Process: 340/2016-T

Date: November 24, 2016

Tax Type: IRC

Source: Original CAAD Decision

Summary

CAAD arbitral decision 340/2016-T addresses the IRC (Corporate Income Tax) exemption for urban rehabilitation funds under Article 71 of the Portuguese Tax Benefits Code (EBF). The dispute centers on whether a Special Closed-End Real Estate Investment Fund for Urban Rehabilitation qualified for the exemption when the Portuguese Tax Authority (AT) denied it based on the fund's failure to meet the 75% asset composition requirement as of 31 December 2014. The fund management company challenged an additional IRC assessment of €13,712.88 for the 2014 tax year, arguing that the exemption should not be conditioned by asset composition ratios during the fund's liquidation phase, which commenced on 20 January 2014. The applicant further contended that the AT's calculation methodology was flawed and that the reference period was inappropriate, proposing instead an average of the last six months. The AT maintained that the statutory prerequisites were not fulfilled, as less than 75% of the fund's assets consisted of real property subject to rehabilitation actions in urban rehabilitation areas. The fund owned properties in Porto's urban rehabilitation zones, but only some underwent actual rehabilitation, while other assets included rental properties in Vila da Conde outside any rehabilitation area. The arbitral tribunal was constituted under the RJAT (Legal Regime of Tax Arbitration) and dispensed with oral hearings, proceeding based on written submissions to determine whether the exemption applies during liquidation and how asset composition should be properly calculated.

Full Decision

ARBITRAL DECISION

1. STATEMENT OF FACTS

1.1. A... – Real Estate Funds Management Company, S.A., registered at the Commercial Registry Office of Lisbon under the unique registration number and collective person number..., with registered office at Av..., in Lisbon (hereinafter referred to as "Applicant"), in its capacity as managing company of the Special Closed-End Real Estate Investment Fund for Urban Rehabilitation – B... (Fund), with tax identification number..., filed on 24/06/2016 a request for arbitral decision with a view to assessing and declaring the illegality of the additional Corporate Income Tax (CIT) assessment no. 2016 ..., and of the interest calculation statement no. 2016 ..., relating to the 2014 tax year, in the total amount of € 13,712.88 (thirteen thousand, seven hundred and twelve euros and eighty-eight cents).

1.2. The Most Honourable President of the Ethics Council of the Administrative Arbitration Centre (CAAD) appointed, on 13/07/2016, the signatory of this decision as sole arbitrator.

1.3. On 13/09/2016 the arbitral tribunal was constituted.

1.4. In compliance with article 17, paragraph 1 of the Legal Regime of Tax Arbitration (LRTA), the Tax and Customs Authority (TCA) was notified on 14/09/2016 to, if it wished, submit its response and request the production of additional evidence.

1.5. On 19/10/2016 the TCA submitted its response, defending itself through opposition.

1.6. On 21/10/2016 the arbitral tribunal decided to dispense with the holding of the hearing referred to in article 18, paragraph 1 of the LRTA, on the grounds of the principle of arbitral tribunal autonomy in the conduct of the proceedings, inviting both parties to, if they wished, submit optional written submissions and scheduled the date for pronouncement of the final decision.

1.7. On 04/11/2016 the Applicant submitted optional written submissions.

1.8. The TCA did not submit optional written submissions.

2. PRELIMINARY EXAMINATION

The arbitral tribunal was regularly constituted and is materially competent.

The parties have legal personality and judicial capacity and are parties with standing.

The proceedings do not suffer from defects that would invalidate them.

Consequently, the conditions for the final decision to be rendered are met.

3. POSITIONS OF THE PARTIES

As the basis of its request, the Applicant alleges in summary that:

a) The Fund's activities did not deviate from the objectives that motivated the introduction of the exemption provided in article 71 of the Tax Benefits Code (TBC);

b) The application of this exemption cannot be conditioned by the verification of the asset composition ratio during the liquidation phase of the Fund;

c) Furthermore, the calculation of the asset composition ratio of the Fund should not consider, in its numerator, only the value contained in items bearing the designation "C";

d) The reference period adopted by the TCA for purposes of the calculation presented (31/12/2014) is not appropriate and is, moreover, contrary to law, and should instead consider, as an alternative, the average of the values verified at the end of each of the last six months.

As for the TCA, it alleged, by way of opposition, in summary that:

a) All of the income obtained by the Fund in 2014 would not qualify for the exemption provided in the said rule, under which income of any nature obtained by real estate investment funds that operate in accordance with national law are exempt from CIT provided they are established between 1 January 2008 and 31 December 2013 and at least 75% of their assets are real property subject to rehabilitation actions carried out in urban rehabilitation areas, since, allegedly, the requirement relating to asset composition would not have been fulfilled;

b) The TCA understood that the requirement relating to asset composition was not fulfilled in the 2014 tax period, that is, the proportion of the Fund's assets corresponding to real property subject to rehabilitation actions carried out in urban rehabilitation areas did not reach 75% with reference to 31/12/2014, concluding that "(…) given that the prerequisites of article 71, paragraph 1 of the TBC are not met, the income of the fund cannot benefit from the CIT exemption that this article provides, being applicable to it the regime of article 22 of the TBC, in accordance with article 71, paragraph 15 of the TBC.";

c) In practice the income is taxed separately, having regard to the nature of each income obtained;

d) Furthermore, the right to tax benefits should be ascertained as of the date of the verification of the respective prerequisites, unless the law provides otherwise.

4. FACTUAL MATTERS

4.1. FACTS CONSIDERED TO BE PROVEN

In view of the documents filed in the proceedings, it is found to be proven that:

4.1.1. The Fund is a special closed-end real estate investment fund for urban rehabilitation, established through private subscription in accordance with article 48, paragraph 1 of the Legal Regime of Real Estate Investment Funds (LRRIF);

4.1.2. Its establishment was authorized by the Securities Market Commission (SMC) on 22 December 2010, and was established on 16 June 2011, with an initial duration of 5 years, counted from the date of its establishment, renewable for periods not exceeding 2 years provided that such extensions are decided by the Assembly of Participants and authorized by the SMC;

4.1.3. The Fund commenced its activities on 16/06/2011, with initial capital of € 5,000,000.00 (five million euros), represented by 500,000 units of participation with a unit value of € 10.00, fully subscribed by the company "D…, S.A.", with tax identification number ...;

4.1.4. In 2013, Mr. E..., taxpayer number ..., acquired from "D…, S.A." 200,000 units of participation of the Fund, corresponding to 40% of all units of participation;

4.1.5. The Fund's activities are dedicated to urban rehabilitation investments in the city of ..., having commenced its activities on 16/06/2011, with the acquisition of part of the residential properties of C... through a deed of sale executed on the same date, which were subject to urban rehabilitation;

4.1.6. In continuing its growth, also in 2011, it proceeded with the acquisition of three adjacent and vacant buildings on Rua ... and Rua ..., which are located in the urban rehabilitation area of the parish of ..., municipality of ..., through a public deed executed on 05/07/2011;

4.1.7. In addition to the urban rehabilitation investment already mentioned, the Fund, at the end of 2011, diversified its real estate portfolio, with the acquisition of 12 separate units intended for rental that make up the property located on Rua..., parish of ..., Municipality of Vila da Conde, through a deed of sale on 23/12/2011;

4.1.8. In the years 2013 and 2014, the Fund maintained its activities, either with the rental of units of the property located in Vila da Conde, or with the continuation of the rehabilitation works on the properties at C..., which were completed in March 2014;

4.1.9. The properties at C..., as well as the properties on Rua ... and Rua ... are integrated in the Urban Rehabilitation area of the Historical Centre of the Municipality of ...;

4.1.10. Although these two sets of properties are located in urban rehabilitation areas, only the properties located at C... were actually subject to urban rehabilitation actions;

4.1.11. With regard to the separate units located in Vila da Conde, they are not located in an urban rehabilitation area nor have they undergone any rehabilitation action;

4.1.12. On 20/01/2014, once its purpose had been fulfilled, the participants resolved the liquidation of the Fund, a process which is ongoing;

4.1.13. The Fund was the subject of a tax audit procedure conducted by the Tax Audit Service of the Finance Directorate of Lisbon, in compliance with Service Order no. OI2015..., for the 2014 tax year, of external nature and broad scope;

4.1.14. The conduct of this audit procedure was requested at the initiative of the Fund itself under article 2, paragraph 1 of Decree-Law no. 6/99, of 8 January, through a request submitted on 18/11/2014;

4.1.15. As a result of the audit action, a CIT correction was made, resulting from separate taxation of the income obtained, in the amount of € 13,368.59, on the basis of which the additional assessment and the compensatory interest assessment disputed were issued, with payment deadline of 30/03/2016, namely:

4.1.16. On 24/06/2016, the Applicant filed the request for arbitral decision that gave rise to these proceedings.

4.2. FACTS NOT CONSIDERED TO BE PROVEN

There are no facts relevant to the decision that have not been found to be proven.

5. THE LAW

As is well known, the State Budget Law for 2008 established tax benefits of a temporary nature for the carrying out of rehabilitation actions on urban properties that are commenced between 1 January 2008 and 31 December 2010 and that are completed by 31 December 2012.

In accordance with the Report on the State Budget for 2008, one of the main objectives defined in fiscal policy was the creation of "incentives for areas considered priority in the field of urban rehabilitation."

Indeed, it is further stated that "The Government intends to promote, through special tax benefits, the conservation and recovery of built heritage, encouraging the carrying out, as urgently and comprehensively as possible, of rehabilitation actions on buildings which make possible the enhancement of defined urban areas, (…) seeking to reverse situations of degradation of zones and historical centres, zones of protection of classified properties and, in general, degraded urban areas (…)."

And it adds that "The pace of rehabilitation of the building stock throughout the national territory requires the taking of urgent measures, founded on a more integrated approach, which articulates the existence of support of a financial nature and new incentives of a fiscal nature, of an exceptional and temporary character, which reward conservation and rehabilitation actions (…)."

Conceptually, the creation of this tax benefit appears to have been intended to introduce a fiscal mechanism which would allow the attraction of investment in priority urban rehabilitation areas, rewarding promoters of rehabilitation actions on degraded buildings located in certain urban areas.

Subsequently, the State Budget Law for 2009 introduced into the TBC a stable regime of incentives for urban rehabilitation, which absorbed all benefits contained in the extraordinary regime, incorporated other new ones in it and extended the periods for commencement and completion of rehabilitation works.

As is stated in the Report on the State Budget for 2009, "It is the Government's objective to accelerate, through the strengthening of fiscal and regulatory measures, the process of urban rehabilitation in defined zones. Over recent years a set of support programs have been established whose results these measures aim to enhance, so that it is possible to promote virtuous cycles of heritage rehabilitation and social dynamics, which bring sustainability to investment directed at priority areas in the field of urban rehabilitation."

As a result of its very designation, the incentive regime provided in article 71 of the TBC applies to properties which have been the subject of urban rehabilitation operations in a limited time period and under defined conditions.

To this end, for this benefit to be applied it is necessary that:

- material rehabilitation actions be executed, i.e. works or parcelling;
- those actions focus on certain types of properties;
- those actions are commenced and completed in a defined time period;
- the application of benefits in the context of property taxes always depends on a set of resolutions by municipal bodies.

In this context was also inserted a specific concept of urban rehabilitation, which contains two essential elements requiring cumulative verification, namely:

- it is necessary to confer on the intervened urban properties the adequate characteristics of performance, in function of their use, as well as of functional, structural and constructive safety. Or to grant the intervened urban properties new functional capabilities, with a view to allowing new uses or the same use with higher performance standards;
- the rehabilitation actions must allow achieving a state of conservation of the property of at least two levels above that assigned before the intervention.

On the other hand, the types of properties to be rehabilitated were limited, since not all rehabilitation actions on urban properties necessarily lead to the application of tax benefits, becoming therefore necessary that:

- rented properties are capable of phased updating of rents;
- urban properties which, although not being rented, are located in an urban rehabilitation area.

For this incentive regime to apply, the temporal location of the commencement and completion of the rehabilitation actions is also necessary. It is not enough that urban rehabilitation occurs; this must be commenced after 1 January 2008 and be completed by 31 December 2020, verification which is carried out by the competent Municipal Services in the property location area.

Among other tax benefits, it is established that "Income of any nature obtained by real estate investment funds that operate in accordance with national law are exempt from CIT provided they are established between 1 January 2008 and 31 December 2013 and at least 75% of their assets are real property subject to rehabilitation actions carried out in urban rehabilitation areas."

Now, the legislator exempts from CIT income of any nature obtained by real estate investment funds, provided that cumulatively:

- they operate in accordance with national law;
- they establish themselves between 1 January 2008 and 31 December 2013;
- at least 75% of their assets are real property subject to rehabilitation actions carried out in the urban rehabilitation area.

The exemption is total and involves all taxable matter subject to CIT of the Fund, as well as income obtained by holders of units of participation in investment funds which comply with the legally required requirements.

In the case at hand, for the Fund to be able to benefit from this regime, it would be necessary that it operated in accordance with national law, which is the case, and that 75% of its assets were real property subject to rehabilitation actions carried out in the urban rehabilitation area.

Specifically, for this requirement to be fulfilled it is not enough that the properties are in the Fund's assets awaiting the carrying out of urban rehabilitation actions. It is necessary that they be subject to them, such subjection being materialized in the "interventions" referred to in article 71, paragraph 22, subparagraph a) of the TBC.

To this end, the 75% of the Fund's total assets corresponding to real property subject to rehabilitation actions is determined as follows:

- through a fraction, in whose numerator appears the value accounted in account 32 - Buildings, which includes property rights over buildings registered in favor of the fund and in whose denominator appears the total value of gross assets, if we want the percentage of the value of gross assets;
- through a fraction, in whose numerator appears the value accounted in account 32 - Buildings, which includes property rights over buildings registered in favor of the fund adjusted by account 38 - Adjustments to Real Estate Assets, which is intended to register potential gains and losses related to the holding of real property, if we want the percentage of the value of total liquid assets.

In order to determine what percentage of assets corresponds to real property subject to rehabilitation actions, the TCA prepared the table presented below:

Now, the accounting value of properties recorded in class 3 comprises the value of the property corresponding to the acquisition value plus, when applicable, the expenses incurred subsequently with remodeling and significant improvement works or with construction works that substantially alter the conditions in which the property is placed for rental or sale in the market; plus favorable adjustments recorded accounting-wise in account 381 or minus unfavorable adjustments recognized in account 382. As follows from this valuation criterion, depreciation is not accounted.

As for the expenses incurred with the remodeling of properties, relating to supplies and services provided by third parties, they are recorded in this way in account 32 - Buildings, to increase the value of the property.

For its part, account 32 already contains all expenses related to the properties at C..., and which could influence this account, as was recorded accounting-wise by the Fund. Thus, the Applicant's claim to include in the numerator other items of assets, which did not constitute, nor should constitute accounting-wise the value of the properties, cannot prevail.

It is thus demonstrated that what is invoked by the Applicant in articles 63 to 104 of its arbitration request has no legal basis, since what follows from the law and is provided therein is that to determine the percentage of at least 75% of its assets being real property subject to rehabilitation actions carried out in urban rehabilitation areas, the numerator can only be considered the value of the properties which were subject to urban rehabilitation actions.

Specifically, in the situation at hand, the properties which were subject to urban rehabilitation actions are limited to the property at C..., and which was recorded accounting-wise in account 32, with the adjustments of account 38.

To this end, the value which was considered by the TCA in the numerator for purposes of the calculation of assets (liquid/gross) was the value which was accounted by the Fund in account 32 - Buildings with the adjustments of account 38.

As to the prerequisite that at least 75% of its assets are real property subject to rehabilitation actions carried out in the urban rehabilitation area, the Applicant included in its calculation the 3 properties which make up the real estate assets of the Fund, Rua ... and ..., situated in the parish of ..., municipality of ..., which are integrated in the Historical Centre of the Municipality of ..., classified as a Monument of National Interest and located in the urban rehabilitation area of ..., in the Intervention Unit of F..., although the same have remained in the same state of conservation in which they were purchased, without any rehabilitation project.

Now, given that the Fund was in liquidation on 20/01/2014, by resolution of the Assembly of Participants and that these 3 properties were not subject to urban rehabilitation actions and were disposed of in mid-2015, in the condition in which they were, the prerequisites for their application to be included in the calculation of the percentage of 75%, and consequently in the application of the exemption regime of article 71 of the TBC, were frustrated.

Indeed, it is not enough that the properties are in the assets of the Funds awaiting the carrying out of rehabilitation actions; it is necessary that they be subject to them, these being understood as "(…) interventions intended to confer adequate characteristics of performance and functional, structural and constructive safety to one or several buildings, or to functionally adjacent constructions incorporated in its courtyard, as well as to its units, or to grant it new functional capabilities, with a view to allowing new uses or the same use with higher performance standards, from which results a state of conservation of the property of at least two levels above that assigned before the intervention (…)."

Finally, the Fund also includes in the calculation of its percentage the property located at ..., which, having regard to the tenor of article 71, paragraph 1 of the TBC, cannot be considered, by virtue of the fact that it is not located in an urban rehabilitation area, nor subject to urban rehabilitation actions.

Thus, and since the prerequisites of article 71, paragraph 1 of the TBC are not met, the income of the fund cannot benefit from the CIT exemption that this article provides, being applicable to it the regime of article 22 of the TBC, in accordance with what is provided in article 71, paragraph 15 of the TBC.

6. DECISION

In view of the foregoing, it is determined that the request for arbitral decision be wholly dismissed and, consequently, the TCA be absolved of the claim.

7. VALUE OF THE PROCEEDINGS

The value of the proceedings is fixed at € 13,712.88 (thirteen thousand, seven hundred and twelve euros and eighty-eight cents), in accordance with article 97-A of the Tax Procedure Code (TPC), applicable by virtue of article 29, paragraph 1, subparagraphs a) and b) of the LRTA and article 3, paragraph 2 of the Tax Arbitration Costs Regulation (TACR).

8. COSTS

Costs to be borne by the Applicant in the amount of € 918 (nine hundred and eighteen euros), in accordance with Table I of the Costs Regulation for Tax Arbitration Proceedings, in accordance with article 22, paragraph 2 of the LRTA.

Notify.

Lisbon, 24 November 2016

The Arbitrator,
Hélder Filipe Faustino

Text prepared by computer, in accordance with article 131, paragraph 5 of the Code of Civil Procedure, applicable by referral of article 29, paragraph 1, subparagraph e) of the LRTA. The wording of this decision is governed by the spelling prior to the 1990 Orthographic Agreement.

Frequently Asked Questions

Automatically Created

What is the IRC tax exemption for urban rehabilitation under Article 71 of the EBF (Estatuto dos Benefícios Fiscais)?
Article 71 of the Portuguese Tax Benefits Code (EBF) provides an IRC exemption for income of any nature obtained by real estate investment funds operating under national law, provided they were established between 1 January 2008 and 31 December 2013 and at least 75% of their assets consist of real property subject to rehabilitation actions carried out in urban rehabilitation areas. This incentive aims to promote urban regeneration by making investments in rehabilitation projects more attractive through tax relief.
Can the Portuguese Tax Authority (AT) deny the urban rehabilitation exemption based on asset composition ratios during a fund's liquidation phase?
This is the central legal question in CAAD decision 340/2016-T. The fund management company argued that the Article 71 EBF exemption should not be conditioned by verification of the asset composition ratio during the liquidation phase, as the fund had already fulfilled its rehabilitation objectives. The Portuguese Tax Authority took the opposite position, arguing that prerequisites must be verified as of the date of assessment (31/12/2014), regardless of the fund's lifecycle stage. The applicant also disputed the calculation methodology and reference period used by the AT, proposing that an average of values from the last six months would be more appropriate than a single year-end snapshot.
How is the asset composition ratio calculated for Real Estate Investment Funds focused on urban rehabilitation?
The calculation dispute involves determining what constitutes the numerator and denominator of the 75% threshold. The Portuguese Tax Authority calculated the ratio as of 31 December 2014, considering only properties actually subject to rehabilitation actions in urban rehabilitation areas. In this case, the fund owned properties in Porto's urban rehabilitation zones (C... properties and properties on Rua... and Rua...), but only the C... properties underwent actual rehabilitation works, completed in March 2014. The fund also held 12 rental units in Vila da Conde that were neither in a rehabilitation area nor subject to rehabilitation actions. The applicant contested both the items included in the calculation and the reference date, arguing for a six-month average methodology rather than a single date snapshot.
What was the outcome of CAAD arbitral decision 340/2016-T regarding the additional IRC assessment?
The text excerpt provided does not include the final arbitral decision or outcome. The document describes the procedural history, factual background, and positions of both parties but is cut off before presenting the tribunal's legal analysis and ruling. To determine the outcome, one would need access to the complete decision showing whether the arbitrator ruled in favor of the fund management company (annulling the additional IRC assessment) or upheld the Tax Authority's position that the exemption requirements were not met.
What procedural steps does CAAD follow in tax arbitration proceedings under the RJAT?
CAAD tax arbitration under the RJAT (Legal Regime of Tax Arbitration) follows these procedural steps as illustrated in this case: (1) filing of arbitration request by the taxpayer (24/06/2016); (2) appointment of arbitrator(s) by the President of the CAAD Ethics Council (13/07/2016); (3) constitution of the arbitral tribunal (13/09/2016); (4) notification to the Tax Authority to submit its response under Article 17(1) RJAT (14/09/2016); (5) submission of the AT's response (19/10/2016); (6) decision on whether to hold an oral hearing pursuant to Article 18(1) RJAT, with the tribunal having autonomy to dispense with hearings (21/10/2016); (7) invitation for optional written submissions from both parties; (8) submission of optional briefs by the parties (applicant submitted 04/11/2016; AT did not submit); and (9) issuance of the final arbitral decision within the statutory deadline.