legally adjusted procedure.

Furthermore, the judgment of the CJEU in the Banco Mais case considered, with respect to financial leasing operations, that the fact that the criterion used was the portion of turnover generated by the operations that conferred the right to deduction, without excluding from that turnover the portion of rents received that compensated for the cost of acquisition of the leased vehicles, had had the effect of distorting the calculation of the deduction pro rata.

Thus concluding that Article 17, no. 5, third paragraph, subparagraph c), of the Sixth Directive (to which corresponds the current Article 173, no. 2, of Directive 2006/112 EC) should be interpreted in the sense that it does not preclude a Member State from requiring a bank that carries on 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 portion of rents paid by customers, within the scope of their financial leasing contracts, that corresponds to interest, when the use of these goods and services is primarily determined by the financing and management of these contracts.

And in that sense the judgment of the Supreme Administrative Court of 29 October 2014, in Case no. 01075/13, also pronounced itself.

Concludes in favor of the inadmissibility of the request.

  1. Following the proceedings, the meeting referred to in Article 18 of the RJAT was dispensed with.

In submissions, the Claimant maintained its previous position. The Tax Authority did not submit a pleading.

  1. The request for establishment of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax Authority in accordance with regulatory procedures.

Pursuant to subparagraph a) of no. 2 of Article 6 and subparagraph b) of no. 1 of Article 11 of the RJAT, as amended by Article 228 of Law no. 66-B/2012, of 31 December, the Ethics Council designated the undersigned as arbitrators of the collective arbitral tribunal, who communicated acceptance of the engagement within the applicable period.

The parties were duly and timely notified of this designation and did not manifest the will to refuse it, pursuant to the combined provisions of Article 11, no. 1, subparagraphs a) and b), of the RJAT and Articles 6 and 7 of the Code of Ethics.

Thus, in accordance with the provision of subparagraph c) of no. 1 of Article 11 of the RJAT, as amended by Article 228 of Law no. 66-B/2012, of 31 December, the collective arbitral tribunal was constituted on 25 September 2018.

The arbitral tribunal was regularly constituted and has material competence, in light of the provision of Articles 2, no. 1, subparagraph a), and 30, no. 1, of Decree-Law no. 10/2011, of 20 January.

The parties possess legal personality and capacity, are legitimate and are represented (Articles 4 and 10, no. 2, of the same decree and 1 of Ordinance no. 112-A/2011, of 22 March).

The proceedings do not suffer from defects and no exceptions are invoked.

It falls to us to assess and decide.

II - Grounds

Matters of Fact

  1. The facts relevant to the decision of the case that may be taken as established are as follows:

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

  • The Claimant is a mixed taxpayer for VAT purposes insofar as it carries out financial leasing operations on movable property in its activity, which are taxable and confer the right to VAT deduction, and financing and credit extension operations, which are exempt from tax and do not permit VAT deduction.

  • On 8 May 2015, the Claimant submitted, via Internet, the periodic VAT declaration relating to April 2015, which was subsequently replaced by the declaration submitted on 1 June 2015;

  • On 8 June 2015, the Claimant submitted, via Internet, the periodic VAT declaration relating to May 2015, which was subsequently replaced by the declaration submitted on 29 June 2015;

  • On 7 July 2015, the Claimant submitted, via Internet, the periodic VAT declaration relating to June 2015, which was subsequently replaced by the declaration submitted on 13 August 2015;

  • In the same periodic declarations, the Claimant excluded from the numerator and denominator of the fraction representing the pro rata calculation the financial amortizations relating to financial leasing contracts and the values of disposal/write-off due to destruction of leased assets, following the position expressed by the Tax Authority in Circular Notice no. 30108, of 30 January 2009;

  • The Claimant thus reduced its pro rata from 59%, which represented the definitive value for 2014 and provisional for 2015, according to the criterion previously followed by the Claimant, to 18%, as a result of the criterion imposed by the Tax Authority;

  • Consequently, the amount to be deducted was reduced from €450,120.79 to €312,765.81;

  • In the information serving as basis for the dispatch dismissing the administrative appeal, the following is considered, in summary:

  • Article 17, no. 5, § 3, of the Sixth Directive permits Member States to authorize or impose specific VAT deduction methods when circumstances warrant it, which is consistent with the provision of Article 23, nos. 2 and 3, subparagraph b), of the VAT Code;

  • The financial lessor should reflect the value of the leased asset as a credit that is reimbursed through financial amortizations and the interest and other charges as income that will affect the profit of the fiscal year;

  • Thus, although Article 16, no. 2, subparagraph h), of the VAT Code states that in financial leasing operations, the taxable value corresponds to the rent received as a whole, the truth is that the portion corresponding to the financial amortization does not assume the nature of income and, as such, does not form part of the concept of turnover and cannot influence the calculation of the deduction percentage;

  • The Tax and Customs Authority issued Circular Notice no. 30108, of 30 January 2009, with the following content:

Subject: VAT - Right to Deduction Rules for the determination of the right to deduction by credit institutions when they simultaneously carry out Leasing or ALD activities

For the knowledge of the Services and other interested parties, and with a view to disseminating the correct interpretation to be given to Article 23 of the VAT Code with respect to its application by credit institutions that carry on, inter alia, Leasing or ALD activity, it is communicated that, by my dispatch of 2009.01.30, issued in information no. 106, of 19 January 2009, from the Office of the Deputy Director-General for VAT Management, the following was determined:

  • Circular notice no. 30103, of 2008.04.23, from the Office of the Deputy Director-General for VAT Management, proceeded to disseminate generic instructions with a view to standardizing the interpretation to be given to the amendments introduced to Article 23 of the VAT Code (CIVA), to ensure proper classification of the various activities in light of the new provisions, to establish the procedures to be followed in determining the deduction of tax, and also to clarify the criteria to be used when actual allocation is utilized in determining the amount of tax to be deducted and whenever mixed-use goods and services are at issue.

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

  • In case of use of actual allocation, whether mandatory or optional, and in accordance with no. 2 of Article 23, the taxpayer to determine the degree of allocation or use of the goods and services in carrying out operations conferring the right to deduction or operations not conferring such right must resort to objective criteria, and in any case the determination of these objective criteria must be adapted to the situation and concrete organization of the taxpayer, the nature of its operations in the context of the overall activity carried on and to the goods or services acquired for the needs of all operations, whether or not integrated in the relevant economic activity concept.

  • The criteria adopted may be corrected or altered by the DGCI, with proper grounds of fact and law, or, if applicable, cause the use of the method to cease, if significant distortions in taxation occur.

  • In the specific case of financial entities that likewise carry on Leasing or ALD activities, the joint practice of credit extension operations and taxable leasing operations, including financial leasing, implies, where there are goods and services acquired that are jointly used in both, the need to resort to the provisions of Article 23 of the VAT Code to determine the portion of the tax incurred that is subject to the right to deduction.

  • Given the previous wording of Article 23 of the VAT Code, in the context of application of the actual allocation method, whenever it was not viable to apply allocation in calculating deductible VAT in relation to mixed-use goods, the solution found and followed by the Services as that which most approached the desired neutrality was in the sense of applying a proportion between the two types of operations, so as to determine, as closely as possible, the allocation of inputs to each of them. However, no. 4 of Article 23 of VAT was not at issue here but the determination of deductible tax by the application of a specific pro rata, since the method previously used had been actual allocation.

  • Given the current wording of Article 23, actual allocation is the method that, having objective criteria of allocation as its basis, most suits the determination of deductible VAT on mixed-use goods and services.

  • In that sense, considering that the determination of deductible VAT in accordance with the application of the general pro rata established in no. 4 of Article 23 of the VAT Code is capable of producing unjustified advantages or disadvantages due to the lack of coherence of the variables employed in it, or, that is, it can lead to "significant distortions in taxation", taxpayers that in the context of financial activities carry on Leasing or ALD operations must use, pursuant to no. 2 of Article 23 of the VAT Code, actual allocation on the basis of objective criteria that permit determining the degree of use of these goods and services, so as to determine the amount of VAT to be deducted in relation to the whole of the activities.

  • In the application of the actual allocation method, pursuant to the foregoing and whenever it is not possible to apply objective criteria of allocation of common costs, a specific allocation coefficient must be used, taking into account the amounts involved, and in calculating the deduction percentage only the annual amount corresponding to interest and other charges relating to Leasing or ALD activity should be considered. In this case, the percentage above referred to does not result from the application of no. 4 of Article 23 of the VAT Code.

The Tribunal formed its conviction as to the proven facts on the basis of the documents attached to the petition and the administrative file submitted by the Tax Authority with its response, taking into account that the facts alleged by the Claimant were not disputed.

Matters of Law

  1. The Claimant is a credit institution covered by the General Regime of Credit Institutions and Financial Companies that carries out financing and credit extension operations, which are VAT-exempt and do not permit the right to VAT deduction, and financial leasing operations, which are subject and not exempt from VAT and confer the right to deduction, being thus characterized for that purpose as a mixed taxpayer.

In the case of financial leasing operations the consideration is realized in the rents that the lessee is obliged to pay for the transfer of the leased assets and which include a portion corresponding to interest and another relating to financial amortization or principal.

The question that arises is whether, in the application of the pro rata method of deduction of tax incurred on mixed-use goods and services, the total rent value or only the portion corresponding to interest which constitutes the income or revenue of the lessor should be considered in the numerator and denominator of the calculation fraction.

The question was analyzed by the CJEU in a preliminary reference raised, in a similar case, by the Supreme Court of Justice in which it concludes that Article 17, no. 5, third paragraph, subparagraph c), of the Sixth Directive (to which corresponds Article 173, no. 2, subparagraph c), of Directive 2006/112/EC) should be interpreted in the sense that it does not preclude a Member State from requiring a bank that carries on 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 portion of rents paid by customers, within the scope of their financial leasing contracts, that corresponds to interest, when the use of these goods and services is primarily determined by the financing and management of these contracts (judgment of 10 July 2014, Case no. C-183/13).

The Claimant contends, however, that this Community rule was not subject to transposition into Portuguese domestic law, and, specifically, was not transposed through Article 23, no. 2 of the VAT Code, whereby it falls to be ascertained whether the Tax Authority has the possibility, within the application of the pro rata method to a taxpayer carrying on financial leasing activities, of considering only interest for purposes of calculating the deduction.

This is the question that must be preliminarily clarified.

  1. The right to deduction of tax, governed in Articles 167 to 192 of the VAT Directive and, in domestic law, in Articles 19 to 25 of the VAT Code, consists essentially in the right of a taxpayer to deduct from the tax levied on a certain taxable operation the tax incurred in the acquisition of goods or services intended for the realization of that operation.

According to the general rule contained in Article 168 of the Directive, the VAT incurred in acquisitions made by a taxpayer is deductible in full whenever the goods or services are used "for the purposes of its taxed operations". This corresponds to a method of direct allocation deduction, and for that purpose a direct nexus must be established between a given active operation and a given passive operation.

Where it is not possible to establish this direct nexus, as occurs when expenses in acquiring goods or services relate simultaneously to taxed operations and tax-exempt operations – a case in which we are dealing with mixed costs or common costs – the right to deduction is limited pursuant to Article 173 of the Directive.

This provision establishes in the first place the pro rata method, whereby with respect to goods and services used by a taxpayer to carry out both operations conferring the right to deduction and operations not conferring the right to deduction, deduction is only permitted with respect to the portion of VAT proportional to the amount relating to the first category of operations and, consequently, only in relation to operations that give rise to the right to deduction.

It is understood in this context that the pro rata method is based on the presumption that mixed costs are used in operations conferring the right to deduction in direct proportion to the value that these operations represent in relation to the total turnover of the company. This is the calculation rule that is contained in Article 174 of the Directive: "the pro rata of deduction is derived from a fraction including the following amounts – (a) in the numerator, the total annual turnover, VAT excluded, relating to operations conferring the right to deduction in accordance with Articles 168 and 169; (b) in the denominator, the total annual turnover, VAT excluded, relating to the operations included in the numerator and to operations not conferring the right to deduction.

The presumption based on the percentage of the value of operations conferring the right to deduction in relation to total turnover is, however, set aside by the actual allocation criterion contained in subparagraph c) of no. 2 of Article 173 of the Directive, which permits Member States to authorize or impose that VAT deduction be effected on the basis, not of turnover, but of the effective use of goods or services.

In the relevant portion, the provision states in these terms:

  1. The Member States may take the following measures:

(...)

c) Authorize or require the taxable person to effect the deduction on the basis of the allocation of all or part of the goods and services;

(...).

It must therefore be concluded that the VAT Directive contemplates three distinct methods of calculating deduction. The direct allocation method, which applies to direct costs, that is, costs associated with operations conferring the right to deduction, and, with respect to mixed costs, which are indistinctly associated with operations conferring or not conferring the right to deduction, the pro rata method and, by way of exception, the actual allocation method (on all these aspects, see Sérgio Vasques, The Tax on Value Added, Coimbra, 2015, pages 351 et seq.).

It cannot fail to be recognized, on the other hand, that the Directive, in the transcribed Article 173, no. 2, subparagraph c), grants Member States some margin of freedom of discretion as to the definition of the actual allocation criterion.

In domestic law, with respect to the deduction method applicable to mixed-use goods, Article 23 of the VAT Code is relevant, which is worded as follows:

1 - When the taxpayer, in the exercise of its activity, carries out operations conferring the right to deduction and operations not conferring such right, pursuant to Article 20, the deduction of the tax incurred in the acquisition of goods and services that are used in carrying out both types of operations is determined as follows:

a) Where it is a good or service partially allocated to the realization of operations not arising from the exercise of an economic activity provided for in subparagraph a) of no. 1 of Article 2, the non-deductible tax as a result of this partial allocation is determined pursuant to no. 2;

b) Without prejudice to the provision of the preceding subparagraph, where it is a good or service allocated to the realization of operations arising from the exercise of an economic activity provided for in subparagraph a) of no. 1 of Article 2, part of which does not confer the right to deduction, the tax is deductible in the percentage corresponding to the annual amount of operations giving rise to deduction.

2 - Notwithstanding the provision of subparagraph b) of the preceding number, the taxpayer may effect the deduction according to the actual allocation of all or part of the goods and services used, on the basis of objective criteria that permit determining the degree of use of these goods and services in operations conferring the right to deduction and in operations not conferring such right, without prejudice to the Tax Authority being able to impose special conditions on it or to cause such procedure to cease in case it is verified that it causes or may cause significant distortions in taxation.

3 - The tax administration may require the taxpayer to proceed in accordance with the provision of the preceding number:

a) When the taxpayer carries on distinct economic activities;

b) When the application of the process referred to in no. 1 leads to significant distortions in taxation.

4 - The deduction percentage referred to in subparagraph b) of no. 1 is derived from a fraction comprising, in the numerator, the annual amount, tax excluded, of operations giving rise to deduction pursuant to no. 1 of Article 20, and in the denominator, the annual amount, tax excluded, of all operations carried out by the taxpayer arising from the exercise of an economic activity provided for in subparagraph a) of no. 1 of Article 2, as well as non-taxed subsidies that are not equipment subsidies.

  1. The preliminary question analyzed in the judgment of the CJEU in Case no. C-183/13 had as its subject the interpretation of Article 17, no. 5, third paragraph, subparagraph c), of the Sixth Directive, within the scope of litigation opposing the Public Treasury to a financial leasing company, regarding the calculation rule that must be used to determine the right to deduction of value added tax owed when acquiring goods and services used to simultaneously carry out operations conferring the right to deduction and operations not conferring such right.

Interpreting the Community rule in its literal and teleological context and in light of the principles of fiscal neutrality and proportionality, the Court concluded that "the principle of fiscal neutrality, inherent in the common VAT system, requires that the methods of calculating the deduction objectively reflect the real portion of expenses incurred in acquiring mixed-use goods and services that can be allocated to operations conferring the right to deduction", and, for that purpose, "the Sixth Directive does not preclude Member States from applying, in a given operation, a method or allocation criterion different from the method based on turnover, provided that this method guarantees a more precise determination of the pro rata of deduction of upstream VAT paid than that resulting from the application of the turnover-based method" (§§ 31 and 32).

In that sense, the Court concluded that "the calculation of the right to deduction in application of the method based on turnover, which takes into account the amounts relating to the portion of rents that customers pay and which serve to compensate the availability of the vehicles, leads to a less precise determination of the pro rata of upstream VAT deduction than that resulting from the method applied by the Public Treasury, based only on the portion of rents corresponding to interest which constitutes the consideration for the costs of financing and managing the contracts borne by the financial lessor" (§ 34).

The Claimant contends, however, that Article 23, no. 2, of the VAT Code does not transpose into domestic law the provision of Article 17, no. 5, third paragraph, subparagraph c), of the Directive based essentially on the following argument: whereas the Directive permitted Member States to authorize or require the taxpayer to effect deduction on the basis of the use of all or part of the goods or services, the national legislature did not confer this prerogative on the Administration, limiting itself to permitting the control of objective criteria that the taxpayer has used when it opts for the actual allocation mechanism.

This is the question that must first be analyzed.

It appears to be beyond doubt that Article 23, no. 1, subparagraph b), establishes the pro rata method for VAT deduction for mixed taxpayers, establishing in no. 4 the calculation of the deduction percentage. On the other hand, pursuant to no. 2, the taxpayer may effect the deduction according to actual allocation of all or part of the goods and services used, which corresponds to the application of an alternative deduction method based on actual allocation according to the effective use of goods. For this latter hypothesis, this no. 2 also provides that the Administration may impose special conditions on the actual allocation method and cause the procedure to cease when significant distortions in taxation are verified. And pursuant to subparagraph b) of no. 3, the Administration may also require the taxpayer to proceed in accordance with the actual allocation method when the application of the pro rata method may lead to significant distortions in taxation.

It cannot fail to be recognized that the combined provisions of nos. 2 and 3 of Article 23 correspond, in substance, to the rule for determining the right to deduction referred to in Article 17, no. 5, third paragraph, subparagraph c), of the Directive, contemplating the possibility that, on the initiative of the taxpayer or by action of the Administration, the actual allocation method for tax deduction may come to be adopted with respect to mixed-use goods. And it is also an established point that no. 2 permits the Administration, through control of the criteria used by the taxpayer in applying the actual allocation method, to impose special conditions, which, in practice, may translate into the application of a criterion that permits more precisely determining the degree of use of mixed-use goods of a company.

However, it cannot be affirmed, in light of a literal and systematic interpretation of nos. 2 and 3 of Article 23, that the legislature has expressly established the possibility of the Administration, on its own initiative, to mitigate the pro rata method so as to institute a third method or a specific method that alters the calculation rule of the deduction percentage contained in no. 4 of that Article 23.

In fact, as has been clarified, the powers that the Code confers on the Administration, through those provisions, only permit that more objective criteria may be used in deduction by the actual allocation method or that the taxpayer be required to use that method in place of percentage deduction. But there does not appear there any reference to the possibility of the Administration fixing a deduction calculation in application of the turnover method different from that provided for in no. 4 of Article 23 and that would permit inserting into the numerator and denominator of the fraction representative of the pro rata only a portion of the income that is subject to VAT.

The specific deduction coefficient that permits calculating the deduction percentage solely on the basis of the annual amount of interest was only introduced by Circular Notice no. 30108, of 30 January 2009, by which the Tax Authority, having concluded, with respect to credit institutions that simultaneously carry on Leasing or ALD activities, that the determination of deductible VAT according to the application of the general pro rata established in no. 4 of Article 23 of the VAT Code can lead to "significant distortions in taxation" determined, in the exercise of the faculty provided for in Article 23, no. 3, that these taxpayers should commence using actual allocation.

According to points 8 and 9 of the Circular Notice, actual allocation may be effected in the following two ways: (a) if possible, actual allocation is done on the basis of objective criteria that permit determining the degree of use of these goods and services, so as to determine the amount of VAT to be deducted in relation to the whole of the activities; (b) if it is not possible to apply objective criteria of allocation of common costs, a specific allocation coefficient must be used, taking into account the amounts involved, and in calculating the deduction percentage only the annual amount corresponding to interest and other charges relating to Leasing or ALD activity should be considered.

As is known, however, circulars are mere generic guidelines intended to standardize, within the services, the interpretation and application of tax rules, but, although they possess binding force for the Tax Authority (Article 68-A, no. 1, of the LGT), they cannot override regulatory acts of higher hierarchical value nor can they therefore serve as valid legal grounds for the imposition of a deduction criterion that does not have sufficient support in legal texts.

It is true that the judgment of the CJEU handed down in Case no. C-183/13 concluded that the provision of Article 17, no. 5, third paragraph, subparagraph c), of the Sixth Directive should be interpreted in the sense that it does not preclude a Member State from requiring an institution carrying on financial leasing activities to include in the pro rata deduction method for mixed-use goods and services only the portion of rents paid that corresponds to interest.

The Community rule does not, however, have the characteristic proper of direct effect, which is only recognized for provisions that confer or impose obligations in a clear, precise and unconditional manner. And, by contrast, it leaves some margin of freedom of discretion to the national legislature as to the definition of actual allocation criteria (Sérgio Vasques, ob. cit., page 356). It suffices to note that the rule, after setting forth the general deduction criterion by percentage, contained in no. 1, merely limits itself to conferring on Member States, in no. 2, subparagraph c), the possibility of taking measures in the sense of "authorizing or requiring the taxpayer to effect the deduction on the basis of the allocation of all or part of the goods and services".

And although the Community rule admits that, in the application of the actual allocation method, only part of the mixed-use goods used be considered, and not all of them, the fact remains that in the transposition carried out by the national legislature only the "actual allocation of all or part of the goods and services used, on the basis of objective criteria that permit determining the degree of use of these goods and services in operations conferring the right to deduction and in operations not conferring such right" is provided for.

Now, it is clear that it is not on the basis of the partial value of the rent (corresponding to interest) that it is possible to determine, with objectivity, the common expenses that are allocated to the financial leasing activity that confer the right to deduction (in this sense, the arbitration award handed down in Case no. 309/2017).

Being thus, it must be concluded that the power granted to the Tax Authority by Article 23, no. 3, does not include the possibility of imposing on the taxpayer the application of a deduction percentage. All the more so because, as is provided in Article 16, no. 1, subparagraph h), the taxable value in operations arising from a financial leasing contract is the value of the rent received or receivable from the lessee, and in the formula legally provided for calculating the deduction percentage the total business value must intervene (Article 23, no. 4).

In summary, the VAT Code has effected the transposition of Article 17, no. 5, third paragraph, subparagraph c), of the Sixth Directive into domestic law but does not permit supporting the application of a specific allocation coefficient that is based on the deduction of the annual amount corresponding to interest associated with the financial leasing activity. It is not determinative, on the other hand, that the Court of Justice has interpreted the Directive in the sense that it does not preclude that, in financial leasing activities, in calculating the percentage to be deducted should enter only the portion of rents corresponding to interest. The Court of Justice limited itself to interpreting Community law and, as has been shown, the rule in question leaves a margin of freedom of discretion to the legislature, it falling to national judicial bodies to verify whether there subsists a rule in the domestic legal system that permits accepting the interpretive criterion adopted by the Court of Justice.

This not being the case and it being verified that the specific deduction criterion was adopted by the Administration following an internal circular, the disputed assessments and the decision dismissing the administrative appeal are tainted by illegality through violation of the provision of Article 23, nos. 2 and 3, subparagraph b), of the VAT Code.

Issues of Prejudiced Knowledge

Given the solution reached on the plane of infra-constitutional law, knowledge of constitutional issues is prejudiced.

Compensatory Interest

  1. The Claimant further requests condemnation of the Tax Authority to pay compensatory interest, at the legal rate, calculated on the tax, until full reimbursement of the amount owed.

In accordance with the provision of subparagraph b) of Article 24 of the RJAT, the arbitration award on the merits of the claim from which no appeal or challenge is available binds the Tax Authority, in the exact terms of the finding of admissibility of the arbitration award in favor of the taxpayer, it being incumbent on the latter to "restore the situation that would exist if the tax act subject to the arbitration award had not been carried out, adopting the necessary acts and operations for that purpose". This is in line with the provision of Article 100 of the LGT, applicable by virtue of the provision of subparagraph a) of no. 1 of Article 29 of the RJAT.

Still pursuant to no. 5 of Article 24 of the RJAT "payment of interest, regardless of its nature, is due in accordance with the provisions of the General Tax Law and the Code of Tax Procedure and Process", which refers to the provision of Articles 43, no. 1, and 61, no. 5, of each of these instruments, implying payment of compensatory interest from the date of the undue payment of the tax until the date of processing of the respective credit note.

There is thus occasion, as a consequence of a declaration of illegality of the assessment acts, for payment of compensatory interest, pursuant to the cited provisions of Articles 43, no. 1, of the LGT and 61, no. 5, of the CPPT, calculated on the amount that the Claimant undue paid, at the rate of legal interest (Articles 35, no. 10, and 43, no. 4, of the LGT).

III – Decision

In these terms it is decided:

  • To find the arbitration request admissible and, consequently, to annul the VAT assessments effected in the periodic declarations relating to the periods of April, May and June 2015, as well as the decision dismissing the administrative appeal against them;

  • To condemn the Tax Authority to reimburse the Claimant in the amount of €312,795.82, plus compensatory interest calculated from the date of undue payment until the respective reimbursement.

Value of the Cause

The Claimant indicated as value of the cause the amount of €312,795.82, which was not contested by the Respondent and corresponds to the value of the assessment that it sought to contest, whereby the value of the cause is fixed at that amount.

Costs

Pursuant to Articles 12, no. 2, and 24, no. 4, of the RJAT, and Article 3, no. 2, of the Regulations of Costs in Tax Arbitration Proceedings and Table I attached to those Regulations, the amount of costs is fixed at €5,508.00, which shall be charged to the Respondent.

Notify.

Lisbon, 25 March 2019

The President of the Arbitral Tribunal

Carlos Fernandes Cadilha

The Arbitrator Member

Cristina Leitão Campos

The Arbitrator Member

Nuno Maldonado Sousa

Frequently Asked Questions

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How should the pro rata method be calculated for VAT deduction in financial leasing operations in Portugal?
The pro rata method for VAT deduction in financial leasing should be calculated according to Article 23(4) of the Portuguese VAT Code, which establishes an objective formula based on the proportion of taxable turnover to total turnover. The claimant argues that since Article 16(2)(h) defines the taxable value of financial leasing as the entire rent (principal plus interest), both components should be included in the pro rata calculation. However, the Tax Authority, citing Circular Notice 30108/2009, contends that only the interest component should be considered, excluding capital amortizations to avoid distorting the deduction percentage and properly reflect the taxed activity.
Can the Portuguese Tax Authority exclude capital amortizations from the pro rata calculation under Article 23 of the VAT Code?
The Tax Authority claims authority to exclude capital amortizations from the pro rata calculation under Article 23 of the VAT Code, relying on the CJEU Banco Mais ruling and administrative guidance in Circular Notice 30108/2009. However, the claimant challenges this position, arguing that Article 23(2) and (4) contain no provision allowing the Tax Authority to modify the statutory components of the pro rata formula. The claimant contends that while the EU Sixth Directive permits Member States to require alternative deduction methods, Portugal did not exercise this option in its VAT Code, making the administrative restriction ultra vires and violating principles of legality, legal certainty, and parliamentary reservation over tax matters under Articles 103, 112(5), and 165(1)(i) of the Portuguese Constitution.
What did the CJEU Banco Mais ruling establish regarding VAT deduction methods for mixed taxpayers?
The CJEU Banco Mais ruling interpreted Article 17(5) of the Sixth Directive (now Article 173(2) of Directive 2006/112/EC), concluding that it does not preclude a Member State from requiring banks engaged in financial leasing to include only the interest portion of leasing rents in both the numerator and denominator of the pro rata deduction fraction, when mixed-use goods and services are primarily determined by financing activities. The ruling found that including capital amortizations distorts the pro rata calculation. However, the claimant argues this judgment merely permits Member States to impose such requirements but does not mandate them, and Portugal has not explicitly transposed this option into Article 23 of the VAT Code, making the Tax Authority's unilateral application legally unsupported.
Does Ofício-Circulado 30108 legally override the pro rata calculation rules in Article 23(4) of the Portuguese VAT Code?
Ofício-Circulado 30108/2009 cannot legally override the pro rata calculation rules established in Article 23(4) of the Portuguese VAT Code. Administrative circulars constitute internal guidance for tax officials and cannot create new legal obligations or modify statutory provisions under the principle of legality enshrined in Article 112(5) of the Portuguese Constitution. The claimant argues that Article 23 provides exhaustive, objective criteria for determining the pro rata percentage, with no statutory authorization for the Tax Authority to exclude specific turnover components. This position is reinforced by the principle of parliamentary reservation over tax matters under Article 165(1)(i) of the Constitution, which requires essential tax elements to be defined by law, not administrative interpretation. The circular's attempted restriction violates the separation of powers doctrine.
Are mixed VAT taxpayers in Portugal entitled to indemnity interest when VAT deduction is wrongly restricted by the Tax Authority?
Mixed VAT taxpayers in Portugal are entitled to compensatory interest when VAT deduction is wrongly restricted by the Tax Authority, pursuant to the general principle that taxpayers have a right to restitution with interest when tax has been unlawfully collected or deductions wrongly denied. The claimant specifically requested condemnation of the Tax Authority to pay compensatory interest as part of the arbitration request. This right derives from the principle of fiscal neutrality and the imperative to restore taxpayers to the economic position they would have occupied had the law been correctly applied. When the Tax Authority improperly restricts deduction rights, the taxpayer suffers a financial loss equivalent to the cost of capital during the period the deduction was wrongly denied, which compensatory interest is designed to remedy.